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Showing posts with label Illinois. Show all posts
Showing posts with label Illinois. Show all posts

Thursday, February 11, 2016

Romancing The Income



Let’s discuss Blagaich, an early 2016 decision from the Tax Court. This is a procedural decision within a larger case of whether cash and property transfers represent income. 

Blagaich was the girlfriend and in 2010 was 54 years old.

Burns was the boyfriend and in 2010 was 72 years old.

Their romance lasted from November 2009 until March 2011.

It appears that Burns was fairly well heeled, as he wired her $200,000, bought her a Corvette and wrote her several checks. These added up to $343,819.

He was sweet on her, and she on him. Neither wanted to marry, but Burns wanted some level of commitment. What to do …?

On November 29, 2010 they decided to enter into a written agreement. This would formalize their “respect, appreciation and affection for each other.” They would “respect each other and … continue to spend time with each other consistent with their past practice.” Both would “be faithful to each other and … refrain from engaging in intimate or other romantic relations with any other individual.”

The agreement required Burns to immediately pay Blagaich $400,000, because nothing says love like a check you can immediately take to the bank.

Surprisingly, the relationship went downhill soon after entering into the agreement.

On March 10, 2011 Blagaich moved out of Burn’s house.

The next day Burns sent her a notice of termination of the agreement.

That same month Burns also sued her for nullification of the agreement, as she had been involved with another man throughout the entire relationship. He wanted his Corvette, his diamond ring - all of it - returned.

Somewhere in here Burns must have met with his accountant, as he/she sent Blagaich a Form 1099-MISC for $743,819.

She did not report this amount as income. The IRS of course wanted to know why.

The IRS learned that she was being sued, so they decided to hold up until the Circuit Court heard the case.

The Circuit Court decided that:

·        The Corvette, ring and cash totaling $343,819 were gifts from him to her.
·        The $400,000 was different. She was paid that under a contract. Flubbing the contract, she now had to pay it back.

Burns had passed away by this time, but his estate sent Blagaich a revised Form 1099-MISC for $400,000.

With the Circuit Court case decided, the IRS moved in. They increased her income by $743,819, assessed taxes and a crate-load of penalties. She strongly disagreed, and the two are presently in Tax Court. Blagaich moved for summary adjudication, meaning she wanted the Tax Court to decide her way without going through a full trial.

QUESTION: Do you think she has income and, if so, in what amount?

Let’s begin with the $400,000.

The Circuit Court had decided that $400,000 was not a gift. It was paid pursuant to a contract for the performance of services, and the performance of services usually means income. Additionally, since the payment was set by contract and she violated the contract terms, she had to repay the $400,000.

She argued that she could not have income when she had to pay it back. In legal-speak, this is called “rescission.”

In the tax arena, rescission runs head-on into the “claim of right” doctrine. A claim of right means that you have income when you receive an increase in wealth without a corresponding obligation to repay or a restriction on your being able to spend. If it turns out later that you in fact have to repay, then tax law will allow you a deduction – but at that later date.

Within the claim of right doctrine there is a narrow exception IF you pay the money back by the end of the same year or enter into a binding contract by the end of the same year to repay. In that case you are allowed to exclude the income altogether.

Blagaich did not do this. She clearly did not pay the $400,000 back in the same year. She also did not enter in an agreement in 2010 to pay it back. In fact, she had no intention to pay it back until the Circuit Court told her to.

She did not meet that small exception to the claim-of-right doctrine. She had income. She will also have a deduction upon repayment.

OBSERVATION: This is a problem if one’s future income goes down. Say that she returns to a $40,000/year job. Sure, she can deduct $400,000, but she can only offset $40,000 of income and the taxes thereon. The balance is wasted. Practitioners sometimes see this result with athletes who retire, leaving their sport (and its outsized paychecks) behind. It may never be possible to get back all the taxes one paid in the earlier year.

Let’s go to the $343,819.

She argued that the Circuit Court already decided that the $343,819 was a gift. To go through this again is to relitigate – that is, a double jeopardy to her. In legal-speak this is called “collateral estoppel.”

The Court clarified that collateral estoppel precludes the same parties from relitigating issues previously decided in a court of competent jurisdiction.

It also pointed out that the IRS was not party to the Circuit Court case. The IRS is not relitigating. The IRS never litigated in the first place.

She argued that the IRS knew of the case, requested and received updates, pleadings and discovery documents. The IRS even held up the tax examination until the Circuit Court case was decided.

But that does not mean that the IRS was party to the case. The IRS was an observer, not a litigant. Collateral estoppel applies to the litigants. That said, collateral estoppel did not apply to the IRS.

Blagaich lost her request for summary, meaning that the case will now be heard by the Tax Court.

What does this tax guy think?

She has very much lost the argument on the $400,000. Most likely she will have to pay tax for 2010 and then take a deduction later when she repays the money. The problem – as we pointed out – is that unless she has at least $400,000 in income for that later year, she will never get back as much tax as she is going to pay for 2010. It is a flaw in the tax law, but that flaw has been there a long time.

On the other hand, she has a very good argument with the $343,819. The Court was correct that a technical issue disallowed it from granting summary. That does not however mean that the technical issue will carry the day in full trial. That Circuit Court decision will carry a great deal of evidentiary weight.

We will know the final answer when Blagaich v Commissioner goes to full trial.

Wednesday, January 2, 2013

The Mexican Fideicomiso and Foreign Trusts



This topic originated with Karl, who owns a condo in Puerto Vallarta, Mexico.

Karl was incredulous when I had him file a foreign trust tax return for his Mexican condo a couple of years ago. Why? Because the IRS was increasing their attention to foreign matters (think FBAR and FATCA, for example), and the penalties for failure to file had marched full-throated into extortion territory – at least for my clients, as I do not represent P&G, Toyota or their executives.

Under the Mexican constitution, noncitizens cannot directly own real estate within 50 kilometers of the coastline. This means that a U.S. citizen (Karl for example) has to use an agent to purchase the real estate. This agency is called a fideicomiso. Mind you the fideicomiso does nothing other than hold title – there is no bank account to pay taxes or insurance or repairs or anything.


The tax issue with the fideicomiso is whether or not the IRS would consider it to be a foreign trust. For many years practitioners (including me) considered it the equivalent of an Illinois land trust. The IRS treats the Illinois land trust as though it doesn’t exist; a technical way to say it is that the owner has a direct interest in the real estate and reports accordingly.

When the IRS tightened up its foreign reporting, it became unclear how they would treat fideicomisos. I called the National Office, for example, but received no clear-cut answer or leaning. This put me in a difficult spot, as the penalties for failure to file a return when assets are transferred to a foreign trust are the greater of $10,000 or 35% of the assets transferred. There is also an annual filing requirement (it is assumed that the trust is not funded annually), and those penalties are the greater of $10,000 or 5% of the value of the trust assets.

You can see how this gets very expensive.

So I had Karl file a tax return to report the funding (Form 3520) as well as an annual tax return (Form 3520-A). I am uncertain what the IRS got out of this, but Karl racked up additional tax compliance fees.

The IRS has recently published a Private Letter Ruling (PLR 201245003) stating that a fideicomiso is not a trust as that term is intended in IRS Reg. 301.7701-4(a), and that the beneficiary of the trust is to be treated as the direct owner. In other words, the fideicomiso is “invisible” to the IRS.

There are issues with PLRs, primarily that the IRS does not consider them as precedent to anyone other than the person to whom the PLR was issued. That means that – while tax advisors can look to them for markers as to IRS positions – they are not a failsafe if the IRS goes against you.  Karl is not completely protected unless he obtains his own PLR. Those cost money, of course. The filing fee alone can be several thousand dollars. Then you have my fee.

Don’t get me wrong: I have used PLRs in IRS representation before, and I have gotten greater or lesser traction depending on the examiner, manager or appeals officer and the magnitude of the specific issue to the exam. I suspect that, in the case of fideicomisos, the IRS is waving the flag and giving advisors a clue on their position and enforcement intentions. But one cannot be sure, and there’s the rub.

So how would you have me advise Karl? Would you advise him/her to get his/her own PLR (for thousands of dollars), would you rely on the issued PLR or would you have Karl continue filing Forms 3520/3520-A?

And remember: all we are talking about is a condo. A nice one, granted, but this "trust" has never even been near Switzerland.