April 2006 - Issue #3
My Status & Plans
I now have only 4-plus months left here at the Lompoc Federal Prison Camp before my transfer to Idaho and home. On September 6th I travel either to an Idaho halfway house for not more than 47 days and/or to home confinement with my official release date (subject to probation for awhile) being October 22, 2006. Being home with Mary Ann in Syringa, Idaho, on the beautiful Clearwater River amid a cedar and pine forest is what we are looking forward to with great anticipation.
On April 3-7, I was on a 5-day furlough (unescorted trip, my expense) to visit Mary Ann in Idaho - what a wonderful opportunity to be with her, as well as to do some preparation for my non-lawyer consulting practice which will commence in September. We see a growing “light at the end of the tunnel” and indeed are fortunate to be in good health and feeling positive about the future. I thank all our family, clients and other friends for their caring support the past several years. This has given both Mary Ann and me strength to persevere in these difficult times.
I have learned much from the self-imposed tragedy of not meeting personal tax obligations properly. One thing is very clear - health and happiness based on solid family values and loyalty are most important. This Fall, I will embark on a consulting practice based upon family, tax and estate planning experience of my over 40 years of law practice. Estate planning, management succession, family relationships and wealth preservation are important areas for families to consider, especially with many recent tax developments impacting such planning. Therefore, estate plans require review, testing and updating to better meet family goals as well as to respond to changes in law and judicial developments.
My Syringa office already is equipped, thanks to Mary Ann and son Mark, with satellite-based Internet access, and my tax law library has been brought up-to-date. In fact, during my incarceration I have had lots of time to study new developments and to think through planning techniques. I believe I can be a valuable, cost efficient resource to clients and their professional advisors. Also, supporting this effort will be the possible return to speaking to professional groups and to writing articles on estate planning issues. More about my consulting practice will be included in future issues of this Newsletter.
Planning Mandate Responding to Estate Tax Uncertainty
During the past year, Hurricanes Katrina and Rita, ongoing controversy over the war in Iraq, the nomination process for two Supreme Court justices, and continuous partisan bickering between Democrats and Republicans in Congress, made certain that the future of the Federal estate tax remained in doubt. No one can predict what will happen this year, so estate owners and their advisors are left with the 2001 Act - increasing exemption equivalents, lowering of rates, the year 2010 estate tax repeal and then the “old law” returns. While this obviously does not help in planning, wealth preservation and distribution planning must continue with uncertainty in mind. A Congressional “fix” is in order and can be expected. While the Administration remains wedded to outright permanent repeal of the estate tax, more likely is a permanent, high exemption equivalent level (e.g. $5 million per person) and a low flat rate of tax (e.g. 15%-20%), hopefully with retention of a stepped-up income tax basis at death. The current fixed $1 million gift tax exemption equivalent should remain in place, and the present $12,000 annual exclusion per donee, per donor will continue to be periodically adjusted for inflation.
So estate owners now should consider, especially as to appreciating assets, so-called “capping” of the estate through gifts, installment sales and the like - designed to fully utilize the $1 million ($2 million for a married couple) gift tax exemption equivalent. In the case of sales using the installment method, planners need to remember that installment sales among family members of depreciable real property and installment sales of marketable securities are not permitted. However, where unimproved real property is involved, gifting an undivided interest therein to children (often in trust) allows for fractional interest discounting (at or above 25%), plus a separate sale of the remaining undivided interest in the same property can be accomplished using the low AFR rate now in the mid-5% range, with the installment note, upon the seller’s death, valued net of a substantial (25-50%) valuation discount under the normal estate tax valuation rule. Better yet, “passing” an opportunity to the younger generation, rather than transferring property, may be the best value shifting technique. It should be noted, however, that early in 2005, the Congressional Joint Committee on Taxation proposed several estate and gift tax “loophole closers” (revenue-raisers), including severe restrictions on valuation adjustments (discounts). But thus far there is no legislation proposed to implement these proposals.
A thoughtful notice recently appeared in the ACTEC Journal, Vol. 31, No. 4 (Spring 2006), at p. 269, authored by a good friend, Virginia attorney Lou Mezzullo. In this article, “Estate Planning after Estate Tax Repeal (or Reform)”, Lou lists the many areas of estate planning impacted by the prospects for repeal or reform. His discussion of planning for an uncertain future should be helpful to practitioners, as is his analysis of how to remove assets from the transfer tax system.
In addition, perhaps of more significance than the tax avoidance side of estate planning, there has been substantially more intra-family litigation over estate plans in recent years. Thus, especially where complex planning is involved, advisors must take great care to avoid conflicts of interest (or deal effectively with same), to fully explain and disclose in writing (in spite of Circular 230 risks to advisors, see below) plan alternatives, choices, legal and tax advantages, etc., and to oversee the plan in its implementation.
Unwarranted Tax Practitioner Response to Circular 230 Changes
Most clients and advisors will agree that estate planning, designed at least in part to minimize the Federal transfer tax (gift, estate and GST taxes), has become more complicated in the past couple of decades, at least for high wealth clients. Thus, it would seem obvious that proposed plans or plan modifications should be supported by written exposition and advice. Ah, but there now is a problem - where written tax advice is involved, the June 21, 2005 effective date substantial revisions to Circular 230 (Treasury Regulations governing tax practice before the IRS by tax practitioners, such as lawyers, CPAs and even valuation appraisers) pose new problems for practitioners.
My initial August, 2005 newsletter mentioned in a summary way the Circular 230 revisions. Now that a few months have passed, practitioners have had an opportunity to digest the new IRS practice rules. Adding to the previously cited articles discussing the new rules are the following articles of interest::
(1) Gardner, Eide and Kastantin, “Amendments to Circular 230" (2 parts), The AICPA Tax Adviser, Jan. 2006, p.24, and Feb. 2006, p.90;
(2) Paravano and Reynolds, “The New Circular 230 Regulations - Best Practice or Scarlet Letter?”, T.M. Memo., at p. 339 (2005).
(3) Akers & Manigault, “Nuts and Bolts of ‘Covered Opinions’ under Circular 230”, ABA Probate & Property, March/April, 2006, at p.34.
Looking at tax advice from the client’s standpoint, the cautious client would do well to insist that such advice in significant planning situations be in writing. This promotes confirmation of facts, clarity of understanding among the client and advisors as to facts and law, and recognition by the client that he or she is the ultimate decision-maker. With written tax advice generally the focus, however, the Treasury Department rewrote and expanded much of Circular 230, covering far more than only the understandable Government reaction to overreaching, egregious “tax shelters”. See Treas. Dec. 9165 (12/20/04) and 9201 (5/11/05), effective June 21, 2005.
Noted tax attorney and author, Howard M. Zaritsky, recently stated “all written advice provided by estate planners will still be subject to some portions of these new restrictions and limitations.” Estate Planning, Vol. 32, p. 47, “Yet More Changes in Circular 230" (August, 2005). This, of course, assumes that the written advice deals at least in some significant way with “tax avoidance”. However broad the new Circular 230 may be and even given it likely will be used selectively in an aggressive manner by IRS, I find it troubling that many legal and accounting professionals have set out broad, confusing disclaimers in virtually all communications. An example of the type of disclaimer that appears to be overkill is as follows:
“To comply with IRS-imposed requirements, we inform you that any Federal tax advice contained in this communication (including any referenced attachments or schedules) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing, or recommending to another party any transaction or tax-related matters.”
See the discussion of such disclaimers in Burgess Raby and William Raby, “Accuracy-Related Penalties and Circular 230 Caveats”, Tax Notes, January 16, 2006, at p. 239. I suggest that the first place to begin with identifying the nature and scope of tax advice, and the extent of a client’s reliance thereon, is the engagement letter. Further, focusing the disclaimer on tax penalties in many cases merely will raise questions by clients as to the correctness or usefulness of the advice as to tax minimization or tax benefits generally.
Clients should insure that their advisors responsible for providing tax advice have reviewed carefully revised Circular 230, adjusting engagement letters and all methods of written advice where tax avoidance or benefits may be involved in a significant manner - all to insure that the client can rely upon the tax advice. Note that in Section 10.33 of Circular 230, setting forth “best practices for tax advisors” the initial goal presented is “communicating clearly with the client regarding the terms of engagement.”
For estate planners, presumably not engaged in “listed transaction” or other identified “tax shelters” relating to the income tax, Section 10.35(b)(2)(i) still provides a “covered opinion” can be involved if it concerns a Federal tax issue arising out of any partnership or other entity... “or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any IRC tax” where a reliance opinion is given. A significant “Federal tax issue” is present if the issue relates to tax treatment of income, gain, loss, deduction or credit, the presence or absence of taxable transfer of property, or the value of property for tax purposes. The issue is “significant” if the IRS has a reasonable basis for a successful challenge (note how the traditional rule was whether the taxpayer had a reasonable basis for his or her claim), and its resolution could have a significant impact on the overall tax treatment of the transaction or item. Under these Circular 230 provisions, it is clear, for example, that the use of family limited partnerships are covered, as likely also are other estate planning-oriented transactions and plans, for e.g. installment sales to defective grantor trusts and even GRATs.
It appears clear that where a client wishes to rely upon his tax advisor(s) to his or her benefit, the best practice standards, or at least the requirements for a covered opinion must be followed - with the resulting higher cost of tax advice. This newsletter discussion is not intended to be a complete review of Circular 230 by any means; but rather, I suggest clients should ask their tax advisors to make abundantly clear what the advice is (which I believe means in writing), the scope of the advice in terms of taxpayer reliance on tax results opined and whether the advice extends to avoidance of tax penalties. The answers to such questions may well mean that some clients opt for the certainty of non-action, rather than not be able to hold their advisors to recommendations given. In high wealth client situations where major estate planning often is involved, I believe the extra due diligence, careful opinion writing and additional fees will be well worth the efforts of tax practitioners and their clients.
In Coming Newsletters
I plan to post a newsletter each month beginning in May and through September when I return to Idaho. These will report in detail on my non-lawyer consulting plans and on several specific estate planning techniques using FLPs or LLCs, plus structuring and operating such entities, in part, to achieve substantial valuation discounts. As always, I welcome email suggestions and comments on my newsletters.
Sincerely and best wishes,
Owen Fiore
