Biden Signs $1.5 Trillion Spending Bill Without Tax Offsets


Are The "Build Back Better" Taxes Lurking?

By Beckett Cantley 1 & Geoffrey Dietrich 2 On March 10, 2022, the U.S. Senate voted 68-31 to pass the Fiscal Year (FY) 2022 omnibus appropriations bill, the Consolidated Appropriations Act of 2022 ( H.R. 2471 , hereafter, the “Omnibus Bill”), providing $1.5 trillion in federal discretionary spending across all 12 appropriations bills. The passage of this massive stop-gap spending bill averts the shutdown of the government until the end of September and was accompanied by the usual fanfare and much Congressional high-fiving—The Wall Street Journal quipped that one might think “it was the 1964 Civil Rights Act … for all the self-congratulation." 3 Conspicuously absent from the Omnibus Bill’s 2,700 pages are any tax provisions that would normally be part of such omnibus spending (and most legislation) to pay for the new spending provisions in the Omnibus Bill. This article briefly discusses the tax provisions from the Build Back Better Act (“BBB Act”) that Congress failed to pass earlier this year and analyzes what the absence of these tax provisions in the Omnibus Bill means and whether their absence is just a delayed reprieve for U.S. taxpayers.

What was in the Biden Administration’s Proposed BBB Act Tax Changes?

The Biden Administration entered office riding promises of increased taxation against wealthy Americans and businesses. We looked at several key tax provisions in depth in our article, “ Uncovering Four Ways that Biden’s American Families Plan Attacks Your Wealth ,” passage of which would have reconfigured wealth and provided a host of social programs. The BBB Act contained numerous tax provisions that theoretically would have increased tax revenue to fund a significant number of spending programs as well as continued COVID-19 pandemic-related expenditures. According to the White House’s “Build Back Better Framework” these ambitious goals were “fully paid for” through the following tax provisions:
  1. the repeal of most of the Trump Administration’s tax cuts;
  2. increasing corporate income taxes, including taxes on global income of corporations while penalizing corporations that hire and produce overseas;
  3. increasing taxes on everyone making more than $400,000 annually (Married Filing Jointly); and
  4. increasing tax enforcement by providing $80 billion in funding to the IRS. 4
The BBB Act died earlier this year when Senator Joe Manchin (D-W.Va.) voted against the new legislation. Sen. Manchin determined that the $2 trillion price tag was excessive spending that would lead to increased inflation in the U.S. economy. Amazingly, after gnashing teeth and screaming about fraud and waste over the $2 trillion in the BBB Act, enough Republicans voted with Sen. Manchin and the Democrat majority to pass the $1.5 trillion Omnibus Act which contained a government spending spree that came just half a trillion shy of the original goal.

How Congress Uses Omnibus Spending

As the legislative branch of the government, Congress is granted the “power of the purse” under Article I of the Constitution. 5 As the federal government has grown in prominence or bloat, the amount of internal funding required to be appropriated by Congress to specific agencies, departments and programs within the federal government has grown quite massive. 6 When you have pennies, dimes sound like a lot. Once you’ve earned a couple quarters, those pennies seem worthless. Once Congress warmed up to the idea of spending a cool trillion, how can we ever go back to mere billions? Looking back, we just can’t seem to fund the government for less anymore. Congress approves funding to the various departments, agencies, and programs in the federal budget through appropriations bills. Although everyone knows there are twelve different appropriations bills—one for each Congressional sub-committee—that need to be passed each year, Congress sometimes struggles to produce and approve each of the twelve appropriations individually. The term “omnibus” denotes a spending bill which packages two or more of the individual appropriations bills into one. Disagreement over spending and packages leads to difficulty approving an individual appropriation on the merits. To shortcut the process and obtain buy-in, members of Congress will engage in “buying” the votes needed for an omnibus package. Since the 1980’s both sides of the aisle have used omnibus packages because “party and committee leaders can package or bury controversial provisions in one massive bill to be voted up or down.” 7 According to Senate Majority Leader Chuck Schumer (D., N.Y.), “This funding bill is awash with good news for our country.” 8 Just over half goes to defense spending and the remainder (a mere $730 billion) goes to non-defense spending, including $13.6 billion in humanitarian assistance to Ukraine. The Ukraine spending was the lever that pushed the Omnibus Bill through. While it would prove both enlightening and enraging to list all the separate pork projects included in the Omnibus Bill, we choose to focus on what is conspicuously absent from the Omnibus Bill: tax provisions. One of the BBB Act’s hallmark provisions was increased funding (to the tune of $80 billion) to the IRS as a blank check to focus on enforcement and chasing down corporations and wealthy people. We will discuss in a separate forthcoming article the increased IRS budget.

Peering Into the Tax Provision Future

Although we see an appropriate amount of handwringing by both sides of the aisle on the lack of tax provisions within the Omnibus Bill, the revenue raising void remains. Without tax provisions, the means for funding the entirety of this $1.5 trillion package falls on the existing funds (or credit) of the U.S. government. As we have seen, there is no shortage of money that can be printed, but with inflation at forty-year highs, that may not be the desired way out. Pres. Biden has seen his previously “completely paid for” BBB Act halt and cannot possibly hope to resurrect his agenda without significant tax increases. If not in the Bill, where are they? The president will likely throw his declining weight toward including some tax items in future legislation, breaking what would have been incredible pain into more manageable—read, passable—chunks. Smaller bills that attempt to do less may be the path forward for many tax provisions in BBB Act. Only time will tell if Sen. Manchin and others will pay attention to the unaccounted-for costs attached to every future bill. However, failing to pass the BBB Act prior to the confluence of bad luck, bad timing, and arguably bad policy leaves the Democrats in the unenviable position of facing Congressional elections in 2022 with eroding support. Even the mainstream media has started to admit Democrats are in trouble heading into this election cycle. Raising taxes before the mid-term elections with significant seats in jeopardy could very well prove strategically suicidal. Additionally, despite the pipe dream that Sen. Manchin would ally himself with his Democrat colleagues, Manchin further indicated his independence of thought through his recent opposition to the Biden administration’s nominee for the Federal Reserve chair. 9 One of the most likely scenarios for the reappearance of tax provisions should the Democrats lose their majority in November, is Congress passing significant legislation during the lame-duck sessions. While lame-duck sessions were historically used to wrap up the business of Congress, the lame-duck session ending Jan. 3, 2021, was historic in that nearly 44% of bills passed by the 116th Congress occurred during the final two months of its term. 10 Could much of this Congress’ hoped-for legislation become a reality in the waning hours of its’ session? Arguably, yes. In the last fifty years, no other Congress has passed as much legislation as this one during that period. For a party moving out of power, it’s highly likely such a move would be used to push as much legislation through as possible. Should that not be the case, the only route left to tax provision package occurs in the final year of Biden’s term. A difficult proposition as most election strategists predict that the GOP will likely take both houses in November. At this point, the GOP needs only to turn over one Democratic Senator seat and eleven Democratic House member seats with thirty-one Democrats having announced they will not seek reelection. 11 As such, if they do not pass legislation in a lame duck session, they will have no chance after the next Congress is seated. + Citations

CIC Services v. IRS: the Supreme Court Hands the IRS a Major Loss



The Anti-Injunction Act (“AIA”) is an important part of administrative procedure law and a crucial piece of the United States tax system. Enacted to help expedite the tax revenue process, the Act works to invalidate any lawsuit to restrict the assessment or collection of taxes. Nonetheless, having the power to bar standing and having the right to do so are two completely different things. For instance, while the AIA gives the power to bar suits brought against administrative rulemaking processes, the Act does not give this right unless the suit was brought with the purpose of restraining the assessment of a tax.

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The Constitutionality and Application of New York’s Proposed Mark-To-Market Tax


The Constitutionality and Application of New York’s Proposed Mark-To-Market Tax

The Constitutionality and Application of New York’s Proposed Mark-To-Market Tax

Abstract: The state of New York has proposed legislation that would implement a mark-to-market taxation system for its’ billionaire taxpayers.  The proposal would tax billionaires on the increase in value that their assets have experienced over the past calendar year, whether or not these assets are sold.  The tax would raise significant revenue for the state by eliminating the ability of taxpayers to hold assets until death to receive a “stepped-up” basis.  Other policy reasons espoused in support of the tax are that it increases fairness and better reflects actual income.  However, there are skeptics of the feasibility and constitutionality of the proposed tax. First, it will be extremely difficult to determine a market value for each asset for purposes of determining the taxpayer’s unrealized appreciation on each asset.  Because of this, there will undoubtedly be numerous challenges by billionaire taxpayers to government valuations of the market value of their assets.

There are also concerns regarding whether the tax violates a taxpayer’s constitutional right to travel and right to equal protection under the laws.  Further, there are unresolved complications with existing law, including how will the tax handle income from federal retirement accounts and the complexity of basis and credits for taxpayers with properties outside of New York.  Those in favor of the tax will focus on the increased revenue generation and policy concerns, while those in opposition will likely stress the complexity associated with administering two different tax systems at the same time.  The tax proposed by New York could be a signal of change to come, as many states look to increase revenue in the wake of COVID-19.

Table of Contents
II. The Proposed Mark-to-Market Tax
 A. Mechanics of the Tax 
 B. New York Billionaire Taxpayer Example 

III. Policy Behind the Mark-to-Market Tax 
 A. Increased Revenue Generation 
 B. Increased Fairness 
 C. The Mark-to-Market Approach Better Reflects Income 

IV. Complications in Administering the Mark-to-Market Tax 
 A. Difficulty in Determining Market Value 
 B. Likelihood of Disputes 

V. Federal Constitutional Issues 
 A. Right to Travel 
 B. Equal Protection 

VI. Existing Law Complications 
 A. Federal Retirement Account Issues 
 B. State Basis and Credit Issues 

VII. Arguments For and Against New York’s Mark-to-Market Tax
 A. Arguments For the Tax 
 B. Arguments Against the Tax 

VIII. Conclusion 

I. Introduction

The United States’ Federal income taxation system has several requirements for one’s monetary gain to be taxable, one of these requirements is the realization doctrine.[3] This doctrine requires an objective identifiable event, such as a sale or other disposition of property, that creates the appropriate time to tax.[4]  As a result, the mere appreciation of property is not taxable under the federal income tax system due to the lack of a realization event.[5] If a taxpayer wants to avoid their economic gain due to appreciation from becoming subject to the federal income tax, they can simply choose to not sell the property. A common strategy employed by wealthy individuals is to allow the property to pass to another, likely a family member, at death.  When the property passes at the decedent’s death, the person acquiring the property receives a “stepped-up” basis equal to the fair market value of the asset at the time of the decedent’s death.[6] This stepped-up basis allows the property’s appreciation to avoid ever being subject to state or federal income tax.

States have become increasingly concerned with the amount of money escaping inclusion in the tax base, with revenue losses associated with the stepped-up basis rule estimated at near $50 billion in 2018.[7] Additionally, COVID-19 has negatively impacted state and local income tax revenues, with projections of declines of 7.5 percent in 2021 and 7.7 percent in 2022.[8]  Given these budgetary concerns, there is motivation for states to seek to expand the tax base.  Moreover, states are allowed to decouple their tax computation from the federal computation, allowing for them to make alterations.[9] As a result, New York has proposed a change to their state income tax law altering when unrealized appreciation and deferred income would be treated as taxable income for billionaires.

The mark-to-market tax proposed in New York would tax billionaires on the increase in value that their assets have experienced over the past calendar year, whether or not these assets are sold.[10]  An individual’s net worth would be assessed on the final calendar day of the year to determine if the taxpayer’s net assets exceed one billion dollars.[11]  Under this proposal, the assets of the taxpayer, their spouse, minor children, and trusts which the taxpayer is a beneficiary of, along with assets contributed by the taxpayer to private foundations and assets transferred by gift within the past five years would be considered in determining if the taxpayer is a billionaire.[12]  Additionally, this date would be used to determine the taxpayer’s gain or loss based on the change in value of the asset over the previous calendar year.[13]  Importantly, the basis of each individual asset would not be altered in the event of an actual sale, despite the inclusion of this appreciation in the taxpayer’s income.[14]

As a result of this proposal, the appreciation of a billionaire’s assets and property would not avoid inclusion in the tax base.  This timing change in recognizing income for billionaires from unrealized appreciation and deferred income would lead to far greater tax revenue for the state.  However, several constitutional concerns may arise from this proposal, which are likely to be raised by those in opposition of the bill, including the right to travel and equal protection.  This article will explain the mechanics of the proposed mark-to-market tax, policy behind the mark-to-market tax, complexities in administering the tax, the federal constitutional issues associated with the proposal, complications created by existing law, and the possible arguments in support and opposition of the tax.

II. The Proposed Mark-to-Market Tax

A. Mechanics of the Tax

The proposed legislation would create a tax on the unrealized appreciation of New York billionaire residents’ assets.[15]  The proposed legislation directs the State of New York to determine how much those unrealized capital gains have increased in market value since the billionaire has been a New Yorker, and then tax that increase in value at the normal income tax rate.[16]  For most of these individuals, that would mean a tax at the standard top income tax rate—8.8%—and repeat the process every year with a deemed sale.[17] Taxpayers would have the option to pay this new tax over a period of ten years with a 7.5% annual interest charge.[18]  For billionaire residents of New York for fewer than five years, the basis used to determine gain would be adjusted to the fair market value on the date that they became a resident.[19]  The tax works by determining the amount the taxpayer’s assets fair market values have increased over the prior year.  The fair market value is defined as “the price at which such asset would change hands between a willing buyer and willing seller,” both of whom are not under any pressure to complete the transaction and possess reasonable knowledge regarding the asset.[20]

The amount that the billionaire taxpayer’s assets have appreciated over the past year would be included in the taxpayer’s income for purposes of the state’s tax base.  While this may seem like a small change, if the mark-to-market tax had been in place in 2020 it is estimated that the state of New York would have raised an additional $23.2 billion.[21]  Given the budgetary concerns addressed earlier, it is apparent why New York, and likely more states in the future, are interested in moving away from the realization doctrine and towards the mark-to-market tax.  An example has been provided below to create a clearer picture of the practical effect that the mark-to-market tax will have on billionaire taxpayers.

B. New York Billionaires Taxpayer Example

Taxpayer (TP), is a billionaire resident of New York for more than five years.  TP owns several assets that have experienced substantial appreciation over the past year.  TP owns real property that has appreciated from $10 million to a fair market value of $11 million, stock of a publicly traded corporation that has appreciated from $500,000 to a fair market value of $750,000, and a second real property asset that has appreciated from $1 million to a fair market value of $5 million.  As a result, the taxpayer would include the $1 million appreciation on the first real property asset, the $250,000 appreciation from the publicly traded corporation’s stock, and the $4 million dollar appreciation from the second real property asset as income for purposes of the New York mark-to-market state income tax.  Thus, TP includes $4.25 million additional realization for state tax purposes.  Taxed at the 8.8% bracket, TP pays $374,000 in additional tax on unrealized and unmonetized gains.

Under the realization doctrine, this appreciation would not be included in the tax base until there was a sale or other disposition of the assets.  Further, the taxpayer would likely hold the property until death to have the property receive a stepped-up basis.  As a result, the asset’s appreciation would avoid taxation once it receives a stepped-up basis.  This holding tactic employed by taxpayers allows for a massive source of revenue to escape the state’s tax base, which would be alleviated by implementing a mark-to-market regime.  The mark-to-market approach targets this otherwise unrealized appreciation and implements an additional state tax.

III. Policy Behind the Mark-To-Market Tax

The main policy arguments for adopting a mark-to-market taxation system are to increase revenue, increase fairness, and that it more effectively reflects income.  The mark-to-market tax is seen as an avenue to much-needed increased revenue, as a way to curb wealth inequality, and better reflect the actual income that a taxpayer has experienced over a specified time period.  Those who support the mark-to-market tax see it as an improvement in these areas, when compared to the realization doctrine.

A. Increased Revenue Generation

The primary driver behind a mark-to-market tax, especially one focused on billionaire taxpayers, is to generate additional revenue.  Given governmental expenditures, a change in the tax system would ideally generate revenue at the same rate or a greater rate.  The mark-to-market tax can certainly maintain revenue levels, and would almost certainly result in increased revenues.[22]  This is because the appreciation of assets that once would have been exempt from inclusion in the tax base would now have to be included.  The incentives for holding property until death in order to receive a stepped-up basis will have been removed.[23]  Additionally, this would increase the market for real estate and other assets, as billionaire taxpayers would be far more willing to entertain selling assets prior to death under a mark-to-market regime.

B. Increased Fairness

A second major policy point thought to be addressed by a mark-to-market taxation is to increase fairness.  Proponents of the mark-to-market tax tend to view the realization doctrine as a major source of unfairness in the United States tax system.[24]  Those who view the realization doctrine as unfair focus on three key issues that they view as being better addressed by a mark-to-market tax: wealth inequality, vertical equity, and horizontal equity.[25]  The wealth inequality issue is thought by some to be exacerbated by the realization doctrine because there are planning opportunities that lead to the asset’s appreciation avoiding taxation.[26]  As a result, this appreciation is never taxed by the government and cannot be a part of any redistributive effort by the government.[27]  This concern would be alleviated by the New York mark-to-market proposal, as billionaires would not have the same planning opportunities that they have employed under the realization doctrine in the past.

The second and third fairness concerns relate to treating similarly situated individuals the same and treating differently situated people differently based on their differing abilities to pay.[28]  A criticism of the realization doctrine is that it violates horizontal equity by allowing individuals with the same amounts of income to face different tax implications based on whether this income is in the form of wages or from asset appreciation.[29]  This would not be the case under the New York mark-to-market system because wages and appreciation of assets would both be included in the tax base, without the need for a sale or other disposition.

On the other hand, vertical equity is violated for similar reasons, as higher income taxpayers would generally have more income from asset appreciation and lower income taxpayers would have a higher percentage of their income earned from wages.  As a result, the higher taxpayer, with likely more asset appreciation, is not taxed on this gain.[30]  Yet, the lower taxpayer, whose income is primarily earned through wages, is subject to tax liability.[31]  The mark-to-market approach would eliminate this advantage for billionaire taxpayers and treat their income earned from asset appreciation identical to the way their income from wages is treated under the realization system.

C. The Mark-to-Market Approach Better Reflects Income

Many tax scholars and commentators find that the mark-to-market approach reflects actual income better than the realization doctrine.[32]  This is because the mark-to-market approach is not limited to wages and assets that have been subject to a sale or other disposition.  As a result, the approach does a better job of showing what the taxpayer’s actual income was.  Additionally, the mark-to-market approach does not disincentivize the disposition of assets like the realization doctrine does.  This allows the taxpayer to act with less influence and pressure from tax law than the taxpayer currently experiences under the realization doctrine.[33]  This concept pertains to the “efficiency” of a tax system.  To determine whether a tax system is efficient, one should look to whether taxes “distort investment or business decisions.”[34]  Given this criteria, the mark-to-market approach would appear to be more efficient than the realization doctrine because it would not distort investment and business decisions as much.  Taxpayers are not overly incentivized to hold assets until death when the mark-to-market approach is employed.

However, there is a strong argument against the inclusion of asset appreciation in income and that the mark-to-market approach is not more efficient.  The reason for this is concerns with liquidity.  When there is a tax imposed on the mere appreciation of property, the taxpayer may be forced to sell the asset to afford the tax.[35]  This is because even though the taxpayer’s assets have experienced substantial appreciation, these assets and wealth are illiquid unless sold.  Even though the affected taxpayers under the New York proposal would be billionaires, they may not have the requisite liquidity to pay income taxes based on substantial appreciation of assets.  As a result, the mark-to-market tax would be distorting the investor’s decision and forcing them to sell assets to afford their income taxes.

IV. Complications in Administering the Mark-to-Market Tax

Despite the policy reasons advocated by those in favor of the mark-to-market tax, implementation of such a tax would be extremely complex.  The primary reason for this is the difficulty in accurately placing a value on assets to represent appreciation over the applicable time period.  This skepticism primarily concerns the inability to determine the market value of an asset without an actual sale or disposition of property.

A. Difficulty in Determining Market Value

It is important to determine the fair market value of the taxpayer’s assets annually in order to properly administer a mark-to-market tax.  However, this value can be troublesome to establish without some sort of sale or other disposition.  Further, the primary criticisms of any mark-to-market system are the issues and uncertainty of asset valuation.[36]  The success of the mark-to-market approach rests on the notion that there is an objective and knowable market value for assets.[37]  However, this is far easier said than done, leaving aside the feasibility of the undertaking, it would be costly for authorities to monitor the market and value of each billionaire taxpayer’s assets on an annual basis.[38]  The proposal states that fair market value is “the price at which such asset would change hands between a willing buyer and willing seller,” however, this value can be hard to determine when there is guesswork involved in what the willing buyer and seller would agree to.[39]

One of the supposed primary benefits of a mark-to-market system is that it more accurately represents income; however, if the valuations are inaccurate this advantage is negated.[40]  Additionally, it would be difficult for the government to ensure that taxpayers are not systematically undervaluing their assets.[41]  As a result, the policy justification of raising additional revenue could, at the very least, be diminished.  Another difficulty in properly valuing assets under the New York proposal is that the assets of a billionaire may be so expensive that there are not comparable assets that are being exchanged in the marketplace that would be helpful in determining the asset’s market value.  Additionally, as a privacy-related policy consideration, the level of disclosures required to permit the taxation of the variety of assets held by billionaires means previously privately held assets may have to be openly shared to taxing authorities and exposing such assets to cyber-attack, potential theft, or other misuse.

B. Likelihood of Disputes

Given the uncertainty in properly valuing New York billionaires’ assets, it is extremely likely that there will be challenges and disputes arising from the differences in opinion between the taxpayers and the government.  This is because many forms of wealth are difficult to value, such as personal effects and future pension rights.[42]  Additionally, the taxpayers subject to the mark-to-market taxation, billionaires, would certainly have the means to contest and fight valuations that they thought to be inaccurate.  Additionally, the billionaire taxpayers could raise these valuation challenges to bring to light the administrability issues involved with the tax and to voice their displeasure with being made subject to the tax.  New York’s billionaire taxpayers could choose to make the tax more burdensome to administer by contesting the valuations of each of their numerous assets.  These individuals lose nothing by contesting what amounts to a surprising and significant tax, whereas the State of New York could lose on expenses of collection and use of these funds through lengthy contests, administrative fees, court costs, and enforcement actions.

V. Federal Constitutional Issues

A. Right to Travel

One of the possible constitutional challenges that may be raised in opposition of the mark-to-market tax is the implications the tax will have on the right to travel.  This right has been described by the Supreme Court as a “liberty” that cannot be deprived without due process of law.[43]  Additionally, a state law implicates the right to travel when the law uses “any classification which serves to penalize exercise of that right.”[44]  In regard to the mark-to-market tax, the proposal could arguably be viewed as penalizing those who exercise their right to travel.  For instance, there are numerous unanswered double taxation issues that could arise.  If a taxpayer lives in New York while holding an appreciated asset in another state, it is possible they would have been taxed in New York for the appreciation on the asset and then taxed in the state the asset resides upon its sale or disposition.[45]  This type of double taxation issue would certainly penalize taxpayers who own appreciated assets in one state and want to or do move to New York.

More generally, there is an argument to be made that the adoption of the mark-to-market tax, even if the double taxation issue is resolved, penalizes billionaires who exercise their right to travel.  Taxpayers who would be subject to the tax will be disincentivized to move and reside in New York to avoid being subject to the new tax.  However, this argument has a distinct weakness, state laws that have drawn the Supreme Court’s ire recently involve classifying residents based on when they established residence and apportioning unequal rights based on this, “among otherwise qualified bona fide residents.”[46]

The mark-to-market tax does not do this, instead, it tries to make the effects of the tax even regardless the length of time the taxpayer has been a resident of New York.  The tax allows taxpayers who were not residents of New York for the preceding five years to adjust the basis of their assets to the fair market value of the asset on “the last day of the last tax year” before they became a New York resident.[47]  This basis adjustment would only be for purposes of the mark-to-market tax and would not apply in the event of an actual sale.[48]  This allows each of the billionaires to only be taxed on gain that their assets experience while the taxpayer is a resident of New York.

There are right to travel challenges available to those in opposition of the mark-to-market tax.  These arguments will be more persuasive if the double taxation issue is not addressed in future versions of the proposal.  However, even resolving the double taxation issue will not completely eliminate the availability and legitimacy of these challenges.

B. Equal Protection

Another avenue for opponents to challenge the proposed mark-to-market tax is through the equal protection clause.  This clause is contained in the Fourteenth Amendment to the United States Constitution, and states that no person within the United States shall be denied “within its jurisdiction the equal protection of the laws.”[49]  The courts have interpreted this clause to mean that all persons “similarly situated shall be treated alike.”[50]  In this situation, billionaires subject to the tax could make the argument that they are being deprived of equal protection of the law by being subjected to a completely different system of taxation.  Further, this is not simply a higher rate of taxation under a progressive rate system, but a complete departure from the realization doctrine for only a portion of the populace.  The argument would likely be that as a New York citizen they are similarly situated to the rest of New York taxpayers, and that being subject to a mark-to-market tax system as opposed to the realization doctrine deprives them of their right to equal protection of the laws.

On the other hand, proponents of the tax would have strong defenses to this argument based on previous decisions of the Supreme Court.  Generally, states are given “great leeway” regarding taxation when it comes to equal protection concerns.[51]  The limit to this leeway has been described as when the difference in treatment amounts to invidious discrimination or if the distinction is palpably arbitrary.[52]  Similarly, the Supreme Court has also held that legislation will be presumed valid and will be upheld so long as the classification is “rationally related to a legitimate state interest.”[53]  If the court were to simply look to whether there was a rational relation to a legitimate state interest the proposal would almost certainly pass this test.  The reason for this, as outlined earlier, is a need for increased revenue for the state of New York and this proposal would help to alleviate this issue.

When it comes to the equal protection particular to tax classification, the constitutionality can only be overcome by “explicit demonstration” that the classification is “hostile and oppressive discrimination.”[54]  This would seem to be a high bar to meet, but selectively utilizing mark-to-market taxation for only a portion of residents may be enough to meet this bar.  Opponents of the mark-to-market tax would be able to argue that billionaire taxpayers are being hostilely and oppressively discriminated against in New York by being subjected to a completely different system of taxation, which is no longer dependent on the realization doctrine and is not employed by any other state in the United States.

VI. Existing Law Complication

A. Federal Retirement Account Issues

One area of complexity for the implementation of the New York mark-to-market tax would be its interaction with retirement accounts and assets.  Commonly used retirement accounts include individual retirement accounts (IRAs) and 401k plans, which allow taxpayers to defer taxes until a later point in time, generally retirement.  Tax deferrals are beneficial to taxpayers because they allow for tax-free growth, and when the tax is incurred, the taxpayer’s earnings and taxes will likely be lower.[55]  The proposal is silent on whether or not retirement accounts and asset appreciation will also be taxed in the same manner as the asset classes explicitly listed.[56]  Further, if the unrealized appreciation of retirement assets are subject to the mark-to-market tax, where does the money come from?  Will the taxes be taken directly from the retirement accounts?  If the state does decide to tax these assets then this would certainly lower the amount of deferred income that taxpayers are allowed to carry forward.

Depending on the type of retirement account, taxpayers are normally taxed on retirement assets when they begin to withdraw from these accounts, typically upon retirement.[57]  If the New York mark-to-market tax were to tax unrealized appreciation on these assets prior to retirement, this would create a conflict with federal income tax deferral until retirement.  This is an important area that lawmakers in New York will need to consider and address in subsequent versions of the mark-to-market legislation.  There needs to be a policy decision articulated regarding retirement accounts and assets.  The most easily administrable policy decision would be to make retirement assets exempt from the mark-to-market tax, thus avoiding the conflict with federal income tax deferral.

B. State Basis and Credit Issues

The adoption of a mark-to-market tax leads to increased complexity for taxpayers in calculating the basis of their assets held in New York, as well as in states other than New York.  Each year the taxpayer’s assets would undergo a basis change, which would be necessary to calculate the appreciation over the past calendar year.  As mentioned earlier, the proposal allows for New York residents to adjust the basis of their property to the fair market value of the property on the date they became a New York resident.  This adds an increased layer of basis complexity, the taxpayer would have one basis for purposes of the mark-to-market tax, the fair market value on first day as a New York resident, and a second basis for purposes of the New York income tax.[58]  This would be the case so that taxpayers could not move to New York, accept a heightened adjusted basis and then sell the asset to minimize gain.  The complexity increases for any New York billionaire resident’s assets outside the state of New York.  The taxpayer would have an adjusted basis in New York reflecting either the fair market value at the beginning of their residency or the inclusion of unrealized appreciation already taxed. Yet, the asset’s basis in the state which it is held would remain unchanged because there would not be an adjustment for imposition of the mark-to-market tax as there is in New York.

Additionally, the mark-to-market tax proposal creates a number of complexities when it comes to state basis and credit issues, especially as it pertains to the proposal’s interaction with other state income tax systems.  As discussed earlier, the issue of double taxation is a critical issue that goes largely unaddressed in New York’s proposal.  The only portion of the proposal addressing this issue simply allows for a credit where a taxpayer has already been taxed on the gain by a state or jurisdiction they were a resident of prior to becoming a resident of New York.[59]  However, this provision is of little value, because the mark-to-market tax in New York would be assessed before any duplicative tax utilizing the realization doctrine.[60]  As a result, there is a distinct need for the proposal to be amended to address this issue.

There are several options that New York could implement to curtail this issue, including: offering a credit for duplicative taxes incurred, offering a tax refund for duplicative taxes incurred after the mark-to-market tax, or they could hope that other states implement a mark-to-market style income taxation system.  Currently, the New York mark-to-market proposal lacks a solution for this credit issue and this is something that needs to be addressed in the next version of the proposal.

VII. Arguments For and Against New York’s mark-to-Market Tax

There are sure to be strong opinions on both sides of the issue of whether to support or oppose New York’s mark-to-market tax proposal.  The proponents of the tax will likely argue that it promotes larger policy goals better than the realization doctrine, raises much needed additional revenue, and that complexity is unavoidable in any tax system and is minimized by the proposal.  On the other hand, those in opposition of the tax will likely focus on the difficulties associated with valuation, the constitutional challenges mentioned above, and the advantages of sticking to the realization doctrine.

A. Arguments For the Tax

Proponents of the mark-to-market will likely argue that the proposal is superior to the realization doctrine when it comes to fairness, efficiency, and complexity.  As was discussed earlier, the realization doctrine is viewed by some as violating notions of fairness by treating those similarly situated differently and by not treating those who can afford to incur greater tax liability differently from those who cannot.[61]  Further, the realization doctrine influences the investment decision of taxpayers by incentivizing that they hold the asset until death so they can receive a stepped-up basis.  The mark-to-market tax eliminates this specific influence on investment and business decisions.

Proponents of the tax also argue that the proposal will also alleviate complexity created by realization doctrine.  The proposal would eliminate the necessity of keeping records regarding basis and depreciation.[62]  Additionally, complex realization based rules such as capitalization and depreciation could possibly be eliminated.[63]  A common political obstacle for mark-to-market proposals is distinguishing which items should be included in the mark-to-market regime.[64]

However, the proposal would not be in danger from this criticism as the proposal would include all the assets of New York billionaires being marked to market value.  Undoubtedly, opponents of the proposal will vehemently challenge the assertion that a mark-to-market system is less complex.  The complexity argument will likely be championed by both sides, it would be hard to implement a comprehensive tax system without a level of complexity.

B. Arguments Against the Tax

On the other hand, opponents of the mark-to-market tax will surely bring up the issues discussed earlier pertaining to valuation of taxpayer assets.  The difficulties associated with valuation could serve to undermine the policy advantages that the mark-to-market tax is argued to provide, increased revenue generation and more accurate reflection of income.  Similarly, opponents of the proposal will claim that the tax is unconstitutional and violates the right to travel and equal protection under the Constitution.

Moreover, opponents would stress the advantages of sticking with the realization doctrine and treating billionaire taxpayers like the remaining taxpayers.  Creating an entirely new system of taxation for a segment of the tax base will add increased complexity for the government.  Regardless of which system is ultimately less complex, the government would have to be able to administer both tax systems simultaneously to different portions of the population.  Additionally, critics will refute the purported policy advantages of the mark-to-market tax.  It is arguable that the mark-to-market tax could be just as inefficient as the realization doctrine, as taxpayers may have to sell assets to ensure they have sufficient liquidity to pay their income tax liabilities.

VIII. Conclusion

New York’s proposed mark-to-market tax would be a stark shift away from the realization doctrine employed by every other state as well as the federal income tax system.  The mark-to-market tax would provide an avenue to increase state revenue by bringing unrealized appreciation into the tax base that would normally avoid inclusion.  Additionally, the proposal would eliminate the effectiveness of taxpayers holding assets until death, allowing their decedents to receive a stepped-up basis.  This new approach to taxation would raise significant revenue for the state of New York, which is needed in the wake of COVID-19.  Additionally, proponents of the tax will view the tax as an improvement over the realization doctrine when it comes to fairness, efficiency, and as a reflection of actual income.

However, there are several possible challenges that opponents will raise in opposition of the tax, including possible violations of the right to travel and equal protection clause.  There are also legitimate concerns about the difficulties in valuing the assets of New York’s billionaire taxpayers.  Without a sale or comparable transaction, settling on a fair value to determine the annual appreciation of an asset will likely lead to billionaire taxpayers disputing the valuation reached by the government.  This issue could also lead to dispute in the inverse, with the government contesting taxpayer valuations as undervaluing their assets.  It is also disputed whether a mark-to-market tax is more efficient than a realization-based system, and this is because of liquidity issues and their possible effect on investment decisions.  Additionally, implementation of the mark-to-market tax would create several complications with existing law.  An unaddressed area of concern for the proposal is how it will treat taxpayer retirement status that enjoys federal income tax deferral.

The New York proposal creates additional complexity in calculating the basis of taxpayer’s assets that could lead to confusion for taxpayers.  Lastly, the proposal is noticeably lacking in solutions for potential double taxation issues that taxpayers will face, and this is an area that could be addressed through giving tax credits or refunds for duplicative taxes.  These concerns will need to be addressed in subsequent versions of the tax in order to ease concerns of those in opposition, and to enhance the likelihood of the legislation passing.

Article authored by:
Beckett Cantley and Geoffrey Dietrich

[1] Prof. Beckett Cantley (University of California, Berkley, B.A. 1989; Southwestern University School of Law, J.D. cum laude 1995; and University of Florida, College of Law, LL.M. in Taxation, 1997) teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C. Prof. Cantley would like to thank Melissa Cantley and his law clerk, Trey Proffitt, for their contributions to this article.

[2] Geoffrey Dietrich, Esq. (United States Military Academy at West Point, B.S. 2000; Brigham Young University Law School, J.D. 2008) is a shareholder in Cantley Dietrich, P.C.

[3] Comm'r of Internal Revenue v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

[4] See I.R.C. § 1001(b) (2018).

[5] See id.

[6] See id. § 1014(a)(1).

[7] Jay A. Soled et al., Re-Assessing the Costs of the Stepped-Up Tax Basis Rule 2 (Tul. Econ. Working Paper Series, Working Paper No. 1904, 2019).

[8] Louise Sheiner & Sophia Campbell, How Much is COVID-19 Hurting State and Local Revenues?, Brookings: The Hutchins Center Explains (Sept. 24, 2020), [].

[9] Henry Ordower, New York’s Proposed Mark-to-Market Tax Decouples from Federal Tax, 99 Tax Notes State 794, 796 (2021).

[10] Robert Frank, Billionaires in New York Could Pay $5.5 Billion a Year Under New Tax, CNBC: Wealth (July 21, 2020), [].

[11] S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[12] Id.

[13] Id.

[14] Ordower, supra note 9, at 798.

[15] David Gamage et al., The NY Billionaire Mark-to-Market Tax Act: Revenue, Economic, and Constitutional Analysis, Ind. Legal Stud. Res. Paper Forthcoming (forthcoming 2021).

[16] S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[17] Id.

[18] Gamage, supra note 15.

[19] Ordower, supra note 9, at 798.

[20] S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[21] Gamage, supra note 15.

[22] Timothy Hurley, “Robbing” the Rich to Give to the Poor: Abolishing Realization and Adopting Mark-to-Market Taxation, 25 T.M. Cooley L. Rev. 529, 544 (2008).

[23] See id. at 547.

[24] Clarissa Potter, Mark-to-Market Taxation as the Way to Save the Income Tax – A Former Administrator’s View, 33 Val. U.L. Rev. 879, 879 (1999).

[25] Charles Delmotte & Nick Cowen, The Mirage of Mark-to-Market: Distributive Justice and Alternatives to Capital Taxation, 24 Critical Rev. of Int’l Soc. & Pol. Phil. 1, 3 (July 2019); Hurley, supra note 22, at 547.

[26] Delmotte and Cowen, supra note 25, at 5.

[27] See id.

[28] Hurley, supra note 22, at 547.

[29] Potter, supra note 24, at 884.

[30] Hurley, supra note 22, at 548.

[31] Id.

[32] Samuel D. Brunson, Taxing Investors on a Mark-to-Market Basis, 43 Loy. L.A. L. Rev. 507, 513 (2010).

[33] Id.

[34] Christopher Hanna, Tax Policy in a Nutshell, 39 (1st ed. 2018).

[35] See Brunson, supra note 32, at 515–16.

[36] David S. Miller, A Progressive System of Mark-to-Market Taxation, Tax Notes 1047, 1073 (Nov. 21, 2005).

[37] Delmotte and Cowen, supra note 25, at 6.

[38] Id. at 7.

[39] See S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[40] Potter, supra note 24, at 896.

[41] Id. at 897.

[42] Delmotte and Cowen, supra note 25, at 7.

[43] Kent v. Dulles, 357 U.S. 116, 125 (1958).

[44] Att'y Gen. of N.Y. v. Soto-Lopez, 476 U.S. 898, 903 (1986).

[45] Ordower, supra note 9, at 799–800.

[46] Att'y Gen. of N.Y., 476 U.S. at 903.

[47] S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[48] Id.

[49] U.S. Const. amend. XIV, § 1.

[50] City of Cleburne, Tex. v. Cleburne Living Ctr., Inc., 473 U.S. 432, 439 (1985).

[51] Lehnhausen v. Lake Shore Auto Parts Co., 410 U.S. 356, 360 (1973).

[52] Id. at 359–60.

[53] City of Cleburne, Tex., 473 U.S. at 440.

[54] Lehnhausen, 410 U.S. at 364.

[55] Michael Rubin, Advantages of Tax Deferred Plans, The Balance: Retirement Planning (Feb. 18, 2021), [].

[56] See S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[57] Rubin, supra note 55.

[58] See S. 4482, 2021 Reg. Sess. (N.Y. 2021).

[59] Id.

[60] See Ordower, supra note 9, at 796.

[61] Hurley, supra note 22, at 548.

[62] Id. at 551.

[63] Id.

[64] Marie Sapirie, A Time of Renewal for Mark-to-Market, 171 Tax Notes Fed. 174, 175 (Apr. 12, 2021).

SSRN Top Ten download list for PSN State Politics Policy

Apple v. European Commission: Losing the War on Corporate International Transfer Pricing


Cantley Dietrich

Apple v. European Commission: Losing the War on Corporate International Transfer Pricing

* Prof. Beckett Cantley (University of California, Berkeley, B.A. 1989; Southwestern University School of Law, J.D. cum laude 1995; and University of Florida, College of Law, LL.M. in Taxation, 1997), teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C. Prof. Cantley would like to thank Melissa Cantley and his law clerk, Austin Schley, for their contributions to this article.

** Geoffrey Dietrich, Esq. (United States Military Academy at West Point, B.S. 2000; Brigham Young University Law School, J.D. 2008) is a shareholder in Cantley Dietrich, P.C.

[1] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338 ¶¶ 2, 23 (July 15, 2020).

[2] . Id. ¶¶ 247, 249, 295, 309, 351, 373.

[3] . Stefano Micossi & Paola Parascandolo, The Taxation of Multinational Enterprises in the European Union, Ctr. for Eur. Pol’y Stud. Pol’y Brief, 1, No. 203 (Feb. 4, 2010).

[4] . Id. at 1, 3.

[5] . Sijbren Cnossen, Corporation Taxes in the European Union: Slowly Moving Toward Comprehensive Business Income Taxation?, 25 Int’l Tax & Pub. Fin. 808, 810 (2017).

[6] . Id. at 816.

[7] . Id. at 815.

[8] . Dirk Verbeken, Fact Sheets on the European Union: General Tax Policy, Eur. Parl. 1-2 (last updated May 2021).

[9] . Id.

[10] . Id.

[11] . Id.

[12] . David G. Chamberlain, Apple, State Aid, and Arm’s Length: EU General Court’s Failure of Imagination, Tax Notes Today Fed., 1179, 1180 (Sept. 16, 2020), The European Commission is the executive wing of the European Union, and, among other things, is in charge of enforcing the European Union’s laws. European Commission, Eur. Union , (last updated July 5, 2020).

[13] . Consolidated Version of the Treaty on the Functioning of the European Union art. 107, May 9, 2008, 2008 O.J. (C 115) 47, 91 [hereinafter TFEU].

[14] . Chamberlain, supra note 12, at 1184.

[15] . Id.

[16] . Id.

[17] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶¶ 1–3 (July 15, 2020).

[18] Id.

[19] . Id. ASI is responsible for “carrying out procurement, sales and distribution activities associated with the sale of Apple-branded products to related parties and third-party customers in the regions covering Europe, the Middle East, India, and Africa (EMEIA) and the Asia-Pacific region (APAC).” Id. ¶ 9. AOE “is responsible for the manufacture and assembly of a specialized range of computer products in Ireland . . .which it supplies to related parties for the EMEIA region.” Id. ¶ 10.

[20] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 11 (July 15, 2020).

[21] . Id.

[22] Id. ¶ 18.

[23] . Id. ¶ 19.

[24] . Id. ¶ 27.

[25] . Id. ¶ 88.

[26] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 91 (July 15, 2020).

[27] . Id.

[28] . Id. ¶ 103.

[29] . Id.

[30] . Id.

[31] . Id. ¶ 129.

[32] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 143 (July 15, 2020).

[33] . Id. ¶¶ 169–71.

[34] . Id.

[35] . Id. ¶ 179.

[36] . Id.

[37] . Id. ¶ 189.

[38] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 231 (July 15, 2020).

[39] . Id. ¶ 26.

[40] . Id. ¶¶ 26–27.

[41] . Id. ¶¶ 32–47.

[42] Id. ¶ 32 (The reference system in State aid cases refers to “the baseline against which the illegal subsidy (or the ‘tax advantage’ in EU parlance) can be measured.); see also Stephen Daly & Ruth Mason, State Aid: The General Court Decision in Apple, 99 Tax Notes Int’l 1317 (2020), (explaining that the reference system in state aid cases refers to “the baseline against which the illegal subsidy (or the ‘tax advantage’ in EU parlance) can be measured”).

[43] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 33 (July 15, 2020).

[44] . Id. ¶ 34 (According to the Commission, the reasoning behind the arm’s length principle is described as, “principle was intended to ensure that intra-group transactions be treated, for tax purposes, in the same way as those carried out between non-integrated stand-alone companies, so as to avoid unequal treatment of companies in a similar factual and legal situation, having regard to the objective of such a system, which was to tax the profits of all companies falling within its fiscal jurisdiction.”).

[45] . Id. ¶ 37.

[46] . Id. ¶ 39.

[47] . Id.

[48] . Id. ¶ 41.

[49] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 45 (July 15, 2020).

[50] . See generally id.

[51] . Id. ¶ 101.

[52] . Id. ¶ 105.

[53] . Id. ¶ 106.

[54] . Id. ¶ 108.

[55] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 108 (July 15, 2020).

[56] . Id. ¶ 110.

[57] . Id. ¶ 111.

[58] . Id. ¶ 122.

[59] . Id. ¶ 150.

[60] . Id. ¶¶ 152–63.

[61] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 175 (July 15, 2020).

[62] . Id.

[63] . Id. ¶ 180.

[64] . Id. ¶ 181.

[65] . Id. ¶ 182.

[66] . Id. ¶ 184.

[67] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 186 (July 15, 2020).

[68] . Id.

[69] . Id. ¶ 187.

[70] . Id. ¶ 196.

[71] . Id. ¶ 215.

[72] . Id. ¶ 225.

[73] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶ 229 (July 15, 2020).

[74] . Id. ¶ 240.

[75] . Id. ¶ 242.

[76] . Id.

[77] . Id. ¶ 245.

[78] . Id. ¶ 249.

[79] . Joined Cases T-778/16 & T-892/16, Apple Sales Int’l v. Eur. Comm’n, ECLI:EU:T:2020:338, ¶¶ 251–311 (July 15, 2020).

[80] . Id. ¶ 310.

[81] . Id.

[82] . Id. ¶ 333.

[83] . Id. ¶ 505.

[84] . Leonie Carter, Commission Lays Out Arguments in Appeal of Apple Tax Case, Politico (Feb. 1, 2021, 2:28 PM).

[85] . Id.

[86] . Id.

[87] See Robert Goulder, Why the European Commission Must Appeal the Apple Decision, 99 Tax Notes Int’l 973 (Aug. 17, 2020),; see also Chamberlain, supra note 12.

[88] . Goulder, supra note 87, at 973.

[89] . Id.

[90] . Id.

[91] . Id.

[92] . Id.

[93] . Robert Goulder, Why the European Commission Must Appeal the Apple Decision, 99 Tax Notes Int’l 973 (Aug. 17, 2020),

[94] . Id.

[95] . Chamberlain, supra note 12, at 1180.

[96] . Id. at 1189.

[97] . Id. at 1180.

[98] . Mark Beasley et al., Make Tax Planning a Part of Your Company’s Risk Management Strategy, Harv. Bus. Rev . (Nov. 13, 2020),

[99] . Chamberlain, supra note 12, at 1189.

[100] . Joined Cases T-755/15 & T-759/15, Grand Duchy of Luxembourg v. Comm’n, ECLI:EU:T:2019:670, ¶ 1 (Sept. 24, 2019).

[101] . Id.

[102] The Fiat & Starbucks State Aid Cases: The Arm’s Length Principle, a New Tool to Challenge (But Also Defend) Transfer Pricing Rulings in Illegal State Aid Investigations?, Eversheds Sutherland (Oct. 14, 2019), [hereinafter Fiat & Starbucks].

[103] . Id.

[104] . Sara White, Starbucks Wins €30m Case Over Disputed Tax Bill, Accountancy Daily (Sept. 24, 2019),

[105] . Fiat & Starbuckssupra note 102.

[106] . Id.

[107] . Id.

[108] . Frans Vanistendael, Apple: Why the EU Needs a Common Corporate Income Tax, 99 Tax Notes Int’l 451 (July 27, 2020),

[109] . See id.

[110] . Id.

[111] . See id.

[112] . Id.

[113] . Robert Goulder, Amazon and the State Aid Doctrine: Unchecked Mission Creep, 1 02 Tax Notes Int’l 1571 (June 14, 2021),

[114] . Id.

[115] . Ryan Finley & Kiarra M. Strocko, Amazon and Engie Cast Doubt On State Aid Enforcement Approach, 102 Tax Notes Int’l 874, 874 (May 17, 2021),

[116] . Id. at 875.

[117] . Id. at 875–76.

[118] . Goulder, supra note 113, at 1571.

[119] . Chamberlain, supra note 12, at 1179.

[120] . Id. at 1179–80.

[121] . Id at 1181.

[122] . Id. at 1182.

[123] . Id.

[124] . Id.

[125] See Stephanie Soong Johnston, Crunch Time: What the Apple Decision Means for Global Tax Reform, Tax Notes Today Int’l , 5 (July 28, 2020),

[126] . Id. at 1–2.

[127] . Id. at 5.

[128] . Id.

[129] . Id. at 6.

[130] . Id. at 1.

Reading Tea Leaves — What Might Happen with the IRS


Reading Tea Leaves What Might Happen with the IRS - Cantley Dietrich

Reading Tea Leaves What Might Happen with the IRS - Cantley Dietrich

Article Authored By Beckett Cantley and Geoffrey Dietrich

As of early January 2022, President Biden’s massive $1.8+trillion “Build Back Better” Bill (“BBB”) was declared dead as a single piece of legislation. While barely passing through the House of Representatives in a 220-213 vote in November, the President’s multiple trips to Capitol Hill and threats across the Senate by various leaders were unable to sway Sen. Joe Manchin (D-WVa.) to vote for the BBB. Sen. Manchin’s vote was necessary to have the BBB Senate vote reach 50-50, which would have allowed Vice President Harris to break the tie. Tucked away inside every version of the BBB was an $80 billion budgetary increase over ten years for the IRS.  Every year, the bureaucracy most despised by the American taxpayer would receive an additional $8 billion in funding.

The Starvation of the IRS

The IRS has been in a budgetary drought for over a decade.  The IRS budget absorbed a twenty percent (20%) cut (adjusting for inflation) since 2010.  IRS funding has not been increased at a proportionate rate to keep up with even then-moderate inflation, much less the inflation we are seeing today.

In its’ report to Congress, the Taxpayer Advocate Service listed the “most serious problems encountered by Taxpayers” in dealing with the IRS.  Said problems included but were not limited to: (1) processing and refund delays; (2) lack of sufficient and highly trained employees; (3) significant challenges reaching an IRS representative for either telephone or in-person services; and (4) lack of proactive transparency (See 2021 Annual Report to Congress, Taxpayer Advocate Service (January 2022)).

The individual income tax return filing season began January 24 and ends April 18, with neither Treasury nor the IRS having any illusion it will go smoothly.  There are no plans to extend the return filing closing date at this time, Treasury officials said on a January 10 call with reporters. Going into it, the administration is anticipating challenges.

A preexisting backlog of tax returns, with millions more in unprocessed returns than in years past, combined with staffing and logistical challenges, are expected to make for an especially frustrating filing season this year for both taxpayers and tax professionals, the officials said. That means that the IRS simply doesn’t have enough resources to provide adequate service or enforcement, they said.

(See Treasury, IRS Set Filing Season Kickoff for January 24, Tax Notes (January 11, 2022)).

This backlog is, in a good year, approximately 1-2 million returns.  Not an insignificant number by any calculus, but going into 2022, there are nearly 35 million unprocessed returns.  That is an astounding figure.  While recognizing that not every American will file a return, that number does represent ten percent (10%) of the population of America if every person filed a return.  What that really represents is a catastrophic backlog of returns that will likely never see the light of day.  To ease the process for both taxpayers and the IRS, officials advised taxpayers to avoid paper if possible, recommending that they file tax returns electronically and use direct deposit or pay taxes owed electronically.

Overall, tax practitioner patience is running out while taxpayer anxiety is growing.  President of Padgett Business Services, Roger Harris, remarked, “The excuse of COVID is about to run out [for lagging IRS services]. It’s already run out for a lot of people.”  Like the rest of the federal government, the IRS is operating on a continuing resolution which delays programs and improvements until the middle of the agency’s fiscal year (See A Look Ahead: In Battle of Wills, Will Congress Fund? Will IRS Reform?, Tax Notes (Dec. 27, 2021)). So, without any new funding and operating on last year’s budget, no change will really be possible until at least February, a less than ideal time to throw new agents, phone representatives, and auditors into the fire.

IRS Facing Off with an Angry Congress

As far back as 2019, the IRS has struggled with its optics.  A ProPublica report released May 30, 2019, found that the IRS audits the poorest Americans at approximately the same rate as the top 1% income earners (See Paul Kiel, It’s Getting Worse: The IRS Now Audits Poor Americans at About the Same Rate as the Top 1%). Recipients of the Earned Income Tax Credit (“EITC”) were audited at a higher rate than all but the richest taxpayers.

The most likely driver for auditing EITC issues is the ease of execution.  Audits of EITC recipients are largely automated and less complicated.  Conversely, the wealthiest Americans—think the billionaires we love to malign in the media—have teams of accountants and money managers that require a team of trained investigators to understand and attack the structures and documentation.  Every year, the IRS loses its trained auditors to retirement.  When subject matter experts disappear from the ranks, they are rarely replaced by similarly qualified persons.  These complicated audits require individual attention and in-person meetings—something the IRS is currently ill-equipped to handle.

Adding to the scrutiny, taxpayers have increasingly turned to their representatives in the House and Senate for assistance solving problems with the IRS.  From 2017-2019, members of Congress requested assistance from the Taxpayer Advocate approximately 10,000 times in a year.  In 2021, that number was 66,453 (See Lawmakers Report Surge in Requests for Help With Unresponsive IRS, Tax Notes (January 14, 2021).  A smaller work force, underfunded and technologically behind, dealing with six times as many calls just to the Taxpayer Advocate.  There were nearly 140 million calls to the IRS itself in 2021.

In typical political fashion, each political party is blaming someone on the other side of the aisle for the problems faced today.  Congressional Republicans have sent a letter to Commissioner of the IRS Chuck Rettig noting that righting the ship of the agency may require “significant tradeoffs” to “meaningfully reduce the backlog” (See House Ways & Means Committee, Letter to Commissioner Rettig (January 19, 2022)). Further advising that the service should take an “all hands on deck” approach to minimize the backlog and prepare for the current year’s filing season.  They also note that, despite the pleas of poverty, the IRS received over $1.4 billion in unobligated supplementary funds from Congress in 2021.

Possibility of a BBB Revival? 

It appears that the Biden administration is still seeking to enact a few provisions from the BBB, even though the larger BBB proposed legislation has been defeated.  On a January 25 2022 virtual meeting of the N.Y. State Bar Association Tax Section, Treasury Assistant Secretary for Tax Policy Lily Batchelder said the $80 billion boost in IRS funding over ten (10) years is among the items intended to be resurrected.  “The administration’s Build Back Better package has faced many twists and turns in its path to enactment,” Batchelder acknowledged. “Having worked in Congress, I can say this is true of every major — and minor — piece of legislation” (See Hope Springs Eternal for Some of Biden’s Tax Priorities, Tax Notes (January 26, 2022)). Batchelder previously served as chief tax counsel for the Senate Finance Committee from 2010 through 2014.  He stated that the Biden Administration remains “confident that many of the top priorities will ultimately be enacted,” including the increase in IRS funding.

House Majority Leader Steny H. Hoyer (D-Md.) has also sounded upbeat on passage of some of the items, saying in a January 25 live interview with Politico that “[y]ou pass what you can pass, and then in future years, future Congresses, you try to improve. And so I’m optimistic that we’re going to pass a significant, very positive for the American people, Build Back Better bill”.  Jorge E. Castro of Miller & Chevalier Chtd., a former House and Senate Democratic tax staffer, told Tax Notes that he thinks a robust BBB package still has a possibility of enactment this year, but the next few weeks will be critical.

Whatever is included in a scaled back BBB will ultimately be determined by moderate members of the House and Senate, Castro said. Lawmakers like Sens. Joe Manchin III (D-W.Va.) and Kyrsten Sinema (D-Ariz.) have shown at least some willingness to support revenue-raising proposals, suggesting IRS funding reforms remain on the table, he added.  Still, the IRS funding provision is intended to offset the BBB spending provisions, Castro continued. “Whatever those spending provisions are, I think that’s going to determine what the scope of the revenue raisers is going to be,” he said.

That being said, 2022 is an election year.  The likelihood is small that the Democratic majority in the House and their effective control of the Senate will remain after the 2022 elections.  President Biden’s unpopularity continues to plummet, so he will be of little assistance to his congressional allies.  Passing pro-IRS legislation is difficult when a political party is popular, but undertaking it in this environment may be devastating to congressional Democrat Party members running in red and purple states.  Recently, Democrat Party members released press statements desperately requesting their retiring members continue to work on the Biden Administration agenda.  We will see how effective these requests are to Democrat Party members who may be looking for new employment in 2023.

Tea Leaves. Divining the Unknowable.

Here we gaze into the hazy crystal ball of the future, pour out the tea and divine meaning from the leaves left, and shake our chicken bones and cast them on ground searching for answers.  We begin with what we know:

  • The IRS has been tragically underfunded for over a decade and, despite cash infusions, pleads continual poverty.
  • During this same season, more than 17% of the IRS workforce has retired or left for other pastures and hiring is down due to a weak job market and lack of applicants.[1]
  • The hoped-for $80 billion of BBB money meant to rescue the IRS may not materialize.
  • There are at least 16 million individual returns outstanding and a similar number of business
  • The Service faces increasingly antagonistic requests from Congress regarding: (1) customer service; (2) failures to provide accurate tax processing to the lowest income brackets who—historically—rely most on tax refunds; and (3) aggressive stances toward audits of wealthy individuals while a historically large backlog prevent even basic services.

What does this mean?  What do the tea leaves tell us?  As is often the case with divination, we may see what we want to see.  We may also guess completely wrong.  With those carefully laid disclaimers, we think that if no BBB money is forthcoming, continued pressures from Congress will likely divert new hires away from audit and toward basic customer service positions like telephone assistance and processing. Typically, one supervisor is needed for four telephone agents.  The IRS will likely have to triage and with new hires have a 1:8 ratio or greater.  This could result in slower outcomes or mistakes but should increase the available agents to take calls and at least ease some of the burden.

There is a distinct possibility things get worse before they get better.  Could the IRS put a “pin” in prior tax years and just set sights on the future?  While possible, certain tax years or risks or demographics may find themselves “outside” any silo shutting down prior tax years.  The IRS will need significant work and transparency in any determination to reduce or even delay collections activity.  Some of these possibilities may result in more paperwork, filings, requests, and delay than just pulling on the big kid boots and mucking through.

[1] IRS Letter to Senator Elizabeth Warren, August 27, 2021, pp. 10-11.

Does a Tax Return Filed in the United States Virgin Islands (“USVI”) Start the IRS Statute of Limitations?


The Internal Revenue Code (“IRC”) § 6662(a) permits the IRS to impose a twenty-percent (20%) accuracy-related penalty to an underpayment of tax, and there are several different defenses to this penalty depending on the facts of the case and the reason for the penalty. One of the most common accuracy-related penalties is the negligence penalty. Although there are multiple different reasons for the application of an accuracy-related penalty, only one penalty may be applied for each understatement.


Wells Fargo v. US: A Potential Beginning of The End of The Objective Reasonable Basis Tax Penalty Defense


The Internal Revenue Code (“IRC”) § 6662(a) permits the IRS to impose a twenty-percent (20%) accuracy-related penalty to an underpayment of tax, and there are several different defenses to this penalty depending on the facts of the case and the reason for the penalty. One of the most common accuracy-related penalties is the negligence penalty. Although there are multiple different reasons for the application of an accuracy-related penalty, only one penalty may be applied for each understatement. If a taxpayer faces the negligence penalty, one common defense is that the taxpayer’s return position has a reasonable basis under the relevant authorities. Until recently, most courts simply proceeded through a discussion on whether the authorities supported the taxpayer’s return position, and did not even reach whether the taxpayer actually relied on relevant authorities when forming a return position. However, over the past few years, several courts have begun to require a subjective actual reliance component to the reasonable basis standard, in addition to the other requirements described under the regulations. This article explores these concepts more in detail in six parts.


How Soon Is Now: Estate of Moore & the Unraveling of Deathbed Estate Planning


How Soon Is Now: Estate of Moore & the Unraveling of Deathbed Estate Planning

Beckett G. Cantley [1]
Geoffrey C. Dietrich [2]

How Soon Is Now: Estate of Moore & the Unraveling of Deathbed Estate Planning

On April 7, 2020 the U.S. Tax Court ruled in Estate of Moore v. Commissioner, T.C. Memo. 2020-40, that certain deathbed transfers should be includible in the decedent’s estate for United States Federal Estate Tax (“estate tax”) purposes. The court applied Internal Revenue Code (“I.R.C.”) § 2036 to the transfers due to the decedent’s continued interests in the transferred property. The Tax Court stated that I.R.C. § 2036 creates “a general rule that brings back all property that a decedent transfers before he dies, subject to two exceptions.” [3] The first exception is for bona fide sales for full and adequate consideration. The second exception is for “any property that [the decedent] transferred in which he did not keep a right to possession, enjoyment, or rights to the issue of the transferred property.” [4] The Tax Court stated that the first exception depends on the transferor’s motivations, and that the decedent’s actions made it clear there was no bona fide sale. As a result, the Tax Court determined that I.R.C. § 2036(a)(1) applied to the transfer.

Estate of Moore is the latest in a line of cases in which taxpayers made deathbed transfers close to the date of death and the IRS successfully argued that the transferred property is includible in the decedent’s gross estate. In Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), the Tax Court created a three-part test to determine whether I.R.C. § 2036 pulls property back into a decedent’s estate.

In Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, aff’d 417 F.3d 468 (5th Cir. 2005), the Tax Court provided additional guidance for how the court interprets I.R.C. § 2036(a)(1).

In Estate of Nancy H. Powell v. Commissioner, 148 T.C. No. 18 (2017), the court builds on the rationale established by Strangi, but ultimately invokes I.R.C. § 2036(a)(2) to include the transferred assets in decedent’s gross estate. This article: (1) provides an overview of deathbed transfers case law; (2) describes typical such deathbed transfers; (3) outlines the I.R.C. § 2036 statute; (4) discusses the main seminal cases in the area of deathbed transfers, including Estate of Bongard, Estate of StrangiEstate of Powell, and Estate of Moore; (5) synthesizes the case law on I.R.C. § 2036 and analyzers policy considerations regarding such law; and (6) concludes with a summary of the article’s findings.

I. Introduction: Death and Taxes

The only thing more inevitable than taxes and death … is taxes on death. When an individual dies, the person is taxed on the right to transfer property at death under the estate tax. [5] The tax is assessed against the individual’s “gross estate,” which consists of the fair market value of all property and certain interests the person owned at the time of death. [6] Once the gross estate is calculated, certain deductions are applied to arrive at the “taxable estate.” [7] Added to the taxable estate is the value of lifetime gifts subject to the United States Federal Gift Tax (“gift tax”). [8] Instead of being a tax on the transfer of property at death, the gift tax is a tax on an individual’s inter vivos transfer of property where the individual receives nothing, or less than full value, in return. [9] After adding the value of lifetime gifts to the taxable estate, the estate tax is computed. Finally, the tax is reduced by the available Unified Credit. [10]

Despite I.R.C. § 2001(a) imposing the estate tax on the taxable estate of every decedent who is a citizen or resident of the United States, [11] very few people end up paying any tax. Out of the 2.8 million people expected to die in 2020, it is estimated that the estates of only 1,900 people will be taxable—less than 0.1% of decedents. [12] The major reason for this is the Unified Credit. After a series of increases, [13] in 2020, a decedent can exclude up to $11,580,000 from his or her taxable estate before he or she must pay any federal estate and gift tax. [14] While most estates fall within the Unified Credit amount, [15] for those that exceed it, the tax consequences are significant. The current estate tax rate is 40%. [16] Thus, for every $1,000,000 included in the taxable estate, the tax bill rises by $400,000.

With such large amounts of money at stake, it is easy to see why high-net-worth individuals engage in estate planning to reduce estate and gift taxes. While many techniques are used to reduce estate and gift taxes, they center on transferring property out of an individual’s estate prior to death. Because the timing of death is uncertain, the earlier individuals plan their estates, the higher the chance their estate plan will accomplish the tax objectives.

Of course, not all individuals plan their estate well in advance of death. Many begin only after a serious decline in health or when death becomes imminent. These last-minute estate plans, or “deathbed transfers,” and how the court interprets I.R.C. § 2036 [which limits them], is the subject of this article. Part II of this article discusses common deathbed transactions. Part III discusses § 2036. Part IV discusses the line of seminal cases which interpret § 2036. Part V discusses: (1) the rules after the holding in Moore; (2) the policy behind the rules; and (3) the potential future of deathbed transactions.

II. Common Deathbed Transactions

Deathbed transactions take many forms. Typical transactions include outright gifts to loved ones, trust funding for the benefit of children, and asset sales to satisfy debts pre and post death. Most of these transfers are done simply to tie up loose ends before an individual’s death. However, as the estate value approaches and exceeds the estate and gift tax exemption amount, the consideration shifts to the reduction of estate and gift taxes. While multiple options exist to lower estate and gift taxes, the following section focuses on two types of transactions which frequently come under increased scrutiny from the IRS: family limited partnerships and discounted transfers.

A. Family Limited Partnerships

A family limited partnership (“FLP”) is a partnership created to administer a family business where members of the immediate family and close relatives serve as partners. [17] Just as in other limited partnership formats, there are general and limited partners. [18] The general partner is responsible for managing and controlling the assets and receiving and distributing profits. [19] The general partner is legally responsible for losses but does not hold title to the underlying assets of the partnership as an individual. [20] The limited partner shares in the profits of the partnership, but has limited liability and does not control day-to-day operations. [21] Limited partners in FLPs differ from other partnerships entities as FLP limited partners commonly receive an ownership interest without first contributing capital to the partnership. [22] In these instances, the limited partner is gifted the ownership interest based solely on the individual being a member of the family. [23]

Family limited partnerships are a popular vehicle for several reasons. [24] They offer centralized management of assets, ability to pool assets across multiple generations, ease of ownership transfers, asset protection, [25] and avoidance of probate. [26] The potential estate and gift tax savings is a particularly persuasive reason why individuals form FLPs. This option reduces estate and gift tax by transferring an underlying asset from an individual’s estate to an FLP in exchange for a partnership interest. [27] When the individual dies, the value of the partnership interest is included in the gross estate, not the fair market value of the underlying asset. [28] The partnership interest has a value less than the underlying asset because of valuation discounts. [29]

Two valuation discounts commonly apply to FLP interests. One is for “lack of marketability” [30] and the other is for “lack of control.” [31] A lack of marketability discount is applied to reflect that a partnership interest in a closely-held business is less attractive and more difficult to market than a publicly traded business interest. [32] The partnership interest can be harder to sell because the interest is only a minority stake or because of the difficulty of removing an underlying asset from a FLP. [33] The lack of a readily available market to sell the FLP interest, in turn, creates potential short-term liquidity problems and increases the risks of ownership. [34] Thus, courts have allowed a discount for lack of marketability to reflect the difficulties inherent in FLP interest ownership. [35] The lack of control discount is a result of the different rights and different levels of control afforded to general and limited partners. [36] Limited partners “lack control” because they are unable to force distributions or control the daily decisions of the partnership. [37]

Valuation discounts are not uniform. The size of the discount depends on several factors, including the type of asset or assets transferred, market conditions at the time of the transaction, the interest the decedent receives, and restrictions on the transfer of property in the partnership agreement. [38] A lack of marketability discount can range as high as 30-60% of the fair market value of the FLP interest. [39] A lack of control discount can be 25-55% of the pre-discount value of the partnership interest. [40] Overall, valuation discounts applied to FLP interests are such an important estate planning tool because they can reduce the value of an asset that was previously part of the decedent’s estate by 30-60%. [41] This “shrinks” the decedent’s estate and results in significant tax savings.

B. Discounted Transfers

Estate and tax planning opportunities do not end once the initial asset transfer into the FLP occurs. Individuals may receive additional estate reduction by transferring the discounted FLP interest. Common discounted transfers include transfers to children, a Grantor Retained Annuity Trust (“GRAT”), and a Charitable Lead Annuity Trust (“CLAT”). Transfers to children within the family accomplish a multitude of objectives. A transfer to a child of a FLP interest can serve the purpose of giving the child a stake in the family business while teaching the child how to run the business while a parent retains control and management of the business as general partner. [42] Depending on the parent’s goals, the transfer can be structured as a gift or a sale. [43] If the transfer is a gift, the value of the FLP interest is removed from the parent’s estate with the gifted interest’s value counting against the gifting parent’s lifetime exclusion amount. [44] Nonetheless, the valuation discounts reduce the gift tax exclusion amount less than if the underlying assets were transferred outright. [45] If the transfer is structured as a sale, the value of the FLP interest is removed from the parent’s estate and the consideration received for the interest remains. [46] Due to valuation discounts, this amount will be less than an outright sale of the underlying asset. [47]

Another popular discounted transfer to reduce estate and gift tax is the transfer of FLP interests to a GRAT. In this arrangement, a FLP interest is transferred to a GRAT, while the grantor retains the right to the FLP interest’s income stream in the form of an annuity for the term of the GRAT. [48] When the term of the GRAT ends, the FLP interest is transferred to the remainder beneficiary (usually another family member). [49] This allows for an even greater valuation discount because the right to the FLP interest’s stream of income is valued less than the value of the actual FLP interest. [50]

A third common discounted transfer is the transfer of an FLP interest to a CLAT. In this arrangement, the FLP interest is transferred to a CLAT where annuity payments are made to a charity for a certain timeframe. [51] Once the specified period ends, whatever remains in the trust is transferred to or for the benefit of the remainder beneficiary. [52] The remainder beneficiary, importantly, does not have to be a charitable organization. [53] Often, they are the descendants of the CLAT’s grantor. [54] Beyond the benefit of transferring the FLP interest out of the donor’s estate, the donor receives a gift tax charitable deduction for the present value of the lead interest. [55] While the present value of the remainder estate is a taxable gift, steps can be taken to reduce the amount of taxable gift to zero. [56] Thus, successful implementation of a CLAT allows the donor to remove the value of the underlying FLP interest from their estate, receive a gift tax charitable deduction, and transfer the FLP interest to their children or other family members. [57]

III. I.R.C. § 2036

When properly structured and executed, FLPs, discounted transfers, and other vehicles can achieve a significant estate and gift tax reduction. However, the transfers must not fall within the scope of I.R.C. § 2036(a). I.R.C. § 2036(a) is an Internal Revenue Code provision that brings the value of certain transferred property back into the decedent’s gross estate. [58] I.R.C. § 2036(a) provides:

(a) General rule. The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—

(1) the possession or enjoyment of, or the right to the income from, the property, or

(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

Essentially, I.R.C. § 2036(a) includes the value of any transferred property in the decedent’s estate where the decedent either retained: (1) the possession or enjoyment of; (2) the right to possess or enjoy; or (3) the right to designate who shall possess or enjoy such transferred property. The purpose of I.R.C. § 2036 is to “prevent the circumvention of federal estate tax by the use of inter vivos transactions which do not remove the lifetime enjoyment of property purportedly transferred by a decedent.” [59] I.R.C. § 2036 is “part of a Congressional scheme to tax the value of property transferred at death,” whether the decedent “accomplishes the transfer by will, by intestacy, or by allowing his substantial control over the property to remain unexercised until death so that the shifting of its economic benefits to the beneficiary only then becomes complete.” [60] The IRS has increasingly turned to I.R.C. § 2036 in order to pull the value of deathbed transfers back into a decedent’s estate. [61] The following cases explore how the court has interpreted I.R.C. § 2036 and responded to the IRS’s increased use of the provision.

IV. I.R.C. § 2036(a) Deathbed Transfers Seminal Cases

Over the past twenty years, courts have issued a line of decisions providing guidance on the application of I.R.C. § 2036(a) to deathbed transfers. Each of these cases resulted from IRS challenges to decedent asset transfers to an FLP. The IRS increasingly disputes these transfers as they “often view these partnerships as efforts to pass valuable assets to one’s heirs at a discount for lack of marketability and lack of control.” [62]

A. Estate of Bongard

In Estate of Bongard v. Comm’r[63] the United States Tax Court (“USTC”) outlined a general test that has become the standard courts use to determine whether an inter vivos transfer falls within I.R.C. § 2036(a). [64] In Bongard, decedent established Empak, Inc. (“Empak”), an electronics materials packaging company, where decedent served as CEO and sole member of Empak’s board of directors. [65] Decedent and an Irrevocable Stock Accumulation Trust (“ISA Trust”) set up for the benefit of decedent’s children owned all the stock of Empak. [66] On January 30, 1996, WCB Holdings, LLC. (“WCB Holdings”) was established to pool the family members’ ownership interests in Empak in preparation of a corporate liquidity event. [67] On December 28, 1996, decedent and ISA Trust contributed their shares of Empak stock to WCB Holdings in exchange for WCB Holdings Class A and Class B membership units. [68] The following day, decedent and ISA Trust created Bongard Family Limited Partnership (“BFLP”). [69] In exchange for a 99% limited partnership interest in BFLP, decedent transferred all of his WCB Holdings class B membership units to BFLP. [70] ISA Trust received a 1% general partnership interest after transferring a portion of its WCB Holdings class B membership units to BFLP. [71] Subsequent gifts and distributions, including a BFLP 7.72% limited partnership interest gift from decedent to his wife, followed up until decedent’s death. [72] On November 16, 1998, Decedent died unexpectantly. [73]

The IRS argued that decedent’s inter vivos transfers to WCB Holdings and BFLP should be included in the gross estate because I.R.C. §§ 2035(a) and 2036(a) and (b) applied. [74] The estate countered the IRS’s argument on the two transfers, stating that they: (1) were not “transfers” within the meaning of I.R.C § 2036, (2) satisfied the bona fide sale exemption, and (3) did not include decedent’s retention of I.R.C. § 2036 interests. [75] The Tax Court held that: (1) decedent’s transfer of Empak stock to WCB Holdings satisfied the bona fide sale exception of I.R.C. § 2036(a); [76] and (2) the value of decedent’s transfer of WCB Holdings class B membership units to BFLP was includable under I.R.C. § 2036(a)(1). [77] First, the USTC explained I.R.C. § 2036 applies when three conditions are met:

(1) the decedent made an inter vivos transfer of property; (2) the decedent's transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest or right enumerated in section 2036(a)(1) or (2) or (b) in the transferred property which he did not relinquish before his death.

Estate of Bongard v. Comm'r, 124 T.C. No. 8, at *112 (2005). Next, the USTC applied their newly created test. The Tax Court found both of decedent’s transactions to be “transfers” within the context of I.R.C. § 2036 because “transfer” is a broadly defined term [78] and decedent voluntarily made the inter vivos transfers of the property. [79]

For the second condition of the test, the UTSC found decedent’s initial transfer of Empak stock to WCB Holdings did qualify for the bona fide sale exception, [80] while decedent’s subsequent transfer of WCB Holdings class B membership units to BFLP did not. [81] As the United States Court of Appeals for the Fifth Circuit did in Kimbell v. United States[82] the Tax Court broke the bona fide sale exception into two prongs: (1) whether the transaction qualified as a bona fide sale; and (2) whether the decedent received adequate and full consideration. [83] For FLPs, the first prong is satisfied when the objective evidence indicates a “legitimate and significant nontax reason” for the FLP creation and the transferors receive “partnership interests proportionate to the value of the property transferred.” [84]

Decedent’s transfer of Empak stock to WCB Holdings satisfied the first prong of the test because the court found the pooling of decedent’s and ISA Trust’s Empak shares was for the significant nontax reason of attracting potential investors and raising capital for additional growth. [85] Furthermore, the Tax Court determined the second prong was satisfied because both decedent and ISA Trust received interests in WCB Holdings proportionate to the amount of shares each transferred. [86] Thus, the Tax Court determined decedent’s transfer of Empak stock to WCB Holdings satisfied the bona fide sale exception of I.R.C. § 2036(a), and there was no need to determine whether decedent retained an I.R.C. § 2036(a) or (b) interest. [87]

The USTC held decedent's transfer of WCB Holdings class B membership units to BFLP did not satisfy the bona fide sale exception because it failed to exhibit a significant nontax purpose. [88] The USTC rejected the estate’s arguments that BFLP was established to provide additional credit protection and to facilitate decedent’s post-marital agreement with his second wife. [89] The tax court reasoned WCB Holdings already satisfied those objectives. [90] Furthermore, decedent “recycled the value” of the property he transferred to BFLP because BFLP did not perform a management function for the assets received or engage in any businesslike transaction. [91] All decedent did was “change the form” in which he held his interest in the transferred property. [92] Thus, decedent’s transfer of WCB Holdings class B membership units to BFLP did not qualify for the bona fide sale exception. [93]

Finally, the USTC turned to the third consideration of the I.R.C. § 2036 test and held decedent retained an I.R.C. § 2036(a) interest in BFLP. [94] The Tax Court stated a right is retained “if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.” [95] The USTC concluded there was an implied agreement between the parties that decedent retained the right to control the WCB membership units based on decedent’s ability to decide whether the membership units and underlying Empak stock would be redeemed. [96] After determining decedent retained the enjoyment of the property transferred to BFLP, the USTC concluded the value of the WCB Holdings class B membership units was included in decedent’s gross estate under I.R.C. § 2036(a). [97]

B. Estate of Strangi

While Bongard established a test for courts to use for I.R.C. § 2036(a) inclusion, [98] Estate of Strangi v. Comm’r [99] outlines the application of I.R.C. §§ 2036(a)(1) and (a)(2) to deathbed transfers. In Strangi, decedent transferred 98% of his wealth to Strangi Family Limited Partnership (“SFLP”) two months before his death. [100] On July 19, 1988, decedent executed a power of attorney naming Mr. Gulig, his son-in-law, as his attorney-in-fact. [101] During 1993, decedent underwent surgery to remove a cancerous mass from his back and was diagnosed with a degenerative brain disorder. [102] After attending a seminar discussing the use of family limited partnerships for asset preservation, estate planning, income tax planning, and charitable giving, on August 12, 1994, Mr. Gulig formed SFLP while acting as decedent’s attorney-in-fact. [103] Property of decedent totaling a fair market value of $9,876,929, or 98% of decedent’s wealth, was transferred to SFLP in exchange for a 99% limited partnership interest. [104] Assets contributed to SFLP included the residence occupied by decedent, securities, accrued interest and dividends, insurance policies, an annuity, receivables, and partnership interests. [105] Stranco, a Texas corporation Mr. Gulig created the same day as SFLP, purchased the remaining 1% of SFLP as managing general partner. [106] Stranco was funded by decedent and his four children. [107] Decedent contributed $49,350 in assets for 47% of Stranco’s common stock, while decedent’s children contributed $55,650 for 53% of Stranco’s common stock. [108] Additionally, decedent and decedent’s children were named as the initial five directors of Stranco and Mr. Gulig was hired by Stranco to manage the day-to-day business of the corporation. [109] Decedent died of cancer on October 14, 1994—less than three months after the transfers to SFLP and Stranco. [110]

In the Tax Court, the IRS argued that SFLP should be disregarded because it lacked economic substance and business purpose. [111] After the subsequent approval of a motion to amend its answer, the IRS further argued the full value of the assets decedent transferred to SFLP and Stranco should be included in decedent gross estate because decedent retained a “right” within the meaning of I.R.C. § 2036(a)(2). [112] On its second trip to the Court of Appeals, the Fifth Circuit affirmed the Tax Court’s holding that the value of the assets decedent transferred to SFLP should be included in decedent’s estate under I.R.C. § 2036(a)(1). [113] The Fifth Circuit stated two requirements were needed to trigger I.R.C. § 2036(a)(1). [114] First, the decedent must retain “possession or enjoyment” of the property.” [115] This requirement is met if the decedent retains a “substantial present economic benefit” from the transferred property. [116] For the second requirement, the court used the same “expressed or implied” agreement test used by the court in Bongard[117] The Fifth Circuit concluded that decedent satisfied both requirements based on numerous facts, [118] including: (1) various payments made from the FLP, both before and after decedent’s death, to meet his needs and expenses; (2) decedent’s continued residence in his house after it was transferred to the FLP; (3) his nonpayment of rent to the FLP for three years; and (4) his failure to retain sufficient assets outside the FLP to meet his living expenses for his remaining life expectancy. [119] Based on these circumstances and the inapplicability of the bona fide sale exception, [120] the Fifth Circuit affirmed the Tax Court’s I.R.C. § 2036(a)(1) holding. [121]

Because the Fifth Circuit held the transferred assets were included in the taxable estate under I.R.C. § 2036(a)(1), the Fifth Circuit did not discuss the IRS’s alternative contention for inclusion under I.R.C. § 2036(a)(2). [122] However, the Tax Court’s assessment of the IRS’s I.R.C. § 2036(a)(2) argument is important to discuss as it serves as the basis for later holdings. [123] The Tax Court held, as an alternative to their I.R.C. § 2036(a)(1) holding, that decedent, through Mr. Gulig, retained the “right to designate the persons who shall possess or enjoy the property or its income” within the meaning of I.R.C. § 2036(a)(2). [124] Specifically, the court found Mr. Gulig’s dual roles as decedent’s attorney-in-fact and manager of Stranco problematic. [125] The SFLP partnership agreement named Stranco managing general partner of SFLP and gave the managing partner sole discretion to determine distributions. [126] When Mr. Gulig was hired as Stranco’s manager, this power was then conferred upon Mr. Gulig, [127] placing decedent in a position “to act, alone or in conjunction with others, through his attorney-in-fact, to cause distributions of property previously transferred to the entities or of income therefrom.” [128]

Citing United States v. Byrum[129] the estate argued I.R.C. § 2036(a)(2) was not applicable because decedent’s “rights” were limited by Mr. Gulig’s fiduciary duties to SFLP and Stranco. [130] The court rejected this argument because: (1) Mr. Gulig already owed fiduciary duties to decedent personally as his attorney-in-fact before the formation of SFLP and Stranco; and (2) the fiduciary obligations of Stranco and its directors were duties essentially owed to decedent himself. [131] The Tax Court then rejected the fiduciary duties argument by stating, “[i]ntrafamily fiduciary duties within an investment vehicle simply are not equivalent in nature to the obligations created by the United States v. Byrum . . . scenario.” [132]

C. Estate of Powell

Estate of Powell v. Commissioner [133] builds on Strangi and is a major victory for the IRS in its battle against FLP deathbed transfers. In Powell, decedent’s son, acting under a power of attorney, transferred approximately $10 million of assets from decedent’s revocable trust to an FLP while decedent was hospitalized in intensive care. [134] Decedent received a 99% limited partnership interest, while her two sons contributed an unsecured note in return for a 1% general partnership interest. [135] Notably, the FLP agreement gave decedent’s son sole discretion over the timing and amount of partnership distributions. [136] The agreement also permitted dissolution of the FLP upon written consent of all partners. [137] On the same day cash and securities were transferred into the FLP, decedent’s son, again acting under a POA, transferred decedent’s 99% limited partner interest to a charitable lead annuity trust (“CLAT”) with her two sons receiving the remainder upon her death. [138] Decedent died seven days after the funding of the FLP and same-day transfer of her limited partner interest to the CLAT. [139]

The IRS argued that I.R.C. § 2036(a)(1) and (2) applied to decedent’s transfer of cash and securities to the FLP. [140] The IRS contended that I.R.C. § 2036(a)(1) applied to the transfer because it was subject to an implied agreement under which decedent retained possession or enjoyment of the transferred property or the right to income from that property. [141] The IRS argued that I.R.C. § 2036(a)(2) applied because of decedent's ability, acting with her sons, to dissolve the FLP and thereby designate who could possess the transferred property or the income from it. [142] Finally, the IRS asserted the bona fide sale exception to I.R.C. § 2036(a) did not apply because the estate failed to demonstrate a “significant nontax purpose” for the creation of the FLP and because, in the light of the claimed valuation discount, the transfer was not made for “full and adequate consideration.” [143]

The USTC held for inclusion of the cash and securities under I.R.C. § 2036(a)(2), making it unnecessary to consider the IRS’s I.R.C. § 2036(a)(1) argument. [144] Drawing heavily from Estate of Strangi[145] the Tax Court found decedent’s cooperative ability to dissolve the FLP with her sons constituted a right in conjunction with others to designate the persons who shall possess or enjoy the transferred property within the meaning of I.R.C. § 2036(a)(2). [146] The USTC found the ability to dissolve the partnership problematic because it comes with the ability to direct the disposition of the partnership assets. [147] While the decedent’s ability is in conjunction with her sons, it was enough to trigger I.R.C. § 2036(a)(2) inclusion. [148] Decedent’s ability to determine the amount and timing of distributions through her son’s dual role as managing general partner and her attorney-in-fact constituted a “right” within the meaning of I.R.C. § 2036(a)(2). [149]

In finding this way, the Tax Court echoed Strangi and precluded the “fiduciary duties” argument. [150] The USTC reasoned Mr. Powell owed duties to decedent prior to or upon formation of the FLP. [151] Since decedent held a 99% interest in the FLP, whatever fiduciary duties limited her son’s ability to determine partnership distributions were duties owed “almost exclusively” to decedent herself. [152] Finally, the court found any fiduciary duties Mr. Powell may have owed to decedent as “illusory” because there was no evidence that the FLP was anything but an investment vehicle for decedent and her sons. [153] Since the estate did not argue that the transfer was exempted by the I.R.C. § 2036(a) bona fide sale exception, the USTC concluded the value of the transferred assets was includible in the value of decedent’s gross estate. [154]

D. Estate of Moore

The most recent case in the deathbed transfer inclusion is Estate of Moore v. Commissioner[155] In Moore, decedent built a successful family farm (“Moore Farms”). [156] In 2004, decedent, in his late eighties, began negotiating a sale of Moore Farms to Mellon Farms. [157] In December 2004, before decedent could complete the deal with Mellon Farms, he was rushed to the emergency room with congestive heart failure. [158] After release from the hospital, a hospice doctor gave him less than six months to live. [159] Decedent then began his estate planning. [160] The result was a complex web of entities including a Living Trust (“Living Trust”), a Charitable Lead Annuity Trust (“Charitable Trust”), a Children’s Trust (“Children’s Trust”), a Family Management Trust (“Management Trust”), an Irrevocable Trust (“Irrevocable Trust”), and a Family Limited Partnership (“FLP”)—all created on the same day. [161] Decedent’s estate planning attorney testified that in decedent’s initial call to him, decedent believed his discharge from the hospital was “an extension of his life” and he wanted to wanted to meet with his attorney in order to try to “save the millions of dollars of taxes.” [162] On February 4, 2005, decedent finalized the sale of Moore Farms to Mellon Farms. [163] Decedent continued to live on the farm and made various transfers among and from the trusts and FLP until his death at the end of March 2005. [164]

The IRS argued the majority of the estate plan failed under I.R.C. § 2036 because: (1) decedent lacked a legitimate nontax reason for forming the FLP, thus, the transfer of four-fifths of the farm to the FLP did not qualify for the I.R.C. § 2036(a) bona fide sale exception; and (2) decedent retained possession and enjoyment of Moore Farms even after its sale. [165] The USTC agreed with the IRS and held the transfer of four-fifths of the farm to the FLP did not meet the requirements of the bona fide sale exception [166] and decedent retained possession or enjoyment of Moore farms within the meaning of I.R.C. § 2036(a)(1). [167] The USTC found decedent’s transfer of Moore Farms to the FLP did not qualify for the bona fide sale exception because the formation of the FLP lacked a significant nontax reason. [168] The Tax Court reached this conclusion because: (1) there was no “business” for the family to run after decedent sold the farm within five days of its transfer to the FLP; (2) the business retained significant amounts of capital for any “alleged” creditors who may make claims; (3) decedent began planning his estate only after he faced significant health problems; (4) decedent told his estate planning attorney he wanted to “save millions of dollars of taxes” through his estate plan; and (5) the decedent’s unilateral actions underlined the general testamentary nature of the plan and transfers. [169] Because the formation of the FLP failed to have a significant nontax purpose, the USTC did not consider the issue of value—i.e. whether decedent’s transfer was for adequate and full consideration—and moved to the “retained possession or enjoyment of” the transferred asset part of the analysis. [170]

The USTC concluded decedent retained possession or enjoyment of Moore Farms after he transferred it to the FLP. [171] Applying the two-prong I.R.C. § 2036(a)(1) test from Strangi[172] the USTC found decedent retained a “substantial present economic benefit” from the farm after he transferred it. [173] The Tax Court pointed to several facts to support its conclusion. [174] First, decedent continued to live on the property and run the farm as he did before the sale, and did so up until his death. [175] Second, while decedent retained sufficient assets to support himself unlike the decedent in Strangi[176] he did not draw upon them. [177] Instead, he used FLP assets to pay his personal expenses and make gifts. [178] Finally, despite not holding the controlling general interest, decedent ignored formalities and continued to exercise control over the farm and make unilateral decisions. [179] The USTC reasoned these facts indicated an implicit understanding between Moore and his children that he would continue to use the FLP assets and that his relationship with the transferred assets “changed formally, not practically.” [180] Thus, the Tax Court held the value of the farm should be included in the value of the gross estate under I.R.C. § 2036(a)(1). [181]

V. Analysis

A. The Post-Moore Rules

After Moore, I.R.C. § 2036(a) tends to bring all deathbed property transfers back into the gross estate, [182] unless: (1) the estate can show the sale was a bona fide sale for adequate and full consideration; [183] or (2) the decedent did not retain a right to possession, enjoyment, or rights to the issue of the transferred property. [184] A sale is bona fide, in the family limited partnership context, when the objective evidence establishes the existence of a “legitimate and significant nontax reason” for the creation and transfer of assets to the FLP. [185] A sale is for adequate and full consideration when the decedent receives a “partnership interests proportionate to the value of the property transferred.” [186] Essentially, the bona fide sale prong is a question of motive, while the “for adequate and full consideration” prong is a question of value. [187]

If a transfer does not qualify under the “bona fide sale” exception, the analysis moves to the second exception. A decedent retains the right to possession or enjoyment if the decedent retains “substantial present economic benefit” from the property after transferring it and there is an “express or implied agreement” that the decedent will continue to possess or enjoy the property “at the time of transfer.” [188] While the right to the issue of the transferred property part of the rule is the least developed, the court has held the ability “to act, alone or in conjunction with others,” [189] to cause partnership distributions [190] or dissolve the partnership triggers inclusion under I.R.C. § 2036(a)(2). [191]

B. The Policy Behind these Rules

The policy behind these rules is clear—prevent the circumvention of federal estate tax by including the value of any inter vivos transfer where the decedent retains an interest or right in the transferred property in the decedent’s gross estate. [192] I.R.C. § 2035 works in conjunction with I.R.C. § 2036 to pull the value of any gift transferred or gift taxes paid within three years of the decedent’s death back into the gross estate. [193] The purpose of I.R.C. § 2035 is the same as the purpose for I.R.C. § 2036, except I.R.C. § 2035 focuses on a different method of transfer: a gratuitous transfer versus a transfer for consideration. [194] While the policy for these rules is simple, whether it is correct is a more complicated question.

As a basic tenant of property and trusts and estates law, individuals have the right to transfer property in life or at death. [195] This “right of disposition” is one of the “sticks” in the bundle of rights that accompany property ownership. [196] The issue with I.R.C. § 2036, and by extension I.R.C. § 2035, is that these rules infringe on this right when an individual makes a deathbed transfer. Although the transfer’s substance is respected, I.R.C. § 2036 violates the transaction’s financial effect by pulling the value of the transferred property back into the decedent’s gross estate. If individuals have the right to transfer property, why does sudden illness or other desperate conditions change this right? In the context of deathbed transfers of family limited partnership interests, the IRS could alternatively adjust the valuation discount and then count the value of the transfer against the decedent’s Unified Credit without pulling the full value of the asset back into the decedent’s gross estate. This approach more directly addresses the IRS’s central concern of the size of the valuation discount. Unfortunately, instead of dealing with the issue in a more straightforward manner, the IRS invokes I.R.C. § 2036 and in turn, seems to create a fraudulent transfer statute.

While adjusting the applied valuation discount is a more precise method, the practical reason for applying I.R.C. § 2036 likely boils down to process simplification. When a dispute arises, it is much less complicated for the court to include the full undiscounted value of the transferred FLP interest in the decedent’s gross estate. This also allows the court to avoid having to make difficult judgements regarding the value of an asset. In the court’s opinion, these types of assessments are better left for CPAs and other valuation experts. While an in-depth discussion of the interplay between I.R.C. § 2036 and the consideration offset provisions in I.R.C. § 2043 is beyond the scope of this article, one only has to look at the Tax Court’s discussion in Estate of Moore regarding of the net inclusion amount to get an idea of just how complex valuation and discounting calculations can get. [197]

With the court’s increased use of I.R.C. § 2036 to pull the value of decedent’s deathbed transfers back into the gross estate raises serious concerns, the court’s decisions can be summed up by the saying “bad facts make bad law.” For example, in Estate of Moore, the decedent knew he only had months to live and clearly stated the purpose of his deathbed planning was to “save the millions of dollars of taxes.” [198] Furthermore, the decedent continued to live on the property and run the farm as he did before the sale and continuously used FLP assets to pay personal expenses. [199] Facts such as these made it easy for the Tax Court to hold for inclusion under I.R.C. § 2036. [200] The facts of Estate of Powell tell a similar story. The day before the partnership was funded, two hospital doctors indicated the decedent lacked capacity and “could not act on her own behalf.” [201] Additionally, objective evidence indicated the FLP had no business purpose. [202] It was merely an investment vehicle for the decedent and her two sons. [203]

While the deathbed element does increase the chances that inclusion may occur, simple steps can be taken to avoid triggering I.R.C. § 2036. In order to qualify for the bona fide sale exception to I.R.C. § 2036, individuals should first and foremost establish a nontax motive for creating the FLP. The decedent in Estate of Moore did not fail the bona fide sale exception because he had a tax purpose for the formation for the FLP, he failed the exception because he only had a significant nontax reason for the transfer to the FLP. [204] To provide additional factual support, the nontax reasons for the entity’s formation can be listed in the recitals of the FLP’s partnership agreement. Furthermore, to increase the chances of satisfying the second prong of the bona fide exception, the interest credited to each partner should be proportional to the fair market of the value of the assets each partner contributed to the FLP. Also, the assets contributed by each partner to the FLP should be properly credited to the respective capital accounts. In the case of an IRS challenge, this provides support to the estate’s position that entity formalities were followed.

When it comes to funding and operating the FLP, additional steps should be taken to avoid the perception that a decedent retained an interest or right in the assets transferred to the FLP. As the court in Strangi made clear, [205] the decedent should not transfer all of their assets to the FLP. If the decedent does, the IRS will likely argue there was an implied agreement for the decedent to continue using the assets as they did before the transfer. Additionally, the decedent keeping sufficient assets outside of the FLP avoids the pitfall of the FLP to pay post-death expenses such as funeral costs. In the same vein as keeping sufficient assets outside of the FLP, the decedent should not commingle FLP and personal funds. This was a major factor in the USTC applying I.R.C. § 2036 in both Strangi [206] and Estate of Moore[207] Another important point is to continue or further the entity’s nontax business purpose. This point was highlighted by the first transfer in Estate of Bongard[208] Decedent’s transfer of stock to the holding company did not trigger I.R.C. § 2036 because pooling family assets in the holding company was part of a legitimate nontax business decision to facilitate the sale of the business. [209] This plan to continue legitimate business operations contrasts with the circumstances in Estate of Moore where the decedent sold the farming business days after forming the FLP. [210] Finally, decedents should make sure to divest themselves of any rights they may have alone or in conjunction with another to affect the operations or distribution of partnership assets. Estate of Powell made clear different individuals should act as the decedent’s attorney-in-fact and manager of the FLP. [211]

C. Where We Go from Here

This string of recent I.R.C. § 2036 decisions make it obvious that the law is moving in an ever-more-restrictive direction. The courts historically have not often used I.R.C. § 2036 to pull the value of assets back into a decedent’s estate. However, this is no longer the case. Due to the IRS’s insistence, the courts have increasingly used I.R.C § 2036 as the main weapon against family limited partnerships asset transfers. The IRS often view FLPs “as efforts to pass valuable assets to one’s heirs at a discount for lack of marketability and lack of control.” [212] This seems to reflect that judges may be implying a general-purpose common law that all types of tax planning must get more restrictive if tax reduction is the principle purpose. This could be a result of the numerous income tax economic substance cases over the last two decades. The economic substance doctrine and the “legitimate and significant nontax purpose” requirement of I.R.C. § 2036(a) share a similar rationale and seek to invalidate aspects of tax transactions.

Beyond the reasons for increased use of I.R.C. § 2036, two aspects of the recent court decisions indicate even greater use of I.R.C. § 2036 to restrict the tax benefits of deathbed transfers. The first comes from Estate of Powell. While the case law regarding the bona fide exception and the restriction on the retention of “possession or enjoyment” of the transferred asset of I.R.C. § 2036(a)(1) are fairly well developed, significant questions remain as to what “rights” fall under I.R.C. § 2036(a)(2). While the court found for inclusion under I.R.C. § 2036(a)(1), [213] the reasoning in Strangi regarding I.R.C. § 2036(a)(2) indicated inclusion may be triggered by decedent’s attorney-in-fact also serving as manager of the FLP. [214] Estate of Powell took this retention of a “right” even further by holding decedent’s cooperative ability to dissolve the FLP with her sons, although decedent made no effort to exercise such a right, constituted a right in conjunction with others to designate the persons who shall possess or enjoy the transferred property within the meaning of I.R.C. § 2036(a)(2). [215] Taking these decision together, they seem to indicate that only the possibility—and not the actual execution—of affecting the operation or distributions of the FLP will pull the value of the transferred assets back into the gross estate. With this as the precedent, future decisions will likely hold things such as the retention of minority interest voting rights cause inclusion under I.R.C. § 2036(a)(2).

The second, and likely more important, indication of greater use of I.R.C. § 2036 to invalidate the tax benefits of deathbed transfers is the tone of the Tax Court’s ruling in Estate of Moore. Initially, the Tax Court stated that the three-part test developed in Estate of Bongard was the test that determined whether I.R.C § 2036 recaptures transferred property back into the decedent’s estate. [216] While the elements of the Estate of Bongard test are still present in the Estate of Moore decision, the emphasis has shifted. [217] In Estate of Moore, when discussing the Estate of Bongard test, the Tax Court stated, “[a]nother way of looking at this--and another way we frequently discuss it--is to look at 2036(a) as creating a general rule that brings back all the property that a decedent transfers before he dies, subject to two exceptions.” [218] Instead of the court “not respect[ing] a transfer” if it does not meet the three requirements under the Estate of Bongard test, [219] the transfer is now automatically not respected and the estate must reestablish the transfer’s validity. [220]

As stated above, this seems to indicate judges will apply a general-purpose common law that all types of tax planning (in which the primary purpose is tax reduction) “smell bad” and the decedent’s estate must prove otherwise. This has procedural and practical consequences as it increases the cost and time required to settle a decedent’s estate. As indicated supra Part IV. Section B, forward-looking steps can be taken to significantly reduce the chance transfers to an FLP will not be included under I.R.C. § 2036. The problem with deathbed transfers though is that many of these planning decisions are made in a chaotic and stressful environment. This has the compounded effect of making it more difficult for individuals to plan their estate to avoid inclusion and to produce sufficient evidence that concerns beyond tax savings motivated their formation and transfer of assets to a family limited partnership. With this in mind, it is of the utmost importance for individuals conducting deathbed planning to seek appropriate counsel and avoid the increasing “squeeze” of I.R.C. § 2036.

V. Conclusion

This article discussed the formation and purpose of family limited partnerships. Further, it outlined the advantages of using such as an estate planning vehicle. This article also detailed the requirements of I.R.C. § 2036 and the seminal cases interpreting the statute. Moreover, the present state of I.R.C. § 2036 was reviewed and the article provided recommendations to avoid the value of transferred assets included in the decedent’s gross estate. Finally, this article discussed the implications of the court’s increased use of I.R.C. § 2036 and the likely results of this change in judicial review.

If you have clients in the upper income brackets who share these concerns, the attorneys at Cantley Dietrich would enjoy having a conversation with you about how you can protect them from some of the challenges they will likely face in the next few years.

[1] Prof. Beckett G. Cantley, teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C. Prof. Cantley would like to thank Melissa Cantley and his law clerk, Joshuah C. Miller, for their contributions to this article.

[2] Geoffrey C. Dietrich, Esq. is a shareholder in Cantley Dietrich, P.C.

[3] Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607, at *29 (citing Kimbell v. United States, 371 F.3d 257, 261 (5th Cir. 2004)).

[4] Id. at *30 (citing Kimbell, 371 F.3d at 261).

[5] Internal Revenue Service, Estate Tax, (last visited July 5, 2020).

[6] Id.

[7] Id.

[8] Id.

[9] Internal Revenue Service, Gift Tax, (last visited July 5, 2020).

[10] Internal Revenue Service, Estate Tax, (last visited July 5, 2020).

[11] I.R.C. § 2001(a).

[12] Tax Policy Center, Urban Institute & Brookings Institution, How Many People Pay the Estate Tax? (last visited July 5, 2020).

[13] See id.

[14] See I.R.S. Rev. Proc. 2019-44, § 3.41.

[15] See Tax Policy Center, supra note 12.

[16] I.R.C. § 2001(c).

[17] See Nathan H. Bernstein, The Formation of the Family Limited Partnership: Fraudulent Transfer Liability and Other Family Problems, 101 Com. L.J. 26, 27 (1996).

[18] See id. at 27.

[19] See id.

[20] See id.

[21] See id.

[22] See id.

[23] See id.

[24] See Robert G. Alexander & Dallas E. Klemmer, Creative Wealth Planning with Grantor Trusts, Family Limited Partnerships, and Family Limited Liability Companies, 2 Est. Plan. & Cmty. Prop. L.J. 307 (2010); S. Stacy Eastland, Family Limited Partnerships: Current Status and New Opportunities, 2009 A.L.I.-A.B.A. Continuing Legal Educ. 1017.

[25] While certain requirements must be followed to accomplish any of the objectives of a family limited partnership, extra care should be given when setting one up for asset protection. State and federal law impose civil and criminal penalties for fraudulent transfer liability. Fraudulent transfer liability occurs when an individual transfers individually owned assets into a family limited partnership, conceals these assets from creditors, and maintains direct or indirect control over the assets. In these instances, the line between “asset protection” and “fraudulent transfer” is often blurred. Nathan H. Bernstein, The Formation of the Family Limited Partnership: Fraudulent Transfer Liability and Other Family Problems, 101 Com. L.J. 26, 39 (1996).

[26] See Bernstein, supra note 17, at 29-30; Alexander, supra note 24, at 316-17.

[27] See D. John Thorton & Gregory A. Byron, Valuation of Family Limited Partnership Interests, 32 Idaho L. Rev. 345, 347-48 (1996).

[28] See id.

[29] See Matthew Van Leer-Greenberg, Family Limited Partnerships: Are They Still a Viable

Weapon in the Estate Planner's Arsenal , 25 Roger Williams U. L. Rev. 37, 42 (2020).

[30] See Thorton, supra note 27, at 363.

[31] See id. at 364.

[32] Id. at 363.

[33] See Martin A. Goldberg & Cynthia M. Kruth, New Life for Valuation Discounts in Family Entities, 16 Quinnipiac Prob. L.J. 48, 49 (2002).

[34] Thorton, supra note 27, at 363.

[35] Id.

[36] See id. at 3; Nathan H. Bernstein, The Formation of the Family Limited Partnership: Fraudulent Transfer Liability and Other Family Problems, 101 Com. L.J. 26, 27 (1996).

[37] See Van Leer-Greenberg, supra note 29, at 43 (citing Goldberg, supra note 33, at 49).

[38] See id. at 44; Dennis I. Belcher, Valuation Discounts: Theory and Practice, Estate Planning In Depth: ALI-ABA Course of Study 273, 308 (2003).

[39] Id.

[40] See Thorton, supra note 27, at 363. See also, Estate of Maxcy v. Comm’r, T.C. Memo. 1969-158, 1969 WL 1276, 28 T.C.M. (CCH) 783, 793 (1969) (holding minority interest per share value in closely held corporation was 75% of the majority interest, thus, resulting in a 25% discount); Estate of Dougherty v. Comm’r, T.C. Memo. 1990-274, 1990 WL 70915, 59 T.C.M. (CCH) 772, 781 (1990) (allowing a 35% discount in valuing stock of a sole shareholder to reflect lack of marketability, cost of liquidation and diversity of asset management).

[41] See Van Leer-Greenberg, supra note 29, at 42, 44.

[42] See Bernstein, supra note 35, at 27.

[43] See id. at 22, 27.

[44] See Internal Revenue Service, supra notes 9, 10.

[45] See John F. Ramsbacher, John W. Prokey & Erin M. Wilms, Family Limited Partnership:

Forming, Funding, and Defending , 18 Prac. Tax Law 29, 30 (2004).

[46] See id.

[47] See id.

[48] Peter J. Parenti, Designing the Family Limited Partnership or the Family Limited Liability Company - Part 2, 9 J. Pract. Est. Plan. 21, 25 (2007).

[49] Id.

[50] See id. See also, Robert G. Alexander & Dallas E. Klemmer, Creative Wealth Planning with Grantor Trusts, Family Limited Partnerships, and Family Limited Liability Companies, 2 Est. Plan. & Cmty. Prop. L.J. 307, 325-26 (2010) (discussing valuation discounts for GRATs and importance of structuring GRATs so that the growth of GRAT assets exceeds the applicable I.R.C. § 7520 rate).

[51] Mitchell M. Gans and Jonathan G. Blattmachr, Family Limited Partnerships and Section 2036: Not Such a Good Fit, at 3 n.7 (2017). Available at: See generally, Jonathan G. Blattmachr, A Primer on Charitable Lead Trusts: Basic Rules and Uses, 134 TR. & EST., Apr. 1995, at 48.

[52] Id.

[53] Id. See generally, Paul S. Lee, Turney P. Berry & Martin Hall, Innovative CLAT Structures: Providing Economic Efficiencies to a Wealth Transfer Workhorse, 37 Actec L.J. 93 (2011) (provides an in-depth discussion of choosing a remainder beneficiary and the associated tax consequences).

[54] Peter Melcher & Matthew C. Zuengler, Maximizing the Benefits of Estate Planning Bet-to-Die Strategies: CLATs and Private Annuities, 9 J. Retirement Plan. 21, 23 (2006). See also, Parenti, supra note 45, at 25.

[55] See Melcher, at 23.

[56] See id. (citing Reg. §25.2522(c)-3(d)(2), Ex. 1).

[57] See id.

[58] I.R.C. § 2036.

[59] Estate of Wyly v. Comm’r, 610 F.2d 1282, 1290 (5th Cir. 1980).

[60] Estate of Lumpkin v. Comm’r, 474 F.2d 1092, 1097 (5th Cir. 1973).

[61] See generally United States v. Byrum, 408 U.S. 125 (1972); Estate of Harper v. Comm’r, 93 T.C. 368; Estate of Thompson v. Comm’r, 382 F.3d 367 (3d Cir. 2004), aff’g T.C. Memo. 2002-246, 2002 WL 31151195; Kimbell v. United States, 371 F.3d 257 (5th Cir. 2004); Estate of Bongard v. Comm’r, 124 T.C. 95 (2005); Estate of Strangi v. Comm’r, T.C. Memo. 2003-145, aff’d 417 F.3d 468 (5th Cir. 2005); Estate of Rosen v. Comm’r, T.C. Memo. 2006-115, 2006 WL 1517618; Estate of Bigelow v. Comm’r, 503 F.3d 955, 969 (9th Cir. 2007); Estate of Stone v. Comm’r, T.C. Memo. 2012-48, 2012 WL 573003, Estate of Powell v. Comm’r, 148 T.C. No. 18 (2017); Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607.

[62] Estate of Moore v. Comm’r, T.C. Memo 2020-40, 2020 WL 1685607, at *13-14.

[63] Estate of Bongard v. Comm'r, 124 T.C. No. 8 (2005).

[64] Id. at *97.

[65] Id. at *130.

[66] Id. at *97.

[67] Id. at *98.

[68] Id.

[69] Id.

[70] Id.

[71] Id.

[72] Id.

[73] Id.

[74] Id. at *113-14.

[75] Id. at *112-13.

[76] Id. at *125.

[77] Id. at *131.

[78] See id. at *113

[79] Id. at *113. (citing Helvering v. Hallock, 309 U.S. 106, n. 7 (1940); Estate of Shafer v. Comm’r, 749 F.2d 1216, 1221-22 (6th Cir.1984), affg. 80 T.C. 1145, 1983 WL 14846 (1983); Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir.1971) (stating that section 2036 “describes a broad scheme of inclusion in the gross estate, not limited by the form of the transaction, but concerned with all inter vivos transfers where outright disposition of the property is delayed until the transferor's death”)).

[80] Id. at *125.

[81] Id. at *129.

[82] 371 F.3d 257, 258 (5th Cir. 2004).

[83] Estate of Bongard v. Comm'r, T.C. No. 8, at *119 (2005) (citing Kimbell v. United States, 371 F.3d 257, 258 (5th Cir. 2004)).

[84] Id. at *117-18 (citing Estate of Stone v. Comm’r, T.C. Memo. 2003-309; Estate of Harrison v. Comm’r, T.C. Memo. 1987-8; Estate of Harper v. Comm’r, T.C. Memo. 2002-121).

[85] Id. at *122, 123.

[86] Id. at *123.

[87] Id. at *125.

[88] Id. at *128-29.

[89] Id.

[90] Id. at *128.

[91] Id. at *128-29.

[92] Id. (quoting Estate of Harper v. Comm’r, T.C. Memo. 2002-121).

[93] Id. at *129.

[94] Id. at *131.

[95] Id. at *129 (quoting Sec. 20.2036–1(a), Estate Tax Regs).

[96] Id. at *131.

[97] Id.

[98] See id.supra note 75.

[99] T.C. Memo. 2003-145, aff’d 417 F.3d 468 (5th Cir. 2005).

[100] Strangi v. Comm’r, 417 F.3d 468, 473 (5th Cir. 2005).

[101] Id.

[102] Id. at 472-73.

[103] Id. at 473.

[104] Id.

[105] Id.

[106] Id.

[107] Id.

[108] Id.

[109] Id. at 474.

[110] Id.

[111] Id. at 475.

[112] Id. at 475, 478 n.7.

[113] Id. at 478.

[114] Id. at 476.

[115] Id. at 478.

[116] Id. at 476 (quoting United States v. Byrum, 408 U.S. 125, 145.)

[117] See Estate of Bongard v. Comm'r, T.C. No. 8, at *113, *131 (2005).

[118] 417 F.3d 468, 477.

[119] Id. at 477-78.

[120] See id. at 478-482.

[121] Id. at 478.

[122] Id. at 478, 478 n.7.

[123] See Estate of Powell v. Comm’r, 148 T.C. No. 18, at *400-05 (2017).

[124] T.C. Memo. 2003-145 (2003), 2003 WL 21166046, at *12, *16.

[125] See id. at *15-16.

[126] Id. at *15.

[127] Id.

[128] Id. at *16.

[129] 408 U.S. 125.

[130] Id. at *14.

[131] Id. at *18.

[132] Id.

[133] 148 T.C. No. 18 (2017).

[134] Id. at *394-95.

[135] Id.

[136] Id. at *395.

[137] Id.

[138] Id.

[139] Id. at *393-95.

[140] Id. at *398.

[141] Id. at *399.

[142] Id.

[143] Id.

[144] Id. at *404.

[145] See T.C. Memo. 2003-145, 2003 WL 21166046, at *12-18.

[146] 148 T.C. No. 18, at *401 (citing I.R.C. § 2036(a)(2)).

[147] Id.

[148] See Id.

[149] Id. at *401-02.

[150] Id. at *404.

[151] Id.

[152] Id.

[153] Id.

[154] Id.

[155] T.C. Memo. 2020-40, 2020 WL 1685607.

[156] Id. at *1.

[157] Id. at *2.

[158] Id.

[159] Id.

[160] Id.

[161] Id. at *3.

[162] Id. at *2.

[163] Id. at *6.

[164] Id.

[165] Id. at *9.

[166] Id. at *12.

[167] Id. at *13.

[168] Id. at *12.

[169] Id. at *11-12.

[170] Id. at *12, *12 n.16.

[171] Id. at *12.

[172] See Strangi, supra notes 116-17.

[173] T.C. Memo 2020-40, 2020 WL 1685607, at *12-13.

[174] Id.

[175] Id.

[176] See Strangi, supra note 119.

[177] Id. at *13.

[178] Id.

[179] Id.

[180] Id. See also, Estate of Thompson v. Comm’r, 382 F.3d 367, 373 (3d Cir. 2004), aff’g T.C. Memo. 2002-246, 2002 WL 31151195 (stating the Tax Court acknowledged the decedent’s transfers altered the “formal relationship” between decedent and his assets, however, as a practical matter, “nothing but legal title changed[]” (quoting T.C. Memo. 2002-246, 2002 WL 31151195, at 387)); Estate of Rosen v. Comm’r, T.C. Memo. 2006-115, 2006 WL 1517618, 91 T.C.M. (CCH) at 1235-36 (explaining given decedent’s old age and poor health, it was implied that decedent’s children would not prevent her from continuing to use her transferred assets).

[181] Id. Because the Tax Court held for inclusion under I.R.C. § 2036(a)(1), the court did not address the Commissioner’s alternative arguments that decedent’s estate plan triggered inclusion under I.R.C. § 2036(a)(2); or that the subsequent transfer of the Living Trust’s assets to the Irrevocable Trust also triggered their inclusion under I.R.C. § 2036. Id. at *13, n.17.

[182] Kimbell v. United States, 371 F.3d 257, 261 (5th Cir. 2004).

[183] Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607, at *10 (citing Estate of Bongard v. Comm’r, 124 T.C. 95, 112 (2005)).

[184] Id. (citing Kimbell, 371 F.3d at 261).

[185] See Estate of Bongard v. Comm'r, T.C. No. 8, at *117-18 (2005) (citing Estate of Stone v. Comm’r, T.C. Memo. 2003-309; Estate of Harrison v. Comm’r, T.C. Memo. 1987-8; Estate of Harper v. Comm’r, T.C. Memo. 2002-121); Estate of Moore v. Comm’r, T.C. Memo 2020-40, 2020 WL 1685607, at *9, *11-12.

[186] Estate of Bongard, T.C. No. 8, at *117-18 (2005).

[187] Estate of Moore, T.C. Memo 2020-40, 2020 WL 1685607, at *10 (citing Estate of Bongard, T.C. No. 8, at *117-18 (2005)).

[188] Strangi v. Comm’r, 417 F.3d at 476 (quoting United States v. Byrum, 408 U.S. 125, 145 (1972)).

[189] Estate of Strangi v. Comm’r, T.C. Memo. 2003-145, 2003 WL 21166046, at *16 (2003).

[190] See id. at *12, *16 (discussing decedent’s ability to act alone, or through his attorney-in-fact, to cause distributions of property previously transferred to partnership triggers inclusion under I.R.C. § 2036).

[191] Estate of Powell v. Comm’r, 148 T.C. No. 18., at *401 (2017).

[192] Estate of Wyly v. Comm’r, 610 F.2d 1282, 1290 (5th Cir. 1980).

[193] I.R.C. 2035; I.R.C. 2036.

[194] Julia Kagan, Three-Year Rule, Investopedia, (June 20, 2020), (last visited August 1, 2020).

[195] Will Kenton, Bundle of Rights, Investopedia (May 19, 2019), (last visited August 1, 2020).

[196] Id.

[197] See Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607, at *14-19. I.R.C. § 2043 provides for a consideration offset for some lifetime transfers by a decedent that I.R.C. §§ 2035-2038 include in the gross estate resulting in a net inclusion amount. Benjamin A. Cohen-Kurzrock, Estate of Moore: Tax Court Finds Estate Tax Traps in ‘Deathbed’ Plan, Tax Practice: Tax Notes Federal 1359, 1361 (May 25, 2020). In Estate of Powell, the Tax Court stated the net inclusion amount as “equal[ing] any discount applied in valuing the partnership interest the decedent received plus any appreciation (or less any depreciation) in the value of the transferred assets between the date of the transfer and the date of death.” 148 T.C. at 408 n.7. This method for determining the net inclusion amount does have the downside of possibly double counting increases or decreases in transfer tax depending on whether posttransfer valuation increases or declines in the value of the transferred assets are reflected in the value of the closely held interest owned by the decedent. Cohen-Kurzrock, at 1361-62. In order to protect against this possible duplication, the Tax Court in Estate of Moore provided a formula for determining the appropriate inclusion amount and provided four hypothetical examples of its application. See Estate of Moore, at *14-16.

[198] T.C. Memo. 2020-40, 2020 WL 1685607, at *2.

[199] Id. at *13-14.

[200] Id. at *12.

[201] Powell, 2017 WL 2211398, at *2.

[202] Id. at *404.

[203] Id.

[204] See Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607, at *12.

[205] 417 F.3d 468, 477-78.

[206] Id.

[207] T.C. Memo. 2020-40, 2020 WL 1685607, at *12-13.

[208] See Estate of Bongard v. Comm'r, T.C. No. 8, at *122-25 (2005).

[209] Id. at 122, 123.

[210] Estate of Moore v. Comm’r, T.C. Memo. 2020-40, 2020 WL 1685607, at *11.

[211] See Estate of Powell v. Comm’r, 148 T.C. No. 18, at *401 (2017).

[212] Estate of Moore v. Comm’r T.C. Memo 2020-40, 2020 WL 1685607, at *5.

[213] Strangi v. Comm’r, 417 F.3d 468, 478 (5th Cir. 2005).

[214] Id. at *15-16.

[215] Estate of Powell v. Comm’r, at *401 (citing I.R.C. § 2036(a)(2)).

[216] Estate of Bongard v. Comm’r, 125 T.C. 95, 112 (2005).

[217] See Estate of Moore v. Comm’r T.C. Memo 2020-40, 2020 WL 1685607, at *10.

[218] Id.

[219] 125 T.C. 95, 112 (2005).

[220] See T.C. Memo 2020-40, 2020 WL 1685607, at *10.


Uncovering Four Ways That Biden’s American Families Plan Attacks Your Wealth


Do the rich pay their fair share? Federal income taxes and adjusted gross income earned in 2018

Beckett Cantley
Geoffrey Dietrich

President Biden sent ripples through the financial world when he proposed a “once-in-a-generation” investment in the foundations of middle-class prosperity [1]  with a tax reform agenda set to neutralize the wealth disparity in our country.

What is the Intent of the Biden American Families Plan? 

The proposed agenda in the American Families Plan (“AFP”) marks an ambitious proposal to reconfigure both how the United States rewards the American Dream and how it proposes to roll out enough social programs to solve what ails our country.  It proposes paying for those programs with an equally ambitious plan to tax the wealthy in ways heretofore unimagined—or if imagined, previously unattainable.

From the outset, it is vitally important to recognize that “tax” is a multi-layered conversation and, depending on the facts used, any conversation about tax will have different outcomes.  This article does not attempt to fully explore all facts. Instead, it seeks to start a conversation and aid in understanding the proposed agenda. Thus, first we will touch on some facts related to the actual amounts of tax paid by the wealthy.  Next, we discus the capital and ordinary income tax proposals raised in the AFP. Finally, we explore some potential outcomes if the AFP is passed into law.

President Biden has said, on several occasions, that America’s wealthy need to “just pay their fair share.”  While we recognize most Americans distrust the tax system (and in many cases, government generally), most Americans do believe they should pay “something” in tax.  After all, this is the greatest nation in the world with access to public services, including free schooling for our children, and rights, such as free speech, which we often take for granted. Most Americans’ views start to differ when “fair share” becomes a rally cry with reports on billionaires qualifying for certain tax credits reserved to the poor.   Again, not to delve into the probably-completely-legal-and-ethical means by which corporations and their owners manage taxation, we present the following graphic from the Heritage Foundation :

As shown above, the “wealthy” (limited to only the top 1%) pay a staggering 40% of all tax revenue, as reported by the IRS.  When you include those Americans making above $200,000 per year as “wealthy,” it becomes 60%.  This is after the 2017 Tax Cuts and Jobs Act “reduced tax bills for the lowest-income Americans by 10% while only cutting taxes for the top 1% by 0.04%” according to the Heritage Foundation. Reasonable minds may differ on what “fair share” amounts to, as—arguably—certain demographics are able to take greater advantage of the tax system than others.

How Does the AFP Tax Plan Attack the Wealthy

The AFP Tax Plan promises to improve life for all Americans with increased taxation on the wealthiest Americans without compliantly reduced taxable income.  It is nearly impossible to keep current with the proposals and all their changes, so we focus on four tax points discussed regularly and the wealth neutralizers “hidden” in plain sight.

  1. First, the Biden Administration proposes raising the top marginal income tax rate from 37% to 39.6%. This would apply to income  over $452,700 for single or head of household filers and $509,300 for joint filers.  This is not good news for well-compensated individuals or joint income families entering the top tax bracket approximately $105,000 sooner than they would otherwise.
  2. Next, the Biden Administration proposes taxing long-term capital gains and qualified dividends at the ordinary income rates for taxpayers with taxable income above $1 million. When combined with the proposed new top marginal rate of 39.6% and the 3.8% Net Investment Income Tax (“NIIT”)—the flat tax affectionately known as the “Obamacare Surcharge”—the  top marginal rate becomes a whopping 43.4% .
  3. We uncover a “hidden” attack on your wealth in the tax on unrealized gains at death above $1 million ($2 million for joint filers, plus the current law capital gains exclusion of $250,000/$500,000 for primary residences).  This is a rally point for the advocates of closing tax “loopholes.”  Sadly, many Americans —especially middle-class taxpayers—pass wealth by transferring appreciated property upon the death of a loved one.  The transfer of a family home, family farms, or other appreciated property with low basis upon the death of a loved one would become a target-rich environment of previously untouchable gains.
  4. The final attack we uncover is hiding in the expansion of previous taxation to which we have already grown accustomed. In addition to the other points previously discussed, the Plan would apply the NIIT 3.8% to  active pass-through business income  above $400,000.  This wealth neutralizer hides in plain sight in a proposal to close perceived “gaps” in the tax law between the FICA and SECA taxes.  There are currently four identified “gaps”:
    1. distributions to active S corporation shareholders;
    2. distributions to active limited partners;
    3. gains from the sale of business property from active non-trading businesses (like an MRI machine used by a radiology practice or a truck used by a construction company) which might not be subject to NIIT for active partners in the business; and
    4. active LLC members.

How Might the AFP Tax Plan Do More Harm Than Good

The Administration makes its projections on eight (or ten) year plans for revenue.  However, the revenue to be raised requires fifteen years to reach its funding goal (in a vacuum).  Thus, the AFP begins with a five-to-seven-year shortfall.  Unfortunately, even if the laws backdate eligibility or claw back income to fall under the future laws, it is unlikely to catch everyone. We wonder how many Fortune-level companies will pay their Big 4 accounting firms to find a way to pay some tax in year one only to plan an escape after that?  If some of the biggest companies do so, the AFP loses tax dollars during the next nine tax years.

Corporations with sufficient revenue at risk are likely to go offshore (again) to take advantage of better tax treaties. Apple’s (and others’) use of the Dutch-Irish Sandwich should provide a good example of the lengths a corporation will go to limit or reduce taxation by even just small percentages.

The truly wealthy are likely to move assets and income to creditor protection jurisdictions and take advantage of legitimate investments with income tax benefits for their investments and wealth. Individuals will find other ways to pass income and transfer wealth or push off selling businesses/stock/houses/etc. The tax on the wealthy may face significant hiccups in tax collection, even with a doubled budget for the IRS.  This could be why the Biden Administration is putting such a priority on global corporate and minimum taxes.  With all the tax minimization options available to wealthy individuals, it is questionable how we will pay for these social programs.

Likely scenarios resulting from Biden’s AFP Tax Plan

The tax starts to trickle down.  We are possibly seeing it now with the lowered upper income bracket.  Increased corporate taxes do not mean less money to the wealthy. It usually means higher prices, increased costs passed on to consumers, and more entry level jobs being handled by robots or self-service kiosks (think Wal-Mart self-check and McDonald’s ordering kiosks).

If you have clients in the upper income brackets who share these concerns, the attorneys at Cantley Dietrich would enjoy having a conversation with you about how you can protect them from some of the challenges they will likely face in the next few years.


  1. Prof. Beckett Cantley (University of California, Berkley, B.A. 1989; Southwestern University School of Law, J.D. cum laude 1995; and University of Florida, College of Law, LL.M. in Taxation, 1997), teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C. Prof. Cantley would like to thank Melissa Cantley and his law clerk, Reed Green, for their contributions to this article.

  2. Geoffrey Dietrich, Esq. (United States Military Academy at West Point, B.S. 2000; Brigham Young University Law School, J.D. 2008) is a shareholder in Cantley Dietrich, P.C.


Captive Insurance Company FAQs


Captive Insurance Company FAQs

by Beckett Cantley[1] and Geoffrey Dietrich[2]

This article is intended to provide a basic set of frequently asked questions on captive insurance companies. The questions are in no way meant to be exhaustive on the subject, but rather solely cover certain basic uniform questions potential captive insurance company owners need to ask before forming one. Please note that the authors only advise captive owners and advisors on specific issues of captive insurance law and do not form or operate captive insurance companies.

Captive Insurance Company FAQs

What is an IRC § 831(b) Captive Insurance Company?

An Internal Revenue Code (“IRC”) § 831(b) small captive insurance company (“CIC”) is, in essence, a corporation formed to offer insurance to a parent corporation or other affiliated entities.[3] The CIC may offer administrative and tax benefits over self-insurance and commercially available insurance. The questions addressed below briefly discuss the history, the structural details, and the potential benefits.

How Did Captive Insurance Start?

Captives emerged as a planning tool in the 1950’s.[4] Fred Reiss created American Risk Management in 1958 to assist U.S. corporations in establishing their own insurance companies as an alternative to conventional risk management.[5] Due to the peculiarities of state insurance laws at the time, most CICs were formed outside the U.S., often in “debtor havens” where the companies experienced few, if any, local tax consequences.[6] After the U.S. passed tax legislation temporarily eliminating many benefits of CIC insurance arrangements for U.S. companies, Reiss formed International Risk Management in Bermuda.[7] This move precipitated the dominance of offshore domiciles in the CIC market for the remainder of the twentieth century.[8]

Historically, CICs were most often utilized by large U.S. corporations.[9] One common motivation was, and continues to be, a company’s inability to purchase commercial insurance at acceptable premium and coverage levels.[10] The taxpayers in Consumers Oil[11] and Weber[12] had operations in areas prone to flooding and neither taxpayer was able to obtain commercial insurance coverage due to the elevated risk.[13] Similarly, the taxpayers in Gulf Oil[14] and Ocean Drilling[15] operated in high-risk industries and were only able to obtain commercial insurance at prohibitively high prices. The companies formed CICs to provide the coverage they could not otherwise obtain under acceptable terms.

Another common theme is a company’s desire for more administrative control over the insurance policy.[16] Beech Aircraft[17] was unable to obtain commercial insurance that would allow the company to control its legal defense in the event of a claim. [18] The company had been sued under a previous policy, and the jury returned a sizeable verdict against the company, the majority of which was designated as punitive damages.[19] After an investigation, the company was convinced that the verdict was a result of a failure by the insurer’s legal team to adequately prepare and try the case.[20] The company had monitored the activity of the insurer’s attorneys during the course of the trial, and even unsuccessfully filed a motion to have those attorneys removed.[21] To afford itself more control over the administrative terms of the policy, the company formed a wholly owned subsidiary CIC.[22]

Throughout the 1970’s and 1980’s, judicial and executive interpretation identified circumstances under which a CIC insurance arrangement would be respected in the U.S.[23] In general, courts ruled captive structures were valid insurance companies when they either insured a sufficiently large number of the parent company insureds[24] or obtained at least 30% non-parent risk.[25] Increased certainty through pro-taxpayer decisions led to increased utilization of CICs as a risk management strategy by major U.S. corporations.[26] States began passing legislation enabling formation of CICs, and more growth to the domestic sector resulted.[27] A concomitant increase in courtroom activity led to a rise in certainty as judges circumscribed the permissibility of CICs.[28] A critical mass accumulated in the 1990’s, and the CIC industry “exploded” as smaller and even privately-held businesses began to view CICs as an attractive alternative to more common risk management strategies.[29] Today, a majority of states have passed CIC-enabling legislation.[30]

What Can a Captive Do?

Generally speaking, a CIC may offer coverage of virtually any type to the operating business, and the terms of the policy are remarkably flexible.[31] By far the most common arrangement is for the parent company to maintain existing coverage through commercially available policies while having the captive fill policy gaps[32] and provide coverage for stochastic (low frequency, higher payout) risks.[33] Also, Congress has provided a tax incentive for the formation of IRC § 831(b) small CICs. In effect, the tax code helps offset the costs of establishing and operating a regulated, small insurance company.

What are the Benefits of a Captive?

A CIC may afford its owners numerous benefits. A CIC can provide niche coverage for unique or specific risks that would not be otherwise transferrable, or not transferrable at an acceptable cost, in the commercial insurance market. This is especially advantageous to an entity with an above average risk profile that seeks to reduce its exposure in a cost-effective manner. Thus, so long as the policies are commercially reasonable, a CIC owner can “create whatever type of coverage for the operating business [he] can dream up.”[34] In his authoritative book on the subject, Jay Adkisson lists dozens of policy types ranging from the relatively mundane, e.g, errors and omissions, and malpractice, to the somewhat esoteric, e.g., confiscation and expropriation, and weather risks.[35] Moreover, as highlighted by the Beech Aircraft case, the policy terms may be tailored to meet the individual needs of the insured, again, subject to commercial reasonableness.

Also, a CIC may be used as a means of cost stabilization for an insured who has grown weary of premium increases in a hardening commercial insurance market. These increases may be based on market forces or underwriting software rather than the claims experience of the insured entity. For a company with a better than average loss experience, a CIC can save premium dollars that would otherwise be used to subsidize the loss experience of other market members.

Next, a CIC can reduce or eliminate brokerage commissions and marketing and administrative expenses, which are typically wrapped into commercial insurance premiums. Thus, a CIC arrangement allows a business to potentially lower its overhead while leaving more premium dollars in reserve for claims payment and surplus investment. If the CIC “wins its gamble” with the insured, it can generate profit for the parent corporation that would otherwise accrue to the commercial insurer. As surplus funds accumulate, the funds can be invested. Moreover, a parent corporation may generally exercise some control over the investment decisions of the CIC.

In addition to these benefits, Congress has provided a tax incentive for CIC formation under IRC § 831(b). In effect, § 831(b) helps offset the costs of establishing and operating a regulated, small insurance company. A valid IRC § 831(b) CIC may allow a parent corporation to manage risk exposure without incurring the income tax problems associated with self-insurance. Whereas contributions to a reserve account for self-insurance are generally not tax deductible, premiums paid to a CIC by its insured entity may be deductible, similar to the deductibility of premiums paid for commercial insurance. IRC § 162(a) provides that “there shall be allowed deductions on necessary and ordinary business expenses incurred in carrying on a business.” Treasury Regulations § 1.162-1(a) states that business expenses include insurance premiums paid on policies covering fire, storm, theft, accident, or similar losses in the course of business. Thus, provided that the CIC is considered an “insurance company,” issuing “insurance” through arrangements that are considered “insurance contracts,” as discussed above, the parent corporation should be able to deduct premium payments to the CIC.

Furthermore, a CIC may earn premiums, within limits, without incurring federal income tax. IRC § 831(a) provides that tax shall be imposed under IRC § 11 on the taxable income of any insurance company other than life insurance companies. However, IRC § 831(b) provides that a non-life property and casualty insurance company, which receives annual premiums not to exceed $2.3 million, can elect to receive these premiums tax-free. Thus, the CIC would incur no tax on underwriting income earned on premiums paid, so long as the aggregate premiums total less than $2.3 million annually.

Notably, the CIC is still taxed on income earned through investment activity. Assuming that the CIC is profitable in its underwriting and investment operations, profits will be distributed to the CIC shareholders in the form of dividends. Alternatively, a CIC shareholder could realize profits through the sale of his shares in the CIC. In either the case of a qualified dividend or sale of stock, the income would be taxed at the long-term capital gains rate, under current law, rather than at the rate applicable to ordinary income.

How is a Captive Owned?

Typically, a CIC is either owned directly by its parent corporation or by the shareholders of the parent corporation. The organizational structure of a CIC closely resembles that of a mutual insurance company, albeit for a more limited number of participants. “CIC” refers to a brother-sister arrangement in the discussion below unless otherwise noted. Without belaboring the details of the day-to-day operation of an insurance company, this discussion seeks to give a brief overview of selected topics. The CIC and its insured should independently operate in an arms-length relationship to the greatest extent possible.[36] Thus, while the CIC should be tightly woven into the parent company’s overall business plan to maximize efficiency, the CIC should maintain its own business goals and plan for success.

Who Manages a Captive?

The ongoing management of the CIC is critical in ensuring the success of the enterprise. The CIC should recruit appropriately credentialed professionals to fulfill management, underwriting, accounting and audit duties. The insurance manager fills the fundamental role of determining which risks to underwrite and drafting the policies that insure the chosen risks. The insurance manager must seek actuarial assistance in evaluating risks and determining premium and reserve levels. Also, it is ultimately the insurance manager’s responsibility to ensure that the CIC complies with its license terms, regulatory requirements, deadlines, and the like.

Are Captives Audited?

Most jurisdictions require annual audits of insurance companies by an accounting firm approved by the Insurance Commissioner. Choosing a firm that is experienced in CIC insurance may help the CIC avoid the myriad pitfalls that await CICs in the IRC.

The CIC should undergo periodic reevaluation to maximize efficiency. Such reevaluation may allow a CIC to underwrite more risk given its capital structure, and the goals of management. Moreover, risks currently underwritten by the CIC may have become more inexpensive to insure in the commercial market, again, subject to management goals. Typically, a CIC must provide notice to the Insurance Commissioner of its jurisdiction when there will be significant changes to its operations or ownership structure.[37]

How are Captive Insurance Companies Formed?

Aside from what structure the CIC will take, many factors must be considered before undertaking the formation of a CIC. First, an experienced attorney or consultant should be engaged to perform a feasibility study.[38] This will provide the prospective owner with an independent, clinical opinion as to whether a CIC is an appropriate vehicle to achieve the desired benefits, given the owner’s business and overall financial plan. This step should also begin to educate the proposed owner of the regulatory and compliance requirements associated with operating an insurance company according to the statutory regime of the licensing jurisdiction.

Also, a detailed actuarial study should be prepared, and, in fact, generally must be submitted with the insurance license application. The actuarial study should determine the amounts and types of coverage that will be underwritten. The study should also include information as to how the premium amounts will be determined and the capitalization requirements associated with the new CIC. There should be no communication between the potential insured, the party supervising the study, and the actuary that attempts to manipulate the numbers to arrive at tax-friendly numbers. Once the feasibility and actuarial studies are completed, the insurance license application can be submitted in the jurisdiction of choice.

Where are Captive Insurance Companies Formed?

A CIC can be formed and licensed pursuant to the laws of a U.S. state, or those of a foreign country. The company will be “domiciled” in the jurisdiction where it was formed. Many factors impact the decision as to whether to form the CIC domestically or offshore and the choice between domiciles in either arena. Those factors include, but are not limited to: (1) the CIC’s exposure to the U.S. tax system; (2) the capitalization burden required at formation; (3) the flexibility the CIC is allowed in investing its resources; and, (4) the asset protection afforded the U.S. shareholders of the CIC.[39]

The tax and compliance burdens imposed by U.S. law on a CIC and its U.S. shareholders may be a consideration in deciding whether to form a CIC domestically or offshore. Notably, an organization in an offshore jurisdiction will not preclude the IRS from assessing and collecting U.S. income tax. Therefore, the decision as to whether to form a CIC in a domestic or offshore jurisdiction should be made based on the local reporting requirements and taxation to which a CIC would be subject, accepting as fact that the IRS is quite capable of visiting federal income taxation on an offshore CIC.[40]

Both domestic and offshore CICs are subject to U.S. income taxation. A foreign CIC may elect to be taxed as a domestic entity under IRC § 953(d).[41] A company making such an election directly subjects all income earned globally to U.S. federal income tax, rather than indirectly through its U.S. shareholders under IRC subchapter F.[42] The benefits to a U.S.-owned offshore CIC making an IRC § 953(d) election include exemption from the federal excise tax (“FET”), simplified compliance and administration and, at least theoretically, communication to the IRS that the CIC need not be subjected to heightened scrutiny by virtue of its offshore domicile.[43] An IRC § 953(d) election is irrevocable absent IRS consent.[44]

A CIC that chooses not to make an IRC § 953(d) election could find itself categorized as a controlled foreign corporation (“CFC”) if more than 25% of its shares are held by U.S. owners.[45] A CFC classification would render the CIC income currently taxable its U.S. shareholders. Under these circumstances, the U.S. shareholders of the CIC would be required to currently include all CIC profits not directly allocable to insurance contracts issued on risks outside the U.S. in the CIC owner’s taxable income, irrespective of the timing of the distributions.[46]

What are the Disadvantages of Forming a Captive Insurance Company Offshore?

The disadvantages of forming a CIC under the laws of a foreign country potentially include subjecting the policy premiums to the FET and increasing the compliance burden of the CIC by exposing the company to a greater risk of an intrusive audit.[47] Policy premiums paid to an offshore CIC by a U.S. insured may be subject to the FET if the IRS views the arrangement as an “importation” of a foreign service. Foreign services imported to the U.S. are subject to the FET. Specifically, property/casualty premiums paid to an offshore CIC by a U.S. insured are subject to a FET of 4% for original insurance and 1% for reinsurance.[48] Because the offshore CIC provides insurance, actuarial, and management services to its U.S. shareholders, the IRS may view the arrangement as an “importation” of foreign services, thus exposing its U.S. shareholders to the increased U.S. tax burden of the FET. While some domestic jurisdictions charge premium taxes, shareholders of a domestic CIC can generally avoid the additional tax liability in the form of premium taxes by simply choosing to organize the CIC in a state that does not require premium taxes.[49]

An otherwise compliant CIC should have nothing to fear from the mere fact that it is domiciled offshore. However, that offshore domicile alone may be enough to subject the company to an “ever-changing and perilous compliance burden” and a risk that the company will be swept up in the increasing number of IRS audits of offshore entities.[50] Around 2005, the Senate Permanent Subcommittee on Investigations (“PSI”), under the leadership of Senator Carl Levin, began to view U.S. taxpayers’ offshore holdings with increasing suspicion.[51] This sentiment grew out of the government’s reduced ability to monitor its citizens’ offshore holdings. When PSI investigations began to uncover empirical evidence supporting this suspicion, Congress, the Department of Justice, and the IRS became engendered with a belief that U.S. holdings in offshore arrangements were potentially abusive and evasive. Congress has enacted and continues to propose, numerous legislative schemes to assist the IRS in enforcing U.S. tax laws offshore. Without addressing the details of the various enacted or proposed legislation, it is sufficient to say that organizing a CIC offshore to reduce one’s exposure to U.S. tax laws is by no means a foolproof strategy.

How are Captives Capitalized?

The capitalization burden, or the sum of money required under local law to be contributed to a reserve account upon formation, will likely affect whether one decides to organize a CIC domestically or offshore, and the choice of domicile within these categories. Domestic jurisdictions have historically required between $300,000 and $300 million capitalization to form a CIC, depending on such factors as the type of CIC, the proposed coverage offered by the CIC, and the relationship between the CIC and the insured. Laypeople, and indeed some tax and insurance professionals, have long espoused the relaxed offshore regulatory environment as a benefit of organizing a CIC offshore. This perception arises in part from the lower minimum capital contributions typically required in offshore jurisdictions and the less restrictive rules and regulations many offshore jurisdictions impose on insurance and financial institutions. For example, offshore regulators generally rely on independent CPA verifications, whereas domestic regulators typically require examinations by state regulatory bodies and state-approved audit firms.

While the local regulatory environment is important in choosing a jurisdiction in which to found a CIC, a planner must not overlook the requirements superimposed on all insurance companies by the IRS The IRS must consider the CIC an insurance company for premiums to be deductible under IRC § 162, and for a CIC to receive the tax benefits of IRC § 831(b), and the policies issued must reflect an insurance arrangement. To consider a policy an insurance arrangement, the IRS must find that the risk of economic loss was shifted from the parent-insured to the CIC, i.e. “risk shifting”. Without adequate capitalization, the CIC may have insufficient reserves to cover its insureds’ current and anticipated claims. Because an insured would bear the entire risk of loss if his insurer failed to satisfy the insured’s claim, adequate capitalization factors heavily in determining whether risk has shifted between an insured and a CIC. Therefore, any CIC seeking to participate in the benefits bestowed upon insurance companies by the IRC may be subject to substantially higher capitalization requirements than those imposed by the offshore jurisdiction.

Notably, some U.S. states have made their minimum capitalization requirements more palatable in recent years. For example, Delaware reduced its requirement to $250,000 combined capitalization among separate CIC entities formed and administered as part of the same series. Under such an arrangement, a group of individual CIC entities may share the same capitalization. Thus, provided that all other CIC law is strictly observed, the individual entities can maintain the reserves necessary for proper risk-shifting while keeping their individual capitalization requirements reasonably low. Such domestic options at least warrant a second look from a prospective owner seeking to minimize his initial capital contribution without inviting IRS scrutiny.

What Investments Can a Captive Insurance Company Make?

One consideration in choosing whether to organize a CIC domestically or offshore is the investment flexibility a jurisdiction affords a CIC with respect to its surplus. Surplus is the income that a CIC retains in excess of the funds needed to satisfy its current claims. Some foreign jurisdictions permit a CIC to invest its surplus in any investment vehicle, provided the investment does not impair the capital base or run afoul of the foundational requirements of the insurance arrangement, including making investments so unreasonably illiquid as to potentially prevent the payment of its actuarially anticipated claims.[52] Because the primary responsibility of an insurance company is to pay claims as they arise, a CIC that fails to abide by its solvency requirements would not be considered a valid insurance company for any purpose. As such, while a foreign jurisdiction may permit a CIC greater investment flexibility, the CIC is still subject to the IRC requirements applicable to all insurance arrangements. A CIC not primarily engaged in the business of underwriting insurance or reinsurance activities would not be considered an insurance company.[53] Thus, CIC compliance with the regulations of the foreign jurisdiction is significant in assessing whether a CIC is primarily engaged in the business of insurance, but the controlling factor in analyzing whether a CIC qualifies as an insurance company is the nature of the business transacted in the taxable year.

IRS pronouncements warn that certain arrangements where an insurance company’s insurance business is outweighed by its investment activities may not withstand this analysis. While some of this guidance appears in the context of life insurance, which a CIC may not insure, the issues raised with respect to life insurance companies should apply with equal force to companies that insure risks other than life. IRS Notice 2003-34 warned taxpayers that investing in certain U.S. shareholder-owned offshore purported life insurance companies to defer recognition of ordinary income, or to re-characterize ordinary income as capital gains, may present a compliance risk. The IRS recognized that arrangements of this type are used to invest in hedge funds or those investments in which hedge funds ordinarily invest, typically resulting in a relatively small proportion of genuine insurance activities in comparison to the offshore entity’s investment activities.

These arrangements result in the offshore entity earning investment income substantially in excess of the entity’s ordinary insurance business needs. Shareholders often eschew any current distribution, claiming that since the appreciation arises from the conduct of insurance business rather than passive investment income, the appreciation constitutes capital gain instead of ordinary income. The IRS recognized that operating an insurance company will almost certainly involve investment activity. However, genuine insurance companies use the returns from their investments to satisfy claims, underwrite more business, and fund distributions to the company’s shareholders. A foreign jurisdiction’s certification of an entity as an insurance company under the jurisdiction’s local rules does not necessarily equate to IRS recognition of the entity as an insurance company, especially where the entity is not primarily occupied in the issuance or reinsurance of insurance or annuities. For federal income tax purposes, an entity is only considered an insurance company when it primarily employs its capital in the pursuit of income from underwriting additional insurance risks. In making this determination, the IRS will analyze an entity’s aggregate operations and sources of income.

The IRS may determine that an offshore CIC is not an insurance company for federal income tax purposes if the CIC is predominantly used as a conduit for hedge fund investment. Under such circumstances, the IRS could impose current taxation on those U.S. persons earning passive income through the offshore entity under the Passive Foreign Investment Company (“PFIC”) rules.[54] Under IRC § 1279(a), a foreign corporation is a PFIC if (1) 75% or more of the entity’s gross income is passive income, or, (2) at least 50% of the entity’s assets produce, or are held for the production of, passive income. Corporations engaged primarily in the active conduct of insurance business are outside the purview of the PFIC rules, as they are subject to federal income taxation under the IRC subchapter L U.S. life insurance company rules. IRS Notice 2003-34 stated that the IRS will challenge the validity of these types of investment schemes, through the application of the PFIC rules, on a finding that a foreign corporation is not an insurance company for federal tax purposes. Thus, the latitude a foreign jurisdiction gives a CIC with respect to investing its surplus may be significantly circumscribed, at least to the extent that the entity’s investment activities may not exceed its insurance activities, lest the CIC find itself challenged as a PFIC.

Does a Captive Insurance Company Provide Asset Protection?

Adding a layer of asset protection may enter into the calculus when deciding whether to organize a CIC domestically or offshore. Various offshore jurisdictions claim that their regulators hold information about CIC assets in strict confidence, allowing a CIC to be organized and operated in secrecy. Many people also believe that disclosure of the identity of the parent entity to the IRS can be avoided through a valid IRC § 953(d) election, on the rationale that the CIC itself is the U.S. taxpayer and owner of all CIC assets. Avoiding disclosure to both foreign and domestic authorities may seem a beneficial attribute of offshore CIC organizations. Such secrecy may render a creditor unable to follow the money, leaving him less enthusiastic about the prospect of costly, protracted litigation, given the uncertainty as to whether the debtor is “judgment proof.”

Moreover, an IRC § 953(d) election could force a creditor to file suit against the CIC in the courts of the offshore domicile, effectively allowing the CIC to choose both the venue and the controlling law. Such a result is possible because a valid IRC § 953(d) election applies only to the IRC, and not to any other titles of the U.S. Code, including the Federal Rules of Civil Procedure. Thus, a creditor would be unable to argue that the CIC was domiciled in the U.S. and would have to prove that the U.S. court had personal jurisdiction over the CIC. A U.S. court could only exercise personal jurisdiction over the corporation on a showing that the corporation had the requisite minimum contacts with the jurisdiction or had purposefully availed itself of the U.S. court’s jurisdiction. An offshore CIC that collects substantial premiums from a U.S. insured in exchange for insurance may indeed have sufficient contacts to fall within the U.S. court’s jurisdiction. However, assuming a U.S. court could not exercise personal jurisdiction over a foreign CIC, creditors would effectively be forced to bring suit against the CIC in the foreign domicile’s courts, under the foreign domicile’s laws. Creditors may be unwilling to undertake such a daunting task, particularly where the offshore domicile has strict asset protection and account secrecy laws. Furthermore, even if U.S. courts are able to exercise personal jurisdiction over the CIC, and a creditor secures a judgment against the corporation, the foreign jurisdiction may be unwilling to enforce the U.S. judgment. Such a blow could be fatal to a creditor in the case of a debtor who has few assets outside the offshore jurisdiction.

If a creditor secures a judgment against a U.S. citizen, a U.S. court may very well declare a transfer offshore illegal or invalid at its source. The Court may be hesitant to relinquish jurisdiction over a transfer it perceives as a fraudulent attempt to evade the transferor’s creditors, especially if the creditor successfully maneuvers the transferor into a bankruptcy action. U.S. bankruptcy courts have broad powers to invalidate transfers that hinder or delay satisfaction of a creditor’s claim, and often use these powers to frustrate offshore asset protection arrangements. A hypothetical debtor could transfer significant assets offshore and outside the debtor’s control and beneficial enjoyment in the form of premium payment to a foreign CIC in an effort to become insolvent. Once found insolvent, creditors could position the debtor into bankruptcy, and the bankruptcy trustee would take control of the debtor’s estate. The trustee may be able to force a waiver of the attorney-client privilege, and obtain any information provided to the debtor by an asset protection attorney. This would likely allow the bankruptcy trustee to uncover documents and information revealing the location of the debtor’s offshore assets. In the case of a CIC, this information would likely include the non-public records of where the CIC assets are located. Once the bankruptcy trustee uncovered this information, it would be an easy task to unwind an asset protection arrangement designed to render the debtor insolvent. Then, the bankruptcy trustee could reclaim the assets, or repatriate premiums paid to the CIC or assets purchased with those premiums to satisfy creditor claims.

U.S. courts have declared that it is against public policy to enforce the laws of a foreign jurisdiction where those laws violate established principles of U.S. law. Foreign jurisdictions that are known for asset protection often intentionally draft legislation to circumvent the laws of other jurisdictions, including the U.S. As such, a U.S. judge may be loath to apply a foreign law that is unlikely to withstand an attack on public policy grounds. Thus, if a U.S. court finds that foreign laws are being used in contravention of public policy, the Court may unwind an offshore CIC.

A creditor may successfully void a transfer of funds from a U.S. party to an offshore CIC if the creditor can convince the Court that the transfer was made for improper asset protection purposes. Thus, a court may rule that capitalization or premium payments made to an offshore CIC by a U.S. shareholder or insured are void ab initio, especially if the debtor is before the U.S. bankruptcy court, as discussed above. Moreover, if the IRS and DOJ suspect that a CIC was formed for asset protection, they may question whether the CIC is being primarily operated as an insurance company, irrespective of creditor claims.

How Do Captive Insurance Companies Operate?

A CIC is, first and foremost, an insurance company, and must be operated in a manner consistent with being predominantly in the business of insurance. To avail itself of the favorable tax treatment the IRC bestows upon insurance companies, a CIC must, of course, meet the definition of “insurance company.”[55] Failure to meet this requirement could result in the exposure of all of the entity’s income to C corporation double taxation. Treasury Regulations § 1.801-3(a) provide that an insurance company is one whose primary and predominant business activity is the issuance of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. Under IRC § 816(a), an “insurance company” is any company more than half the business of which during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by an insurance company.

Captives must also comply with the “Harper Test,” so named because it is based on three factors outlined in the Harper case.
The three factors are:
(1) Whether the arrangement involves the existence of an “insurance risk”;
(2) whether there was both risk-shifting and risk distribution; and
(3) whether the arrangement was for “insurance” in its commonly accepted sense.[56]

“Insurance risk” requires the insurance company to specifically define the risk, which is contained in the policy. In addition, the insured must be able to demonstrate a premium was paid and the insurance company issued an insurance policy. Risk shifting and distribution are covered below.

Insurance in its commonly accepted sense requires the transaction to comply with generally accepted industry practice.

The Harper court found adequate capital and arms-length premiums determinative, as was the existence of regulatory authority (here, the Hong Kong government). Other IRS documents have discussed the need for the captive to comply with the state law definition of an insurance company and the existence of standard insurance company documentation.[57]

If a CIC charges commercially unreasonable premiums and/or otherwise engages in non-arms-length transactions, the IRS may not respect the CIC as a legitimate insurance company. While arms-length dealing and separate management fees alone are not sufficient to prove that an entity is an insurance company, such conduct telegraphs the existence of a bona fide “insurance company.” As discussed above, any CIC hopeful of recognition as an “insurance company” must otherwise operate as an “insurance company,” employ professionals with the appropriate credential to fill critical roles within the company and comport with local licensing and capitalization requirements.

Also, an “insurance company” must provide “insurance” through “insurance contracts.”[58] Unfortunately, the IRC provides little guidance in defining these terms. In general, an agreement must transfer the risk of economic loss, contemplate the occurrence of a stated contingency, and comprise something more than a mere business or investment risk to receive insurance treatment for federal income tax purposes.[59] Insurance Services Offices often provide policies for captives.[60] A CIC must show that it has adequately shifted the risk of economic loss from the insured to the insurer (“risk shifting”), and that the insurer has adequately spread that risk among various insurance companies or other unrelated entities such that no single entity bears the entire risk of economic loss (“risk distribution”).[61] A CIC may accomplish this goal using IRS safe harbors or otherwise.

What is Risk Shifting?

In Helvering v. LeGierse, the United States Supreme Court (“Supreme Court”) analyzed the risk-shifting issue. In LeGierse, an elderly, uninsurable taxpayer purchased a life insurance policy and a life-only annuity contract one month before her death.[62] By purchasing the annuity contract from the same insurer, without which the insurer refused to issue the life insurance policy, the taxpayer neutralized the insurer’s risk with respect to the life insurance policy. The taxpayer purchased the life insurance policy primarily to take advantage of favorable estate tax treatment available, and the arrangement had a little net effect on her economic position. The Court held that because the life insurance policy and the annuity contract offset one another, there was no risk shifting from insured-to-insurer.

Risk shifting is only present when a party facing the risk of economic loss transfers some or all of the financial consequences of that potential loss to an insurer.[63] Risk shifting generally requires an enforceable written insurance contract, with premiums negotiated and actually paid at arms-length, and the insurance company to be a discrete entity capable of satisfying its obligations and properly formed under the laws of the applicable jurisdiction. The thrust of the risk-shifting analysis is whether the premium-paying party has truly transferred the economic impact of the potential loss to the insurer.[64]

The Humana[65] court held that an arrangement solely between a parent company and a subsidiary CIC could not be considered insurance for federal income tax purposes because it failed to shift risk from the insured to the insurer. Humana paid premiums on its own behalf to a wholly-owned CIC in exchange for coverage. The Court noted that the similarities between such an arrangement and a reserve account for self-insurance, contributions to which are not tax-deductible, were impossible to ignore. The underlying rationale for the Court’s decision was that Humana did not truly transfer any risk of loss to the CIC, since any loss incurred by the CIC would ultimately be absorbed by Humana as the sole owner of the CIC. Nonetheless, the Humana court held that an arrangement between a subsidiary CIC and several dozen other subsidiaries of the parent entity did satisfy the risk-shifting element. The Court reasoned that a loss incurred by the CIC would not directly transfer to the sibling subsidiaries in the same way a loss would transfer between a wholly-owned subsidiary CIC and its parent.

Notably, the Court stated that the doctrine of substance over form, discussed in greater detail in another of our FAQ articles, could be invoked to challenge the existence of separate and distinct entities, which are required to show the existence of risk shifting. However, the Court went on to state that the doctrine would only be applicable where no valid business purpose exists for the transactions or where a clear Congressional intent to curtail such transactions can be shown. The Humana court concluded that Congress had not yet manifested any intent to disregard the separate corporate entity in the context of CICs and respected the separate identities of the entities.

With proper planning and execution, a CIC should have no trouble showing a valid business purpose for maintaining separate corporate entities. Thus, a substance over form argument employed to challenge the existence of risk shifting should be ineffective unless the transaction is found to lack economic substance aside from mere tax benefits (discussed further, below).

Since Humana, the IRS has provided broad “safe harbor” rulings. In the main “safe harbor” provision, found in Revenue Ruling 2002-90, the IRS explained that an arrangement of at least twelve subsidiaries paying premiums to an affiliated CIC constitutes effective risk-shifting where each subsidiary has no more than 15% and no less than 5% of the total risk insured and none of the claimed twelve subsidiaries are disregarded entities.

Since the promulgation of the “safe harbor” provisions, the IRS appears eager to challenge a CIC on the grounds of risk-shifting in only the most egregious and abusive of circumstances. This underscores the importance of adhering to the general guidelines discussed above. Risk shifting may be questioned where guarantees exist to neutralize a CIC risk of loss and where contracts are not entered into at arms-length. Other factors the IRS may consider in a risk-shifting challenge include: whether the insured parties face a genuine hazard of economic loss in an amount which justifies premium payments made at commercially reasonable rates; whether the validity of insurance claims was investigated and established before the claims were paid; and, whether the CIC business operations and assets are maintained separately from the business operations and assets of the parent entity.

What is Risk Distribution?

Risk distribution is also required for an arrangement to be considered insurance. Risk distribution involves the pooling of insurance premiums from separate insured entities so that an individual insured is not paying for a significant portion of its own risk. Rather, the risks, and claims, of an individual insured would be subsidized in large part by the premiums paid by other insured entities in the pool.[66] The law of large numbers dictates that the likelihood of a single claim exceeding premium payments for a given period of time decreases as the length of time and number of insureds in a given pool increase.

A risk distribution analysis is broader in focus than that of a risk-shifting analysis. The risk distribution analysis looks to whether an insurer has distributed the risk of an individual insured over a larger group of entities, rather than strictly between the insurer and the single insured. Unfortunately, authority adequately discussing what constitutes risk distribution where risk shifting is found to exist is scarce. However, the Humana[67] court found that an arrangement where a CIC insured multiple sibling subsidiaries from an affiliated group constitutes valid risk distribution since the premiums paid by each insured could offset the CIC losses as a whole. While decisions have never established the minimum quantity of unrelated business sufficient to constitute risk distribution, courts have ruled that 30% is sufficient and 2% is not.

The IRS has issued several Private Letter Rulings that outline two different risk distribution models. In the first, the insured pays a premium to an insurance company, which then cedes risk back to the insured’s captive. For example, the insured pays a premium of $100,000 to an insurer, which then cedes a percentage of the risk (anywhere between $30,000 and $90,000) back to the captive. Here, the risk distribution occurs within the financial accounts of the insurance company, as the insured's premium is combined with those from other, unique insureds.

In the second, the insured pays the full premium to his captive, which then cedes at least 50% of its risk to a pool where other, unique insureds do the same. Then, after an insured’s pool contribution is mixed with other, unique insureds, the pool cedes most of the original contribution back to the insured.
For example, an insured pays $100,000 to his captive, which then cedes at last $50,000 of its premiums to a pool, which in turn returns a majority of the original funds to the captive.

In summary, to be treated as an insurance company for federal income tax purposes, a Captive Insurance Company must show that its insureds have adequately shifted their risk of loss to the CIC and that the CIC has adequately distributed that risk over various diverse entities. A CIC maintaining its own arms-length operational identity and conducting its business in a manner consistent with standard insurance industry norms will also support such treatment. If a CIC can meet these requirements, many advantages may be available to the CIC and its owner.


  • [1] Beckett G. Cantley, Esq. (University of California, Berkley, B.A. 1989; Southwestern University School of Law, J.D. cum laude 1995; and University of Florida, College of Law, LL.M. in Taxation, 1997) teaches International Taxation at Northeastern University and is a shareholder in Cantley Dietrich, P.C.
    The author may be reached for comment at
  • [2] Geoffrey C. Dietrich, Esq. (United States Military Academy at West Point, B.S. 2000; Brigham Young University Law School, J.D. 2008) is a shareholder in Cantley Dietrich, P.C.
  • [3] Beckett Cantley, Steering into the Storm: Amplification of Captive Insurance Company Compliance Issues in the Offshore Crackdown, Hous. Bus. & Tax L. J. 224 (2012).
  • [4] Beckett Cantley, F. Hale Stewart, Current Tax Issues with Captive Insurance Companies, Bus. L. Today, February 2014, 1.
  • [5] Jay D. Adkisson, Adkisson’s Captive Insurance Companies: An Introduction to Captives, Closely-Held Insurance Companies, and Risk Retention Groups, iUniverse, Inc., (2006) p. xiii.
  • [6] Id.
  • [7] Id.
  • [8] Id. at xiv.
    Beckett Cantley, F. Hale Stewart, Current Tax Issues with Captive Insurance Companies, Bus. L. Today, February 2014, 1.
  • [10] F. Hale Stewart, U.S. Captive Insurance Law, iUniverse, Inc. (2010) p. 5-6.
  • [11] Consumers Oil Corporation of Trenton v. United States, 166 F. Supp. 796, 797-798 (N.J. 1960).
  • [12] United States v. Weber Paper Co., 320 F.2d 199, 201 (8th Cir. 1963).
  • [13] Stewart, supra at 6.
  • [14] Gulf Oil Corp. v. C.I.R., 914 F.2d 396 (3d Cir. 1990).
  • [15] Ocean Drilling and Exploration Co. v. United States, 988 F.2d 1135 (Fed. Cir. 1993).
  • [16] F. Hale Stewart, U.S. Captive Insurance Law, iUniverse, Inc. (2010) p. 5-6.
  • [17] Beech Aircraft Corp. v. United States, Civil No. 82-1369, 1984 WL 988, *1 (D. Kan. 1984).
  • [18] Beech Aircraft Corp. v. United States, Civil No. 82-1369, 1984 WL 988, *1 (D. Kan. 1984).
  • [19] Id.
  • [20] Id. at *3.
  • [21] Id.
  • [22] Id. at *4.
  • [23] Id.
  • [24] Humana, Harper, Amerco
  • [25]
  • [26] Id.
  • [27] Id.
  • [28] Id.
  • [29] Id.[30] Id.
  • [31] Jay D. Adkisson, Adkisson’s Captive Insurance Companies An Introduction to Captives, Closely-Held Insurance Companies, and Risk Retention Groups, iUniverse, Inc., (2006) p. 56.
    [32] Donald S. Malecki, CGL Commercial General Liability, © 2005 The National Underwriter Company, (For example, the commercial general liability policy usually excludes coverage for product recall and damage to “your product.” A captive could write a “difference in conditions” or DIC policy to specifically fill all gaps in the third party policy.)
  • [33] Like commercially available insurance, captives have menu of standard coverages such as administrative actions, legal liability, product liability, product recall, pollution liability, etc…
  • [34]Jay D. Adkisson, Adkisson’s Captive Insurance Companies An Introduction to Captives, Closely-Held Insurance Companies, and Risk Retention Groups, iUniverse, Inc., (2006), 56.
  • [35] Id. at 56-68.
  • [36] Jay D. Adkisson, Adkisson’s Captive Insurance Companies An Introduction to Captives, Closely-Held Insurance Companies, and Risk Retention Groups, iUniverse, Inc., (2006) p. 2.
  • [37] Id. at 54-55.
  • [38] F. Hale Stewart, U.S. Captive Insurance Law, iUniverse, Inc. (2010) p. 31.
  • [39] Beckett Cantley, Steering into the Storm: Amplification of Captive Insurance Company Compliance Issues in the Offshore Crackdown, Hous. Bus. & Tax L. J. 224 (2012), 227.
  • [40] Id. at 269.
  • [41] See IRC § 953(d).
  • [42] Beckett Cantley, Steering into the Storm: Amplification of Captive Insurance Company Compliance Issues in the Offshore Crackdown, Hous. Bus. & Tax L. J. 224 (2012), 269.
  • [43] Id.
  • [44] Id.
  • [45] Id. at 268.
  • [46] Id.
  • [47] Id.
  • [48] See IRC § 4371.
  • [49] Id. at 269-70.
  • [50] Id. at 251-52.
  • [51] Id. at 242.
  • [52] Id. at 272.
  • [53] Treas. Reg. § 1.801-3(a).
  • [54] IRC§§ 1291-98.
  • [55] Beckett Cantley, The Forgotten Taxation Landmine: Application of the Accumulated Earnings Tax to I.R.C. § 831(b) Captive Insurance Companies, 11 Rich. J. Global L. & Bus. 159, 160 (2012), 163.
  • [56] Harper Group and Subsidiaries v. C.I.R., 96 T.C. 45, 58 (T.C. 1991)
  • [57] by F. Hale Stewart and Beckett Cantley, Captive Guidance After The ‘Dirty Dozen’ Listing, Tax Notes, June 8, 2015, p. 1191
  • [58] IRC § 816(a).
  • [59] Helvering v. LeGierse, 312 U.S. 531, 542 (1941); Rev. Rul. 89-96, 1989-2 C.B. 114 (1989).
  • [60] See
  • [61] Humana, Inc. v. C.I.R, 881 F. 2d 247, 251 (6th Cir. 1995) (citing Helvering, 312 U.S. at 539).\
  • [62] Helvering v. LeGeirse, 312 U.S. 531, 539 (1941).
  • [63] Bobbe Hirsh & Alan S. Lederman, The Service Clarifies the Facts and Circumstances Approach to Captive Insurance Companies, 100 J. Tax’n 168, 169 (Mar. 2004).
  • [64] Clougherty Packing Co. v. C.I.R., 84 T.C. 948, 959, aff’d, 811 F. 2d 1297, 1300 (9th Cir. 1987).
  • [65] Humana, Inc. v. C.I.R, 881 F. 2d 247, 251 (6th Cir. 1995) (citing Helvering v. LeGierse, 312 U.S. at 539).
  • [66] See Kidde Indus., Inc. v. United States, 40 Fed. Cl. 42, 53 (Fed. Cl. 1997) dismissed, 194 F.3d 1330 (Fed. Cir. 1999).
  • [67] Humana, Inc. v. C.I.R, 881 F. 2d 247 (6th Cir. 1995).