LEGISLATIVE UPDATE

Pension Funding Relief Bill Signed into Law

H.R. 7327, the Worker, Retiree and Employer Recovery Act of 2008 (the Pension Act), (PL 110-458, December 23, 2008, 122 Stat 5092) was signed into law December 23, 2008, by President Bush. The Act includes important tax changes in response to the current difficulties in the economy and the effect the turbulence in the market has had on pension plans. It also includes a number of technical corrections to the Pension Protection Act of 2006 (Pub. L. No. 109-280).

In an effort to give taxpayers some flexibility in dealing with shrinking retirement accounts, the Act waives the required minimum distributions for 2009 from individual retirement plans and employer-provided qualified defined contribution plans. The one-year freeze on mandatory distributions applies to lifetime distributions to employees and IRA owners, and after-death distributions to beneficiaries.

The law also eases the funding requirements for defined benefit plan sponsors imposed by the Pension Protection Act that were scheduled to take effect in 2009, giving most sponsors one more year to comply with the phased-in funding requirements. In addition, for plan years beginning between Oct. 1, 2008, and Sept. 30, 2009, sponsors can use the preceding year to determine whether the plan's funding status requires freezing of benefit accruals, and, for purposes of determining whether a plan is in endangered or critical status under I.R.C. § 432, sponsors may elect to keep the plan's status the same as it was in the preceding year.

One important technical correction included in the Act affects nonspouse beneficiaries. Under the Pension Protection Act nonspouse beneficiaries of qualified plan participants and IRA owners are allowed the option of directly rolling over the distribution to an inherited IRA. Under the new law, effective for plan years beginning after December 31, 2009, rollovers by nonspouse beneficiaries are generally subject to the same rules as other eligible rollovers.

In a joint statement praising enactment of the law, Reps. George Miller (D-Calif.), chairman of the House Education and Labor Committee, and Rob Andrews (D-N.J.), chairman of its Health, Employment, Labor and Pensions Subcommittee, said, "Countless jobs and retirement benefits will remain intact thanks to the enactment of the ... Act."

Source:
Westlaw: Worker, Retiree, and Employer Recovery Act of 2008, PL 110-458, December 23, 2008, 122 Stat 5092; Government Printing Office: PL 110-458 (pdf).

Tax Court Disregards FLP and Private Annuity Discounts in Decedent's Estate

Last month, the U.S. Tax Court determined in Estate of Thelma G. Hurford v. Commissioner (T.C. Memo. 2008-278, Nos. 23954-04, 23964-04 (12/11/08)) that despite Thelma Hurford's attempt to reduce estate taxes through the creation of family limited partnerships and a private annuity as part of her estate plan, all property is included in her estate at fair market value upon her death.

Decedent's husband, Gary Hurford, rose from humble beginnings to President of Hunt Oil Company prior to his death in 1999. During his life, Mr. Hurford accumulated a sizeable estate consisting of real estate, phantom stock in Hunt Oil, a retirement plan, and other assets. Both Gary and Thelma had "mirror" wills, which divided the majority of the property of whichever spouse died first into two trusts, a bypass trust and a qualified terminable interest property (QTIP) trust. One home and any personal effects, however, passed directly to the surviving spouse. At the time of Mr. Hurford's death, his estate was valued at over $14 million.

After her husband's death, Mrs. Hurford sought legal counsel from the attorney that drafted the couple's wills to assist her with her husband's estate and her own estate plan. Early in 2000, she was diagnosed with cancer. During this time, Thelma had become dissatisfied with the attorney, so hired a new attorney, Joe Garza. Attorney Garza designed a plan whereby Mrs. Hurford created three family limited partnerships, giving an interest in each to herself, her husband's estate, and each of their three children. The majority of her assets and the assets of her husband's estate were transferred to the three FLP's. She then sold both her and her husband's estate interests in the FLPs to their children through a private annuity agreement. The intention of the plan recommended by Attorney Garza was for the majority of the value of the assets to be transferred to the FLPs and, since Mrs. Hurford had cancer, for the value paid under the private annuity to be a fairly small sum in comparison to the estate value.

Under the terms of the private annuity, Mrs. Hurford received payments of $80,000 per month, but early in 2001 she passed away. Attorney Garza prepared and filed the estate tax return, which was signed by Mrs. Hurford's son as executor, reporting a taxable estate of $846,666. The decedent's son also filed a 2000 gift tax return for his mother. Upon audit of the returns, the IRS assessed a deficiency of $9.8 million on the estate and $8.3 million on the gift tax returns, plus $3.6 million in penalties.

The IRS argued that the property that Attorney Garza tried to transfer out of Thelma Hurford's estate via the FLPs and private annuity are actually includible in her estate under I.R.C. §§ 2035, 2036 and 2038. The estate claimed that the estate and gift tax returns were correct and that these sections of the code were not applicable because the property was transferred into the FLPs and then into the private annuity through bona fide sales for adequate and full consideration, and the decedent did not retain possession or enjoyment of, or the right to receive income from, the property after it was transferred. The IRS countered that a bona fide sale under I.R.C. § 2036(a) was not made and that the decedent had retained enjoyment of the property.

Upon review, the Court determined that multiple errors were made in drafting the various documents, in administering the trusts created under Gary Hurford's will, in valuing the private annuity and even in the documentation of Attorney Garza's fees. As a result, the Court held that when the FLPs were funded there was not a fair market transfer and that the value of the private annuity was incorrect. Further, the Court found that Mrs. Hurford had commingled personal funds with FLP assets and essentially treated the FLPs as her own. As a result, the FLPs and private annuity are disregarded. Additionally, since the assets from the bypass trust created by Gary Hurford's will were distributed to one of the FLPs, the assets are includible in Thelma's taxable estate and the estate tax avoidance normally available to assets in a bypass trust is lost. Since the FLPs and private annuity were disregarded, all assets, including the assets in the bypass trust, are taxable at their full fair market value.

Source:
Westlaw: Estate of Hurford v. C.I.R., T.C. Memo. 2008-278, Nos. 23954-04, 23964-04 (12/11/2008), 2008 WL 5203652; U.S. Tax Court: Estate of Thelma G. Hurford, Deceased, Donor, G. Michael Hurford, Independent Executor v. C.I.R., T.C. Memo. 2008-278, Nos. 23954-04, 23964-04, (12/11/08)

IRS Extends Full Deductibility of Bundled Investment Advisory Fees

The Internal Revenue Service recently issued Notice 2008-116 extending to taxable years beginning in 2008 the interim guidance provided in Notice 2008-32, which addressed the treatment of investment advisory costs and other costs subject to the 2-percent floor under I.R.C. 67(a) incurred by a nongrantor trust or estate that are "bundled" as part of one fee paid to the trustee or executor. Under Notice 2008-32, taxpayers were not required to determine the portion of the "bundled fiduciary fee" that was subject to the 2-percent floor under Section 67 for any taxable year beginning before January 1, 2008.

The new notice reiterated that the IRS and the Treasury Department expect to issue regulations under Treas. Reg. § 1.67-4 to reflect the U.S. Supreme Court's decision in Knight v. C.I.R. (2008-17 I.R.B. 828, 128 S.Ct. 782 (2008)), which held that costs paid to an investment advisor by a nongrantor trust or estate generally are subject to the 2-percent floor for miscellaneous itemized deductions under I.R.C. § 67(a). The expected regulations will also address the tax treatment of "bundled fiduciary fees". However, the new regulations are still pending and will not be issued in time to apply to the 2008 taxable year.

As a result of extending the interim guidance, taxpayers may deduct the full amount of the bundled fiduciary fee for any taxable year beginning before January 1, 2009. However, payments by the trustee or executor to third parties for expenses subject to the 2-percent floor are readily identifiable and must be treated separately.

Source:
Westlaw: Extension of Interim Guidance on Section 67 Limitations on Estates or Trusts, Notice 2008-116, 2008-52 I.R.B. 1372, 2008 WL 5171853; Internal Revenue Service: Extension of Interim Guidance on Section 67 Limitations on Estates or Trusts, Notice 2008-116, 2008-52 I.R.B. 1372, published December 29, 2008

Court Finds Decedent's Children Liable for Estate Taxes

Last month, the U.S. District Court for the Eastern District of California ruled in United States v. Bevan (E.D. Cal., No. 2:07-cv-1944 MCE JFM PS, 12/10/08) that the two children of the decedent were liable for the outstanding estate taxes of their mother's estate plus interest and statutory additions.

Lela D. Kimball passed away in 1993, leaving assets held by the Lela D. Kimball Trust, of which Lela D. Kimball Bevan, the decedent's daughter, was a trustee. In 1994, an estate tax return was filed with the Internal Revenue Service reporting a gross estate of $2,911,615.00 and federal estate taxes due and owing in the amount of $756,438.00.After the decedent's death, assets were transferred from the trust to the decedent's two children, Ms. Bevan and Richard C. Kimball, as beneficiaries, with $977,730.70 transferred Ms. Beven and $1,584,602.19 transferred Mr. Kimball.

The federal estate tax return was audited by the Service, who subsequently assessed additional taxes, penalties, and interest against the estate. The Service determined that the decedent's estate contained property from Frank C. Kimball's estate, which should have been included in the return that was filed and that, at the time of decedent's death, the value of the assets held by the trust was $3,125,945.00. Notice and demand for payment of the outstanding tax liabilities was given by the IRS to Ms. Bevan, as trustee of the decedent's trust, however the additional assessments were not paid. The Service then moved for entry of summary judgment against the decedent's two children for the outstanding estate taxes as well as interest and statutory additions, which continue to accrue, as provided by law, until paid in full.

The defendants presented no defenses declaring that they were not indebted to the plaintiff in the amounts claimed nor did they address any of the issues, facts, or law presented by the government. Rather, they returned the court documents claiming that the court had no jurisdiction over the matter.

The Court determined that the plaintiff was entitled to summary judgment against defendants, noting that "[p]ursuant to 26 U.S.C. 6324(a)(2), Ms. Bevan is liable for the estate's unpaid tax liabilities as both trustee of the trust and as a beneficial transferee of non-probate assets she acquired upon the decedent's death. Ms. Bevan's personal liability for the estate's unpaid tax liabilities, as trustee of the trust, is $3,125,945.00, which is the value of the assets held by the trust on the date of the decedent's death… Ms. Bevan's personal liability, for the estate's unpaid tax liabilities, as a beneficial transferee is $977,730.70, which is the value of the [assets] transferred to Ms. Bevan, which were held by the trust on the date of the decedent's death… Mr. Kimball is also liable for the estate's unpaid tax liabilities as a beneficial transferee of non-probate assets he acquired upon the decedent's death. Mr. Kimball's personal liability, for the estate's unpaid tax liabilities, as a beneficial transferee is $1,584,602.19, which is the value of the [assets] transferred to Mr. Kimball, which were held by the trust on the date of the decedent's death."

The Court concluded by explaining that the amount awarded was greater than the original assessments because, as of September 30, 2008, the outstanding tax liability was $3,330,743.46, with interest and other statutory additions continuing to accrue until paid.

Source:
Westlaw: United States v. Bevan, No. 2:07-cv-1944 MCE JFM PS. (E.D.Cal.), 2008 WL 5179099, Dec. 10, 2008.

Applicable Federal Rates for January 2009 (Revenue Ruling 2009-01)

TABLE 1
Applicable Federal Rates (AFR) for January 2009

Period for Compounding

TABLE 2
Adjusted AFR for January 2009 for purposes of I.R.C. § 1288

Period for Compounding

TABLE 3
Rates under I.R.C. § 382 for January 2009

TABLE 4
Appropriate Percentages under I.R.C. § 42(b)(2) for January 2009

Note: Under Section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008, and before December 31, 2013, shall not be less than 9%.

TABLE 5
Rate under I.R.C. § 7520 for January 2009

TABLE 6
Deemed Rate for Transfers to New Pooled Income Funds During 2009

Source:
Westlaw: Federal Rates; Adjusted Federal Rates; Adjusted Federal Long-term Rate and the Long-term Exempt Rate, Rev. Rul. 2009-1, 2008 WL 5246792; Internal Revenue Service: Rev. Rul. 2009-1, Index of Applicable Federal Rates (AFR) Rulings, published December 19 2008.

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