GIFT TAX GROSS-UP DOES NOT APPLY TO NONRESIDENTS

Under Code Section 2035(b), if a U.S. person makes a gift and pays gift tax within 3 years of his or her death, the amount of the gift tax is included in his or her gross estate for federal estate tax computation purposes. In an interesting ruling, the IRS has indicated that such inclusion will not apply if the decedent is a nonresident alien of the U.S. for transfer tax purposes.

Code Section 2104(b) generally applies Code Sections 2035 through 2038 to the estates of nonresidents.  However, Code Section 2104(b) by its language only applies to “property of which the decedent has made a transfer.” The IRS is interpreting this language to require a “gratuitous transfer,” and further believes that the payment of gift tax is not such a gratuitous transfer. Thus, Code Section 2035(b) will not apply.

Nonresidents have various transfer tax planning opportunities that are not available to U.S. citizens and residents. Add this to the list!

CCA 201020009

HOMESTEAD CAN STILL BE SUBJECT TO FRAUDULENT CONVEYANCE WHEN IRS INVOLVED [Florida]

A transferee of an insolvent debtor that receives property from the debtor may be required to disgorge the received property or its equivalent value to the debtor’s creditors, if the transfer to the transferee was a “fraudulent conveyance.” However, a fraudulent conveyance only applies to a transfer of property of a debtor. Property of a debtor for this purpose does not include property that is “generally exempt under nonbankruptcy law.”

In a recent case, an insolvent debtor transferred his homestead property to his transferee. The creditor sought to recover the homestead property from the transferee as a fraudulent conveyance. Per the above rules, the transferee defended the creditor’s claim per the homestead property being exempt from creditor claims under Florida law – thus, it was not “property” of the debtor for this purpose so that the fraudulent conveyance laws did not apply.

A strong argument, but the twist in this case was that the creditor was the Internal Revenue Service. The IRS is a supercreditor in that, as a matter of federal supremacy, it is not bound by state law homestead protections. Since the IRS could have levied on the transferred homestead prior to its transfer and regardless of its homestead status, the Tax Court held that the transferred homestead was not “generally exempt under nonbankruptcy law” (at least as to the IRS) and thus was an asset of the transferor that could be reached by the IRS under Florida’s fraudulent transfer laws.

Scott E. Rubenstein, et al. v.  Commissioner, 134 T.C. No. 13 (2010)

DESIGNATED BENEFICIARY COULD NOT BE CREATED THROUGH A POST-DEATH TRUST REFORMATION

Individual retirement account (IRA) assets can be made payable to a trust at the death of the account owner. If the trust has a “designated beneficiary” under the Code and Regulations, the payout from the IRA can typically be spread (and tax deferral maximized) over the lifetime of the designated beneficiary.

In a recent private letter ruling, a beneficiary trust of an IRA did not have a designated beneficiary. The trustee undertook a reformation action in state court to modify the trust so that after the reformation the trust then had a designated beneficiary.

In the ruling, the IRS rejected the attempt to create a designated beneficiary. The IRS indicated that a retroactive modification to the date of death of the account owner would not be respected for federal tax purposes. While the IRS will respect state court orders in many circumstances, it will respect it in regard to a reformation only if reformation is specifically authorized by the Code.  For example, Code §2055(e)(3) specifically allows parties to reform a charitable split interest trust to make the charitable interest eligible for the charitable deduction. Since there is no applicable Code provision authorizing a reformation so as to qualify a trust as having a designated beneficiary, the reformation would not be given effect.

Private Letter Ruling 201021038