Are You Concerned that if Substantial Gifts Were Made Which Exceed the Pre-TCJA Estate and Gift Tax Exemption That Your Estate would Be Adversely Impacted?

In REG-106706-18 the IRS has issued proposed regulations that provide that individuals taking advantage of the increased gift and estate tax exclusion amounts in effect from 2018 to 2025, as provided for by the Tax Cuts and Jobs Act (TCJA), will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels. 

Background

In computing the amount of Federal gift tax to be paid on a gift or the amount of Federal estate tax to be paid at death, the gift and estate tax provisions of the Internal Revenue Code (Code) apply a unified rate schedule to the taxpayer’s cumulative taxable gifts and taxable estate on death to arrive at a net tentative tax. The net tentative tax then is reduced by a credit based on the applicable exclusion amount (AEA), which is the sum of the basic exclusion amount (BEA) within the meaning of section 2010(c)(3) of the Code and, if applicable, the deceased spousal unused exclusion (DSUE) amount within the meaning of section 2010(c)(4). In certain cases, the AEA also includes a restored exclusion amount.

Prior to January 1, 2018, for estates of decedents dying and gifts made beginning in 2011, section 2010(c)(3) provided a BEA of $5 million, indexed for inflation after 2011. The credit is applied first against the gift tax, on a cumulative basis, as taxable gifts are made. To the extent that any credit remains at death, it is applied against the estate tax.

Section 11061 of the TCJA amended section 2010(c)(3) to provide that, for decedents dying and gifts made after December 31, 2017, and before January 1, 2026, the BEA is increased by $5 million to $10 million as adjusted for inflation (increased BEA). On January 1, 2026, the BEA will revert to $5 million. Thus, an individual or the individual’s estate may utilize the increased BEA to shelter from gift and estate taxes an additional $5 million of transfers made during the eight-year period beginning on January 1, 2018, and ending on December 31, 2025 (increased BEA period).

Section 11061 of the TCJA also added section 2001(g)(2) to the Code, which, in addition to the necessary or appropriate regulatory authority granted in section 2010(c)(6) for purposes of section 2010(c), directs the Secretary to prescribe such regulations as may be necessary or appropriate to carry out section 2001 with respect to any difference between the BEA applicable at the time of the decedent’s death and the BEA applicable with respect to any gifts made by the decedent.

Given the cumulative nature of the gift and estate tax computations and the differing manner in which the credit is applied against these two taxes, there are several questions regarding a potential for inconsistent tax treatment or double taxation of transfers resulting from the temporary nature of the increased BEA.

Analysis

·       First, in cases in which a taxpayer exhausted his or her BEA and paid gift tax on a pre-2018 gift, and then either makes an additional gift or dies during the increased BEA period, will the increased BEA be absorbed by the pre-2018 gift on which gift tax was paid so as to deny the taxpayer the full benefit of the increased BEA during the increased BEA period?

§  The IRS’s response is that the gift tax determination appropriately reduces the increased BEA only by the amount of BEA allowable against prior period gifts, thereby ensuring that the increased BEA is not reduced by a prior gift on which gift tax in fact was paid.

·                Second, in cases in which a taxpayer made a gift during the increased BEA period that was fully sheltered from gift tax by the increased BEA but makes a gift or dies after the increased BEA period has ended, will the gift that was exempt from gift tax when made during the increased BEA period have the effect of increasing the gift or estate tax on the later transfer (in effect, subjecting the earlier gift to tax even though it was exempt from gift tax when made)?

§  The IRS responded by ruling the only time that the increased BEA enters into the computation of the estate tax is when the credit on the amount of BEA allowable in the year of the decedent’s death is netted against the tentative estate tax, which in turn already has been reduced by the hypothetical gift tax on the full amount of all post-1976 taxable gifts (whether or not gift tax was paid). Thus, the increased BEA is not reduced by the portion of any prior gift on which gift tax was paid, and the full amount of the increased BEA is available to compute the credit against the estate tax.

·                The third situation considered is whether the gift tax on a gift made after the increased BEA period is inflated by a theoretical gift tax on a gift made during the increased BEA period that was sheltered from gift tax when made. If so, this would effectively reverse the benefit of the increased BEA available for gifts made during the increased BEA period. This issue arises in the case of donors who both made one or more gifts during the increased BEA period that were sheltered from gift tax by the increased BEA in effect during those years, and made a post-2025 gift. The concern raised is whether the gift tax determination on the post-2025 gift will treat the gifts made during the increased BEA period as gifts not sheltered from gift tax by the credit on the BEA, given that the post-2025 gift tax determination is based on the BEA then in effect, rather than on the increased BEA.

§  The IRS responded by ruling the gift tax from prior periods includes the gift tax attributable to the gifts made during the increased BEA period. In this way, the full amount of the gift tax liability on the increased BEA period gifts is removed from the computation, regardless of whether that liability was sheltered from gift tax by the BEA or was satisfied by a gift tax payment. All that remains is the tentative gift tax on the donor’s current gift. Even if the sum of the credits allowable for prior periods exceeds the credit based on the BEA in the current (post-2025) year, the tax on the current gift cannot exceed the tentative tax on that gift and thus will not be improperly inflated. The gift tax determination anticipates and avoids this situation, but no credit will be available against the tentative tax on the post-2025 gift.

·                The fourth situation considered is whether, for estate tax purposes, a gift made during the increased BEA period that was sheltered from gift tax by the increased BEA inflates a post-2025 estate tax liability. This will be the case if the estate tax computation fails to treat such gifts as sheltered from gift tax, in effect reversing the benefit of the increased BEA available for those gifts. This issue arises in the case of estates of decedents who both made gifts during the increased BEA period that were sheltered from gift tax by the increased BEA in effect during those years, and die after 2025. The concern raised is whether the estate tax computation treats the gifts made during the increased BEA period as post-1976 taxable gifts not sheltered from gift tax by the credit on the BEA, given that the post-2025 estate tax computation is based on the BEA in effect at the decedent’s death rather than the BEA in effect on the date of the gifts. In this case, the statutory requirements for the computation of the estate tax, in effect, retroactively eliminate the benefit of the increased BEA that was available for gifts made during the increased BEA period.

§  The IRS responded by ruling to implement the TCJA changes to the BEA under section 2010(c)(3), the proposed regulations would amend §20.2010-1 to provide that, in the case of decedents dying or gifts made after December 31, 2017, and before January 1, 2026, the increased BEA is $10 million.

The proposed regulations also would amend §20.2010-1 to provide a special rule in cases where the portion of the credit as of the decedent’s date of death that is based on the BEA is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable within the meaning of section 2001(b)(2). In that case, the portion of the credit against the net tentative estate tax that is attributable to the BEA would be based upon the greater of those two credit amounts.

Can the Filing of an Amended Tax Return Result in the Waiver of the Attorney-client Privilege Between Taxpayer and Accountant?

U.S. v. Adams, 122 AFTR 2d ¶2018-5380, (DC MN 10/27/2018)

Under United States v. Kovel, 296 F.2d 918, 921–22, 9 AFTR 2d 366 (2nd Cir. 1961) the attorney-client privilege applies to an individual's communications with an accountant if the communications are “made in confidence for the purpose of obtaining legal advice from the lawyer” The party asserting that a communication is protected by the attorney-client privilege has the burden to establish that it applies. U.S. v. Horvath, 53 AFTR 2d 84-1138, (8th Cir 1984).

In Adams the district court concluded that communications between a taxpayer and his accountant was protected by the attorney-client privilege. However the court concluded that any such privilege could be waived by filing an amended tax returns, and that that even if they were protected, the crime-fraud exception vitiated the privilege.

Under the crime-fraud exception, the attorney-client privilege does not extend to communications made for the purpose of getting advice for the commission of a fraud or a crime. Though the attorney-client privilege protects an individual's consultation with a lawyer with respect to past wrongdoings, the privilege is lost if the communication is made to further a continuing or contemplated criminal fraud or scheme. Similarly, a client who has used his attorney's assistance to perpetrate a crime or fraud cannot assert the work product privilege as to any documents generated in furtherance of his misconduct. See, In re Green Grand Jury Proceedings, 492 F.3d 976 (8^th Cir. 2007); Zolin v. U.S., 63 AFTR 2d 89-1483 (S. Ct. 1989)

Before the crime-fraud exception may be applied, the government must make a threshold showing that legal advice was obtained to further an illegal or fraudulent scheme. It's required to demonstrate "a factual basis adequate to support a good faith belief by a reasonable person… that in camera review of the materials may reveal evidence to establish the claim that the crime-fraud exception applies." In re Green Grand Jury Proceedings,  492 F.3d 976, 979 (8^th Cir. 2007); Zolin v. U.S., 63 AFTR 2d 89-1483, (S Ct 1989).

Notwithstanding, to make the ultimate showing that the crime-fraud exception applies, and that the purportedly privileged documents should be disclosed, a higher level of proof is required. In re Gen. Motors Corp., 153 F.3d 714 (8^th Cir. 1998) The Supreme Court in Zolin expressly declined to specify the quantum of proof required to establish the crime-fraud exception, but noted that the standard is higher than the threshold showing required for in camera review.

The taxpayer, Edward Adams, invoked the attorney-client privilege over numerous communications between himself and accountants at Murry LLC, who were retained by his tax counsel under a so-called "Kovel arrangement."

The government raised three challenges to the assertion of privilege with regard to the communication with the accountants:

·      that the protections provided under Kovel were not applicable to these individual communications;

·      that any such protection was waived by the taxpayer's subsequent filing of amended tax returns; and

·      that the crime-fraud exception invalidated any claim of privilege.

In addition to the communications with his accountants, the government sought, and Mr. Adams asserted privilege with regard to, communications that he had with his law and business partner and their paralegal, and with lawyers that represented several companies (including the Apollo corporation, noted below).

The district court conducted an in camera review of the various Murry LLC communications.

The district court rejected the government's argument that the protections of Kovel did not apply to the Murry LLC communications. The court found that the declaration and supplemental declaration by Mr. Adams' attorney sufficiently demonstrated that the attorney-client privilege extended to the documents at issue. In these declarations, the attorney thoroughly explained how communications with Murry LLC and the information Mr. Adams provided to the accountants assisted in his provision of legal advice to his client regarding tax-related matters. The court found that this was sufficient to invoke the attorney-client privilege. The court also stated that its in camera review of the communications did not contradict the attorney's explanation.

The Amended Tax returns. The district court also concluded that Mr. Adams' subsequent filing of amended tax returns for 2008, 2009, and 2010 did not result in a waiver of the privilege as to the Murry LLC communications submitted for in camera review. The district noted that in Cote, the Eighth Circuit stated that

"[n]otwithstanding our recognition that the attorney-client privilege attached to the information contained in the accountant's workpapers under the circumstances existing here, we find that by filing the amended returns the taxpayers communicated, at least in part, the substance of that information to the government, and they must now disclose the detail underlying the reported data."

Notably the Cote court distinguished between "workpapers [that] contain detail of unpublished expressions which are not part of the data revealed on the tax returns," and other workpapers to which the rule of waiver would apply. Mr. Adam's attorney explained in his supplemental declaration that, in responding to a subpoena from the government, he provided copies of files that contain data and information that that was included on the amended returns for 2008-2010. However, the attorney did not disclose information communicated by Mr. Adams in connection with requests for legal advice. The district court found that the explanation of Mr. Adam's attorney distinguished this case from Cote, where the accountant "testified that the information on his workpapers was later transcribed onto the amended returns which were filed by the taxpayers with the government," thereby waiving the privilege.

The district court said that it could not conclude on the record before it (including its in camera review) that Mr. Adams was claiming privilege over the underlying details for the data that was ultimately transmitted to IRS when he filed the amended returns. Instead, the record suggested that the information conveyed to the accountants at Murry LLC comprised the type of unpublished expressions that were not later revealed on the amended tax returns.

As to the government's contention with regard to the crime-fraud exception, the district court found that while the government met the initial threshold requirement, it failed to make the ultimate showing that the crime-fraud exception applied.

Conclusion. While amended tax returns have the potential to unravel the Koval privilege, if communications are maintained properly the waiver of the attorney-client can be maintained.