Category Archives: Tax Planning

How to Protect Inherited IRAs After the Clark v. Rameker Decision

will with clockMy Comments: If you have an IRA today, there is a chance there will still be money in it when the inevitable happens and you permanently leave the building. What then with this money?

If you have a spouse, and they are the named beneficiary, that money now belongs to them and it becomes their IRA. If your spouse has predeceased you, it becomes an Inherited IRA, benefiting someone else, perhaps one or more of your children.

Recently the Supreme Court declared that while YOUR IRA is protected against the claims of creditors, an Inherited IRA is not. Because it represents money earned by someone other that YOU. Before this decision, it was assumed from IRS regs that it would be protected.

If none of this applies to you, then read no further. I’d like to attribute this to the correct author but somehow that name went missing.

In a landmark, unanimous 9-0 decision handed down on June 12, 2014, the United States Supreme Court held that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law. This means they are therefore available to satisfy creditors’ claims. (See Clark, et ux v. Rameker, 573 U.S. ______ (2014))

The Court reached its conclusion based on three factors that differentiate an inherited IRA from a participant-owned IRA:

1. The beneficiary of an inherited IRA cannot make additional contributions to the account, while an IRA owner can.

2. The beneficiary of an inherited IRA must take required minimum distributions from the account regardless of how far away the beneficiary is from actually retiring, while an IRA owner can defer distributions at least until age 70 1/2.

3. The beneficiary of an inherited IRA can withdraw all of the funds at any time and for any purpose without a penalty, while an IRA owner must generally wait until age 59 1/2 to take penalty-free distributions.

These factors characterize an inherited IRA as money that was set aside for the original owner’s retirement and not for the designated beneficiary’s retirement. This simple analysis has sent shock waves through the estate planning and financial advisory worlds, because its logic is also applicable to all inherited defined contribution retirement plan accounts, so inherited 401(k) and 403(b) accounts are also affected. What can be done to protect inherited IRAs from creditors? Could the Clark decision put IRAs inherited by spouses at risk? Could state law still protect inherited IRAs? In this issue we will answer these questions and provide guidelines for you and your team to follow when advising clients who or what to name as the beneficiaries of their IRAs.

What Can Be Done to Protect Inherited IRAs From Creditors?
In view of the Clark decision, clients must thoughtfully reconsider any outright beneficiary designations for their retirement accounts if they want to insure that the funds will remain protected for their beneficiaries after death. By far the best option for protecting an inherited IRA is to create a Standalone Retirement Trust for the benefit of all of the intended IRA beneficiaries. If properly drafted, this type of trust offers the following advantages:

• Protects the inherited IRA from each beneficiary’s creditors as well as predators and lawsuits
• Insures that the inherited IRA remains in the family bloodlines and out of the hands of a beneficiary’s spouse, or soon-to-be ex-spouse
• Allows for experienced investment management and oversight of the IRA assets by a professional trustee
• Prevents the beneficiary from gambling away the inherited IRA or blowing it all on exotic vacations, expensive jewelry, designer shoes and fast cars
• Enables proper planning for a special needs beneficiary
• Permits minor beneficiaries, such as grandchildren, to be immediate beneficiaries of the inherited IRA without the need for a court-supervised guardianship
• Facilitates generation-skipping transfer tax planning to insure that estate taxes are minimized or even eliminated at each generation
Downsides to tying up an IRA inside of a trust include compressed tax brackets which max out at $12,150 of income (in 2014), ongoing accounting and trustee fees, and the sheer complexity of administering the trust year after year. In addition, a well-drafted trust can be completely derailed by an uncoordinated IRA beneficiary designation. Therefore, all of the pros and cons of a Standalone Retirement Trust must be carefully considered before committing to this strategy.

Planning Tip: In most cases a standard revocable living trust agreement will not be well-suited to be named as the beneficiary of an IRA. This is because in order to provide all of the benefits listed above and avoid mandatory liquidation of the inherited IRA over a period as short as five years, the trust agreement must be carefully crafted as a “See Through Trust.” A See Through Trust insures that the required minimum distributions can either remain inside the trust (an “accumulation trust”), or be paid out over the oldest trust beneficiary’s life expectancy (a “conduit trust”).

Thus, a Standalone Retirement Trust that has specific provisions for administering retirement accounts, and that is separate and distinct from a client’s revocable living trust that has been drafted to address the entire gamut of the client’s non-retirement assets, is the preferable type of IRA trust beneficiary. If your clients have not considered a Standalone Retirement Trust before the Clark decision, then the time is now to educate them about its far-reaching consequences and how a Standalone Retirement Trust can benefit their IRA beneficiaries.

Could the Clark Decision Put IRAs Inherited by Spouses at Risk?
The Clark decision dealt with an IRA inherited by the daughter of the owner. What if the IRA was instead inherited by the spouse of the owner, would the decision have been different?

When a spouse inherits an IRA, he or she has three options for what to do with it:

1. The spouse can cash out the inherited IRA and pay the associated income tax.

2. The spouse can maintain the IRA as an inherited IRA.

3. The spouse can roll over the inherited IRA into his or her own IRA, after which it will be treated as the spouse’s own IRA.

In scenario 1 the cashed-out IRA will not have any creditor protection since the proceeds will become comingled with the spouse’s own assets. Extending the Supreme Court’s rationale to scenario 2, the inherited IRA will not be protected from the spouse’s creditors since the spouse is prohibited from making additional contributions to the account, may be required to take distributions prior to reaching age 70 1/2, and can withdraw all of it at any time without a penalty. In scenario 3, a rollover is not automatic, and even after a rollover is completed, the inherited funds were certainly not set aside by the spouse for his or her own retirement before the rollover was initiated.

As a result of the Clark decision, will an IRA inherited by a spouse lose its qualification as a “retirement fund” under federal bankruptcy law once it is actually inherited by the spouse? Could the rollover of an inherited IRA into the spouse’s own IRA now be considered a fraudulent transfer under applicable state law? Unfortunately the answers to these questions are not clear at this time.

Planning Tip: Provisions can be made in a Standalone Retirement Trust for the benefit of a spouse. This may be important for many reasons aside from creditor protection, including a second marriage with a blended family or, when coupled with disclaimer planning, for a spouse who eventually needs nursing home care and seeks to qualify for Medicaid. A layered IRA beneficiary designation which includes a Standalone Retirement Trust and disclaimer planning can offer a great deal of flexibility for clients who want to insure that their hard-saved retirement funds stay in their family’s hands and out of the hands of creditors and predators.

Could State Exemptions Still Protect Inherited IRAs?
In the wake of the Clark decision, a handful of states – including Alaska, Arizona, Florida, Idaho, Missouri, North Carolina, Ohio and Texas – have either passed laws or had favorable court decisions that specifically protect inherited IRAs under state bankruptcy exemptions for federal bankruptcy purposes. If the IRA beneficiary is lucky enough to live in one of these states, then the beneficiary may very well be able to protect their inherited retirement funds by claiming the state exemption instead of the federal exemption.

Planning Tip: Caution should be used in relying on state exemptions to protect a beneficiary’s inherited IRA. People are more mobile than ever and may need to move from state to state to find work, pursue educational goals, or be closer to elderly family members in need of assistance. Aside from this, federal bankruptcy laws now require a debtor to reside in a state for at least 730 days prior to filing a petition for bankruptcy in order to take advantage of the state’s bankruptcy exemptions. Therefore, long-term planning should not rely on a specific state’s laws but instead should take a broad approach.

The Bottom Line
Given the amount of wealth held inside retirement accounts, planners have got to become adept at helping their clients figure out who or what to name as the beneficiary of these special assets. The Clark decision has amplified the need to become knowledgeable about the pros and cons of all of the different beneficiary choices for retirement assets.

This is certainly not one-size-fits-all planning and can only be done on an individual, case by case basis. We are here to answer all of your questions about protecting beneficiaries of retirement accounts through Standalone Retirement Trusts, disclaimer planning, and layered beneficiary designations.

5 QLAC Questions and Answers

My Comments: QLAC? What the heck is a QLAC?

By Jeffrey Levine / July 18, 2014

On July 1, 2014 the Treasury Department released the long-awaited final regulations for Qualifying Longevity Annuity Contracts (QLACs). These new annuities will offer advisors a unique tool to help clients avoid outliving their money.

The QLAC rules, however, are a complicated mash-up of IRA and annuity rules, and clients may need substantial help in understanding their key provisions. To help advisors break down the most important aspects of QLACs, below are 5 critical QLAC questions and their answers.

1) Question: What are QLACs?
Answer: QLACs, or qualifying longevity annuity contracts, are a new type of fixed longevity annuity that is held in a retirement account and has special tax attributes. Although the value of a QLAC is excluded from a client’s RMD calculation, distributions from QLAC don’t have to begin until a client reaches age 85, well beyond the age at which RMDs normally begin.

2) Question: Why did the Treasury Department create QLACs?

Answer: Prior to the establishment of QLACs, there were significant challenges to purchasing longevity annuities with IRA money. The rules required that unless an annuity held within an IRA had been annuitized, its fair market value needed to be included in the prior year’s year-end balance when calculating a client’s IRA RMD. This left clients with non-annuitized IRA annuities with an inconvenient choice to make after reaching the age at which RMDs begin. At that time, they needed to either:
1) Begin taking distributions from their non-annuitized IRA annuities, reducing their potential future benefit, or
2) Annuitize their annuities, which would obviously produce a lower income stream than if they were annuitized at a more advanced age, or
3) “Make-up” the non-annuitized annuity’s RMD from other IRA assets, drawing down those assets at an accelerated rate.

None of these options was particularly attractive and now, thanks to QLACs, clients will no longer be forced to make such decisions.

3) Question: How much money can a client invest in a QLAC?

Answer: The final regulations limit the amount of money a client can invest in a QLAC in two ways: a percentage limit; and an overall limit. First, a client may not invest more than 25 percent of retirement account funds in a QLAC.

For IRAs, the 25 percent limit is based on the total fair market of all non-Roth IRAs, including SEP and SIMPLE IRAs, as of December 31st of the year prior to the year the QLAC is purchased. The fair market value of a QLAC held in an IRA will also be included in that total, even though it won’t be for RMD purposes.

The 25 percent limit is applied in a slightly different manner to 401(k)s and similar plans. For starters, the 25 percent limit is applied separately to each plan balance. In addition, instead of applying the 25 percent limit to the prior year-end balance of the plan, the 25 percent limit is applied to the balance on the last valuation date.

In addition, that balance is further adjusted by adding in contributions made between the last valuation and the time the QLAC premium is made, and by subtracting from that balance distributions made during the same time frame.

In addition to the 25 percent limits described above, there is also a $125,000 limit on total QLAC purchases by a client. When looked at in concert with the 25 percent limit, the $125,000 limit becomes a “lesser of” rule. In other words, a client can invest no more than the lesser of 25 percent of retirement funds or $125,000 in QLACs.

4) Question: What death benefit options can a QLAC offer?
Answer: A QLAC may offer a return of premium death benefit option, whether or not a client has begun to receive distributions. Any QLAC offering a return of premium death benefit must pay that amount in a single, lump-sum, to the QLAC beneficiary by December 31st of the year following the year of death.

Such a feature is available for both spouse and non-spouse beneficiaries. In addition, the final regulations allow this feature to be added regardless of whether the QLAC is payable over the life of the QLAC owner only, or whether the QLAC will be payable over the joint lives of the QLAC owner and their spouse.

QLACs may also offer life annuity death benefit options. In general, a spousal QLAC beneficiary can receive a life annuity with payments equal to or less than what a deceased spouse was receiving or would have received if the latter died prior to receiving benefits under the contract. An exception to this rule is available, however, to satisfy ERISA preretirement survivor annuity rules.

If the QLAC beneficiary is a non-spouse, the rules are more complicated. First, clients must choose between two options, one in which there is no guarantee a non-spouse beneficiary will receive anything; but if payments are received, they will generally be higher than the second option.

The second option is a choice that will guarantee payments to a non-spouse beneficiary, but those payments will be comparatively smaller than if payments were received by a non-spouse beneficiary under the first option. Put in simplest terms, a non-spouse beneficiary receiving a life annuity death benefit will generally fare better with the first option if the QLAC owner dies after beginning to receive benefits whereas, if the QLAC owner dies before beginning to receive benefits, they will generally fare better with the second method.

5) Question: Are QLACs available now
Answer: Yes…and no. Quite simply, the QLAC regulations are in effect already, but that doesn’t mean that insurance carriers already have products that conform to the new IRS specifications.

To the best of my knowledge, and as of this writing, QLACs exist in theory only.
It’s likely, however, that in the not too distant future, QLACs will go from tax code theory to client reality. Exactly which carriers will offer them and exactly which features those carriers will choose to incorporate into their products remains to be seen.

But make no mistake: QLACs are coming (or here, depending on your point of view). If such products may make sense for clients, it probably makes sense to reach out to them now and begin the discussion.

Why the IRS Wants You to Watch Your IRA Rollovers

IRS logoMy Comments: Can you say esoteric? Can you say huh? Can you say obscure?

The IRS recently issued a ruling, or perhaps more accurately a tax court decision made it for them that limits a persons ability to make an IRA rollover more than once in any calendar year. Used to be if you had 10 different IRA accounts, it didn’t matter. Now you are limited to ONE.

Mind you this doesn’t necessarily apply to transfers, which are technically different from rollovers. This article, assuming you give a damn, will tell you why.

By Mark Miller / April 24, 2014

CHICAGO (Reuters) – Memo from the Internal Revenue Service to retirement investors: Be careful with those individual retirement account rollovers.

That’s the gist of a recent IRS ruling that puts new restrictions on the number of “indirect rollovers” from one IRA to another you can do annually. The ruling comes on the heels of a federal court decision in January in which a complex strategy involving multiple rollovers executed by a New York City tax attorney, Alvan Bobrow, and his wife, Elisa, was disallowed. They were hit with a $51,298 income tax bill and a penalty of $10,260.

The new IRS rule only affects indirect rollovers, in which money isn’t sent direct from one financial trustee to another. Until now, such rollovers were permitted once every 12 months from each IRA account that a taxpayer owns. Starting January 1, 2015, the 12-month rule applies to all IRAs a taxpayer owns collectively. (Rollovers completed in 2014 won’t be affected.)

An indirect rollover allows an investor to withdraw funds from an IRA and then take up to 60 days to reinvest the proceeds in a different IRA without incurring income tax liability or the 10 percent withdrawal penalty for investors younger than 59 1/2. The court case, Bobrow v. Commissioner, involved several large indirect rollovers (just over $65,000 apiece) in 2008.
At issue is a sophisticated strategy, allowable under the old rules, aimed at drawing what amounts to an interest-free loan through a series of indirect rollovers. It’s usually executed by financial advisers or other financial experts because the penalties for mistakes are severe.

“We’ve executed it with a handful of clients over the past decade,” says Michael Kitces, partner at Maryland-based Pinnacle Advisory Group, “although I usually caution strongly against it, because if you botch it for any reason, you can’t fix it.”

In this case, Bobrow took an indirect distribution of $65,064 from his IRA in April 2008. In June he took a distribution of the same amount from a second IRA and four days later used those funds to repay the first IRA. In July he took a third distribution of that amount from an IRA owned by his wife, repaying that money into his second IRA days later. In September he made a final deposit to repay his wife’s IRA.

The IRS held that the timing of some of the transactions didn’t comply with the 60-day rule, and other aspects of the maneuver violated its rules. Bobrow sued the IRS, but the court wound up not only backing the IRS on the issue of the Bobrows’ timing but also ruling more broadly that all indirect rollovers are subject to an aggregate once-per-year rule.

That set the stage for the IRS rule that takes effect next year, which aims to clamp down on this maneuver. It applies to transfers from one IRA to another, or from a Roth IRA to another Roth account. It also covers SEP (simplified employee pension) plans and Simple (savings incentive match plan for employees) IRAs. It doesn’t apply to rollovers from a workplace account to an IRA, or to Roth conversions.

The rule has caused a stir among financial advisers because it contradicts language in IRS Publication 590, which spells out the IRA rules. (The IRS will amend the publication.) Nonetheless, the shift should not pose problems for most taxpayers, who typically execute rollovers directly between financial institutions.

“People really shouldn’t do indirect rollovers,” says Ed Slott, an IRA educator and author. “The only advantage is to get temporary use of the money, and that’s not really the spirit of the law.” Slott says some financial institutions do make it tough to execute direct rollovers, which could lead some taxpayers to the indirect route.

“I’ve heard of cases where the investor goes into a bank or brokerage and the staff person doesn’t know how to do a trustee-to-trustee transfer – or they try to talk the customer out of moving the money to another institution,” he says. “So, the investor will say, ‘Just give me a check, I haven’t decided what to do with it yet.’ “

Slott thinks the safest way to handle rollovers is direct trustee-to-trustee – with the receiving institution doing the paperwork. “If you are moving from bank A to broker B, broker B is getting the money, so let him do the paperwork. He’ll do it the right way, because he has an incentive to do so.”

But I’ll wave a caution flag: Don’t use an adviser simply because she offers to streamline your paperwork. Brokers and other financial advisers may be able to help you do the rollover paperwork, but you still need to do due diligence on the quality of investments offered and the fees charged. The U.S. Labor Department is gearing up to propose broad new rules later this year that would require brokers to act as fiduciaries, including when they advise clients on rollovers.

(The opinions expressed here are those of the author, a columnist for Reuters.)

Top 10 Benefits and Risks of Forming a Captive

retirement_roadMy Comments: I recently published an eBook with the title CAPTIVE WEALTH!

It explains how to use an 831(b) Captive Insurance Company to create, to grow, and to preserve wealth.

While not a simple idea, it does have the blessing of the IRS if you do it the right way, under the right circumstances. That alone makes it valuable and something to know about.

From the perspective of a successful small business owner, it allows him or her to turn a current expense item into an asset at a later date. Think about it; money spent now comes back later as an asset, which can be used many different ways. This article outlines some of the caveats you should be aware of.

By Donald Riggin, from Guide to Captives and Alternative Risk Financing | November 11, 2013
Top-10-issues

9 Tax Breaks Expiring at Year’s End

IRS-formsI’m sure you agree that we live in a world of political correctness. Sometimes that’s a good thing and many times it just gets in the way of common sense. Right now, I have to tell you I am NOT licensed or qualified to dispense tax advice. But as a financial planner, for which I am licensed and qualified, I can tell you there are tax issues you should perhaps be aware of. Some of them qualify as simple common sense.

Another year has nearly passed, and it’s time to make sure your have your tax ducks in a row.
It’s important to make sure you know about the key changes made to the tax code before you make your end-of-year moves.

The slogan for this month might just be “use it or lose it.” That’s because there are several tax breaks that are set to expire as 2014 dawns. Whoever your clients are — teachers, students, small-business owners and big spenders to name a few — make sure they take advantage before it’s too late.

“The days of relying on Congress to automatically renew expiring tax provisions … might finally be coming to a close as the strain on the federal budget becomes more evident with each new round of budget negotiations,” wrote William H. Byrnes and Robert Bloink on ThinkAdvisor.

(Not all tax news is bad. The IRS recently gave high-income taxpayers a break with the release of the final regulations governing the new 3.8% tax on net investment income.)

Read about all NINE of them HERE:

A Long Walk Off a Short Cliff

Social Security 3My Comments: An area of expertise that I claim, involves a topic known as “captive insurance companies.” This concept applies to successful small business owners and the companies they own. These folks are in the news a lot lately because they get talked about in the context of the Affordable Care Act and what some pundits say will ruin them.

But since 99% of small businesses have less than 50 employees, which means the PPACA is not in play, there is a more important reason to pay attention, and that’s the government shutdown and the effect a potential default will have on them going forward.

For those of you who are small business owners and don’t know about captives, you can find out much more elsewhere on this web site. (or click on the attached image…) For now, know that it represents a way for you to improve cash flow, minimize risk exposure, and set aside funds for the future with favorable tax consequences.

Sitanta O’ Mahony October 10, 2013

By the time you read this, the fiscal crisis afflicting the US may appear to be over. Indeed despite the markets being roiled by talk of a possible US default, reaching the debt ceiling – as the government is forecast to do on October 17th – does not mean the government will default.

In fact the American constitution prevents such an eventuality; the 14th Amendment states that “the validity of the public debt of the United States, authorized by law” is sacrosanct and “shall not be questioned.” Despite this, perhaps because of remarks by the US press secretary appearing to dismiss the 14th amendment as a solution, the markets continue to be spooked.

Captive insurers are also being affected by the legislative deadlock, and unfortunately this will continue whether or not the impasse is resolved.

Lawrence Prudhomme, vice president at management and consultancy firm GPW and Associates, Inc. says the shutdown of the Internal Revenue Service (IRS), which is closed for business until the impasse is resolved, is one of the most immediate and visible ways the government shutdown is affecting captives.

It is also a short-term issue, he says. “For captive insurance companies domiciled outside the United States, obtaining an employer identification number requires direct contact with the IRS and cannot be done electronically.

So, as a result, until the IRS is reopened, nothing can be done in this area. It’s inconvenient, but not critical to the overall process of forming a new captive. We are anticipating that things will be resolved shortly and any backlogs will be overcome in a reasonable amount of time” says Prudhomme.

The biggest fiscal cliff development which Gary Osborne, President of USA Risk Group, Inc., the largest independent captive management firm in the US, has seen is an increase in firms utilising their captive, or starting a captive, to fulfil obligations under The Patient Protection and Affordable Care Act (PPACA), aka Obamacare.

“We’re seeing a big increase in smaller companies looking at utilising captives to self-insure. Self-insurance can be used to meet the requirements of PPACA and it gives companies much greater flexibility and choice in terms of the coverage they provide compared to remaining in one of the health insurance exchanges”.

Osborne cites the case of Vermont which mandates the provision of unlimited fertility treatments in its exchanges. However if a firm self-insures, a cap of one or two such treatments can be implemented.

“The coverage provided under a self insured plan can be tweaked as long as it meets the minimum federal standard which is generally much lower than many states are imposing under the health insurance exchanges.”

Although states can’t stop firms self-insuring under the federal law, in a bid to maximise higher standards of health care for all employees, they are limiting the ability to buy stop loss insurance and Osborne says this is forcing companies with fewer than 100 employees back onto the exchanges.

The other area in which the impasse is impacting captives is in relation to the renewal of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), commonly known as TRIA, which is set to expire on December 31, 2014.

“TRIA is one of the areas the government are considering cutting, people are beginning to question why the government is getting involved and whether or not it’s really needed”, says Osborne. With trenchant cuts in public spending on the table TRIA seems an easy target.

Yet notwithstanding the tag of ‘corporate welfare’ being lobbed at it by the Cato Institute and others, in fact TRIA doesn’t cost a lot of money, says Osborne. “It’s a pooling mechanism, an advance from the government, which insurance companies (including domestic captives) contribute to by paying up to 3% of their premium. Unfortunately it’s one of those symbolic issues that has been caught up in the fight.”

Despite this, Osborne thinks TRIA’s future is assured. “There are enough vested interests fighting for it”. Let’s hope the same can be said for affordable healthcare.

The Legality of Offshore Planning: an Introduction

imagesMy Comments: This blog post by Hale Stewart, derives in part from his expertise with captive insurance companies, and the fact that they are often set up in an offshore jurisdiction to provide a layer of asset protection for those using the concept. There are now approximately 17 states that allow and encourage the creation of domestic captives, as opposed to offshore captives.

Mr. Stewart and I are acquainted as a result of my involvement with captive insurance companies and privately owned medical practices. Physicians are troubled these days by the financial pressures resulting from the PPACA or what many folks think of as “Obamacare”. Introducing a captive insurance company allows the practice owners to keep more of their money and minimize those financial pressures.

A captive insurance company, by definition and design, sells insurance policies to no one other than the company that owns it. It is a valid and economically viable tool that can significantly benefit the owners of a successful small business, if done correctly and appropriately.

by Hale Stewart, Esq. on June 26, 2013

Apple’s tax plan — and subsequent appearance before Congress defending their plan — has again drawn attention to the idea of offshore planning. The overall debate has fallen into the fairly predictable pattern of the political right saying Apple is 100 percent allowed to do whatever they can to lower their taxes, while the political left has decried the practice as a deliberate evasion of taxes.

What both sides have failed to do is place the idea of offshore planning in the context of U.S. anti-avoidance law in order to determine if the structure would indeed stand-up to scrutiny in the event it was challenged in court. While the analysis that follows will hardly be an in-depth treatment, it should serve to highlight some of the legal issues involved with complex international tax planning of this nature.

By way of introduction, there are two core concepts of U.S. anti-avoidance law, both of which are derived from the same case, Gregory v. Helvering. The concept which is by far most cited is that taxpayers are allowed to structure their affairs to minimize taxation. However, just as important — but not cited with nearly the same frequency — is that all transactions must have substance; merely complying with the technical requirements of the code is insufficient.

In Gregory, the taxpayer performed a corporate formation and liquidation over a three-day period. The court ruled this short duration indicated the corporation was not meant to be used for a legitimate business purpose, but was instead a technical shell game used to minimize taxes. In ruling against the taxpayer, the court forever added an additional layer to tax planning — the need to demonstrate transactional “substance.”

Further complicating our analysis are two issues. The first is that “legal substance” is an ephemeral and ill-defined concept. Little to no scholarship has been performed on the idea. The vast majority of courts dealing with this issue gloss over it, usually stating the act of formation is sufficient in and of itself to demonstrate a legitimate enterprise.

However, this is exactly what the taxpayer did in Gregory only to have the court rule against her. Perhaps the best list of factors for practitioners to use to demonstrate substance (or at lease corporate separateness) comes from veil piercing law, where many courts have a list of factors to determine if a company is in fact an “alter ego” of the person incorporating the company.

A strong argument could also be made that the material participation standards of 26 U.S.C. 469 could provide some much needed parameters for comparison. However, no court decision that I’m aware of has formally applied these commonly used and understood concepts to the area of corporate substance.

The best explanation I have found for “substance” is from a law review article titled “Business Purpose, Economic Substance and Corporate Tax Shelters” by Peter C. Canellos (54 SMU L. Rev. 47) where he notes that the vast majority of legitimate business transactions (which would therefore survive a substance over form challenge) have at their core, one of three purposes: increasing profit, lowering expenses or acquiring/raising financing. However, it should be noted that only lowering a tax expense is insufficient.

Unfortunately from a practicing perspective, whether or not a transaction falls into one of the three categories usually falls under the, “I know it when I see it” column.

The second problem complicating an analysis of the transaction is that substance over form law is itself a conceptual briar patch. Despite it’s importance to tax law, no case law book has ever been written on this topic.

Shepherdizing the Gregory case returns over 1,000 cases, law review articles, CLE materials and practitioner’s guides. Courts routinely use various substance over form terms interchangeably and incorrectly, and return conflicting decisions on the same or similar facts. While five actual anti-avoidance law concepts have been cited and developed in the case law (substance over form, the sham transaction, business purpose, the economic substance doctrine and the step transaction doctrine), legitimate scholarly debate could support the contention that there is only one, or three, four and five doctrines.

Going forward, I’m going to look at offshore from three perspectives: substance over form, economic substance and business purpose. Substance over form will use the concepts outlined above (“material participation” and the factors in “alter ego” analysis will be used. There will also be an explanation of legislative intent). I will make the assumption that the economic substance doctrine is a latter day version of the sham transaction doctrine (“sham transaction” language was used primarily in the 1950s-1970s, while “economic substance” language was used from the late 1980s/early 1990s onward; both contain an objective and subjective component). The business purpose doctrine will use the factors outlined in the Frank Lyon case. As the step transaction doctrine is most often used in corporate reorganizations or shorter duration transactions, it will not be used.