Page 46 - TaxAdviser_2022

TAX TRENDS

Background to recompute the taxes for the year the retained an unrestricted right to the in-
In January 2004, Kenneth and Ardyce taxpayer received the income. In order come when the stock was repurchased
Heiting created a revocable trust that to establish a claim for relief under Sec. by the trust.
was treated as a grantor trust, with a 1341(a), taxpayers must plead that: The IRS conceded that the first
bank as the trustee. As a grantor trust, ■ An item was included in gross element of Sec. 1341(a) was satisfied
the trust itself filed no tax returns, and income for a prior tax year (or years) because the trust had received an item
the Heitings reported the trust’s gains because it appeared that the taxpayer of income, the $5.6 million gain on
and losses on their own returns. had an unrestricted right to the the sale of the restricted shares, and
Under the terms of the trust, the item; that income was taxable to the Heit-
trustee had broad authority over the ■ A deduction is allowable for the tax ings because the revocable trust was
trust assets in general, but that power year because it was established after a disregarded entity for tax purposes.
was explicitly limited with respect to the close of the prior tax year (or However, according to the IRS, the
two particular categories of assets: years) that the taxpayer did not have second element of Sec. 1341(a) was not
For Bank of Montreal Quebec com- an unrestricted right to the item or met because the Heitings had failed to
mon stock and Fidelity National to a portion of the item; and show that they did not have an unre-
Information Services Inc. common ■ The amount of the deduction stricted right to the income from the
stock, the trustee had “no discretionary exceeds $3,000. stock sale and that they were under a
power, control, or authority to take any The IRS rejected the Heitings’ legal obligation to restore that income
action(s),” including any sale or pur- claim for refund, stating that under the to its actual owner. The IRS reasoned
chase of that stock, absent the Heitings’ exception in Sec. 1341(b)(2), the stat- they did have an unrestricted right to
express authorization. ute did not apply to “the sale or other the income because they had the power
Nonetheless, in October 2015, the disposition of the Stock in trade of the to approve a restricted stock sale and
trustee sold restricted stock held in the taxpayer.” The Heitings filed a refund retain any proceeds from the sale. The
trust and incurred a taxable gain of $5.6 suit in district court. IRS asserted that the trustee’s purchase
million on the sale, which the Heit- In district court, the IRS moved to of stock in 2016 was an attempt to
ings included in gross income on their dismiss the case because the Heitings reverse the effect of the 2015 stock sale
2015 tax return and paid taxes on. The failed to state a claim upon which relief but that there was no question that the
trustee afterward realized that it was could be granted. The IRS abandoned taxpayers had the right to the income
prohibited from selling the stock by the its argument that the couple were not from the 2015 sale.
trust agreement. To remedy its error, in entitled to a refund based on the ex- The Heitings in turn contended
January 2016 the trustee purchased the ception in Sec. 1341(b)(2). Instead, in that because the tax obligations of the
same number of shares of the restricted support of its motion, the IRS argued trust were at issue, not their own tax
stock with the sale proceeds from the that under Sec. 1341, the Heitings were obligations as individuals, the deter-
earlier transaction. entitled to a credit only if they were mination should focus on whether the
On their 2016 income tax return, the legally obligated to return the proceeds trust had an unrestricted right to the
Heitings sought to invoke the claim- of the prohibited stock sale and that, sale income in 2015 and 2016. The
of-right doctrine in Sec. 1341 to claim under the facts of the case, they were Heitings admitted that they had an un-
a deduction related to the repurchase. not obligated to do so. The district restricted right to the funds as the sole
Under the claim-of-right doctrine, as court granted the IRS’s motion to beneficiaries of the trust because they
set out in Sec. 1341, a taxpayer must dismiss, and the Heitings appealed that had the absolute authority to choose
report income in the year in which it decision to the Seventh Circuit. to accept the funds and authorize the
was received if it appears the taxpayer trust’s actions. Nonetheless, they argued
has an unrestricted right to the income, The Seventh Circuit’s decision that the proper focus was on the trust’s
even if the taxpayer could be required The Seventh Circuit upheld the dis- actions and whether the trust retained
to return the income later if it is es- trict court’s decision that the Heitings an unrestricted right to the funds,
tablished the taxpayer did not have an were not entitled to a refund under arguing that they merely stepped into
unrestricted right to the income, but if Sec. 1341. The court concluded that the shoes of the trust in including the
repayment is required in a later year, the the Heitings did not meet the second trust income on their taxes. The court
taxpayer is entitled to a deduction for requirement of Sec. 1341(a)(2) because did not address whether the Heitings
the repayment of the income in the year there was only a potential restriction on stepped into the trust’s shoes because,
of that repayment or, as an alternative, the trust’s sale of the stock, so the trust even considering only whether the trust

44 January 2022 The Tax Adviser