October 9, 2011 Update

[Gutter Chaves Josepher Rubin Forman Fleisher Law Firm]

October 9, 2011
An Electronic Newsletter of Gutter Chaves Josepher Rubin Forman
Fleisher P.A.
Charles (Chuck) Rubin, Editor/Author (except as otherwise noted) ©
2011

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CONTENTS:

1. SETTLEMENT ALLOCATION PRINCIPLES, IN ACTION

2. IRS TEMPTS EMPLOYERS WHO HAVE BEEN MISCLASSIFYING EMPLOYEES

3. REPORTING OF INTERESTS IN MEXICO FEDEICOMISOS

4. APPLICABLE FEDERAL RATES–OCTOBER 2011

5. TAX COURT GOES EASY ON LAX CRUMMEY PROTOCOLS

6. SAFELY DETERMINING PUBLIC CHARITY STATUS

7. LIMITED OBJECTION PERIOD UPHELD FOR NONQUALIFIED PERSONAL
REPRESENTATIVES [FLORIDA]

8. FIRM ANNOUNCEMENTS

9. ABOUT OUR FIRM

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1. SETTLEMENT ALLOCATION PRINCIPLES, IN ACTION

When amounts are paid in settlement of litigation, different tax
consequences can apply based on what the payments are for. For
example, punitive damages will typically generate ordinary income for
the recipient, while payments for damage to goodwill can generate
capital gain. Such differing tax consequences bring about taxpayer
efforts to characterize payments in the manner most favorable to them.

Two principles are important in determining whether the IRS will
respect an agreed-upon characterization of settlement proceeds.

The first is the origin of the claim doctrine, under which the tax
treatment of the proceeds of a settlement or judgment will depend on
the nature of the claims made and the actual basis of the recovery.
The tax consequences of a settlement depend on the nature of the claim
that was the basis for the settlement, rather than the validity of the
claim.

The second is that the IRS will be more likely to respect a settlement
allocation of the parties if they have adverse interests as to that
characterization. If one party is indifferent to the allocation, or
both parties obtain tax advantages from the same characterization, the
risk of IRS challenge is heightened.

A recent Tax Court case demonstrates the real world application of
these principles. The case involved the settlement of a lawsuit for
false advertising, unfair competition, and trademark dilution, with
damages relating to loss of goodwill and reputation, lost profits, and
punitive damages.

ORIGIN OF THE CLAIM. The Tax Court determined that the character of
the settlement proceeds paid was to be allocated among the various
claims made, in accordance with the origin of the claim doctrine. The
parties characterized only a relatively small portion of the
settlement to lost profits (an item which would produce ordinary
income and not capital gain to the recipient) and no portion to
punitive damages (another ordinary income item). Under the origin of
the claim doctrine, the settlement proceeds should have been allocated
among all the claims made.

ALLOCATION AMONG CLAIMS – NO ADVERSE INTERESTS. The court determined
that the parties’ allocation was suspect since the payor was generally
indifferent to the characterization (and the payee would benefit from
allocations away from ordinary income items). Thus, the parties did
not have an adverse interest to each other and their allocation was
subject to much higher scrutiny. As to the punitive damages question,
the taxpayer pointed out that the payor was against paying punitive
damages and was not indifferent, since it would put the payor in a bad
light and implied wrongdoing. Thus, the implied argument was the
allocation away from punitive damages was not collusive and done
solely to avoid ordinary income for the recipient, but was a bargained
for element by the payor and was perhaps sought but compromised away
by the recipient. This was an interesting argument, but the Tax Court
did not buy into it since the payor was agreeable to the amount to be
paid for punitive damages but just didn’t like the label applied.

An important aspect of this case is that just because the settlement
arises from a bona fide dispute involving unrelated and truly adverse
parties, the parties cannot count on IRS acceptance of a damages
allocation unless the parties have adverse interests over the
allocation itself. The type of adversity that most impresses courts in
these circumstances is where a given type of payment produces a tax
negative for one party while producing a better tax result for the
other – that was not the situation here.

ALLOCATION AMONG CLAIMS – THE SEARCH FOR OBJECTIVE EVIDENCE. The
origin of the claim doctrine does not provide any direct guidance on
how to allocate settlement proceeds among various claims when there is
more than one. In this situation, one can expect taxpayers, the IRS,
and courts, to search for objective guidelines to use in the
allocation. Such objective guidelines may not always exist – however,
in the instant case they did. The lawsuit at issue was actually the
second lawsuit arising from similar facts and claims. Since the
original lawsuit was tried and a judgment was made by a jury that
allocated the damages, the Tax Court used the percentage allocations
from that case and applied them to the settlement.

ALLOCATION AMONG CLAIMS – OTHER HELPFUL ASPECTS. Taxpayers seeking to
uphold an allocation that does not involve truly adverse issues should
look long and hard for some methodology or expert opinion to help
backstop their allocation. Such contemporaneous methodology and
analysis will put the taxpayer in a better defensive position than the
parties simply agreeing on an allocation with no methodology or
analysis to justify it.

Healthpoint, Ltd, et al, TC Memo 2011-241

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2. IRS TEMPTS EMPLOYERS WHO HAVE BEEN MISCLASSIFYING EMPLOYEES

Employers have a strong withholding and employment tax incentives to
classify their workers as independent contractors instead of
employees. Such a course avoids income tax withholdings and FICA,
FUTA, and Medicare taxes and withholdings, shifting responsibility of
such items to the worker.

As such, employers may have aggressively or inappropriately classified
employees as independent contractors. An IRS settlement program known
as the “Voluntary Classification Settlement Program,” or VCSP,
provides a semi-painless way for employers to correct their
classifications and come into the fold of compliant taxpayers. A
recent set of FAQs provides details on the new program. Below is a
summary of the key provisions.

WHO CAN USE THE PROGRAM?

Businesses, tax-exempt organizations, and government entities.

BASIC ELIGIBILITY REQUIREMENTS

To be able to apply, the employer must:

(1) have consistently treated the subject workers as
nonemployees,

(2) have filed all required Forms 1099 for the workers for the
previous three years, and

(3) not be under audit by IRS, or currently under audit
concerning the classification of the workers by the Department of
Labor or a state government agency.

EFFECT OF PROGRAM

The employer will have to pay a relatively small sum to enter the
program, but will then receive absolution for its mischaracterizations
for past years. More particularly, the employer will:

(1) owe 10% of the employment tax liability that may have been
due on compensation paid to the workers for the most recent tax year,
applying the special reduced rates of Code Section 3509, and without
interest or penalties being imposed on that liability,

(2) be safe from an employment tax audit for the worker
classification of the subject workers for prior years, and

(3) have to agree to extend the period of limitations on
assessment of employment taxes for three years for the first, second
and third calendar years beginning after the date on which the
taxpayer has agreed under the VCSP closing agreement to begin treating
the workers as employees.

Of course, the employer will begin classifying the subject workers as
employees and paying appropriate employment and withholding taxes.

Given the relatively small amount that is due, the program provides an
excellent opportunity for taxpayers to put themselves into compliance.
In an example provided in the FAQ, an employer who paid $1,500,000 to
workers in the subject tax year owed only $16,020 for the required 10%
payment.

Application for the program is made on Form 8952, Application for
Voluntary Classification Settlement Program. More information on the
VCSP is available in Announcement 2011-64.

Voluntary Classification Settlement Program (VCSP) Frequently Asked
Questions

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3. REPORTING OF INTERESTS IN MEXICO FEDEICOMISOS

U.S. residents, and other nonresidents of Mexico, are restricted from
owning certain real estate in Mexico. The Mexican Constitution
prohibits foreigners from purchasing or owning real estate within 60
miles of an international border or within 30 miles of the Mexican
Coast.

To facilitate foreign ownership, Mexico law allows for foreign persons
to own property through a fideicomiso. A fideicomiso is a Mexico trust
arrangement under which a Mexico bank acquires title to the real
property, and foreigners own the beneficial interest.

A recently released letter from the Office Chief Counsel warns that
such arrangements may constitute foreign trusts for U.S. tax purposes,
and thus may trigger Form 3520 and 3520-A filing requirements for U.S.
beneficiaries. Interestingly, the letter does not conclude one way or
the other whether a fideicomiso will be treated as a trust, only that
it may be. The taxpayer recipient of the letter was instructed to
review Regs. Section 301.7701-4 for the definition of a trust for U.S.
tax purposes, and Code Section 7701(a)(31)(B) and the Regulations
thereunder for whether a trust is foreign.

There is a reasonable possibility that many fideicomisos will meet the
regulatory definition of a trust (at least in the opinion of the IRS),
even though common law trusts are not a regular feature of Mexico law.
The Regulations define a trust as:

…an arrangement created either by a will or by an inter vivos
declaration whereby trustees take title to property for the purpose of
protecting or conserving it for the beneficiaries under the ordinary
rules applied in chancery or probate courts. Usually the beneficiaries
of such a trust do no more than accept the benefits thereof and are
not the voluntary planners or creators of the trust arrangement.
However, the beneficiaries of such a trust may be the persons who
create it and it will be recognized as a trust under the Internal
Revenue Code if it was created for the purpose of protecting or
conserving the trust property for beneficiaries who stand in the same
relation to the trust as they would if the trust had been created by
others for them. Generally speaking, an arrangement will be treated as
a trust under the Internal Revenue Code if it can be shown that the
purpose of the arrangement is to vest in trustees responsibility for
the protection and conservation of property for beneficiaries who
cannot share in the discharge of this responsibility and, therefore,
are not associates in a joint enterprise for the conduct of business
for profit.

Further, if a fideicomiso is considered a trust, it should then be
considered a foreign trust, at least if a Mexico bank serving as
trustee.

However, one may be able to argue that a fideicomiso is more akin to a
“business trust” which is subject to taxation as a business entity
under Regulations Section 301.7701-4(b).

Some facets of U.S. reporting of interests in foreign trusts only
apply if distributions are made to U.S. beneficiaries. However, rent-
free use of trust properly can be treated as a distribution to a
beneficiary, so this is a reporting trap for many if the fideicomiso
is characterized as a foreign trust since most beneficiaries will not
be paying rent to use the Mexico property.

The actual income taxation of the U.S. beneficiaries will depend on
whether the trust is a grantor trust or a nongrantor trust (or, of
course, whether the fideicomiso is taxed as a trust or a business
entity). Also, different reporting requirements are triggered based on
grantor vs. nongrantor trust status or busines entity status.

Thus, the IRS’ letter is helpful in reminding taxpayers of potential
reporting and income tax issues relating to a fideicomiso interests.
However, each case will require its own analysis as to whether a
foreign trust or other entity exists, if a trust whether it is a
grantor or nongrantor trust, and what particular reporting is
required. If worth the cost, a private letter ruling as to “trust”
status could also be sought from the IRS.

INFO 2011-0052 dated 11/17/2010 (released 6/24/11)

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4. APPLICABLE FEDERAL RATES–OCTOBER 2011

For a chart and table of the rates, go to http://goo.gl/Nov7v.


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5. TAX COURT GOES EASY ON LAX CRUMMEY PROTOCOLS

Irrevocable life insurance trusts are a mainstay of transfer tax
planning with the object of avoiding estate tax on life insurance
policy payouts. Such trusts often provide a Crummey withdrawal feature
to one or more trust beneficiaries, so that premium payments by the
grantor are eligible for exclusion from taxable gifts as present
interest annual exclusion gifts.

Clients are instructed that the grantor should transfer premium
payments to the trust, and that the trust should remit the proceeds to
the insurance company. Further, the trustee should provide notice to
the beneficiaries of their withdrawal rights at or about the time of
the contributions of premium amounts to the trust. These protocols are
intended to minimize the risks of IRS challenge to present interest
status of the contributions.

Oftentimes, clients disregard these instructions, and the grantor
makes direct payments of premiums to the insurance company. This is
what occurred in the recent Tax Court case of Estate of Turner v.
Commissioner. As one might expect, the IRS challenged the present
interest exclusion status of the premium payments. However, in a boon
to other taxpayers who have similarly funded their premium payments,
the Tax Court still allowed the present interest exclusion treatment.

The IRS first argued that the trust beneficiaries had no meaningful
rights to withdraw the premium payments since they were not first paid
to the trust. The Tax Court noted that the key factor in a present
interest gift such as this is whether the beneficiary had the "legal
right to demand" the withdrawal. Under the terms of the trust, the
beneficiaries have the absolute right and power to demand withdrawals
from the trust after each direct or indirect transferred to the trust.
That the funding occurred indirectly was thus irrelevant to the right
to demand.

The IRS also argued that there was no meaningful withdrawal rights
because some, or even all, of the beneficiaries may not have known
they had the right to demand withdrawals per the absence of notice to
them. Again, the Tax Court indicated such lack of notice did not
affect the "legal right to demand" withdrawals and thus lack of notice
was not determined to be an impediment to present interest status. The
court appropriately noted that lack of notice was not an impediment in
the Crummey case, either.

Does this mean that taxpayers can now make direct premium payments
that bypass the trusts, and avoid delivering withdrawal notices to
beneficiaries? For taxpayers that end up in the Tax Court, and that
are willing to front the litigation costs to get there, the answer is
probably yes. However, since the IRS has not conceded this issue, and
since other courts may not agree with this interpretation, proper
contribution and withdrawal notice protocols should still be observed
(but with the comfort that favorable Tax Court treatment will backstop
the protocols if they are not fully observed). Also, practitioners
should confirm that their life insurance trust forms allow for
withdrawals for both direct and indirect contributions.

Estate of Turner v. Comm'r, T.C. Memo. 2011-209 (Aug. 30, 2011)

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6. SAFELY DETERMINING PUBLIC CHARITY STATUS

Grantors and contributors to charities often need to know if the
charities qualify as "public" charities under Internal Revenue Code
Section 170(b)(1)(A)(vi), so as to properly determine various tax
consequences. Code Sections for which such status is relevant include
Sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)
(2), and 2522.

Grantors and contributors can request a copy of the charity’s
exemption letter to determine if the IRS has recognized its status
under Section 170(b)(1)(A)(vi). Alternatively, the status can be
reviewed in IRS Publication 78, “Cumulative List of Organizations
described in Section 170(c) of the Internal Revenue Code of 1986.”
This publication is available in paper, or online through http://www.irs.gov.

But what if the charity has had its Section 170(b)(1)(A)(vi) revoked,
but the grantor or contributor is not informed of this? For example,
the charity may provide the contributor with a copy of the original
exemption letter, even though it has been revoked. Alternatively, the
grantor or contributor may check the status online and see the charity
has the proper status, but perhaps the IRS had not yet updated its
database to show a revocation.

Under recently issued Regulations, the IRS will allow a contributor or
grantor to rely upon an IRS determination letter or ruling
(notwithstanding its revocation) until the IRS publishes notice of a
change of status. Reg. Section 1.170A-9(f)(5)(ii). This is both a good
and a bad thing. It is good, in that it provides a clear methodology
to determine status, without risk that the status may have been
changed. It is bad, since it imposes a clear burden on the taxpayer to
review Publication 78, as updated, to confirm that there has been no
revocation.

Previously, newly formed charities had only a five year advance ruling
period for their “public charity” status – at the expiration of the
period the charity had to go back to the IRS and seek a permanent
ruling. While this process has been changed, there are organizations
out there with ruling letters that have a fixed advance ruling period
expiration date, but that are no longer obligated to seek a permanent
ruling. The Regulation provides that a taxpayer may rely on advance
rulings that expired on or after June 9, 2008.

A taxpayer cannot use these reliance rules if it was responsible for,
or aware of, an act or failure to act that resulted in the
organization's loss of classification under Section 170(b)(1)(A)(vi)
or acquired knowledge that the IRS had given notice to such
organization that it would be deleted from such classification. At
first glance, this would appear to be a problem for large
contributors, since if a contributor makes a large enough contribution
to an organization, this may mathematically remove it from “public
charity” status. However, the Regulations anticipate this and provide
that an outsider to the charity (that is, is not a founder, creator,
or foundation manager) will not be considered responsible for, or
aware of, a loss of public status if it received and relied upon a
written statement by the charity that the grantor contribution will
not result in the loss of public status. Reg. Section 1.170A-9(f)(5)
(iii). Such written statement must meet specific criteria, including
the provision of five years of financial data to allow for a
computation of public charity status.

Note that the online Publication 78 describes various types of exempt
organizations. Various codes are used to assist readers to determine
the status of the organization. The code needed to confirm public
charity status is actually the absence of a code, or “none.” A table
of the various codes can be viewed at http://goo.gl/7vXtj (scroll to
the end).

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7. LIMITED OBJECTION PERIOD UPHELD FOR NONQUALIFIED PERSONAL
REPRESENTATIVES [FLORIDA]

Individuals who were not domiciled in Florida are not eligible to
serve as a Personal Representative of a Florida decedent, except under
limited circumstances (e.g., if they are related within certain stated
family relationships to the decedent). Fla. Stats. Section 733.304.
Florida law also provides that persons who are served a copy of the
Notice of Administration must file an objection to the appointment of
a Personal Representative within three months of service. Fla.Stats.
Section 733.212(3).

A recent Florida Supreme Court case took on the question whether the
three-month objection period applies to a challenge of an individual
to serve as Personal Representative when that person is not within the
class of persons authorized to serve as a Personal Representative (in
this case, because he was not domiciled within Florida and was not
within the requisite family relationship). The Supreme Court took on
the case due to a split between appellate courts on this question.

The Court determined that the three-month objection period does apply.

This is an important case because many times estate beneficiaries do
not engage counsel to assist them until a dispute or problem arises,
and that often occurs beyond the three-month objection. At that time,
their counsel may note that the Personal Representative is not
qualified to serve. Per this decision, in most cases it will now be
too late to seek the removal of the Personal Representative as a
disqualified person under the statute.

The door to objections is not completely closed, however. The opinion
is clear that if there was fraud or misrepresentation relating to the
petition for administration, a later action for removal should not be
time-barred.

Hill v. Davis, Fla. Supreme Court case No. SC 10-823, September 2,
2011

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8. FIRM ANNOUNCEMENTS

Our attorneys are available for speaking engagements at Bar,
accountant, and other professional organization meetings and seminars
(schedules permitting). Feel free to contact us with any requests.

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9. ABOUT OUR FIRM

Our firm seeks to protect and enhance the individual, family and
business wealth of our clients in the following principal practice
areas: Planning to Minimize Taxes (U.S. & International) • Probate &
Trust Litigation • Estate Planning, Charitable, Marital & Succession
Planning • Business Structuring & Transactions • Trusts & Estates
Administration • Tax Controversies • Creditor Protection.

Please visit our website at http://www.floridatax.com for information
about the firm, our attorneys, articles from recent monthly
newsletters, interesting articles and tax guides, and federal and
Florida tax rates and information. The firm and its attorneys have
been recognized in numerous peer rating guides, such as U.S. News &
World Report law firm rankings, Best Lawyers, Martindale-Hubbell,
Chambers, Who's Who in American Law, Florida Trend's Legal Elite,
Superlawyers, and South Florida Legal Guide Top Lawyers.

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DAILY TAX AND BUSINESS UPDATES AVAILABLE. View prior articles, updates
that we didn't have room for in this newsletter, or read the above
postings when they are first published, by visiting http://www.rubinontax.blogspot.com.

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The Usual Disclaimer: This newsletter summarizes for informational
purposes only information of interest to the clients and friends of
Gutter Chaves Josepher Rubin Forman Fleisher P.A. The information is
condensed from, and a general summary of, legislation, court
decisions, administrative rulings and other information, and should
not be construed as legal advice or opinion, and is not a substitute
for the advice of counsel.

Gutter Chaves Josepher Rubin Forman Fleisher P.A.

Boca Corporate Center
2101 Corporate Blvd., Suite 107
Boca Raton, Florida 33431
561.998.7847
www.floridatax.com