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Showing posts with label transfer. Show all posts
Showing posts with label transfer. Show all posts

Sunday, September 14, 2025

A Paycheck As A Treasure Trove

 

I am looking at a case where the taxpayer was using Cesarini to argue her position.

COMMENT: Cesarini is one of my favorite tax decisions and a big reason this case caught my eye. The family purchased a piano at auction for $15. Seven years later – while cleaning the piano – they discovered approximately $4,500 in currency. The tax case addressed when the $4,500 was taxable – when they bought the piano, when they found the money, or some other date. It also introduced us to the “treasure trove” doctrine, addressing – not surprisingly – when finding a treasure is taxable.

COMMENT: $4,500 does not strike as that much money in 2025. Cesarini however was decided in 1964, when median U.S. household income was about $6,000. We probably would agree that finding 75% of your annual household income by fluke could be described as a treasure trove.

Let’s introduce Corri Fiege, who worked in Alaska for a U.S. subsidiary of an Australian corporation. She participated in a performance rights plan and was granted 60,000 unvested rights in parent company stock. The rights vested over three years, and she received 20,000 shares on each of July 31, 2011, 2012 and 2013.

There of course was tax involved. She had the company sell 1/3 of the stock and send the cash as federal tax withholding. She owed tax. She paid tax. There was no problem with these years.

In 2013 she received a fresh tranche of rights - 400,000 rights vesting over the four-years ending December 21, 2013, 2014, 2015 and 2016.

This time the grant was a handcuff. The parent company was in financial distress and was firing people left and right. However, they wanted to keep Corri - that is, until they let her go on November 24, 2014.

Vesting did not happen until December 21. She wasn’t going to make it.

But the company did something unexpected: it transferred 100,000 shares of stock into her Charles Schwab account. She assumed they made a mistake, and she was required by plan terms to report if there was a mistake. She called someone in Brisbane, Australia; that person had left. She called another in Houston, Texas. That person had left too. She gave up trying to report the matter to the company.

She received a W-2 showing an additional $75,660 from the stock.

But this time there was no selling 1/3 of the shares for tax withholding. She would be writing a check to Uncle Sam.

What to do?

She did not file a joint income tax return for 2014.

COMMENT: Worst. Possible. Decision.

This was easy picking for the IRS computers.

Off to Tax Court they went.

Corri and the IRS had two very different arguments.

She argued that the treasure trove doctrine applied.

Corri argued that the shares were transferred contrary to the performance rights plan, making the money subject to an ongoing claim by her employer under Alaska law.

I get it: she argued treasure trove because it would delay taxation until the taxpayer had undisputed possession.

This of course put a lot of pressure on her argument that she had disputed possession.

The IRS came from an altogether different angle.

·       Corri had an employment relationship.

·       She was compensated both in cash and property.

·       Under the tax Code, both cash and property are taxable.

·       The Code does have a specific provision (Section 83) for property transferred with restrictions on its further transfer or with a risk of forfeiture. This is what happened here. Corri was awarded rights, exercisable in the future. If she remained employed, the rights were exchangeable for actual shares, which she was free to keep or sell without further restriction. The rights were not taxable when awarded, as Corri had to remain employed until the exercise date. Once she reached that date, the restrictions came off and she had taxable compensation.

The IRS argument proved formidable against Corri. She had no further obligations to the company after she left. In addition, she was not required to refrain from acting (think a covenant not to compete). There was no risk of forfeiture from her acting or not acting. She was also free to sell or otherwise transfer the shares.

And it was there that she lost the argument of disputed possession. In Cesarini nobody knew who the cash had belonged to, and the matter of its possession had to be sorted out under state law. In this case all parties knew who the shares belonged to, and there remained nothing to be sorted out under Alaska law.

There was no treasure trove.

There was no delay.

The IRS won.

There are two things in this case that bother me. Neither are tax driven. I would describe them instead as common sense.

  1. The Company had the right to overrule the terms of the performance rights plan and award shares even if plan terms were not met. To rephrase, the company was not allowed to remove a benefit already granted but it was allowed to grant a benefit an employee would otherwise not receive. I believe that is what happened here: Corri was a diligent and valued employee, and the company wanted to show appreciation, even if they had to release her.
  2. If an employer gives me free money, why wouldn’t I pay tax? It seems to me that I am still better off than without the free money.

Our case this time was Corri Feige v Commissioner, T.C. Memo 2025-88.


Sunday, July 13, 2025

An Intrafamily Loan, A Death And A Reportable Gift

 

Let’s talk about a (somewhat) high-end tax strategy: intrafamily loans.

At its core, it involves wealth and the transfer of wealth within a family.

Let’s walk through an example.

You want to help out your son. Your attorney or CPA mentions that one way is to loan money and charge your son as low an interest rate as possible. The fancy word for this is arbitrage, and it is how a bank makes money.

Let’s go with an easy example:

·       You loan the money at 2.45%.

·       Your son can invest in a CD at 5.45%

We are arbitraging 3 points, meaning $3 grand per $100 thousand.

Lend $1 million and you have moved $30 grand.

What is the term of the loan?

Coincide it with the term of the CD.

Let’s say 5 years.

I am seeing you move $150 grand ($30,000 times 5 years).

Then what?

He pays you back $1 million when the CD matures.

How does the IRS view intrafamily loans?

With suspicion. The IRS has multiple points of interest here.

·       Are you reporting the interest income for income tax purposes?

·       Is there a gift component to this? If so, have you filed a gift tax return?

·       If you die with the loan outstanding, is the loan properly reported and valued on the estate tax return?

·       If the loans involve grandchildren, are there generation-skipping tax considerations? If so, have you filed that return?

The IRS’ primary line of attack will be that the debt is not bona fide. How do you know if it is or isn’t? The landmark case in this area is Miller v Commissioner, and the Tax Court looked at nine factors:

·       Is there a written promissory note?

·       Is adequate interest being charged?

·       Is there security or collateral for the loan?

·       Is there a maturity date?

·       Is there a believable demand for repayment?

·       Is the loan being repaid?

·       Can the borrower repay the debt?

·       Have you created and maintained adequate records?

·       Have you properly reported the loan for tax purposes?

The closer you get to a bank loan, the better your odds of defeating an IRS challenge. There is tension in this area, as courts will tell you that an intrafamily loan does not need to rise to the underwriting level of a bank loan while simultaneously testing whether an actual loan exists by comparing it to a bank loan.

Let’s go through our CD example. What can we do to discourage an IRS challenge?

·       We can create a written promissory note.

·       We will look at the Galli case in a moment to discuss adequate interest.

·       We probably will not require collateral.

·       The loan is due when the CD matures.

·       It is not our example, but a common way to show repayment intent is to amortize the debt: think monthly payments on a house or car.

·       The loan will be repaid when the CD matures.

·       Probably. Your son never had a chance to spend the loan amount.

·       Let’s say you have good records.

·       Let’s say you use a competent tax practitioner.

Let’s review the Estate of Barbara Galli case to discuss adequate interest.

In 2013 Barbara Galli lent $2.3 million to her son Stephen. They paid attention to the Miller factors above: a written note, paying 1.01% interest and due in nine years. Stephen paid the interest reliably and Barbara reported the same as income on her tax return.

Barbara passed away in 2016.

The IRS challenged the loan for both estate and gift tax purposes. The two cases (one for gift and another for estate) were consolidated by the Tax Court for disposition.

Here is the IRS:

·       The loan was unsecured and lacked a legally enforceable right to repayment reasonably comparable to the loans made between unrelated persons in the commercial marketplace.

·       It has not been shown that the borrower had the ability or intent to repay the loan.

·       It has not been shown that the decedent had the intent to create a legally enforceable loan, or that she expected repayment.

·       The decedent did not file a gift tax return relating to the loan.

·       The estate valued the note for tax purposes at $1,624,000.

The IRS points are predictable.

Note that Barbara did not file a gift tax return. This is because she did not consider herself as having made a gift. She instead had made a loan, with interest and repayment terms. In retrospect, she should have filed a gift tax return, if only to start the statute of limitations. The return might look odd if the loan were the only item reported, as the amount of reportable gifts would be zero. It happens. I have seen gift tax returns like this.

I suspect however that it was the last factor - the difference in values - that caught the IRS’ attention. The IRS saw a loan of $2.3 million. It then saw the same loan reported on an estate tax return at $1.624 million.

Now the IRS was in Tax Court trying to explain why and how they saw a gift rather than a loan.

The amount by which the value of money lent in 2013 exceeds the fair market value of the right to repayment set forth in the note is a previously unreported and untaxed gift

The Court was confused. Its reading (and mine) of the above is that the IRS wanted the difference between the two numbers to be the gift and not the original $2.3 million.

How can we get to the IRS position?

The easiest way would be to charge inadequate interest. The inadequate interest over the life of the loan would be a gift.

Bad argument, however. There used to be endless contention between the IRS and taxpayers on loans and adequate interest. In some cases, the IRS saw additional compensation; in others it saw reportable gifts. In all cases, taxpayers disagreed. There was constant litigation, and Congress addressed the matter during the Reagan administration with Section 7872.

    26 U.S. Code § 7872 - Treatment of loans with below-market interest rates

               A screenshot of a computer

AI-generated content may be incorrect.

This Section introduced the concept of minimum interest rates, which the IRS would publish monthly. Think of it as a safe harbor: as long as the loan used (at least) the published rate, Congress was removing the issue of adequate interest from the table.

Let’s look at these rates for February, 2013.

                       REV. RUL. 2013-3 TABLE 1

 

           Applicable Federal Rates (AFR) for February 2013

  _____________________________________________________________________

                                       Period for Compounding

                          _____________________________________________

  

                         Annual    Semiannual  Quarterly    Monthly

  _____________________________________________________________________

  

                              Short-term

  

      AFR                 .21%        .21%        .21%        .21%

 

                               Mid-term

  

      AFR                1.01%       1.01%       1.01%       1.01%

 

Barbara made a nine-year loan, which Section 7872 considers “mid-term.” The published rate is 1.01%.

What rate was Barbara was charging Stephen?

1.01%.

Coincidence? No, no coincidence.

 Here is the Court:

We reiterated the point later … by concluding that ‘Congress indicated that virtually all gift transactions involving the transfer of money or property would be valued using the current applicable Federal rate …. Congress displaced the traditional methodology of valuation of below-market loans by substituting a discount methodology.'

To sum up, the issue on these motions are whether the transaction was a gift, a loan, or a partial gift. We determine that the Commissioner is not asserting that the transaction was entirely a gift and would lose on the proof if he were. This leave us to apply section 7872, and under that section, this transaction was not a gift at all.”

The IRS lost. I would say that Section 7872 did its job.

Our case this time was Estate of Galli v Commissioner, Docket Nos 7003-20 and 7005-20 (March 5, 2025).