Archive by Author

May 24

Why would Eduardo Saverin renounce his U.S. citizenship?  Saverin is one of the Facebook insiders and presently is unbelievably wealthy.

Saverin was not born here. His family is from Brazil, and they were wealthy before Mark Zuckerberg starting working on a networking site from his Harvard dormitory. Saverin became a citizen in 1998 and is now expatriating to Singapore.

A possible reason is U.S. tax policy. The U.S. will tax a citizen or permanent resident (think green card) no matter where you are on planet earth, how long you have lived there or whether you have any intention of ever returning to the U.S. I have family, for example, that has lived outside the U.S. since the 80s, yet the IRS expects to receive a tax return from them annually. If they have over $10,000 in a foreign bank account, Treasury expects an FBAR every June 30th. If they have accumulated enough assets over the last 30-something years, they are subject to the new IRS “specified foreign financial asset” filings. Their bank may even have to report their banking activity to the U.S. under the new FATCA rules. That is assuming the bank doesn’t close their account to avoid having to deal with these U.S. mandates.

Does this sound even remotely reasonable? Do we wonder why someone would renounce his/her citizenship?

Let’s go over the general rules in this area. The U.S. tax system differentiates between U.S. citizens and permanent residents, on the one hand, and nonresident aliens (NRAs) on the other. We can further differentiate the tax system between income taxes and estate and gift (i.e., transfer) taxes.


A  U.S. citizen or permanent resident is taxed on his/her worldwide income. It doesn’t matter where you earned the income (you could be mining ore from the ocean floor) or whether you have or have not been in the U.S. since elementary school. That citizenship will follow you like a bad tattoo.

A nonresident alien (NRA) is a different matter. How an NRA pays income tax is generally based on one key question: is there a business activity involved? The tax term is “effectively connected.”

  • If no, then figure on a flat 30% tax rate
  • If yes, then the NRA gets the same graduated tax rates that you or I use


You can guess the drill at this point. A U.S. citizen or permanent resident is taxed on everything, wherever located, whether in the sky above or the earth below, in days past or yet to come. 

In contrast that NRA is subject to estate tax only on property located in the U.S.

There is an odd rule that stock of domestic corporations is treated as property located in the U.S. I have never quite understood that one. Fortunately, that tax overreach can be stymied by relatively easy tax planning, such as putting the stock in a foreign entity.

The gift tax applies to an NRA to the extent of tangible personal property or real estate located in the U.S. That definition excludes most stock from the reach of the gift tax.


Let’s clarify terms. Any American who lives overseas is an expatriate. It doesn’t mean the one has renounced his/her citizenship. However, renouncing also uses the term “expatriate.” Unfortunate, somewhat like the track record of Bengals linebackers and the court system. We will use the term “expatriate” to refer to renouncing citizenship for the balance of this article.


Back when, a person renouncing citizenship was subject to tax for the succeeding 10-year period, unless he/she could show that expatriation did not have as one of its principal purposes the avoidance of taxes.

The expatriate was subject to income tax on income from sources within the U.S. or effectively connected with the U.S. There were convoluted rules to slow down the tax planners, such as shutting-down nontaxable exchanges of property and outbound transactions with a controlled foreign corporation.

It didn’t take much to prompt the government to think that one was tax-driven:

(1)     Average income (not tax) for the last 5 years exceeding $100,000, or

(2)    Net worth of $500,000

The estate tax continued to apply, but it was generally limited to assets located in the U.S.

The gift tax however was expanded to include gifts of stock.

One could contest the government’s presumption that one was tax-motivated. One would request and pay for a tax ruling. I presume that everyone did so.

Also, one had to send-in an annual Christmas card to the U.S. government which included one’s address, the foreign country of residence as well as information on one’s assets and liabilities.


The IRS found it very difficult to determine tax motivation as previously required under the tax Code. Interestingly, it also found that it could not keep up with the number of people requesting rulings. Congress in response changed the determination standard from a subjective to an objective test.

If one met the new income and asset thresholds, one was now presumed guilty of tax avoidance.

At least they increased the thresholds:

(1)    Average tax of $124,000 for the last 5 years

(2)    Net worth of $2 million

An expatriate under those limits would not be taxed under the expatriate rules even if the motivation was tax-driven. Conversely, one over those limits would be taxed, even if there was no tax motivation. Congress removed the option to request a ruling from the IRS to exempt the expatriate from taxation.

The annual Christmas card was revised to include one’s annual income and the number of days physically present in the U.S. The expatriate could not be present in the U.S. for 30 days in any one year, or one would be treated for tax purposes as a citizen and taxed on all worldwide income.

NOTE: This is pretty harsh stuff, and the U.S. may have been alone among advanced countries with this extraterritorial tax reach. Obviously, you do not spend 30 days in the U.S., for any reason.

2008 and the Heart Act

The current expatriation regime came into the Code in 2008, and it was a revenue-raiser intended to “pay” for other tax provisions of the Heart Act.


Let’s add one new threshold:

(1)    Average tax of $124,000 for the last 5 years

(2)    Net worth of $2 million, or

(3)    Fail to certify that one has complied with all tax requirements for the preceding five years

If one falls into one of these categories, one is a “covered” expatriate. Generally speaking, in taxation the adjective “covered” is bad.

There is a brand-new mark-to-market income exit tax.  The tax applies to the unrealized gain in the expatriate’s property as if the property had been sold for its fair market value. One is granted an exemption of $600,000, adjusted for inflation.

NOTE: This “make believe” sale may be surprising, but other countries – for example, Australia and Denmark – do it with their expatriates.

So you now pay tax on the way out.

The covered expatriate can defer tax on property by posting a bond or other security acceptable to the government. This is an election, and the election is irrevocable. One can elect on a property-by-property basis. The deferred tax is due the year the covered expatriate sells the property. 

There are special rules for deferred compensation, trusts and such matters which do not concern us here.


The key here is whether the “covered expatriate” transfers to a U.S. resident or permanent resident. These transfers are called “covered” gifts or bequests and have their very own special transfer tax. The rate will be the maximum estate or gift tax rate at the time.

If the transfer is made to a domestic trust, then the trust has to pay the tax. If made to a foreign trust, the tax is payable when distributions are made to a U.S. citizen or permanent resident.

The transfer tax appears to be in addition to existing estate and gift tax. One already had to pay transfer tax on property located in the U.S. This new tax also pulls-in transfers of property located outside the U.S., if the transfers are to a U.S. citizen or permanent resident.

So if my wife and I renounce but our daughter stays in the U.S., we would have a problem transferring assets to her. Those would be “covered” transfers and trigger tax at the maximum rate. I suppose our daughter will have to renounce with us to avoid that “covered” problem.


In truth, the new regime is an improvement – in many ways – over the previous system. The potential tax is now calculated once, although its payment may be deferred. The previous system required monitoring for 10 subsequent years and was very difficult to administer. In addition, this regime is not based on one’s ability to live on non-covered assets for 10 years. That of course was a previous way to wait-out the tax and favored the uber-wealthy over the merely wealthy.     

Expect disagreement with the IRS over the valuation of difficult-to-value assets. Here is an example: Eduardo Saverin’s pre-IPO stock in Facebook. The stock was restricted and non-tradable. What do you think it was worth, before its IPO, when Saverin renounced? I’ve got nickels-to-dollars that the IRS will come-in with higher numbers than Saverin does.

Another issue is when to expatriate. If one has assets that are going to appreciate significantly and soon, one wants to leave immediately. Why? Because there is little or no present appreciation in the asset, but the clock is ticking. An example would be land where a new interchange or mall will be built, or Facebook pre-IPO stock. Compare this to prior law where one would still be subject to U.S. tax for 10 years.

What if you have a big inheritance? Same incentive. The inherited asset received a step-up to fair market value at the date of death. If it is appreciating and fast, it is in one’s interest to exit as soon as possible.


We will talk more about Eduardo Saverin and his expatriation in another post.

May 22

Yesterday the IRS announced that it was relaxing its rules under the offer in compromise (OIC) program. This is part of the IRS’ “Fresh Start” program, and is in response to the ongoing unemployment and financial crisis.

For example:

(1) The IRS will look at one year’s future income for offers paid in five or fewer months. This is down from four years.

(2) The IRS will look at two years of future income for offers paid in six to 24 months. This is down from five years.

Fewer months means a reduced collection potential. You can negotiate a smaller payment now. These offers must be paid within 24 months, however. This may exclude some taxpayers, but it will open the door to many others.

Many practitioners, including me, have been frustrated by the IRS’ unwillingness to acknowledge certain expenses and payments when evaluating installment agreements and OICs. The classic is credit card payments. We are presently negotiating child care payments with a revenue officer, as another example. The IRS has now expanded the National Standard miscellaneous allowance to allow for bank fees and credit card payments.

The IRS is also relaxing how it handles student loan payments when evaluating offers. It intends to do the same with state income tax obligations.

There is good stuff here.

May 19

I have previously argued against draconian laws to protect against the morally unscrupulous. The key concept here is draconian: the little good the law does is far outweighed by its burden on society. Sometimes I believe that recent tax regulation is approaching this line.

And then I read about Todd Halpern, a tax preparer in New Jersey.

In 2008 Halpern purchased a tax preparation business from the widow of the prior owner. He received all the computers and client records in the purchase. Makes sense: the widow didn’t need them. The new practice required a new electronic filing number, but Halpern did not obtain one. He kept the previous owner’s number. Why? Because Halpern’s criminal record would keep him from getting a new number.

Then he prepares a tax return for the mom of a client. The problem is that the mom had no income. She collected social security and was claimed as a dependent on her son’s return.  Halpern falsified her return, using fake income and deductions, to generate a refund. To complete the loop, he had the refund deposited to his account.

He kept doing this. After all, what could go wrong? The IRS estimates that he received approximately $375,000 in diverted refunds between July and August, 2009.

The guy is a crook. There exist enough laws to put him in jail.

Or maybe he can run for Congress.

May 18

I am somewhat impressed with the amount of information the IRS processes in order to generate CP2000 notices. The CP2000 is the “Underreported Income” notice. I have seen the IRS flag bank and broker accounts, independent contractor payments and even W-2s that clients failed to clue us on.

The IRS receives almost 2 billion information statements (think W-2s and 1099s) annually.

NOTE: Do you wonder what the cost to employers and financial institutions is to generate these documents? The government doesn’t care, but it is a societal cost. Ignoring it doesn’t make it free.

It matches these against approximately 140 million individual tax filers.

The IRS generates notices to almost 5 million taxpayers.

The IRS unit responsible, the Automated UnderReporter Unit, has approximately 2,500 employees.

You have to admit, there is lot going on for only 2,500 employees.

CP2000 notices come out twice a year. The IRS begins matching information during the summer with the goal of a December mailing. The second wave comes right after tax season – in the second half of April.

The IRS is notorious for skipping line with these ACS notices. You might find yourself with a deficiency notice while you still have time remaining on the ACS notice. Been there. Often you can get the IRS to walk-back the deficiency notice.

By the way, do not send an amended return in response to an ACS notice. These go to different units and will likely cause unnecessary correspondence and telephone time with the IRS. Been there too.

May 18

Good grief!

U.S. Senator Charles Schumer (D, N.Y.) has proposed a 30% exit tax on people like Facebook co-founder Eduardo Saverin. Schumer is unhappy because Saverin has renounced his U.S. citizenship. Schumer believes this is tax-motivated, because Saverin is coming into quite a bit of money from Facebook’s IPO.

Here is the senator:

“Eduardo Saverin wants to de-friend the United States of America just to avoid paying taxes.  We aren’t going to let him get away with it.”

Schumer apparently is a telepath, as he can read other people’s minds. Maybe he can star in the next X Men movie.

Let’s take this a step further. Have you ever heard of Jack Reed? This guy is a Democrat senator from Rhode Island. He wants Homeland Security Secretary Janet Napolitano to bar Saverin from entering the U.S.


I wager I could get a million signatures – without really trying – wanting to bar Congress from entering the United States.

May 17

You may know that Facebook is going public. This means an IPO, hotly anticipated and all but guaranteed to make the founders incredibly wealthy. You may have read about Eduardo Saverin, who has renounced his U.S. citizenship and intends to become a resident of Singapore. There is discussion about tax motivations for his expatriation. Could be. Singapore has more lenient tax treatment of capital gains than the U.S. To be fair, Saverin only became a U.S. citizen in 1998, so his ties may not be as strong as that of a natural-born citizen.

I intend to blog about on Saverin and his tax implications, but for today I wanted to talk about founder Mark Zuckerberg. Facebook’s prospectus lists eight “annuity trusts” set up by insiders, including Zuckerberg, Dustin Moskovitz, Sean Parker, Sheryl Sandberg, Reid Hoffman and Michelle Yee. These trusts hold approximately 22 million shares, which could be worth around $700 million at IPO.

You can afford a lot of tax planning with $700 million. The insiders have not spoken about this matter, nor should one expect them to. I have been reading tax commentary speculating that these trusts are grantor retained annuity trusts, also called GRATs. I agree. Let’s talk about it.

A GRAT is used to shift wealth from one taxpayer to another. In my experience, it has been from one generation to another.

The GRAT has to pay-out a stream of payments to its settlor (the grantor). The payment stream is called the annuity. There are two more considerations: how much to pay out and for how long. The shortest GRAT I have seen is two years. At the end of the term, the remaining money in the GRAT goes to the beneficiary.

All right, so the settlor gifts the remaining money in the GRAT. There may be gift tax, depending on the amount of money gifted. There is a version of a GRAT where “nothing” passes at the end, so the gift is zero. Why the quotation mark around “nothing?” Ah, there is where tax planners make their money.

You see, “nothing” does not actually mean nothing. In this area of the tax world, “nothing” can be something, and quite a lot of something. The “nothing” is a mathematical calculation and not an actual dollar amount. The key to the calculation is the interest rate. 

Say that I put $1 million into a GRAT. I want payments over ten years. I have to use an interest rate, because payments are being made over time. The IRS publishes minimum interest rates for this purpose. As long as I use their interest rate (or higher), there is no problem. Say that their interest rate is 5% and I am looking to zero-out the GRAT. In year one I would take out $150,000 ($1,000,000 divided by 10 years plus $1,000,000 times 5%). What if the money was invested in something that pays – or appreciates – at more than 5%? That is the key that starts the GRAT engine. Let’s say that the investment actually pays 10%. The GRAT is paying out 5%, or only ½ of its actual earnings. The trust is accumulating, isn’t it? Let it accumulate for 10 years and I can transfer a tidy sum at the end. However, for IRS purposes I am deemed to have transferred zero, zippo, nada, because the IRS allows me to assume that the investment is paying only 5%. According to IRS math, there is no money left over to accumulate. Ten years of zero is zero. There is no gift. There is no gift tax. The IRS cannot be wrong.

Let’s go back to the Facebook insiders. What interest rate do they have to use? Last time I checked it was around 1.6%. Do you think there is an accumulation possibility here with Facebook stock? Yes, I think so.

I am not making this up. I wish I could have been one of the advisors.

Actually, I wish I could have been one of the insiders.

May 15

We have received several inquiries over the last year or so about using IRAs for nontraditional investments. This frequently means real estate, perhaps commercial real estate to house a closely-held business. It might also mean using the IRA to start the business itself.

These types of transactions are not without risk. One has the risk of business failure or decline in property value, of course, but also the risk of disqualifying the IRA itself. This would be very bad, as this makes the IRA immediately taxable. To protect against this, one should roll-over the required funds from the “main” IRA into a separate IRA. Should the unfortunate occur, only the roll-over IRA will blow-up. One has contained the damage.

A nontraditional investment requires a self-directed IRA. You will need to find a custodian that will permit nontraditional investments. Most will not. Let’s say you found one. Let’s use the acronym SDIRA for a self-directed IRA in our discussion.

A SDIRA can invest in a privately-owned business. We already know that an IRA can invest in a non-private business, as these are the publicly-traded companies whose stocks are in your IRA or are in the mutual funds in your IRA. This is your Google stock or your Fidelity Contrafund.

The type of business entity is important. The SDIRA can invest in a C corporation but not in an S corporation. Why not? Because the IRS does not permit an IRA to be a shareholder in an S corporation.

The level of involvement in the business owned by the SDIRA is also critical. There are two key tax issues here:

  • The SDIRA cannot enter into a “prohibited transaction.” This is a death sentence. The SDIRA will lose its tax-exempt status and become immediately taxable. If you are under age 59 ½, there will also be penalties.
  • The SDIRA might enter into investments which themselves trigger a tax. This is not as bad as a prohibited transaction, as the overall SDIRA does not become taxable. There is tax only on the income. If the deal is good enough, paying tax may be acceptable.

Prohibited Transactions

The IRS defines a disqualified person as

  • The IRA account holder
  • A family member of the account holder.
    • This goes vertical: grandparents, parents, children and spouses
  • An entity owned 50% or more by the account holder

Think about that last one. Here at Kruse & Crawford, I could theoretically use my IRA, buy an office building and rent it to the firm, as I am not a 50%-or-more owner. Rick Kruse however could not.

Let’s go though the prohibited transactions:

(A) Sale, exchange or leasing of any property between an IRA and a disqualified person

Example 1: My SDIRA purchases property from me or my wife.  This is prohibited. It doesn’t matter if it purchases the property in a “commercially reasonable” manner – i.e. obtain an appraisal. It is not allowed. Period.

Example 2: My SDIRA pays my daughter twenty-five dollars to mow the lawn on the property.  My daughter is a family member. It is prohibited. The amount of money is irrelevant. 

(B) Lending of money or other extension of credit between an IRA and a disqualified person

Example 3: I lend you $10,000 from my IRA.

Example 4: I personally guarantee a bank loan to my IRA.

Example 5: My IRA loans money to me. 

(C) furnishing of goods, services, or facilities between an IRA and a disqualified person

Example 6: I buy a piece of property through my SDIRA and hire my wife to manage the property.

(D) transfer to, use by or for the benefit of a disqualified person of IRA income or assets

Example 7: My SDIRA purchases real estate in Ireland. The SDIRA rents out the property for most of the year. However, my wife and I use the property for one week twice a year.   Even if my wife and I pay fair-market-value rent, this is a prohibited transaction. 

 (E) Act by a disqualified person who is a fiduciary whereby he deals with IRA income or assets in his own interest or for his own account

Example 8: I charge my SDIRA a fee to manage its stocks, bonds, mutual funds or other investments.

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the IRA in connection with a transaction involving IRA income or assets.

Example 9:  My SDIRA purchase a vacation house is in Augusta. I am offered the use of a Wyoming condo in exchange for use of the Augusta property during the Master’s tournament.

IRA Taxes

(1) Active Business Income (UBTI)

Earnings within an IRA are generally tax exempt. However, certain investments can create taxable income called “unrelated business taxable income” (UBTI).  Generally, UBTI is trade or business income which is not otherwise related to the tax-exempt purpose of the IRA. The idea here is that Congress does not want a tax-exempt entity competing with the taxable business enterprise next door to it.

So if you buy a Panera’s or a Caribou Coffee, you have UBTI.

There are some exceptions to UBTI, including but not limited to:

  • dividends
  • interest
  • royalties
  • rent from real property (however see debt-financed below)
  • sales of real property, if the property is not held as inventory or held in the ordinary course of business

Dividends and interest make immediate sense, as this means stocks and bonds – the traditional investments in an IRA.

UBTI Examples:

Example 1:  The SDIRA purchases a restaurant.  The income from the restaurant will be treated as UBTI.

Example 2:  The SDIRA purchases 25% of an LLC that flips (buys, fixes and sells) real estate. Since the real estate is considered inventory, the income to the SDIRA will be UBTI. 

(2) Debt-Financed Income ( UDFI)

If there is debt involved there will likely be UDFI.

Fortunately, UDFI refers only to the percentage of income resulting from the debt-financed portion of the property,

UDFI Example:

Example 3: My SDIRA purchases a B&B in Ireland putting down 75% and borrowing 25%. 

Note that if there was no debt, the rent would be tax-free to the SDIRA.

But there is 25% debt. This means that 25% of the rent is taxable to the SDIRA. The SDIRA does get to claim rental expenses, however.

Wealth Planning

You may have read that nontraditional IRAs are being used for wealth planning. For example, Max Levchin, the chairman of the social review site Yelp, sold over 3 million shares of Yelp held in his Roth IRA. There is no tax on Roth withdrawals if one waits until age 59 ½. Levchin is in his mid-30s. He will have to wait a while, but the money will be tax-free when it comes out.

Peter Thiel did a similar transaction. He bought shares of PayPal for approximately 30 cents per share while he was CEO of the company. In 2002 eBay bought PayPal for $19 a share. 

Now how did Levchin and Thiel avoid the prohibited transaction rules? Actually, it is very simple. You have to control the company to get into a prohibited transaction. Control is usually defined as at-least-50%. When you drain your IRA to buy that Five Guys Burgers and Fries location, chances are you will own 100%. Compare that to a publicly-traded company with tens if not hundreds of millions of shares. Neither Levchin nor Thiel came close to owning 50%. 

Is this fair? I would lead off by noting that “fair” is subjective, somewhat like asking what music one likes. Levchin and Thiel played the game between the lines. You or I could do the same. It might take a new skill set and a tractor-trailer load of luck, but you or I could (theoretically) do it.

Congress has noted these transactions. There is debate about whether this type of wealth accumulation should be permitted. Discussion has sometimes involved a “ceiling” on the amount invested/deferred in the Roth, but until now nothing has developed.

May 11

One of the downsides of increased electronic tax filing is increased identity theft. We had one of our e-filings intercepted this year by the IRS for identity mismatch. The IRS did not accept the e-file and instead required a paper return with Form 14039, Identity Theft Affidavit, attached.

I was looking at (OK, I was skimming) a report from the Treasury Inspector General for Tax Administration issued May 3rd. Imagine my surprise to learn that the IRS has no special procedures for our return with Form 14039 attached.

The IRS considers the paper filing to be a duplicate return and does not immediately process it. An employee enters a transaction code into the taxpayer file to memorialize receipt. The return then goes to a separate queue to be worked on, possibly after April 15 when the filing season has ended. The IRS transfers the file to Duplicate function for initial review. If Duplicate considers it an identity theft case, the file is again transferred, quite likely to the Accounts Management function. It is there assigned an assistor, who requests copies of the original tax returns and begins the process, including correspondence, of determining who the legitimate taxpayer is.

This process is slow and the refund can be delayed until late in the year or even the following year. The average case resolution is 414 days.

The assistor very likely works in Accounts Management. The problem is that these employees also answer the toll-free telephone lines during busy season. According to TIGTA, 87% of assistors working identity fraud also answered the phones, and 60% stated that they worked the toll-free line exclusively. TIGTA considers the optimal assistor inventory (that is, caseload) to be 100 to 125 per assistor, but the average assistor had an inventory exceeding 300 cases.

The identity problem is new enough that IRS guidelines are spread out over almost 40 sections in the Internal Revenue Manual. Sometimes the guidelines are inconsistent. The IRS in addition does not have procedures to spot trends which could be useful in detecting or preventing future fraud. One problem, for example, is sending notices to the last address of record, which could just be the person perpetrating the fraud.

Training has also been an issue. TIGTA’s survey showed that almost half of the assistors believed that their training was not sufficient. In one office, 13% of assistors had received no identity theft training.

To be fair, the IRS has agreed with TIGTA’s findings and has begun implementation of many recommendations. For example, there will be specialized units in Accounts Management to work only identity fraud cases.

Then we have Congress. Three representatives this week introduced the “Fighting Fraud Act,” which would double the current penalties for tax preparers who are involved with identity theft. The intent is to give the IRS greater incentive to prosecute this type of theft, presumably because the potential payoff is greater.

Really? This is the best the mandarin class can dream up? Here is an idea: the IRS assigns a PIN to every preparer. Require every professionally-prepared return to require the preparer’s PIN. If a preparer is involved with this type of nonsense, the IRS revokes the PIN and bans the preparer from working before the IRS.

Will this stop the completely unscrupulous? Here is a question in return: in human history, has it ever been possible to stop the completely unscrupulous?

May 10

Let’s talk this time about gift taxation.

Let’s say that you have a family-owned company.  You desire to pass this on to your kids and grandkids. There are ways to do this, but the method best for you is annual gifts of $13,000, which is the amount of the gift tax annual exclusion. Both you and your spouse can give away $13,000 per beneficiary, so you are transferring $26,000 at a clip. Enough beneficiaries and this can add up.

You ask: what could go wrong?

What if the IRS challenged the value of the gift? Remember, partnership or LLC units generally do not have the same value as a direct and uninterrupted transfer of the asset(s) in the partnership or LLC.

Why is that? Well, if you are a limited member, you have to obtain the general member’s permission to asset. If you are my daughter and I am the general member, rest assured that permission is not happening for a while.  My daughter may “own” $26,000 (2 annual gifts of $13,000) in the LLC, but is it really worth $26,000?  Remember: you need my permission to get to the $26,000. Would you pay her $26,000 today on the hope and prayer that someday I will distribute $26,000 to you? 

Let’s say that IRS comes in says that the LLC units are not worth $26,000. Instead the units are worth $40,000.  What just happened? What happened is that I have to amend my gift tax return. I am now using my lifetime exemption so as not write a check to the IRS. Had I already used-up my lifetime exemption, I would be writing a check. I would not be happy.

What if I changed the terms of the gift? Instead of saying that my wife and I transferred X number of units, we say we transferred units (or fractions thereof) worth $13,000 to our daughter. If the IRS adjusts the gift value upward, then – as far as I am concerned – I “actually” gifted fewer units. Remember, I gifted $13,000 in value, NOT a set number of units. Brilliant!

Except that the IRS thought it too brilliant. This tax technique is called a “defined value clause,” and the IRS has pursued these cases on multiple grounds, including being against public policy.

One of the first cases was Proctor. There the donors gifted remainder interests using the following clause:

“In the event it should be determined … that any part of the transfer in trust hereunder is subject to gift tax, it is agreed by all parties hereto that in that event the excess property hereby transferred which is decreed by such court to be subject to gift tax, shall automatically be deemed not to be included in the conveyance in trust hereunder and shall remain the sole property of the taxpayer.”        

The Fourth Circuit of Appeals nixed the Proctor clause as being after-the-fact. It was a condition subsequent. The IRS continued its win streak with Ward and with Harwood.

Those cases are easy to understand: you cannot undo what has already been done. Let’s make it more challenging.

What if you are not trying to undo anything?  What if you have two beneficiaries: your family and any excess going to charity? Think about this for a moment. If the IRS revalues the gift, the revaluation would be “excess” and go to the charity. There is no gift tax on transfers to charity. There would be little motivation for the IRS to pursue you. The IRS still did not like this and litigated the matter in Christiansen, McCord and Petter. This time, they were not as successful.

What if you like the result in McCord but it is not your intent to include a charitable beneficiary? Congratulations. You are Dean and Joanne Wandry. The Wandry’s gifted partnership units worth $1,099,000 on January 1, 2004. The actual number of units was not fixed, pending a later valuation. The valuation was completed July 26, 2005. The IRS examined the gift tax returns and issued the tax assessment in February, 2009.

The IRS argued that

  • The descriptions on the gift tax returns sounded like a transfer of units and not dollars
  • The entry the accountant made to the books sounded like a transfer of units and not dollars
  • The attorney’s documents sounded like a transfer of units and not dollars
  • It was against public policy to transfer dollars and not units, and
  • In any event the taxpayers smelled funny.

The Wandry’s took the matter to Tax Court. They won their case this past March, and they are now famous as being the first taxpayers to win against the IRS using a formula clause that doesn’t have a charitable element. Granted, this is not the same as winning the Peyton Manning sweepstakes, but it is something.

My take: I expect to see Wandry clauses as standard boilerplate in FLP transfer documents from this point on.

Apr 28

This is an actual letter sent to the IRS approximately 15 years ago Remember to laugh at least once daily. Enjoy!


I am responding to your letter denying the deduction for two of the three dependents I claimed on my 1994 Federal Tax return. Thank you!

I have questioned whether or not these are my children for years. They are evil and expensive. It’s only fair that, since they are minors and no longer my responsibility, the government should know something about them and what to expect over the next year. Please do not try to reassign them to me next year and reinstate the deduction. They are yours!

The oldest, Kristen, is now 17. She is brilliant. Ask her! I suggest you put her to work in your office where she can answer people’s questions about their returns. While she has no formal training, it has not seemed to hamper her mastery of any subject you can name. Taxes should be a breeze. Next year she is going to college. I think it’s wonderful that you will now be responsible for that little expense. While you mull that over, keep in mind that she has a truck. It doesn’t run at the moment, so you have the choice of appropriating some Department of Defense funds to fix the vehicle, or getting up early to drive her to school. Kristen also has a boyfriend. Oh joy! While she possesses all of the wisdom of the universe, her alleged mother and I have felt it best to occasionally remind her of the virtues of abstinence, or in the face of overwhelming passion, safe sex. This is always uncomfortable, and I am quite relieved you will be handling this in the future. May I suggest that you reinstate Dr. Jocelyn Elders who had a rather good handle on the problem.

Patrick is 14. I’ve had my suspicions about this one. His eyes are a little closer together than those of normal people. He may be a tax examiner himself one day, if he is not incarcerated first. In February, I was awakened at three in the morning by a police officer who was bringing Pat home. He and his friends were TP’ing houses. In the future, would you like him delivered to the local IRS office, or to Ogden, UT? Kids at 14 will do almost anything on a dare. His hair is purple. Permanent dye, temporary dye, what’s the big deal? Learn to deal with it. You’ll have plenty of time, as he is sitting out a few days of school after instigating a food fight in the cafeteria. I’ll take care of filing your phone number with the vice-principal. Oh yes, he and all of his friends have raging hormones. This is the house of testosterone and it will be much more peaceful when he lives in your home. DO NOT leave him or his friends unsupervised with girls, explosives, inflammables, inflatables, vehicles, or telephones. (They find telephones a source of unimaginable amusement. Be sure to lock out the 900 and 976 numbers!)

Heather is an alien. She slid through a time warp and appeared as if by magic one year. I’m sure this one is yours. She is 10 going on 21. She came from a bad trip in the sixties. She wears tie-dyed clothes, beads, sandals, and hair that looks like Tiny Tim’s. Fortunately you will be raising my taxes to help offset the pinch of her remedial reading courses. “Hooked On Phonics” is expensive, so the schools dropped it. But here’s the good news!

You can buy it yourself for half the amount of the deduction that you are denying me! It’s quite obvious that we were terrible parents (ask the other two). She cannot speak English. Most people under twenty understand the curious patois she fashioned out of valley girls/boys in the hood/reggae/yuppie/political double speak. The school sends her to a speech pathologist who has her roll her “r’s”. It added a refreshing Mexican/Irish touch to her voice. She wears hats backwards, baggy pants, and wants one of her ears pierced four more times. There is a fascination with tattoos that worries me, but I am sure that you can handle it. Bring a truck when you come to get her, she sort of “nests” in her room and I think that it would be easier to move the entire thing than find out what it is really made of.

You denied two of the three exemptions, so it is only fair that you get to pick which two you will take. I prefer that you take the youngest two, I will still go bankrupt with Kristen’s college, but then I am free! If you take the two oldest, then I still have time for counseling before Heather becomes a teenager. If you take the two girls, then I won’t feel so bad about putting Patrick in a military academy. Please let me know of your decision as soon as possible, as I have already increased the withholding on my W-4 to cover the $395 in additional tax and made a down payment on an airplane.

Yours truly,


By the way, the IRS allowed the dependency exemptions.