The Clintons And Their Residence Trusts

I am looking at a Bloomberg article titled” Wealthy Clintons Use Trusts to Limit Estate Tax They Back.”

I get the hypocrisy. There truly cannot be any surprises left with this pair, but I get it.

I also have no problem with the tax strategy. I would use it unapologetically, if I were within its wheelhouse.

This trust is known as a Qualified Personal Residence Trust (QPRT), pronounced “cue-pert.” I use to see more of them years ago, as this trust works better in a high interest rate environment. We haven’t had high interest rates for a while, so the trust is presently out of its natural element.

You can pretty much deduce that this trust is funded with a house. It can be funded with a main residence or a second home. I have seen it done with (very nice) vacation homes. There are income tax and gift tax consequences to a QPRT. 

Let’s go through an example to help understand the hows and whys of this thing.

Let’s say that we have a modestly successful, low-mileage, middle-aged tax CPA. We shall call him Steve. Steve owns a very nice second home in Hailey, Idaho. Word is he bought it from Bruce Willis. Steve and Mrs. Steve are meeting with their tax advisor, and they are discussing making gifts to their children. The advisor mentions gifting the Hailey residence, using a QPRT.

Mrs. Steve: How does that work?

Advisor:      The house is going to go the kids eventually, someday. We are just putting it in motion. We set up a trust. We put the house in the trust. We have the trust last a minimum number of years – in your case, maybe 15 years. At the end of the trust, the house belongs to the kids. Maybe it belongs to a trust set up for the kids. You can decide that.

Mrs. Steve: What’s the point? In any event the kids will wind up with house anyway.

Advisor:      The point is to save on estate and gift taxes. Someday this house will pass to the kids. If it happens while you are alive, we have to discuss gift taxes. If it happens at your or Steve’s death…

Steve:         I am right here, people.

Advisor:      Just explaining the process. If it happens at death, we have to discuss estate taxes.

Mrs. Steve: So, either way …

Advisor:      … you are hammered.

Mrs. Steve: How do I save money?

Advisor:      You continue to live in the house for a while, say fifteen years. The house is eventually going to the kids, so there is a gift. However the house is not going to the kids for fifteen years, so the value of the gift is the house fifteen years out.

Mrs. Steve: Wait. The house will be worth more fifteen years out. How is this possibly helping me?

Advisor:      I said it wrong. The IRS considers the gift to be made today for something to be delivered fifteen years out. That long wait reduces the value of the gift, which is what drives the gift tax planning with a QPRT.

Mrs. Steve: Should I just invite the IRS to an audit?

Advisor:      Not at all. We can find out what the house is worth today. The IRS has given us tables and interest rates to calculate the fifteen years wait. Since we are using their tables and their rates, it is fairly safe mathematics. There isn’t much to audit.

Steve:         I am stepping out to stretch my legs.

Mrs. Steve: Give me an example.

Steve:         Is there fresh coffee in the break room?

Advisor:      We have seen cases where someone has transferred a house worth $2 million in a ten-year QPRT and the IRS says the gift was only around $550 thousand.

Mrs. Steve: Which does what?             

Advisor:      You get to hold on to your lifetime gift tax exemption as long as possible. You can make more, or larger, gifts and not owe any gift tax as long as you have some lifetime exemption amount remaining.

Mrs. Steve: Who pays for the house; you know, the utilities, the maintenance, taxes and all that?

Advisor:      You do. And Steve, of course.

Steve:         (from outside the room) Did I hear my name?

Mrs. Steve: No! Go find your coffee.  

Mrs. Steve: Who gets to deduct the real estate taxes – the trust?

Advisor:      The trust is “invisible” for tax purposes. It is a “grantor” trust, which means that – to the IRS – there is no trust and it is just you and Steve. You get to deduct the real estate taxes.

Mrs. Steve: Wait a minute. If there is no trust, how can there be a gift?

Advisor:      This part gets confusing. For income tax purposes, the IRS says that there is no trust. For gift tax …

Steve:         (from outside the room) Where’s the cream?

Advisor:      For gift tax purposes, the IRS says there is a trust. Because there is a trust, you can make a gift.

Mrs. Steve: You are kidding.

Advisor:      No. Tax law can be crazy like that.

Mrs. Steve: What happens if after fifteen years I still want to live there? Does the trust boot me out?

Advisor:      Nope. You can rent the house, but you will have to pay fair market value, of course.

Mrs. Steve: Because I no longer own it.

Advisor:      Right. Also, since you do not own it, technically the kids could act against you and sell the house, even if against your will. That is a reason for keeping the house in some kind of trust, even after the QPRT term, as it allows for an independent trustee.

Mrs. Steve: What is the downside to this QPRT thing?

Steve:         (walking back into room, with coffee) We done yet?

Advisor:      You have to outlive the trust.

Steve:         I intend to. What are you talking about?

Advisor:      If the QPRT is for fifteen years, then you have to live at least fifteen years and a day for this thing to work.

Steve:         And if I don’t?

Advisor:      It will be as though no trust, no gift, no anything had ever happened. The house would be pulled back into your estate at its value when you die.

Steve:         Why do I keep dying with you two?

Mrs. Steve: OK. Steve dies before fifteen years. What can I do to minimize the risk to me of him dying….

Steve:         Risk to you?

Mrs. Steve:  … of him dying before his time?

Advisor:      Several things. You and Steve own the house jointly, right?

Mrs. Steve: Of course.

Steve:         (under his breath) As though there was a choice.

Mrs. Steve: What was that, dear?

Steve:         Just blowing on the coffee to cool it down, dear.

Advisor:      We set up two trusts. One for Steve and one for you. It helps with the odds.

Mrs. Steve: I like that.

Advisor:      We can even “supercharge” that by putting fractional interests in the trusts. Say you put a 1/3 fractional interest each. You and Steve would be able to fund six different trusts. We could vary the term of the trusts – say from ten to twenty years – again improving your odds.

Steve:         Are we still talking about me?

Mrs. Steve: It’s not about you, dear.

Believe it or not, this is pretty straightforward and well-marked tax planning for folks who know they will be subject to the estate tax. Few planners would describe QPRTs as aggressive. There are some twists and turns in there – say if the trust sells the house during the trust term, for example – but that can be a blog for another day.

How and why would the Clintons be pursuing this strategy? Remember that they own two houses: one in Washington (worth approximately $2 million) and another in Chappaqua, New York (worth approximately $5 million). They have quite a bit of money tied-up there. They are almost certain to face an estate tax some day, bringing them well within the wheelhouse of a QPRT.

Not bad for dead broke.

Z Street Decision Will Force IRS To Disclose How It Reviews – And Delays - Tax-Exempt Applications

I am reading things that make me wonder what is going on at the IRS. It repetitively appears that the agency – or at least influential partisan players – think that the job of the IRS is to take sides in political issues.

I am looking at Z Street v Shulman. It is a Court decision from the District of Columbia. There are some interesting points in here, embalmed in yawn-inducing legalese.

Let’s talk about this case.

Z Street is a non-profit corporation. It comes out of Pennsylvania, was organized in 2009 and immediately applied for tax-exempt status. Its purpose is to educate the public about Zionism; about facts on the formation of the Jewish state; and about Israel’s right to refuse to negotiate with terrorists.

We know about that the IRS instituted a policy of 501(c)(4) suppression prior to the 2012 presidential election. The 501(c)(4)s are a different animal from a (c)(3), the “traditional” charity. A (c)(4) may engage in an unlimited amount of lobbying, as long as it stays within the issues for which it was organized. If someone felt strongly about blue M&Ms, for example, I suppose that someone could organize a (c)(4) and lobby nonstop – as long as they stayed within the issues concerning blue M&Ms. A (c)(4) can also engage in some partisan political activity, as long as it does not become its primary activity. There is a price however for this freedom to till so close to political soil: deductions to a (c)(4) are not deductible.

Contrast that to a (c)(3), contributions to which are tax-deductible. As a trade-off, there are severe restrictions on lobbying activities of a (c)(3).

Anyway, Z Street applies for (c)(3) status. It wants that tax-deductible status, understandably. It is possible that – in the future – it will spin-off a (c)(4). 

Here are some quick dates:

·       12/29/09 - applies for exempt status with IRS

·       5/15/10 – IRS send a letter requesting additional information

·       6/7/10 – Z Street provides additional information to the IRS

·       7/10/10 – Z Street’s attorney tracks down the IRS person (Dianne Gentry) handling the file.  Agent Gentry tells the attorney that she has two reservations:

o   Z Street is engaged in “advocacy” activities that are not permitted under Section 501(c)(3)

o   The IRS has special procedures for applications from organizations whose activities relate to Israel, and whose positions with respect to Israel contradict the current policies of the U.S. government. She further stated, “these cases are being sent to a special unit in the D.C. office to determine whether the organization’s activities contradict the Administration’s public policies."

I am stunned.

I immediately pick up on the issue of a (c)(3) and advocacy. I expected that issue, and frankly, I wonder why Z Street didn’t organize a (c)(4) instead.

But “special procedures” and the “Administration’s” current policies? My tax-exempt application is to be judged on whether the Administration “likes” me and whether I say “politically correct” things? Good grief, bring on Kristallnacht.

Z Street brought a lawsuit. They alleged that the IRS maintains a special policy when it comes to Israel and to (c)(3)s whose stance does not agree with the Obama Administration, and that such applications are subject to special procedures not applied to other organizations. 

What does Z Street want?

·       A declaration that policy is unconstitutional, and

·       An injunction forcing the IRS to disclose the policy and barring the IRS from employing the same.

The IRS stalled this thing almost long enough to put your kid through college. I am disturbed that the IRS core argument seems to be “we can do whatever we want.” Here are their arguments:

(1)  The Anti-Injunction Act

The AIA was first enacted in 1867, and states that ”no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax is assessed.”

The IRS argued that the AIA barred the Court from granting injunctive relief.

(2)  Code Section 7428

Code Section 7428 already provides remedy for organizations that seek to challenge IRS determination of their (c)(3) status.

(3)  The IRS also argued that the case should be dismissed on “sovereign immunity” grounds.

The Court goes to work:

(1)  The D.C. Circuit had already decided a case (Cohen) rejecting  that the AIA’s “assessment and collection” language bars any and all lawsuits that might ultimately impact revenue to the Treasury. It has to be so, otherwise one could pass virtually any law and render it unreachable by calling it a “tax.”

(2)  By its terms, Section 7428 applies when there is controversy concerning qualification of an organization as a (c)(3). The only available remedy under Section 7428 is a “declaration with respect to … initial qualification or continuing qualification.”

The Courts points out that Z Street is not asking the Court for (c)(3) qualification. Rather it is asking the Court to force the IRS to follow a “constitutionally valid process” – nothing more and nothing less.

(3)  The Administrative Procedure Act expressly waived sovereign immunity for lawsuits such as this. The APA waives sovereign immunity for suits for nonmonetary damages that allege wrongful action by an agency or its officers or employees.

The Court points out the obvious: that is exactly what Z Street is doing.

Judge Ketanji Brown Jackson observed:

Defendant struggles mightily to transform a lawsuit that clearly challenges the constitutionality of the process that the IRS allegedly employs when it determines the tax-exempt status of certain organizations into a dispute over tax liability as a means of attempting to thwart this action’s advancement.”

In legalese, this is like being punched in the face.

The Court decided that the Z Street’s lawsuit could proceed. After the IRS files its response, the case will go to discovery. The IRS will have to pony up what it has been doing with tax-exempt applications these last few years. Anticipate that Z Street attorneys will seek depositions from other groups similarly treated by the IRS.  

Good.

If proven, this type of behavior by the IRS is thuggish and needs to be punished. People need to lose their jobs, if not their freedom for a while. Perhaps we could build a Lois Lerner wing at a prison somewhere. Perhaps somewhere near the District of Columbia so these people would not have to travel far.

Why do I say this? Our taxation system relies – to an overwhelming extent – on voluntary compliance. The function of the IRS is to administer and collect taxes and process records of the same. Whatever our political stance, we can have common ground on the assessment and collection of tax. We can all hate the IRS equally.

If we disagree on tax law, however, we take that disagreement into the legislative arena. Allow elected representatives to hash it out. At least the representatives have to run for reelection occasionally, so there is some chance for an accounting of their decisions and actions. This is greatly preferable – and healthier for our system of governance – than partisan berserkers bending whatever lever of government they can access to impose their dogma du jour.

Remember: there will be a future White House with very different attitudes and values than the present one. If this behavior goes unpunished, those now in power will then be out of power, and it will be their views and causes that will be handed to the tender mercies of the partisan berserkers then in power.

Don’t come crying then.

The IRS Will Begin Taxing Your Employer-Reimbursed Health Insurance

There was an article last week in the New York Times titled “IRS Bars Employers From Dumping Workers into Health Exchanges.” I scanned it quickly and made a note to return to the topic.

The IRS published Notice 2013-54 last year addressing, among other things, employer use of health reimbursement arrangements (HRAs). HRAs were popular for many years as a way to offer employees a tax-free fringe benefit. A common plan was employer reimbursement of qualifying medical expenses up to a limit (say $1,500 annually, for example). I used to be in one several years ago. Twice a year I would submit medical expenses for reimbursement. Shortly thereafter, I would receive a check, all without a nick to my W-2.

Then came ObamaCare.

There are questionable definitional rules under ObamaCare. For example, ObamaCare defines a coterie of health services to be “essential health benefits” (EHBs). You cannot have limits – either annual or lifetime – on EHBs. Why no limits?  It sounds great, like free ponies and summers off, but the government had to promise the insurance companies that it would subsidize them too if ObamaCare ran off the rails.

Think about the interaction of an HRA with the rule concerning EHBs. If an HRA is considered an EHB plan, then the plan will fail because there are annual limitations on the benefit. In our example, the limitation is $1,500, the maximum the plan would reimburse any one employee.

Notice 2013-54 considered HRAs to be just that, and now HRAs – with extremely limited carve-outs – are going the way of the dodo bird.

Let’s put a twist on the HRA example. Let’s say that you buy and your employer reimburses you for health insurance. Can that reimbursement be left off your W-2?

The New York Times was addressing that question.

Let’s go through the decision grid. I see three general ways an employer can approach health insurance:

(1)  The employer provides you with health insurance.

a.     In which case the rest of this discussion does not apply

(2)  The employer does not provide you with health insurance.

a.     Your employer may have issues depending on whether it has 50 employees or more.

                                                              i.     If no, there are no penalties.

                                                            ii.     If yes, your employer has penalties.

b.    You still have no insurance, though.

(3)  The employer does not provide you with health insurance but it does provide you with money to buy health insurance.

a.     Again, your employer may have penalties, depending on whether it has 50 or more employees.

b.    You have more money, but … do you have to pay tax on that money?

Since before Alaska and Hawaii became states, the answer to that question has been “No.”

With ObamaCare, the answer is now “Yes.”

The IRS has stated that any monies provided by your employer in scenario (3) above have to be included on your W-2. This means of course that you are paying taxes on it, and your employer is also paying taxes on it. You and your employer are unhappy with this. Retailers, homebuilders and car dealers are also unhappy with this, as you will have less after-tax money to spend with them. The only one who is happy with this is the government.

You know that there will be employers who are uninformed of these new rules - or informed but not care about any new rules. What will be their penalty for noncompliance?

That is what the IRS clarified last week. The penalty is $100 per day. Yes, that is $100 times 365 days = $36,500 per year. For each employee.

Let’s gain altitude and get some perspective on why the government is being so harsh. 

Remember that policies on the individual health exchanges are eligible for subsidy if one’s family income is less than 400% of the poverty line. The government does not want an employee to go the exchange and possibly receive a government subsidy at the same time that his/her employer is also providing a nontaxable employee benefit. That would be a double-dip.

You have to admit, it is a valid point.

It is also a valid point to question what the real government policy is here: for you to have health insurance or for the government to tax you? If the former, then the government could have reduced – or denied – health exchange subsidies to compensate for an employer reimbursement plan. If the latter, then the most recent IRS pronouncement makes perfect sense.