July 26, Dear Clients and Colleagues:

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1 July 26, 2017 Dear Clients and Colleagues: The following is a summary of some of the more important tax developments that have occurred during the first half of 2017 that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable. House and Senate Bills Introduced in New Congress to Prevent Finalization of Code Sec Proposed Regulations. Two bills were introduced in the new Congress to prevent the Treasury and IRS from finalizing the proposed regulations under Code Section The first was introduced by Senator Marco Rubio (R-Fla.) and referred to the Senate Finance Committee while the second was introduced by Representative Warren Davidson (R- Ohio) and referred to the House Committee on Ways and Means. The proposed regulations under Code Section 2704 target high net worth families which conduct closely held businesses or have significant wealth concentrated in a family business; namely, those who have enough wealth to have federal estate tax exposure. If finalized, the proposed regulations would eliminate minority and marketability valuation discounts for transfers of interests in closely held family businesses. Tax Reform: Senate Majority Leader Signals Later Timeline. House Speaker Paul Ryan (R-WI) previously indicated his wish to tackle tax reform in the spring, after healthcare reform and the spring budget pass but before the congressional August recess. Nevertheless, Senate Majority Leader Mitch McConnell (R-KY) observed, I think finishing on tax reform will take longer, but we do have to finish the healthcare debate up or down, win or lose, before we go to taxes. However, given the recent conflicts regarding healthcare reform in Congress, and the possible reduction or cancellation of the congressional August recess, attention may turn to tax

2 reform prior to the end of Summer. Although, there are calls for infrastructure matters to be attended to first. Trump Administration Institutes Regulatory Freeze, Leaving Recently Issued Regulations in Limbo. White House Chief of Staff Reince Priebus has issued a memorandum to the heads of executive departments and agencies describing a regulatory freeze process. Specifically, no regulations are to be submitted to the Office of the Federal Register (OFR) until they have been reviewed and approved by an appointee or designee of President Trump. In addition, the memorandum orders certain regulations that have been filed with the OFR, but not yet published, to be withdrawn. Federal Regulation Cut-Down May Not Impact Tax Regulations. On a related note, President Trump on January 30, 2017, signed an executive order that will seek to dramatically pare back federal regulations. The executive order includes a provision that requires agencies to cut two existing regulations for every new regulation introduced. Moreover, the order provides that, the cost of planned regulations [will] be prudently managed and controlled through a budgeting process. For the rest of fiscal 2017, under that process, the cost of any additional regulations must be completely offset by undoing existing rules. The Director of the Office of Management and Budget has the ability to waive or phase in the new policy in certain instances. Most importantly, while the order did not expressly provide a carve-out for IRS regulations, a memorandum issued by the Acting Administrator of the Office of Information and Regulatory Affairs on implementing the EO, appears to limit the EO's application to significant regulatory actions a category that excludes the vast majority of IRS regulations. Due to Budget Cuts, IRS Suspends Transfer Tax Rulings and Conferences. At a Federal Bar Association Tax Law Conference, an IRS Office of Chief Counsel branch chief announced that the IRS has temporarily suspended the issuance of private letter rulings regarding certain generation-skipping trust matters and has temporarily suspended pre-submission conferences on estate, gift, and generation-skipping transfer (GST) tax issues. The GST tax is imposed on transfers outright or in trust to beneficiaries more than one generation below the transferor's generation. In addition, Melissa C. Liquerman, an IRS Office of Chief Counsel branch chief observed that the IRS has temporarily suspended issuing private letter rulings with respect to modifications to GST tax-exempt trusts, such as dynasty trusts.

3 IRS Issues Revenue Procedure Allowing Late Portability Election. The IRS has issued Revenue Procedure which addresses a method by which certain estates may obtain an extension of time to make a late portability election. Prior to the issuance of this Revenue Procedure, the only way to obtain an extension of time to make a portability election was to request a Private Letter Ruling from the IRS. Such a request is significantly costly and time consuming to the taxpayer; nevertheless, the IRS appears to have been overwhelmed by such requests. As a result, Revenue Procedure was issued. It permits certain estates to obtain such an extension of time by filing an estate tax return for the decedent s estate either within two years after the date of death, or January 2, 2018, whichever is later. This simplified procedure is only available to those estates which would have otherwise not been required to file an estate tax return. For example, if a decedent died in 2015 having a gross estate that, when combined with adjusted taxable gifts, was valued below the exemption amount in effect for that year, and no estate tax return was ever filed for the decedent s estate to elect portability, the Executor can now file such a return to make a portability election prior to January 2, Conversely, if a decedent died in 2015 having a gross estate that, when combined with adjusted taxable gifts, exceeded the exemption amount in effect for that year, the estate is not entitled to now file a return under this Revenue Procedure and make a late portability election. Old Masters Artwork Substantially Undervalued. In Estate of Kollsman, the Tax Court held that two old master paintings had been worth almost $1.8 million for estate tax purposes, finding that the IRS appraiser was more credible than the taxpayer's appraiser. See Estate of Kollsman v. Commissioner, T.C. Memo There, the Tax Court rejected valuations by the estate's expert due to the fact that the expert had a significant conflict of interest and therefore stood to gain from providing a low estimate and that he exaggerated the paintings' dirty condition and the risks of cleaning them. Furthermore, the court found that he did not offer supporting comparables for his valuations and did not adequately explain the fact that the first painting sold a few years later for almost 5 times the amount he estimated. In contrast, the IRS expert s estimates were largely acceptable; however, they were subject to adjustment and discount to account for the fact that, even though the estate's expert exaggerated the paintings' dirty condition, they were in fact dirty at the valuation date and had some risk associated with cleaning. Discounts were also required to account for the bowed condition of the second painting and issues surrounding its attribution.

4 $64 Million Charitable Deduction Lost for Failure to Obtain Contemporaneous Written Acknowledgement. In 15 West 17th Street LLC, the Tax Court held that an LLC could not take a $64.49 million income tax deduction for a charitable contribution when it failed to obtain a contemporaneous written acknowledgement, noting, among other things, whether the recipient provided the donor with any goods or services in exchange for the gift. See 15 West 17th Street LLC v. Commissioner, 147 T.C. 19 (2016). Moreover, the court held that as the Treasury has not yet issued regulations on how the substantiation requirements can be met if the charity files a return, on such form and in accordance with such regulations as the Secretary may prescribe, the charity cannot satisfy this requirement by filing such information. No Charitable Deduction Without Adequate Substantiation. The Tax Court recently held that a taxpayer could not deduct cash charitable contributions for which he lacked adequate substantiation, such as bank records, a receipt, a letter from the donee, or reliable written records showing the name of the donee and the date and amount of the gift. See Luczaj & Associates et al. v. Commissioner, T.C. Memo Once again, this case illustrates the importance of maintaining proper records and substantiation to support deductions. Without such backup, it becomes highly difficult, if not impossible, to defend an IRS audit. Tax Court Erred on Burden of Proof in Gift Tax Valuation Case. The First Circuit has reversed in part a Tax Court decision that misstated the burden of proof in a gift tax case and improperly refused to allow the taxpayers to challenge an IRS expert's valuation report which served as the basis of their disputed tax liability. See Cavallaro v. Commissioner, (2016, CA1) 118 AFTR 2d In general, an IRS notice of deficiency is presumed correct. As a result, the taxpayer normally bears the burden of proving that the IRS's tax assessment is erroneous. Provided the taxpayer shows that the IRS's determination is invalid, he or she has no further obligation to show... how much money is owed. Nevertheless, and in limited situations, the IRS bears the burden of proving a tax deficiency such as when an assessment is shown to be excessive and arbitrary or utterly without foundation. Furthermore, the burden of proof shifts to the IRS in the case of any new matter, i.e., when the IRS attempts to establish the deficiency on a basis not described in the deficiency notice. In Cavallaro, the Tax Court reasoned that since it rejected the taxpayers' valuations, they would be unable to prove their proper liability and as such, it would serve no useful purpose to

5 allow them to dispute the report. However, the Appellate Court disagreed and found that the taxpayers' burden was simply to show that the IRS's assessment was erroneous, not to prove the amount actually owed. Provided the taxpayer could make this showing of an incorrect assessment, the Tax Court must determine the correct amount due. IRS Examines Income, Estate, Gift and GST Tax Consequences of Trust Division. In PLR (March 3, 2017), the IRS provided guidance with respect to the division of irrevocable trusts. Specifically, the IRS stated that the division of an irrevocable trust by the trustees into seven separate irrevocable trusts, one for each of the grantor's children and each such child's descendants, would not produce taxable income, a change in the income tax basis of assets, a taxable gift, inclusion of trust assets in the grantor's gross estate or a change in the GST exclusion ratio of any of the trusts. The division was authorized by the trust instrument and an order of a local court. Gift Tax Assessment Period Remained Open Due to Failure to Properly File Form 709. In a matter where a donor made gifts in each of seven different tax years and failed to file Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for the first six years, then filed a Form 709 in year seven which failed to adequately report the year seven gift, the IRS has concluded, in a Legal Advice Issued by Field Attorneys (LAFA F), that under Code Sec. 6501(c)(3), the period of limitations on assessing gift tax remained open for the years that a donor failed to file any Forms 709. The IRS also found that, for another year, the period of limitations remained open under Code Section 6501(c)(9) because the Form 709 that was filed neither described the transferred property nor provided a description of the method used to determine its value. Generally, absent an exception, the IRS must assess the amount of any gift tax within three years after Form 709 is filed. An example of such an exception would apply to the tax on a gift not adequately disclosed on a gift tax return on which it was required to be reported. If no return was filed, the tax may be assessed, or a collection proceeding begun without assessment, at any time. If a transfer of property is not adequately disclosed on a gift tax return filed for the calendar period in which the transfer occurs, then any gift tax on the transfer may be assessed, or a proceeding for the collection of the appropriate tax without assessment begun, at any time. In the LAFA, the IRS concluded the donor did not file any Forms 709 for years one through six and, accordingly, the period of limitations on assessing tax on those gifts did not expire. Nor did

6 the period for assessing tax on the year seven gift expire since the donor failed to adequately report any of the gifts for that year. A gift is not adequately disclosed unless it is reported in a manner adequate to apprise [IRS] of the nature of the gift and the basis for the value so reported. See, Reg (c)- 1(f)(2). A transfer will be considered adequately disclosed if the following information is provided: (1) a description of the transferred property and any consideration received by the transferor, (2) the identity of, and relationship between, the transferor and each transferee, (3) if the property is transferred to a trust, the trust s tax identification number and a brief description of its terms, or a copy of the trust agreement, (4) a detailed description of the method used to determine the fair market value of the property transferred (for example, an appraisal, financial data, balance sheets, etc.) and (5) a statement describing any position taken that is contrary to any proposed, temporary or final Treasury regulations or revenue rulings published at the time of the transfer. Levy Applied to Wife's Estate as Previous Payment Was Properly Applied to Husband's Liabilities. The Tax Court upheld the IRS's determination to collect via levy a deceased wife's unpaid additions to tax and interest stemming from a late-filed gift tax return. See Estate of Lillian Beckenfeld v. Commissioner, T.C. Memo By way of background, the IRS must provide a taxpayer with written notice when a federal tax lien is filed upon the taxpayer's property, or when the IRS intends to levy upon the taxpayer's property. The notice must inform the taxpayer of the right to request an administrative Collection Due Process hearing in the Appeals Office. If a hearing is timely requested, it is held before an impartial officer or employee of the IRS during which time the taxpayer may raise any relevant issue. Thereafter, the Appeals Office issues a written notice of determination indicating whether the notice of federal tax lien should remain in effect and/or whether the proposed levy may proceed. A taxpayer may appeal the Appeals Office determination to the Tax Court within 30 days of the determination and if an appeal is timely filed, the court will have jurisdiction with respect to the matter. In this matter, Ms. Beckenfeld's estate acknowledged that her late husband s estate's instructions to the IRS were to apply the check against Mr. Beckenfeld's 2007 liability, but argued that the check was intended to pay Ms. Beckenfeld's 2007 liability. However, the court found that the IRS properly applied that check to the husband's near-identical liability, in

7 accordance with the clear instructions from his estate. In rendering its decision, the court emphasized the relevant caselaw which establishes that the IRS must honor a taxpayer's designation of a voluntary tax payment. Here, the IRS used the check to cover Mr. Beckenfeld's 2007 liability as it was plainly and unambiguously instructed to do. Accordingly, the court found that Ms. Beckenfeld's 2007 liability remained unpaid and upheld the IRS's determinations. Closely Held Businesses: Deductions for Management Fees. Home health care company which was owned equally by shareholders who also had equal ownership of its parent was denied deductions for purported management fees that it paid to the parent. The taxpayer failed to establish that such payments were for services rendered and/or were reasonable in accordance with Code Section 162. See Home Team Transition Management v. Commissioner, T.C. Memo None of the shareholders were employees of the parent and no one was paid salary for any services rendered to or on the parent's behalf. Furthermore, the court found that the shareholders were paid equal amounts as director's fees. Finally, the fees were originally booked as loan payments which varied depending on the taxpayer's revenues. 50% Owner Liable for Trust Fund Penalty Despite Not Having Primary Responsibility Over Taxes. A district court has determined on summary judgment that a 50% owner of a member-managed company, who was required to sign off on all significant decisions relating to the company, was liable for the trust fund recovery penalty under Code Section See United States v. Commander, (DC NJ 4/3/2017) 119 AFTR 2d In general, Code Section 6672 imposes a responsible person penalty (commonly known as the trust fund recovery penalty) on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The amount of the penalty is equal to the amount of the tax that was not collected and paid. The court noted that responsibility is a matter of status, duty or authority, not knowledge. Quattrone Accountants, Inc. v. IRS, (CA ) 65 AFTR 2d Here, the owner s approval was required for all company decisions, actions and many significant financial transactions. He also had check-signing authority. In addition, the court concluded that the owner acted willfully. In his deposition testimony, the owner stated that he became aware that the taxes were not being paid somewhere between 2007 and 2009, and that he received regular updates concerning correspondence with the IRS during that time. The court found that it

8 appeared that he had actual knowledge that the taxes were not being paid and that as one of two managing members, he clearly ought to have known and was in a position to find out for certain. As such, the court granted summary judgment in favor of the government. Tax Negligence Penalties Upheld Despite Reliance Upon Professional. Accuracy-related negligence penalties were upheld against a pro se dentist/wife and husband for years in which they underreported their income and claimed unsubstantiated business deductions. See Saeid Zolghadr, et ux. v. Commissioner, T.C. Memo The court held that the IRS met its burden for establishing penalties with proof that the taxpayers presented little credible evidence and kept inadequate books and records for the wife's dental practice; moreover, they failed to show a good faith effort to correctly determine their liabilities. Although they hired a return preparer, they did not demonstrate what if any records they provided to that person to substantiate their income and expenses or that the preparer was competent. Widow Keeps Double Tax Benefit - Tax Benefit Rule Not Applied. In Estate of Backemeyer, the court concluded that a farmer's widow could deduct expenses for seed, fertilizer and fuel when she used them in her farming activities, even though they had already been deducted by her late husband when he bought them. See Estate of Backemeyer v. Commissioner, 147 T.C. 17 (2016). There, the taxpayer's late husband was a sole proprietor farmer when he bought the farm crop inputs in 2010, intending to use them to cultivate crops in The husband deducted the costs in 2010 and died in 2011, before he had used any of the purchases. The widow received the items from her husband's revocable trust and accordingly used them in her own farming business. Most interestingly, and despite her husband's earlier deductions, the Tax Court refused to apply the tax benefit rule, and held that the widow could deduct the value of the farm inputs she had inherited. Business Owner Cannot Escape Liability Despite Inadvertently Filed Lien Release Certificates. A district court, adopting a magistrate judge's recommendation, has reduced a taxpayer's unpaid income taxes and trust fund taxes to judgment. See U.S. v. Wallis, (DC VA 3/08/2017) 119 AFTR 2d In an action for unpaid tax liabilities, tax assessments carry a presumption of correctness and the government can establish a prima facie case by showing that an assessment has been made against a defendant. The government may demonstrate that it has properly assessed a tax liability by placing into evidence a Certificate of

9 Assessments and Payments. Such certificates are presumed correct unless the defendant proves otherwise. In this case, the taxpayer asserted that lien release certificates inadvertently filed by the IRS raised significant questions as to the amount he owed. Nevertheless, the court rejected this assertion as insufficient to rebut the IRS's presumptively correct assessment certificates. Moreover, the court rejected their attempt to challenge the IRS's calculation of the amount of wages that one of his companies paid, finding that any imprecision was the result of his failure to maintain adequate records. New Jersey Division of Taxation Clarifies Waiver Requirements for IRAs. In its Spring, 2017 New Jersey State Tax News quarterly newsletter, the Division of Taxation addressed the issue of obtaining tax waivers for Individual Retirement Accounts (IRA). In general, those assets which belong to a resident decedent may not be transferred without the written consent of the Director of the Division of Taxation via a tax waiver. Due to the nature of IRAs, blanket waiver provisions permitting the release of up to fifty percent (50%) of the decedent s funds in certain accounts do not normally apply. If an asset comprising an IRA would not normally require a waiver (i.e., an annuity) then no waiver is required and none will be issued. If, however, an asset comprising an IRA would normally require a waiver (i.e., brokerage account or CD) then a waiver is required for the IRA. The Division goes on to instruct that where no waiver is required for an IRA and a New Jersey Inheritance Tax Return (Form IT-R) and New Jersey Estate Tax Return (Form IT-Estate) using the Column A simplified method are filed, the IRA should be reported on Schedule B(1): All Other Property. Where the asset would require a waiver, the IRA should be reported on Schedule B(1): Bank Accounts/Brokerage Accounts. Where no New Jersey Inheritance Tax Return is filed and a New Jersey Estate Tax Return is filed using the Column B method, waivers should be requested on Schedule E-5: Waiver Request Schedule. The named beneficiaries and their respective shares should be reported on the New Jersey Inheritance or Estate Tax Return, but are not required to be listed on the waiver. Number of IRS Audits Down: What Are Your Chances? Finally, IRS audits have dropped. During 2016, the IRS examined 0.6% of all returns filed, about 0.7% of all individual income tax returns filed in 2015 and 1.1% of corporation income tax returns (excluding S corporation returns). Individual income tax returns in higher adjusted gross income classes were more likely to be examined than returns in lower adjusted gross income classes.

10 We note the following: For business returns with total gross receipts of $100,000 to $200,000, 2.2% of returns were audited in 2016 (down from 2.5% in 2015). For business returns with total gross receipts of $200,000 or more, 1.9% of returns were audited in 2016 (a decrease from 2% in 2015). For individual returns with total income of $200,000 to $1 million, 1% of returns were audited (down from 1.8% for the previous year). For all corporate returns, the audit rate in 2016 was 1.1% (down from 1.3% in the previous year). For small corporations with balance sheet returns showing total assets of: $250,000 to $1 million, the rate was 1%; for $1 to $5 million, the rate was 1%; and for $5 to 10 million, the rate was 1.6%. For large corporations with returns showing total assets of: $10 to $50 million, the audit rate was 4.7%; for $50 to $100 million, the rate was 10.3%; for $100 to $250 million, the rate was 11.1%; and for $250 to $500 million the rate was 12.2%. The above excerpts reflect just some of the recent tax developments that you should be aware of. Please contact us if we may be of assistance in any way. Very truly yours, GENOVA BURNS LLC Judson M. Stein, Esq. Lauren M. Ahern, Esq. For more information, please contact: Judson M. Stein at or Lauren M. Ahern, Esq. at