On January 2, 2015, the IRS issued annual revenue procedures in the Internal Revenue Bulletin, which included its annual list of “no-rule” areas. Traditionally, the issues on which the IRS refrains from issuing letter rulings or determination letters tend to be inherently factual. In the domestic area, there are a number of modifications but no major additions to the no-rule list; in the international arena, however, the list was expanded to include Foreign Account Tax Compliance Act (“FATCA”) issues.
International No-Rule Areas
In the international no-rule area, the IRS will “not ordinarily” rule on FATCA issues unless the taxpayer can establish “unique and compelling” reasons. This addition to the list is the only change made to the no-rule list of international issues. Under Rev. Proc. 2015-7, 2015-1 I.R.B. 231, the IRS will now not ordinarily rule on whether a taxpayer, withholding agent, or intermediary has properly applied the requirements of Chapter 4 of the Internal Revenue Code (Code Sections 1471 through 1474, also known as “FATCA”) or of an applicable intergovernmental agreement to implement FATCA.
FATCA was enacted in 2010 in order to prevent tax evasion by US persons holding foreign assets or offshore accounts. Regulations enacted under FATCA require certain US taxpayers holding offshore financial assets to report such assets to the IRS by submitting Form 8938, Statement of Specified Foreign Financial Assets.
Specifically, Code Section 6038D(a) requires any individual who holds any interest in specified foreign financial assets that are worth $50,000 or more in aggregate to report information about those assets. Code Section 6038D(b) defines the term “specified foreign financial asset” to mean any financial account maintained by a foreign financial institution, and any foreign asset that are not held in an account maintained by a financial institution. Reporting applies for assets held in taxable years beginning after March 18, 2010. Under Code Section 6038D(c), if a specified foreign financial asset that is being disclosed is a foreign account, the US taxpayer must disclose the name and address of the financial institution in which such foreign account is maintained and the account number and the maximum value of the asset during the taxable year. With respect to any stock, security, or any other instrument, the name and address of the issuer and such information as is necessary to identify the instrument or class of which such stock or security is a part are required to be disclosed. Failure to comply with the foregoing rules results in a penalty of $10,000, and there may additional penalty if an individual fails to furnish the required information after receiving a notice of such failure from the IRS.
Chapter 4 Requirements Imposed on FFIs
Chapter 4 of the Code further provides obligations imposed on foreign financial institutions (“FFI”) under FATCA. In order to avoid being withheld upon, FFIs may register with the IRS and agree to report to the IRS certain information regarding financial accounts held by US taxpayers or by foreign entities in which US taxpayers hold a substantial ownership interest.
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Code Section 1471(a) requires any withholding agent to withhold 30% of any withholdable payment to a FFI, unless such payment meets the requirements of section 1471(b). For this purpose, section 1471(d)(5) defines the term “financial institution” to include any entity that accepts deposits in the ordinary course of a banking or similar business, holds financial assets for the account of others as a substantial portion of its business, or is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in the foregoing. In order to meet the requirements, unless other exceptions provided under the Code are applicable, an FFI must enter into an agreement with the IRS to fulfil certain obligations such as obtaining relevant information regarding each account holder and complying with due diligence procedures. Under sections 1471(b)(1)(C) and (E), an FFI must furnish the relevant information with respect to accounts held by US taxpayers to the IRS on an annual basis and any additional information as requested by the IRS. Relevant information that the IRS may require an FFI to report under the agreement includes personal information of each account holder (a US taxpayer), the account number, and the balance, as prescribed by section 1471(c)(1). Perhaps because any inquiry regarding compliance with the above requirements is likely to be very fact specific, the IRS will not rule on whether a taxpayer, withholding agent, or intermediary has properly applied the Chapter 4 requirements, absent “unique and compelling” reasons that must be established by the taxpayer.
Domestic No-Rule Area
Under Rev. Proc. 2015-3, 2015-1 I.R.B. 129, there are two categories of issues on which the IRS will not issue letter rulings or determination letters. Section 3 lists those areas in which rulings or determination letters will not be issued. Section 4 sets forth those areas in which rulings or determination letters will “not ordinarily” be issued. “Not ordinarily” means that unique and compelling reasons must be demonstrated to justify the issuance of a ruling or determination letter. This year, there were no major changes to the overall list of no-rule items. However, two issues with respect to the termination of a charitable remainder trust were moved from section 4 to section 3, meaning that the IRS will not issue private letter rulings or determination letters on this matter. The first issue is whether, upon the termination of a charitable remainder trust, the deemed sale of a term interest is the sale of a capital asset defined under Code Section 1221, and the second issue is the determination of amount of, and recognition of, gain or loss upon termination of a charitable remainder trust.
Charitable Remainder Trusts and Early Termination
A charitable remainder trust is defined by Code Section 664(d)(1) as a trust from which a certain amount of money is transferred to individual beneficiaries, at least one of which is not a charity, for life or for a term of years, with an irrevocable remainder interest held for the benefit of, or paid over to, charity. Generally, a charitable remainder trust is not subject to income tax, which is why it is a commonly used tax-deferral tool. Naturally, there has been an increasing interest in early termination of such charitable remainder trusts, and the IRS has issued several private letter rulings that discuss the income tax treatment of the termination. For planning purposes, a common federal income tax question that arises upon an early termination of the trust is whether a beneficiary may receive proceeds equal to his interest in the trust free of capital gains tax.
Generally, Code Section 1001(e) governs the determination of gain or loss from the sale or disposition of a term interest in property, such as a life or term interest in a charitable remainder trust. This particular code section was enacted to address trust terminations. Furthermore, Code Section 1221(a) defines a capital
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asset as property held by a taxpayer with certain exceptions, which do not include a term interest. In previously issued rulings, the IRS has taken the position that a term interest in a charitable remainder trust is a capital asset on the rationale that the right to receive income from a trust is equivalent to a right in the trust itself.
The reason that the IRS has consistently taken the position that it will no longer rule on the amount of gain or loss upon termination of a charitable remainder trust and characterization of the deemed sale of a term interest may be that it has become aware of the complicated and controversial nature of early termination cases of charitable remainder trusts.