Category: Tax

Treasury Department Recognizes All Legal Marriages for Tax Purposes

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On August 29, 2013, the Treasury Department issued Revenue Ruling 2013-17, Internal Revenue Bulletin 2013-38, which states that same-sex couple legally married in jurisdictions that recognize their marriage will be treated as married for ALL federal tax purposes. As a result, legally married same-sex couples are treated the same as legally married opposite-sex couples for federal tax purposes if the state of ceremony of their marriage recognizes same-sex marriage even if their state of residence does not recognize same-sex marriage.

This Ruling has significant impact for legally married same-sex couples and their tax advisors. However, it does not impact state law rules regarding the definition of marriage and may complicate income tax filings for same-sex couples legally married but living in a state that does not yet recognize their marriage, like Wisconsin and Illinois.

Background Leading Up to the Ruling

The Defense of Marriage Act (DOMA) was enacted by President Clinton in 1996. Section Two of DOMA says states do not have to recognize same-sex marriages performed in other states. Section Three of DOMA defined marriage for all federal purposes as only between one man and one woman.

On June 26, 2013, in Windsor v. United States (Windsor), the United States Supreme Court held that Section Three of DOMA was unconstitutional. Therefore, any same-sex married couple that lives in a state that recognizes same-sex marriage is to be treated the same for all purposes as any other married couple, and thereby are entitled to all of the 1,138 rights and privileges under federal law that are granted to married persons, which includes federal tax law.

Section Two of DOMA was unaffected by Windsor. Therefore, a same-sex couple that marries in one of the thirteen states that recognizes same-sex marriage who then moves to one of the thirty-seven states that does not recognize same-sex marriage would not be treated as married if the state of residence determines whether a couples is considered married, as opposed to the state of ceremony determining if a couple is married.

Absent guidance from the Treasury Department, a same-sex couple legally married in a recognition jurisdiction who then move to a state that does not recognize same-sex marriage, would most likely not be treated as married for federal tax law purposes. This is because the majority of federal tax laws are determined by a couple’s state of residence, not the state of ceremony of their marriage.

State of Ceremony Versus State of Residence

Consider the following examples to illustrate Windsor and this Ruling:

Britney and Jason are married in a drive-through chapel by an Elvis impersonator in Las Vegas and then go home to California. Their opposite-sex marriage is recognized for federal tax law purposes in California (and all other states) because California recognizes legal Nevada marriages. Sadly, Britney and Jason’s marriage only lasted 55 hours.

Mitchell and Cam are a same-sex couple married in New York (New York being a state of ceremony that recognizes same-sex marriage) and move back to Milwaukee (Wisconsin being a state of residence that does not recognize same-sex marriage). Prior to the Revenue Ruling, Mitchell and Cam are not married for federal law purposes, even though their marriage would be recognized if they stayed in New York. This is because Article Two of DOMA says that Wisconsin does not have to recognize New York marriages.

After the Revenue Ruling, with an effective date after September 16, 2013, Mitchell and Cam in Wisconsin will be treated as married for federal tax law purposes just like Britney and Jason in California. Mitchell and Cam will be able to utilize all federal tax laws Britney and Jason would be able to utilize (if Britney and Jason had respected the sanctity of their marriage).

Federal Tax Impact of Ruling

As a result of the Revenue Ruling, regardless of a couple’s state of residence, if they are married in a state that legally recognizes their marriage, the couple will be entitled to the following federal tax law benefits (among others): filing status as married filing jointly, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA, spousal rollovers of IRA’s, unlimited marital deduction for estate and gift tax purposes, gift tax splitting, and estate tax exemption portability.

The Revenue Ruling does not apply to registered domestic partnerships, civil unions, or similar formal relationships recognized under state law that are not considered “marriage” under state law.

Legally married same-sex couples must file their 2013 income tax returns as either “married filing jointly” or “married filing separately.” They may also, but are not required to, file amended returns for open years (generally 2010, 211, and 2012) to be treated as married for federal tax law purposes.

Also, if an employee purchased health insurance coverage from their employer on an after-tax basis for their same-sex spouse, they may now treat the amounts paid for that coverage as pre-tax and excludable from their income, and file amended returns for a refund for open years. Further, if their employer paid Medicare and Social Security tax on those taxable benefits to the employee, the employer may file for a refund for both the employee and employer portions of those overpayments for open years.

Continuing Issues in Non-Recognition States

As of August 30, 2013, the District of Columbia and thirteen states (California, Connecticut, Delaware, Iowa, Maine, Massachusetts, Maryland, Minnesota, New Hampshire, New York, Rhode Island, Vermont, and Washington) recognize same-sex marriage. Therefore, clients who get married in those states or have employees who get married in those states, but subsequently reside in a non-recognition state, need to be aware of the new federal tax law benefits and obligations.

Even though married same-sex couples may now file as “married filing jointly” for federal income tax purposes, states like Wisconsin and Illinois that do not recognize same-sex marriage would still require those couples to either file as single or as married filing separately on their federal returns. This is because most state income tax forms use federal income tax amounts as the starting point for preparing the state return, and most state returns require the federal return to be attached to the state return. Without further guidance from state tax authorities, this could complicate income tax filings for same-sex married couples in non-recognition states.

Estate, gift, and generation skipping transfer tax laws now treat all legally married same-sex couples the same as opposite-sex couples, but, like opposite-sex couples, the Revenue Ruling does not mitigate the need for same-sex married couples to prepare estate plans. Many property law issues are driven by whether someone is classified as a “spouse” under state law, including who inherits under intestacy and other survivorship rights, all of which can be controlled by a will or trust in non-recognition states (like Wisconsin and Illinois). Finally, some states (like Illinois) have state estate and gift tax exemptions that are lower than the current federal estate and gift tax exemptions, which requires careful estate tax planning for all married couples, be they opposite-sex or same-sex.

The impact of Windsor and how same-sex couples are recognized for federal and state laws is a fast changing arena, and additional federal and state guidance will be required.

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Is a Limited Liability Company (LLC) good for Canadians buying in the U.S.?

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If you are Canadian, the answer to that question is: it depends.

People purchasing real estate in the U.S. are faced with different challenges depending on whether they plan on using the property personally or renting it. In this article, we will address the latter issue and its different implications.

A Tax Efficient Structure

There are two main issues to be considered when renting property in the U.S.; income tax and liability. Because rental properties generate income, it is necessary to determine the most tax efficient structure in which to hold the property. On the other hand, because a third party (most likely a tenant) will be using the property, it is essential to create a structure that also offers creditor protection to protect against potential civil liability claims from such third party. A limited liability company (LLC) provides both those elements.

In the U.S., an LLC allows a purchaser to benefit from the low individual tax rates and therefore avoid the higher corporate tax rates inherent to owning property in a corporation. A corporation is an independent taxpayer and is taxed at a higher rate. However, an LLC is not an independent taxpayer but rather a “flow through” entity, which means that its revenue is taxed in the hands of its owner. Therefore, if the owner is an individual, the LLC’s revenue is taxed at the low individual rate.

Creditor Protection

Although one of the main goals of tax planning is to minimize tax, the main advantage of the LLC is creditor protection. When owning property in your personal name, you are exposed to liability claims from creditors such as a tenant who may have suffered injuries on your property while renting it. Should a judgement be rendered against you finding you liable for the injuries, the creditor could seek execution of this judgment not only against your U.S. property but also against the rest of your assets. However, when owning property in an LLC, only the assets in your LLC (i.e. your U.S. property) are within reach of the creditor.

The Issue for Canadian Buyers

After reading this, you may be thinking an LLC is the best solution for your U.S. real estate purchase. Unfortunately this structure can be disastrous for Canadian residents due to double taxation. Under the Canada-U.S. Tax Treaty, a Canadian resident is granted foreign tax credits for any tax paid to the Internal Revenue Service (“IRS”). Those credits can be used to offset the tax owed to the Canada Revenue Agency (“CRA”) on the same revenue or capital gain. Although the IRS considers the LLC as a flow through entity and taxes only the owner personally, the CRA does not recognize the flow through nature of the LLC but rather considers it a separate taxpayer, therefore creating a mismatch on said foreign tax credits. In this type of situation, the CRA will tax the owner of the property on the full amount of the revenue or capital gain and will not allow the use of any foreign tax credits for what was paid to the IRS. This is the known and dreaded double taxation. The owner of the property will pay taxes twice on the same revenue or capital gain, once in the U.S. and once in Canada. Depending on the values and amounts involved, Canadian residents can be required to pay in excess of 70% of taxes on their property income or capital gain due to double taxation. In extreme circumstances, this rate can even climb up to 80%.

That being said, even though LLCs should be avoided in the above-described situation, LLCs can be a valuable tool in a carefully planned structure. As general partner of a Limited Partnership for example. When used in such a structure, an LLC can help provide an extra layer of creditor protection to a Canadian resident while creating very limited tax consequences.

As you probably realised by now, the way you own property in the U.S. is crucial and putting your asset(s) in the wrong structure can lead to very unpleasant surprises. Always talk to a cross-border legal advisor before making any decisions in order to make sure you are aware of all the tax implications.

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Could Your Business Qualify for a 179D Green Building Tax Break?

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If your company has built a new facility or upgraded an existing one anytime in the past six years, you might find that you qualify — at least partially — for a tax break of up to $1.80 per square foot under federal tax code section 179D, or the energy efficient commercial buildings deduction. This could be the case even if you had no concrete intention to focus on green building standards at the time.

A couple of great features of this deduction are, first, that you might be able to substantially mitigate your tax burden  as far back as six years and, second, it’s very likely that you will qualify if your facility exceeds 50,000 square feet and it meets current state building codes, according to a business tax writer for Forbes, who spent eight years as the U.S. Senate Finance Committee’s tax counsel.

The 179D tax deduction gives the business an immediate deduction in the current year plus a basis reduction for the value of the facility, which can be anything from a warehouses or parking garage to an office park or a multi-family housing unit. For private-sector projects, the building owner, assuming it paid for the construction or improvements, generally gets the deduction. In public projects, the architect, engineer or contractor can obtain it by seeking a certification letter from the government unit. Nonprofits and native American tribes are not eligible.

The green building deduction was created in recognition of the fact that around 70 percent of all electricity used in the U.S. is consumed by commercial buildings. The deduction, which is up for renewal — and possible expansion — this year, has already proven that efforts to mitigate the tax burden of businesses in a technology-neutral way is an effective way to encourage energy efficiency, according to the Forbes writer.

What improvements must be made to qualify for the green building credit? Currently, the new or renovated building merely needs to exceed the 2001 energy efficiency standards developed by the American Society of Heating, Refrigerating and Air Conditioning Engineers, or ASHRAE — and most state building codes already require this. That means the vast majority of new and improved buildings already meet this requirement.

It’s also possible to partially qualify for the deduction by meeting the standards only for the building envelope itself, which includes HVAC, the hot water system, and the interior lighting system. A building could qualify based upon only one of these systems, or all three.

Source: Forbes, “179D Tax Break for Energy Efficient Buildings — Update,” Dean Zerbe, Aug. 19, 2013

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Further Postponements of Fair and Accurate Credit Transactions Act (FATCA) Effective Dates Announced

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Once again, the IRS has pushed back FATCA effective dates due to further delays in the process of finalizing FATCA materials.

Under Notice 2013-43, released July 12, 2013, several key effective dates have been deferred another six months, to July 1, 2014.  That date is now:

  • the first date on which FATCA withholding will apply to US-source payments;
  • the cut-off date for grandfathering of existing obligations; and
  • the date by which withholding agents generally will be required to implement new FATCA-compliant account opening procedures.

The process of foreign financial institutions registering with, and reporting to, the IRS as participating foreign financial institutions (PFFIs) has also been deferred:

  • The online registration mechanism that was to have been in place by the beginning of this month is now expected to become available in mid-August, and online registrations will not actually become effective before January 1, 2014.
  • The first reports that PFFIs will be required to begin filing in 2015 with respect to their U.S. accounts will be required to cover just the 2014 calendar year (rather than including the 2013 calendar year, as had previously been the case).

The notice also touches on procedures relating to the intergovernmental agreements (IGAs) that the US is still in the process of negotiating with a number of foreign countries.  These IGAs will be designed to facilitate FFIs’ compliance with FATCA through reporting of US accounts to the tax authorities in their home countries rather than having to register with the IRS as PFFIs.

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Treasury and IRS Postpone the Effective Dates of Several Key Foreign Account Tax Compliance Act (FATCA) Provisions

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On July 12th, the IRS issued Notice 2013-43, which postpones the effective dates of several key FATCA provisions.   This Notice provides: (i) revised timelines for implementation of FATCA; and (ii) additional guidance concerning the treatment of financial institutions located in jurisdictions that have signed intergovernmental agreements (IGAs) for the implementation of FATCA but have not yet brought those IGAs into force.

Overview

FATCA, which will be phased in between 2013 and 2017, subjects many categories of payments made by U.S. persons to “Foreign Financial Institutions” (including most banks, funds, investment entities, depositories and insurance companies, collectively referred to as  “FFIs”) and certain non-financial foreign entities (including multinationals, partnerships and trusts, collectively referred to as “NFFEs”) to a 30% U.S. withholding tax unless the foreign recipient, and each member of its affiliated group, have agreed in advance to provide information to the IRS on their (direct and indirect) U.S. owners, creditors and investors (“U.S. Account Holders”).

FATCA generally (i) requires FFIs to provide information to the IRS regarding their U.S. Account Holders; (ii) requires certain NFFEs to provide information on their “Substantial U.S. Owners” to withholding agents; (iii) requires certain certifications that the FFI or NFFE is compliant with FATCA rules; (iv) enhances certain withholding tax rules and imposes a withholding tax on certain payments (“Withholdable Payments”) to FFIs and NFFEs that fail to comply with their obligations; and (v) imposes increased disclosure obligations on certain NFFEs that present a high risk of U.S. tax avoidance.

The burden of complying with FATCA falls on both the foreign recipients of Withholdable Payments, which have to identify and disclose their U.S. Account Holders in order to be exempt from the FATCA withholding, and on the payors of such payments (as withholding agents), which are required to obtain certification of such exemption from the foreign payees in order not to withhold.  A failure to obtain such certification can subject the payors to personal liability for any taxes not withheld.

Treasury Regulations under FATCA were issued on January 17, 2013.  In addition, the United States has begun the process of signing IGAs with other countries to implement FATCA on a government to government basis. The IGAs currently fall into two categories, Model 1 and Model 2, which contain different terms and requirements.

Notice 2013-43

Notice 2013-43 provides a six-month extension (from January 1 to July 1, 2014) for when FATCA withholding will begin and for implementing new account opening procedures as well as related requirements to comply with FATCA.  Importantly, the definition of “Grandfathered Obligation” (i.e., an obligation not subject to withholding) will be revised to include obligations outstanding on July 1, 2014 (whereas under the current rules, “grandfathered obligations” were obligations issued before January 1, 2014).  Withholding on gross proceeds is still scheduled to begin on January 1, 2017.

The timeline for foreign financial institutions (FFIs) to register as participating foreign financial institutions (PFFIs) is also extended, with the registration portal expected to open on August 19, 2013.  When the FATCA registration website opens, a financial institution will be able to begin the process of registering by creating an account and inputting the required information.  Prior to January 1, 2014, however, any information entered into the system, even if submitted as “final,” will not be regarded as a final submission, but will merely be stored until the information is submitted as final on or after January 1, 2014. Thus, financial institutions can use the remainder of 2013 to get familiar with the registration process, to input preliminary information, and to refine that information. On or after January 1, 2014, each financial institution must finalize its registration information and submit the information as final.  The IRS will electronically post the first IRS FFI List by June 2, 2014, and will update the list on a monthly basis thereafter. Thus, to ensure inclusion in the June 2014 IRS FFI List, FFIs would need to finalize their registration by April 25, 2014.

Finally, a jurisdiction will be treated as having in effect an IGA with the United States if the jurisdiction is listed on the Treasury website as a jurisdiction that is treated as having an IGA in effect. In general, Treasury and the IRS intend to include on this list jurisdictions that have signed but have not yet brought into force an IGA. The list of jurisdictions that are treated as having an IGA in effect is available at the following address: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx.

Conclusions

Six months ago, when the IRS issued the final FATCA Regulations, it intended to provide some clarity and certainty for FFIs and other affected taxpayers intending to comply with FATCA this year.  However, as of today, FFIs still face significant uncertainties pertaining to the implementation of FATCA in accordance with the timeline provided in the Regulations.  In addition, the progress of the IGA program has been much slower than expected.  At the beginning of the year, the Treasury and IRS indicated that active negotiations on IGAs were taking place with dozens of countries.  Nevertheless, as of today, only 10 IGAs have been signed.  FATCA compliance may differ depending on whether the FFI is in an IGA or non-IGA jurisdiction (and if the FFI is from an IGA jurisdiction, there will be a different term; depending on whether the IGA is a Model 1 or Model 2 IGA and whether the IGA is reciprocal or not).  Thus, there is growing concern among FFIs from jurisdictions that have yet to sign an IGA with the IRS with respect to the course of action to comply with FATCA.

Furthermore, last year, the IRS issued a draft version of the IRS Form W-8BEN-E, which foreign persons would use to certify as to their FATCA status.  The proposed W-8BEN-E form is an eight page long complex form containing a list of over 20 types of FATCA categories.  It was expected that the IRS would finalize the W-8BEN-E, and, importantly, would issue guidance on how to prepare it early enough so that all affected taxpayers would be able to comply with it.  Nevertheless, the IRS instead issued another draft in May 2013, and still expects comments from the tax community on the new draft.  As a result, it is not expected that the final W-8BEN-E Form, with the instructions, will be issued before the fall of 2013.

The six-month extension provided in Notice 2013-43, will hopefully allow Treasury and the IRS, on the one hand, to provide more guidance with respect to implementation of FATCA; and affected taxpayers, on the other hand, to get more clarity as to how to comply with FATCA.

Defense of Marriage Act’s Demise (DOMA) – What it Means for Canadian Residents with U.S. Ties

Altro Levy LogoLast week, the US Supreme Court issued an historic and landmark ruling in the case of US v. Windsor. It has been hailed in the media as the demise of the Defense Of Marriage Act (“DOMA”), and celebrated as an extension of more than 1,000 federal benefits to same-sex couples.

In US v. Windsor, Edith Windsor brought suit against the US government after she was ordered to pay $363,000 in US estate tax upon the death of her wife Thea Spyer. Edith and Thea were legally married in Canada in 2007, but the US federal government did not recognize their marriage when Thea passed away in 2009. Under DOMA gay marriage was not recognized, even if it was legal in the jurisdiction where it was performed. This lack of recognition meant that Edith could not take advantage of the marital deduction that would have allowed her to inherit from her wife without paying US estate tax.

In its ruling on June 26th, the US Supreme Court ruled that the US federal government could not discriminate against same-sex married couples in the administration of its federal laws and benefits as previously dictated by DOMA. Same-sex couples, who are legally married in one of the 13 states that recognize gay marriage, or a country like Canada, now have access to the same federal protections and benefits as a heterosexual married couple.

Tax Benefits

The demise of DOMA will bring with it a multitude of changes under US tax law. We will not attempt to enumerate all of them here, though we will provide a brief overview of key changes for our Canadian and American clients.

i. US Estate Tax

The case of US v. Windsor was based on the US estate tax, which is imposed by the US federal government on both US citizens and residents, as well as non-residents who own US assets worth more than $60,000 USD. Currently US citizens and residents with less than $5.25 Million USD in worldwide assets do not owe US estate tax on death. Canadians with worldwide assets of $5.25 Million USD or less receive a unified credit under the Canada-US Tax Treaty that works to eliminate any US estate tax owed on their US property.

Under federal law a US citizen may pass his entire estate to his US citizen spouse tax-free upon death. Up until last week this rollover was unavailable to same-sex couples.

Canadian same-sex couples should now benefit from the Canada-US Tax Treaty provisions that provide a marital credit to the surviving spouse. This allows for a doubling up of credit against any potential US estate tax due on US property. Now a Canadian same-sex spouse can inherit a worldwide estate worth up to $10.5 Million USD and should see little to no tax on US assets due upon the death of the first spouse.

ii. Gift Tax

The US imposes a tax on gifts if they exceed $14,000 USD per recipient per year. There is an exemption for gifts between spouses, which are generally not taxable.

Gifts made in the US between non-US citizen non-resident spouses are taxable, but the annual exemption is $139,000 USD instead of $14,000 USD. Canadian spouses who gift each other US property, US corporate stocks, etc. may gift up to $139,000 USD per year without incurring US gift tax.

These exemptions have now been extended to same-sex couples, expanding their ability to use gifting for tax and estate planning.

iii. US Income Tax

Many Canadians move to the US each year, in part because of the lower personal tax rates. In the US spouses are allowed to engage in a form of income splitting by filing a joint income tax return. By filing jointly, married couples are also generally able to take advantage of further credits and deductions not afforded to individual or single filers. Being able to file jointly can be highly tax advantageous.

Previously, same-sex couples had to file either separately or as head of household. Now they have the option of filing jointly as spouses, and gaining access to the aforementioned income splitting, credits and deductions.

Couples may file up to three years of amended US Income Tax returns if they believe that they would have been entitled to a larger tax return by filing jointly in those years.

iv. Other Tax Benefits

In the US most individuals receive health insurance through their employer at least up until they qualify for US Medicare at age 65. Previously, if the employer sponsored health insurance plan covered the same-sex spouse as well, then it was considered a taxable benefit. Such coverage will now also be tax-free for same-sex couples.

Retirement Benefits

Among the many benefits now extended to same-sex couples are a variety of “Retirement Benefits.”

i. Social Security and Medicare Benefits

With the end of DOMA, same-sex couples may now qualify for retirement, death, and disability Social Security benefits based on their spouse’s qualifying US employment history. For example, same-sex couples that do not have the required US employment history to qualify for US Social Security benefits on their own may now qualify for spousal Social Security benefits based on their spouse’s qualifying employment history. These spousal Social Security benefits are typically equal to 50% of the Social Security benefits received by the spouse with the qualifying employment history.

Additionally, spouses can qualify for US Medicare based on only one spouse’s qualifying US employment. This allows access to premium-free, or reduced-premium, health coverage in retirement.

Previously these important retirement benefits were not available to same-sex spouses.

ii. Individual Retirement Accounts

Important changes to the rights and recognition of spouses under US retirement savings plans result from the end of DOMA. Same-sex couples will now be recognized under 401(k), 403(b), IRA, Roth IRA, and similar plans. Spouses will be required to give their consent for any non-spouse beneficiary designations for these accounts. They will be treated as spouses for purposes of determining required distributions. For example, an inheriting same-sex spouse will not have to begin IRA distributions until age 70 ½, whereas previously he would have had to begin required distributions immediately as would any non-spouse beneficiary.

Immigration

One of the biggest questions after the US Supreme Court’s ruling on DOMA was whether there would be immediate changes to US immigration policy. Previously the US government did not recognize same-sex couples for immigration purposes. This meant that a US citizen spouse could not sponsor his husband for immigration to the US as a permanent resident (a.k.a. green card holder).

Last week, shortly after the ruling on DOMA, Alejandro Mayorkas, the director of US Citizenship and Immigration Services (“USCIS”) announced at the American Immigration Lawyers Association annual conference that the USCIS would begin issuing green cards to qualifying same-sex couples.

As of Friday, June 29, 2013, USCIS began issuing green cards to same-sex spouses. USCIS has stated that it has been keeping a record of spousal green card petitions denied only due to a same-sex marriage for the past two years. It is expected to reopen and reconsider these spousal sponsorship petitions that were previously denied due to same-sex marriage.

Conclusion

The demise of DOMA is exciting news for Americans, and Canadians with US ties. It provides same sex couples a wealth of new tax and estate planning opportunities, not to mention new opportunities for retirement and immigration planning. It is not too early to review your current planning, and take advantage of these changes.

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Financial Innovation for Clean Energy Deployment: Congress Considers Expanding Master Limited Partnerships for Clean Energy

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Technological innovation is driving renewable energy towards a future where it is cost competitive without subsidies and provides a growing share of America’s energy. But for all the technical progress made by the clean energy industry, financial innovation is not keeping pace: access to low-cost capital continues to be fleeting, and the industry has yet to tap institutional and retail investors through the capital markets. This is why a bipartisan group in Congress has proposed extending master limited partnerships (MLPs), a financial mechanism that has long driven investment in traditional energy projects, to the clean energy industry.

Last month Senators Chris Coons (D-DE) and Jerry Moran (R-KS) introduced the Master Limited Parity Act (S. 795); Representatives Ted Poe (R-TX), Mike Thompson (D-CA), and Peter Welch (D-VT) introduced companion legislation (H.R. 1696) in the House of Representatives. The bills would allow MLP treatment for renewable energy projects currently eligible for the Sec. 45 production tax credit (PTC) or 48 investment tax credit (ITC) (solar, wind, geothermal, biomass, hydropower, combined heat and power, fuel cells) as well as biofuels, renewable chemicals, energy efficient buildings, electricity storage, carbon capture and storage, and waste-heat-to-power projects. The bill would not change the eligibility of projects that currently qualify as MLPs such as upstream oil and gas activities related to exploration and processing or midstream oil and gas infrastructure investments.

MLPs have been successfully utilized for traditional fossil-fuel projects because they offer an efficient means to raise inexpensive capital. The current total market capitalization of all energy-related MLPs exceeds $400 billion, on par with the market value of the world’s largest publicly traded companies. Ownership interests for MLPs are traded like corporate stock on a market. In exchange for restrictions on the kinds of income it can generate and a requirement to distribute almost all earnings to shareholders (called unitholders), MLPs are taxed like a partnership, meaning that income from MLPs is taxed only at the unitholder level. The absence of corporate-level taxation means that the MLP has more money to distribute to unitholders, thus making the shares more valuable. The asset classes in which MLPs currently invest lend themselves to stable, dividend-oriented performance for a tax-deferred investment; renewable energy projects with long-term off-take agreements could also offer similar stability to investors. And since MLPs are publicly traded, the universe of potential investors in renewable projects would be opened to retail investors.

The paperwork for MLP investors can be complicated, however. Also, investors are subject to rules which limit their ability to offset active income or other passive investments with the tax benefits of an MLP investment. Despite the inherent restrictions on some aspects of MLPs, the opportunities afforded by the business structure are generating increasing interest and support for the MLP Parity Act.

Proponents of the MLP Parity Act envision the bill as a way to help renewable energy companies access lower cost capital and overcome some of the limitations of the current regime of tax credits. Federal tax incentives for renewable energy consist primarily of two limited tools: tax credits and accelerated depreciation rates. Unless they have sizeable revenue streams, the tax credits are difficult for renewable project developers to directly use. The reality is only large, profitable companies can utilize these credits as a means to offset their income. For a developer who must secure financing though a complicated, expensive financing structure, including tax equity investors can be an expensive means to an end with a cost of capital sometimes approaching 30%. Tax credits are a known commodity, and developers are now familiar with structuring tax equity deals, but the structure is far from ideal. And as renewable energy advocates know all too well, the current suite of tax credits need to be extended every year. MLP treatment, on the other hand, does not expire.

Some supporters have noted that clean energy MLPs would “democratize” the industry because private retail investors today have no means to invest in to any meaningful degree in clean energy projects. Having the American populace take a personal, financial interest in the success of the clean energy industry is not trivial. The initial success of ‘crowd-funded” solar projects also provides some indication that there is an appetite for investment in clean energy projects which provide both economic and environmental benefits.

Sen. Coons has assembled a broad bipartisan coalition, including Senate Finance Energy Subcommittee Chair Debbie Stabenow (D-MI) and Senate Energy and Natural Resources Ranking Member Lisa Murkowski (R-AK). Republican and Democratic cosponsors agree that this legislation would help accomplish the now-familiar “all-of-the-above” approach to energy policy.

However, some renewable energy companies that depend on tax credits and accelerated depreciation are concerned that Republican supporters of the legislation will support the bill as an immediate replacement for the existing (but expiring) suite of renewable energy tax credits. Sen. Coons does not envision MLP parity as a replacement for the current production tax credits and investment tax credits but rather as additional policy tool that can address, to some degree, the persistent shortcomings of current financing arrangements. In this way, MLPs could provide a landing pad for mature renewable projects as the existing regime of credits is phased out over time, perhaps as part of tax reform.

So would the clean energy industry utilize MLP structures if Congress enacts the MLP Parity Act? The immediate impact may be hard to predict, and some in renewable energy finance fear MLP status will be less valuable than the current tax provisions. This is in part because the average retail investor would not be able to use the full share of accompanying PTCs, ITCs, or depreciation unless Congress were also to change what are known as the “at-risk” and “passive activity loss and tax credit” rules. These rules were imposed to crack down on perceived abuse of partnership tax shelters and have tax implications beyond the energy industry. Modifying these rules is highly unlikely and would jeopardize the bipartisan support the bill has attracted so far. But other renewable energy companies believe they can make the structure work for them now, and industries without tax credits — like renewable chemicals, for instance — would not have the same concerns with “at-risk” and “passive activity loss” rules. Furthermore, over the long term, industry seems increasingly confident the structure would be worthwhile. Existing renewable projects that have fully realized their tax benefits and have cleared the recapture period could be rolled up into existing MLPs. Existing MLP infrastructure projects could deploy renewable energy assets to help support the actual infrastructure. Supporters of the legislation see the change as a starting point, and the ingenuity of the market will find ways to work within the rules to deliver the maximum benefit.

The future of the MLP Parity Act will be linked to the larger conversation in Congress regarding tax reform measures. The MLP Parity Act is not expected to pass as a stand-alone bill; if it were to be enacted, it would most likely be included as part of this larger tax-reform package. Congress currently is looking at ways to lower overall tax rates and modify or streamline technology-specific energy provisions. This has many renewable energy advocates on edge: while reform provides an opportunity to enact long-term policies (instead of one-year extensions) that could provide some level of stability, it also represents a chance for opponents of renewable energy to exact tough concessions or eliminate existing incentives. As these discussions continue in earnest this year, the reintroduction of the MLP Parity Act has already begun to generate discussions and mentions in policy white papers at both the House Ways and Means Committee and the Senate Finance Committee. Whether a highly partisan Congress can actually achieve such an ambitious goal as tax reform this year remains uncertain. But because of its bipartisan support, the MLP Parity Act certainly will be one of the many potential reforms Congress will consider seriously.

Estate Planning Opportunities Arising from Recent Landmark Supreme Court Decisions Concerning Marriages of Same-Sex Couples

Katten Muchin

On June 26, 2013, the US Supreme Court (the “Supreme Court”) struck down Section 3 of the federal Defense of Marriage Act (DOMA) as unconstitutional in the case of United States v. Windsor (“Windsor”). In a related case, the Supreme Court also dismissed an appeal from the federal district court ruling that struck down California’s Proposition 8 (which overturned marriages of same-sex couples in California) as unconstitutional in the case of Hollingsworth v. Perry (“Perry”), leaving intact the district court’s ruling that Proposition 8 is unconstitutional and cannot be enforced. This advisory summarizes the estate and income tax planning opportunities and other topics for consideration arising from the Windsor and Perry decisions. Married same-sex couples should consult with their advisors in light of their particular facts and circumstances in order to take maximum advantage of the change in the law. Unmarried same-sex couples should now consider whether to marry.

In Windsor, Edith Windsor and Thea Spyer, a same-sex couple, were married in Canada in 2007 after having been together in New York for over forty years. New York law did not permit marriages between same-sex couples at the time but recognized marriages of same-sex couples performed in other jurisdictions. Spyer died in 2009, and Windsor inherited all of Spyer’s estate as Spyer’s surviving spouse. However, because of DOMA, which defines “marriage” as “a legal union between one man and one woman as husband and wife” and “spouse” as “a person of the opposite sex who is a husband or a wife”, the federal government refused to recognize the couple’s marriage for federal estate tax purposes. As a result, Windsor’s inheritance from Spyer was not entitled to the unlimited marital deduction from federal estate tax that would have been available had Windsor and Spyer’s marriage been recognized by the federal government. After paying the estate taxes owed on her inheritance as a result of DOMA, Windsor sued for a refund of the estate taxes on the grounds that DOMA unconstitutionally discriminated against same-sex married couples. Windsor prevailed in the US District Court for the Southern District of New York and also in the US Court of Appeals for the Second Circuit. The Supreme Court has now agreed with Windsor, holding that “DOMA seeks to injure the very class [of married same-sex couples] New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government.” The Supreme Court further explained that DOMA’s “demonstrated purpose is to ensure that if any State decides to recognize same-sex marriages, those unions will be treated as second-class marriages for purposes of federal law.”

In Perry, two same-sex couples wished to become married in California. Though the California Supreme Court held in 2008 that the California Constitution required the State of California to recognize marriages of same-sex couples, California voters passed Proposition 8 later the same year, amending the California Constitution to provide that only “marriage between a man and a woman is valid and recognized in California.” As a result of Proposition 8’s passage, the two couples were unable to marry. They sued the California governor, attorney general and various other state and local officials responsible for enforcing California’s marriage laws (the “California officials”), claiming that Proposition 8 violated their rights to due process and equal protection under the US Constitution. In the US District Court for the Northern District of California (the “district court”), the California officials refused to defend Proposition 8, but the private parties who were the proponents of Proposition 8 (the “Proposition 8 proponents”) successfully intervened to defend the measure. After the district court held that Proposition 8 was unconstitutional, the California officials declined to appeal the decision and the Proposition 8 proponents appealed. The US Court of Appeals for the Ninth Circuit upheld the district court’s ruling that Proposition 8 was unconstitutional. The Supreme Court dismissed the appeal from the district court on the grounds that the Proposition 8 proponents lacked standing to appeal because they were merely private parties and were not properly authorized under state law to defend the constitutionality of Proposition 8. As a result of the Supreme Court’s ruling, the district court’s ruling that Proposition 8 is unconstitutional remains in place and California soon will be required to permit same-sex couples to marry. As a result of the Windsor decision, such marriages also will be entitled to federal recognition.

Estate Planning Opportunities Arising from Windsor 

The Supreme Court’s ruling in Windsor requires the federal government to recognize marriages of same-sex couples. Note, however, that the Supreme Court limited the scope of its decision to “lawful marriages”. Therefore, the decision likely will not be interpreted to require the federal government to recognize so-called “marriage equivalent” status that is not actually “marriage” under state law, i.e., civil unions, domestic partnerships and registered domestic partnerships. The District of Columbia and thirteen states permit marriages of same-sex couples. Those states are California (effective once the stay issued by the Ninth Circuit is lifted pursuant to the Perry decision, which is likely to be imminent), Connecticut, Delaware (effective July 1, 2013), Iowa, Maine, Maryland, Massachusetts, Minnesota (effective August 1, 2013), New Hampshire, New York, Rhode Island (effective August 1, 2013), Vermont and Washington.

Another unresolved issue is whether the Supreme Court’s decision applies to married same-sex couples who lawfully married in a jurisdiction that permits marriages of same-sex couples (e.g., New York), but who are domiciled and/or resident in a state that does not permit or recognize such marriages (e.g., Texas). Accordingly, until these issues are resolved as a result of subsequent litigation, legislation and/or regulation, it is not clear whether Windsor will be interpreted also to apply to same-sex couples with a marriage-equivalent status (but not marriage) or married same-sex couples who are domiciled and/or resident in a state that does not permit and/or recognize marriages of same-sex couples.

Against that background, at a minimum, married same-sex couples domiciled and/or resident in states that permit and/or recognize marriages of same-sex couples likely will be entitled to the more than 1,000 benefits available to married opposite-sex couples under federal law. Some of those 1,000 benefits present immediate estate planning opportunities, including the following:

1. Review estate planning documents to ensure that the amount and structure of any spousal bequests remain appropriate. 

Federal recognition of marriages of same-sex couples leads to the availability of the unlimited marital deduction from federal estate tax and gift tax for transfers between same-sex spouses. Existing estate planning documents may have been drafted with the assumption that any gift or bequest to a spouse of the same sex over and above the individual’s applicable exclusion amount from federal estate tax and/or federal gift tax (the “Applicable Exclusion Amount” —currently $5,250,000, adjusted annually for inflation) would be subject to federal estate tax (currently at a maximum rate of 40%). However, that assumption is no longer true. Indeed, such gifts and bequests, if properly structured, are now entitled to the unlimited marital deduction. In addition, under the so-called “portability” provisions of federal gift and estate tax laws, under certain circumstances a surviving spouse of the same sex will also be entitled to use any portion of the deceased spouse’s unused Applicable Exclusion Amount (the “DSUE”), allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s applicable exemption from the federal generation-skipping transfer tax (“Federal GST Exemption”)). Accordingly, a married same-sex couple may wish to modify their estate planning documents to provide that any assets included in their estates in excess of the Applicable Exclusion Amounts will pass to the surviving spouse, either outright or in a properly structured marital trust for the spouse’s benefit, thus deferring all federal estate taxes until the death of the surviving spouse.

Estate planning documents may also be revised, if appropriate, to include a separate marital trust that is designed to permit a spouse to use any of the individual’s unused Federal GST Exemption that remains after the individual’s death.

2. Review retirement account beneficiary designations and joint and survivor annuity elections to ensure that they remain appropriate. 

A surviving spouse is entitled to roll over a decedent spouse’s retirement account into the surviving spouse’s retirement account without being required to take minimum distributions or lump sum distributions until such time as the surviving spouse ordinarily would be required to take minimum distributions (usually upon reaching age 70½). As a result of the Windsor decision, this benefit is now available to married same-sex couples. Accordingly, married same-sex spouses should consider naming each other as the beneficiary of his or her retirement accounts in order to defer income tax on the rolled over retirement account as long as possible.

With regard to any retirement plans that are covered by the Employee Retirement Income Security Act of 1974 (ERISA), the spouse of a participant in such a plan may automatically be a beneficiary of the retirement plan as a result of the Windsor decision. Accordingly, if a participant in an ERISA-covered plan (e.g., a 401(k) plan) wishes to designate someone other than his or her spouse as a beneficiary, such participant will need to obtain the consent of his or her spouse to make such a designation effective. Prior to Windsor, consent was not needed from a spouse of the same sex. However, afterWindsor, such consent is now required. Separately, if a participant previously made an election to waive joint and survivor annuity benefits after the date of the marriage, the participant may be able to make a new election at this time, and a new election may be required in order to be valid if the marriage is newly recognized under Windsor.

3. Consider replacing individual life insurance policies with survivor policies. 

Many same-sex spouses previously purchased individual life insurance policies of which the other spouse is the beneficiary (either directly via beneficiary designation or indirectly through a life insurance trust) in order to provide the surviving spouse with sufficient liquid assets that may be used to pay federal estate taxes due upon the death of the first to die. With the unlimited marital deduction and DSUE now available to married same-sex couples, as explained above, there may be little or no need for such liquidity upon the death of the first spouse to die. Thus, a married same-sex couple should consider replacing such individual policies with so-called “survivor” or “second-to-die” policies that pay benefits only upon the death of the surviving spouse. Such policies will still provide liquidity to children or other beneficiaries of the married same-sex couple and are generally less expensive than individual policies having the same death benefits.

4. Consider splitting gifts between spouses. 

Until now, each spouse could make gifts only up to the annual exclusion amount from federal gift tax and/or federal generation-skipping transfer tax (the “Annual Gift Tax Exclusion Amount” and the “Annual GST Exclusion Amount”, respectively—each currently $14,000) without using any portion of his or her Applicable Exclusion Amount. Going forward, however, each spouse may now make gifts from his or her own assets and, with the other spouse’s consent, have such gifts deemed to have been made one-half by the other spouse for purposes of federal gift tax and GST tax laws. Both spouses acting together in this way currently may give up to $28,000 to any individual without using any portion of either spouse’s Applicable Exclusion Amount (note that the Annual GST Exclusion Amount does not always apply to gifts made in trust).

5. Amend previously filed federal estate, gift and income tax returns and/or file protective claims as appropriate.

Gifts made to spouses. If one spouse previously made taxable gifts to the other spouse and reduced the donor’s Applicable Exclusion Amount by the amount that the gift exceeded the Annual Gift Tax Exclusion Amount and/or the donor’s Federal GST Exemption by the amount that the gift exceeded the Annual GST Tax Exclusion Amount, it may be possible to amend the donor’s prior gift tax returns (subject to the limitations period discussed below) and retroactively claim the marital deduction for the gifts made in those years, thus increasing the donor’s Applicable Exclusion Amount and/or reclaim the Federal GST Exemption used. By doing so, the donor may make additional tax-free gifts and/or reduce federal estate and/or GST taxes due upon his or her death. Similarly, any gift taxes or GST taxes actually paid may be refundable.

Gifts made to third parties. To the extent that either spouse previously used a portion of his or her Applicable Exclusion Amount and/or paid gift taxes or GST taxes by making gifts to third parties over and above his or her Annual Gift Tax Exclusion Amount and/or Annual GST Exclusion Amount, it may be possible to amend prior federal gift tax returns in order to retroactively split such gifts with the other spouse, thus increasing the donor’s Applicable Exclusion Amount and/or Federal GST Exemption. Again, doing so will allow the donor to make additional tax-free gifts and/or reduce federal estate taxes and GST taxes due upon the donor’s death. Similarly, any gift or GST taxes actually paid may be refundable.

Inheritances from decedent spouses. In cases where a decedent spouse’s estate paid federal estate taxes on assets that were inherited by a surviving spouse of the same sex, it may be possible to amend the decedent spouse’s federal estate tax return (subject to the limitations period discussed below) and retroactively claim a refund for the estate taxes paid. If the decedent spouse’s estate did not pay estate taxes and he or she died in 2010 or a subsequent year, under the portability provisions of federal estate tax laws, the surviving spouse may be able to claim the deceased spouse’s DSUE, thus allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s Federal GST Exemption).

Income taxes. Both spouses may also amend prior year income tax returns to change their filing status from single to married filing jointly and obtain a refund if the amount of tax owed based on their married filing status is less than that owed based on their prior single status.

Retroactivity. The extent to which married same-sex couples will be allowed to amend prior tax returns depends on the extent to which Windsor is applied retroactively and whether the applicable limitations period has passed with regard to each tax return (i.e., ordinarily three years from the date the tax return was originally due or filed (if on extension) or two years from the date the tax was paid, whichever is later). For example, it may no longer be possible to amend a 2009 individual income tax return due on April 15, 2010, that was not put on extension, but individual income tax returns for 2010, 2011 and 2012 likely may be amended. That said, it is conceivable that the Internal Revenue Service (IRS) will permit amendments as far back as the year of the marriage on the basis that neither spouse lawfully could have amended his or her tax returns prior to theWindsor decision. In either case, it will take some time for the IRS to develop policies and procedures to implement Windsor, and amended returns should be filed in accordance with applicable published guidance from the IRS, if available. In any situation where the limitations period is about to expire for a particular tax return, a married same-sex couple should consider filing a protective claim for a refund with the IRS in order to preserve the ability to obtain such a refund after the IRS has provided a means to amend the return.

6. Reside in a state that permits and/or recognizes marriages of same-sex couples. 

If a married same-sex couple was lawfully married in a jurisdiction that permitted the marriage but now reside in a state that does not permit and/or recognize the marriage, that couple should consider moving to a state that either permits marriages of same-sex couples or recognizes such marriages lawfully performed in other states if they wish to be certain to enjoy the federal benefits now potentially accorded to marriages of same-sex couples.

7. Non-citizen spouses should consider seeking permanent residency and/or becoming citizens. 

Until now, non-citizen spouses were not eligible for citizenship or permanent residency on the basis of their marriage to a spouse of the same sex who was a US citizen. As a result of the Windsor decision, however, non-citizens may be eligible for permanent residency and/or citizenship on that basis. Though there are many benefits to becoming a permanent resident or citizen, there are also numerous tax and non-tax consequences that should be carefully considered before making such an important decision.

Estate Planning Opportunities Arising from Perry 

California will now be required to permit marriages of same-sex couples, but other states that do not permit and/or recognize marriages of same-sex couples will not be required to do so. California married same-sex couples will enjoy all of the benefits available to married couples under federal law and thus should consider the above recommendations. In addition, married same-sex couples in California should consider the following recommendations:

1. Amend previously filed California income tax returns and/or file protective claims as appropriate. 

Married same-sex couples may be permitted to amend prior year California income tax returns to change their filing status and obtain a refund for any income taxes that were overpaid. Note that the normal limitations period for amending California returns expires four years after the original due date of the return (or the actual filing date if the return was put on extension) or one year from the date the tax was paid, whichever occurs later. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the State of California provides appropriate guidance for amending prior returns. Note that, as discussed above with regard to the limitations period for federal tax returns, it is conceivable that a married same-sex couple may be permitted to amend their returns through the first year of their marriage.

2. Amend previously filed tax returns and/or file protective claims with other states as appropriate. 

Married same-sex couples may also be entitled to amend prior gift tax and/or estate tax returns filed with other states that recognized marriage but not marriage equivalents (e.g., California registered domestic partnerships) at the time in question and receive a refund of taxes paid and/or reclaim any state gift tax and/or estate tax exemption. Again, the limitations period (if one applies) for amending such returns will vary by state. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the state provides appropriate guidance for amending prior returns.

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Senate Finance Committee Leadership Releases Tax Reform Framework

Bracewell & Giuliani Logo

A major step forward on tax reform occurred today with Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) releasing their tax reform framework.  They are planning a “blank-slate” approach:  stripping the tax code of all current tax deductions, credits, and expenditures in place of a lower individual and corporate tax rate.

In their “Dear Colleague” letter sent out today, Senators Baucus and Hatch announced their plan to hold a markup on a bill after the August recess.  Members of the Senate have been invited to submit by July 26th a “wish list” of which tax provisions they would like to keep alive, and the Senators are encouraging the submission of legislative language.  This approach, requiring Senators to defend the provisions they would like retained, rather than cut breaks they don’t support, is a departure from current practice.  Baucus and Hatch did note that any benefit that ends up in the tax code will reduce the amount of revenue that could go towards reducing the overall rate or reducing the deficit.

Final Section 336(e) Regulations Allow Step-Up in Asset Tax Basis in Certain Stock Acquisitions

Sheppard Mullin 2012

Final regulations were issued last month under IRC Section 336(e). These regulations present beneficial planning opportunities in certain circumstances.

For qualifying transactions occurring on or after May 15, 2013, Section 336(e) allows certain taxpayers to elect to treat the sale, exchange or distribution of corporate stock as an asset sale, much like a Section 338(h)(10) election. An asset sale can be of great benefit to the purchaser of the stock, since the basis of the target corporation’s assets would be stepped up to their fair market value.

To qualify for the Section 336(e) election, the following requirements must be met:

  1. The selling shareholder or shareholders must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder or shareholders.
  2. The selling shareholder or shareholders must own at least 80% of the total voting power and value of the target corporation’s stock.
  3. Within a 12-month period, the selling shareholder or shareholders must sell, exchange or distribute 80% of the total value and 80% of the voting power of the target stock.

Although the rules of Section 338(h)(10) are generally followed in connection with a Section 336(e) election, there are a few important differences between the two elections:

  1. Section 336(e) does not require the acquirer of the stock to be a corporation. This is probably the most significant difference; and, to take advantage of this rule, purchasers other than corporations may wish to convert the target without tax cost to a pass-through entity (e.g., LLC) after the purchase.
  2. Section 336(e) does not require a single purchasing corporation to acquire the target stock. Instead, multiple purchasers—individuals, pass-through entities and corporations—can be involved.
  3. The Section 336(e) election is unilaterally made by the selling shareholders attaching a statement to their Federal tax return for the year of the acquisition. Purchasers should use the acquisition agreement to make sure the sellers implement the anticipated tax strategy

Section 336(e) offers some nice tax planning opportunities, by allowing a step up in tax basis in the target’s assets where a Section 338(h)(10) election is not allowed.

Example: An S corporation with two shareholders wishes to sell all of its stock to several buyers, all of which are either individuals or pass-through entities with individual owners. A straight stock purchase would not increase the basis of the assets held inside the S corporation, and an LLC or other entity buyer would terminate the pass-through tax treatment of the S corporation status of the target. A Section 338(h)(10) election is not available since the purchaser is not a single corporation. However, a Section 336(e) election may be available, whereby the purchase of the stock would be treated as a purchase of the corporation’s assets (purchased by a “new” corporation owned by the purchasers). The purchasers could then convert the purchased corporation (the “new” corporation with the stepped-up assets basis) into an LLC, without tax, thereby continuing the business in a pass-through entity (single level of tax) with a fully stepped-up tax asset basis.

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