Three new inherited IRA wins in bankruptcy court (Cutignola in New York, Methusa in Florida, and Johnson in Washington), an overturned 2010 bankruptcy court loss (Chilton in Texas), and new legislation in Florida to strengthen that state's protection for inherited IRAs in its state (non-bankruptcy) courts add to the good news for inherited IRAs in 2011.

Advisors would do well to counsel heirs of retirement plans to limit their withdrawals to the minimum required by law, now not only for income tax reasons, but also for protection against creditors, at least when it comes to bankruptcy court. To help bring the point home, use our newly named and updated "Inherited IRA Scorecard" found here.

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.

There has been a difference of opinion among lawyers and accountants as to whether to disclose a sale to an intentionally defective grantor trust ("IDGT") on the seller's gift tax return (Form 709). Some taxpayers disclose the sale so as to start the running of the gift tax statute of limitations. Absent disclosure, the IRS can audit the transaction at any time, and can assert gift tax, interest and penalties. Other taxpayers do not disclose the sale, so as to reduce the likelihood of an audit. Until recently, absent disclosure on the gift tax return, there was a good chance that the IRS would never have become aware of the transaction.

However, Part 4, question 12e on page 3 of Form 706 (Rev. 9-2009) asks whether the decedent ever transferred or sold an interest in a partnership, limited liability company or closely-held corporation to a trust in existence at the decedent's death that the decedent created or under which the decedent possessed any power, beneficial interest or trusteeship [emphasis added]. If so, the return asks for "the EIN number to this transferred/sold item". As a result of this question, the IRS will know about the transaction at that time - if the trust is in existence at the seller's death.

Having to disclose the sale on the Form 706 can be avoided by terminating the trust during the seller's lifetime. However, distributed trust assets will be subject to the claims of the beneficiary's creditors (including ex-spouses), and will be subject to estate taxes at the beneficiary's death. A better choice might be to use a GRAT instead of a sale to an IDGT. The reason is that if the values are changed on audit, the result is a change (increase) in the annuity payments rather than in the gift tax. Another option is to use a defined value clause in connection with the sale to an IDGT to avoid any unintended gift.

While some taxpayers may continue to sell assets to IDGTs without disclosing the sale on a gift tax return, they proceed at their own peril. Admittedly, it would be more difficult for the IRS to audit the sale after the taxpayer's death, especially if many years have passed and the partnership, LLC or closely-held corporation no longer exists, but it would not be impossible to do so.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.

On December 16, 2010, recent amendments to Michigan's Limited Liability Company Act ("LLC Act") took effect. While many of the changes involved technical fixes and clarifications of the law, one in particular stands out.

One of the primary advantages to organizing an LLC is that, when properly operated, it can limit the liability for its members (i.e., owners). There have been several court cases in other states which have LLC statutes similar to Michigan's. In those cases, creditors of LLC members have attempted to take over the benefits of the membership of an LLC, actively manage the LLC, sell the membership interest, liquidate the LLC's assets, or distribute LLC funds to satisfy the debt. Recognizing that Michigan courts could rely upon these cases, which were adverse to the LLC owners, Michigan legislators sought to clarify the original intent of the LLC Act with respect to the rights of creditors. Through its recent amendment, the LLC Act makes it clear that a judgment-creditor is entitled to receive only the distributions of a debtor-member. Moreover, it states that the debtor-member remains a member of the LLC and retains all rights and powers of membership provided by law, as well as the operating agreement (obviously, other than the above-referenced right for the creditors to receive distributions to the extent that they are distributed to the debtor-member). Finally, the amendments to the LLC Act further provide that the lien on the creditor's right to receive distributions cannot be foreclosed upon, nor can the membership interest be sold as personal property.

For more information regarding this topic, please e-mail your requests to Thomas P. Cavanaugh, or call Tom at (248) 457-7218.

In Estate of Jorgensen v. Commissioner; T.C. Memo, 2009-66; No. 21936-06 (26 Mar 2009), the Tax Court determined that no valuation discounts would be permitted for two family limited partnerships. The IRS maintained that there was inclusion of the assets at full value under Sec. 2036(a) and, alternatively, under Sec. 2038. The court noted that inclusion under Sec. 2036(a) is applicable when (1) there is a transfer of property, (2) there is not a bona fide sale for adequate and full consideration, and (3) the decedent retained a life interest in the gifted property.

The Tax Court determined there were indeed transfers to the FLPs by the decedent, and that since she stood on "both sides of the transaction", there was no bona fide sale for adequate and full consideration. The Tax Court then turned to the following "disregard of partnership formalities":

1. No books and records (other than checkbooks) were maintained for the FLPs.
2. The checkbooks were never reconciled.
3. There were no formal partnership meetings.
4. There were no minutes at any meetings.
5. FLP checks were used to pay the decedent's personal expenses.
6. FLP funds were commingled with the decedent's personal funds.
7. FLP assets were used for the decedent's personal gifts to her children.

Because the decedent retained multiple and significant rights with respect to the liquid assets in the partnerships, the Tax Court determined that Sec. 2036(a)(1) required full estate inclusion of "the value of the assets" in the FLPs.

This is yet another IRS victory in a "bad facts" FLP case. The value of these cases is that they do present a roadmap for successful FLP operation. By retaining sufficient assets outside the FLP, documenting business purpose, conducting appropriate meetings, and maintaining minutes and other records, the FLP discounts should be upheld.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.