MERS and the Tax Man

Section 61 of the Internal Revenue Code (IRC 61, 26 U.S.C. §61) defines “gross income,” the starting point for determining which items of income are taxable for federal income tax purposes in the United States. Section 61 states that”except as otherwise provided in this subtitle gross income means allincome from whatever source derived”. The United States Supreme Court has interpreted this to mean that Congress intended to express its full power to tax incomes to the extent that such taxation is permitted under Article I, Section 8, Clause 1 (the Taxing and Spending Clause) of the Constitution of the United States and under the Constitution’s Sixteenth Amendment.[1]The Internal Revenue Service has become aware that nominee individuals are being listed as principal officers, , grantors, owners, and Trustors in the Employer Identification Number (EIN) application process.

A NOMINEE IS NOT ONE OF THESE PEOPLE. RATHER, NOMINEES ARE TEMPORARILY AUTHORIZED TO ACT
ON BEHALF OF ENTITIES DURING THE FORMATION PROCESS.

The use of nominees in the EIN application process prevents the IRS from gathering appropriate information on entity
ownership, and has been found to facilitate tax non-compliance by entities andheir owners.The IRS does not authorize the use of nominees to obtain EINs. All EIN applications (mail, fax, phone, electronic) must disclose the name andTaxpayer Identification Number (SSN, ITIN, or EIN) of the true principalofficer, general partner, grantor, owner or trustor.

THIS INDIVIDUAL OR ENTITY,WHICH THE IRS WILL CALL THE “RESPONSIBLE PARTY,” CONTROLS, MANAGES, OR DIRECTS
THE APPLICANT ENTITY AND THE DISPOSITION OF ITS FUNDS AND ASSETS.The IRS statesNominees do not have the authority to authorize third party designees to fileForms SS-4, and should not be listed on the Form SS-4. If a nominee is used in
the state formation process and the true responsible party has not yet beenidentified, the entity must identify that individual before applying for anEIN. The IRS will continue to pursue enforcement actions to prevent the misuseof EIN applications.

Third Party Trust  – Property placed into a structure via atax-free sale, while continuing to retain control over the property. The client
may continue to use the property and receive distributions of the income orprincipal there from. A trustee has total discretion, without limits, to makethese distributions. Also, in most cases, the client personally retains the ability to direct the TPT to make transfers to any other person. The TPT canaccomplish all this while protecting the property from potential futurelawsuits. Further, it is typically designed to hold the property outside of the client’s taxable estate.

Although the client will ultimately transfer property tothe trust via an installment or other sale, a third party is the TPT’s settlor,
(1) and the onlytransferor who can gift assets to it; hence, the name “third-party (client) were the settlor, the trust would be a “self-settled” trust,
(2) and would not protect assets from the client’s creditors in the vastmajority of states, regardless of any spendthrift provisions.

 

Thus, when a client sells assets to a trust previouslysettled by a third party, the sale is treated as an arm’s-length transactionbetween the client and the TPT.The TPT can be the trust with stronger asset-protection features, yet be treated as a domestic trust for Federal
income tax reporting purposes.Settling a TPT Thesettlor should fund the trust with sufficient assets to avoid any appearance
that he or she is making such initial contribution as an accommodation to theclient or as the client’s agent. (3) The settlor should have an independentmotive for settling the TPT.  The amountwith which the third party funds the TPT should be sufficient to allow the mast
to meet its initial payment obligation on any anticipated installment sales theclient intends to make to the TPT. There is no safe harbor. However, 10% of thevalue of the assets the client intends to sell to the TPT may suffice as”seed money.”

Managing TPT Assets A TPT typically hasat least two trustees.

One is an independenttrustee who possesses the power to make distributions and provide benefits tothe client. This avoids a situation in which a client’s creditor can access thetrust assets by forcing the trustee to make distributions. Also, it avoidsproviding the client with tax-sensitive powers that could cause the trustassets to be taxable in his or her estate. As the TPT’s primarybeneficiary, the client may receive distributions at the complete discretion ofthe independent trustee. This trustee may also allow the client to use TPTassets (such as living in a TPT-owned home rent-free).

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: