Debt Forgiveness: Accounting and Tax Implications

25th Annual Accounting Show September 29 – October 1, 2010 Ft. Lauderdale

8:00-8:50am Powers of Appointment - General and Special...... 1 George Elias, Jr., Esquire Attorney & Counselor at Law / George Elias, Jr., Esquire, P.A. Bay Harbor Islands

9:40 - 11:20am Debt Forgiveness: Accounting and Tax Implications ...... 21 Diane J. Reich, CPA, MBA President / Reich CPA LLC Tampa and Barry M. Weins, CPA, JD Tax Partner / Cherry, Bekaert & Holland Tampa

2009 - 2010 Accounting Shows Committee

Frank P. Ward - Chair Christine Moreno - Vice Chair Randee M. Abramson Paulette M. Holder Cecil Patterson, Jr. Alan D. Campbell Stanislav Jansta Martin M. Prague Lynn H. Clements Sharon S. Lassar Robert M. Rankin Lenice A. DeLuca James M. Luffman Diane J. Reich Wayne T. DeWitt William L. Maloney Poornima Srinivasan Richard M. Dotson Patricia M. McDougle Denise M. Stubbs Gary A. Fracassi Rhonda S. Mowry Cheryl L. Whitehead Lucinda L. Gallagher Mario R. Nowogrodzki Donna C. Zeitler

Powers of Appointment – General and Special

George Elias, Jr., Esquire

1 George Elias, Jr. Attorney & Counselor at Law George Elias, Jr. Esquire, P.A.

George Elias, Jr. is a graduate of Case-Western Reserve University at Cleveland, OH (B.B.A.) and received his law degree from George Washington University in Washington D.C. (Juris Doctor with Honors in 1955). Upon graduating, selected as one of 30 law graduates in the U.S. for appointment to the Attorney General’s Honor Law Program, Tax Division, U.S. Department of Justice in Washington, D.C. Entering the private practice of law in 1965, Mr. Elias concentrated his practice in the areas of drafting wills, trusts and estate and tax planning documents, probate and guardianship administration, trust law and administration, probate and trust litigation, elderly and disability law. He is certified as a civil actions Mediator in the Dade County courts. He also has extensive legal experience in negotiating and drafting commercial/hospital and residential architectural/construction contract documents. Mr. Elias has been responsible for the administration of hundreds of decedents' estates, trusts and guardianships during more than 35 years of practice. His broad range of experience enables him to offer advice to efficiently and effectively probate estates, administer trusts, prosecute and defend litigation involving wills and trusts, and protectively handle the affairs of incapacitated persons, all in compliance with the duties and obligations of law. Mr. Elias holds membership in the Real Property, Probate and Guardianship Sections of both The Florida Bar and the American Bar Association. He is also a member of the Dade County Bar Association, wherein he served as Chairman of the Tax Committee (1967), and Chairman of the Probate and Guardianship Committee (1988). He was the Founder, Lecturer and Permanent Chairman of the Dade County Bar Association's "Annual Surviving Spouse Seminar" (1984– 1994). Additionally, Mr. Elias serves on the governing Boards of several charitable institutions, including St. Jude Children's Research Hospital in Memphis, TN, its Executive Management Board (1970 to present), serving as CEO/Chairman of the Board (1988-1990), and member (and Chairman (1990-1997)) of the Building Committee (1986 to present), overseeing hospital construction exceeding $500 Million. He also served on the Boards of Trustees and Directors and Secretary of the Miami Heart Institute, Miami Beach, FL (1965-1991), and the Papanicolaou Cancer Research Institute, n/k/a Sylvester Comprehensive Cancer Center (1984-1990).

2 “To Exercise or Not to Exercise” Powers of Appointment By George Elias, Jr., Esquire 1090 Kane Concourse, Suite 202 Bay Harbor Islands, Florida 33154

If we wish to know the force of human genius, we should read Shakespeare, but if we wish to see the insignificance of human learning, we should study his commentators. (William Hazlitt: On the Ignorance of the Learned.) Without further commenting, we can only guess what Shakespeare’s reaction might have been if confronted by powers of appointment.

“All the rest, residue and remainder of my estate, (including any property over which I may have any power of appointment), I give to X.” or “All the rest, residue and remainder of my estate, (but excluding any property over which I may have any power of appointment), I give to Y.” or “All the rest, residue and remainder of my Trust I give to such person, persons, or body corporate, and for such use and purposes as Z shall, by his Last Will & Testament, or by codicil thereto, in writing, direct, limit and appoint, provided that any such exercise of his power of appointment that is executed within 18 months of his demise, shall be invalid, unless the same shall have been prepared and executed in the presence of such officers of my corporate trustee as may be delegated to perform in that capacity.”

INTRODUCTION1

It is generally agreed that before drafting a will, trust or other property dispositive documents (hereafter collectively a “will”), diligent attempts

1 Due to the extreme sparsity of cases dealing with powers of appointment, per se, the writer wishes to acknowledge that portions of this presentation have been gleaned from, and the writer’s discussion thereon, are based on the learned article of Professor Edward H. Rabin, “Blind Exercises of Powers of Appointment,” in Volume 51, Fall 1965 edition of the Cornell Law Quarterly.

3 should be made to discover any powers of appointment2 which the client may possess. This is particularly true in cases involving the elderly, who may be afflicted with loss of memory or other problems of the aged. Not only may the draftsman fail to discover an existing power, but frequently has no way of knowing what if any powers the testator may acquire after executing his will. Although the draftsman is presumably an attorney, in many, if not most, instances, it is the client’s certified public accountant (hereinafterii “accountant”) who has greater client access and may be most knowledgeable as to the existence of a client’s powers. Thus, in providing the most effective services, the attorney and accountant should consult and cooperate to maximize their fiduciary client services. These and other later discussed possibilities pose problems for the testator-donee and donor of the power. Professor Rabin poses problems as follows: (1) Should the testator who does not have any specific powers of appointment in mind attempt to exercise all powers he may have at his death, and if so, how? (2) Should the donor of a power of appointment seek to prevent such a “blind” exercise by the donee, and, if so, how? Although many other questions are beyond the scope of this article, the writer suggests some additional problems and questions which should be considered: since many clients are not native Floridians, diligent search and inquiries should be made to discover whether they have powers located outside of Florida and, if so, the substance, nature and type. And the current uncertainties as to the post-2010 estate tax law suggest other problems, charitable deduction issues, and other questions which must be considered: what is the size and nature of the client’s estate assets, and whether the power is a general or non-general power (i.e., sometimes referred to as “special” or “limited” powers)? Considering these and other factors, will a release or disclaimer of the power be advisable. Myriad other questions can be raised.

Definition of Powers of Appointment and Tax Consequences.

Definitions. At the time of publication of Professor Rabin’s learned article in 1965, Florida Statutes had not defined a “general power of

2 “Power(s) of appointment” will sometimes hereinafter be referred to as “power(s).”

4 appointment.” In 1999, however, B732.2025(3), Fla.Stat., was enacted, which explained/defined, in convoluted language, that:

“General power of appointment” means a power of appointment under which the holder of the power, whether or not the holder has the capacity to exercise it, has the power to create a present or future interest in the holder, the holder’s estate, or the creditors of either. The term includes a power to consume or invade the principal of a trust, but only if the power is not limited by an ascertainable standard relating to the holder’s health, education, support or maintenance.

During the years before enactment of B732.2025(3), since Florida is a common law State (B2.01, Fla.Stat.), applicable rules relating to powers of appointment were determined and controlled by the common law. Statutory rules, however, had years earlier been enacted to provide how powers of appointment could be released (BB709.02 through 709.07, Fla.Stat.), and/or disclaimed (B739.104 (Fla.Stat.).3

The federal Powers of Appointment Act, enacted in 1951, providing the bases for federal estate taxation, more clearly and simply defined a “general power of appointment” as one which may be “exercised in favor of the donee, his estate, his creditors or the creditors of his estate.” (B2041(b)(1), IRC)

A non-general,“limited”or “special” power of appointment (hereafter collectively “special power”) is one that cannot be exercised in favor of the donee or his or her estate but may be exercised only in favor of identifiable person(s) or class of persons other than to the donee or his estate, etc.

3 Powers of appointment over any property, real, personal, intangible or mixed, may be released, in whole or in part, by a written instrument signed by the donee of such power in the presence of two witnesses. It need not be sealed, acknowledged or recorded to be valid. Nor is it necessary for a spouse to join in the execution of the release to be valid. B709.02, Fla.Stat. B739.104, Fla.Stat., provides that a person may disclaim, in whole or in part, any interest in or power over property, including a power of appointment. To be effective, the disclaimer must be in writing, declare the writing as a disclaimer, describe the interest or power disclaimed, and be signed by the disclaimer and witnessed and acknowledged in the same manner provided for deeds to be recorded in Florida, i.e., in the presence of two witnesses and notarized.

5 Tax Consequences. Under B2041, IRC (and B2514) serious tax consequences result from the exercise of a general power of appointment created on or before October 21, 1942. However, for powers created after October 21, 1942, the mere possession of a general power of appointment is sufficient in and of itself to produce such tax consequences. Therefore, whenever it is established that the testator/donee has a power of appointment, the date of its creation and whether it is a “general” power must be determined so that its tax effects can be weighed, and decisions made whether or not to exercise the power, in whole or in part, or whether an effective disclaimer or release should be considered.

The assets in a “special” power of appointment, however, are exempt from being taxed in the donee’s estate. A “power to consume, invade, or appropriate property for the benefit of the donee of the power, which is limited by an ascertainable standard relating to health, education, support or maintenance” of the donee does not come within the definition of a general power under B2041(b)(1)(A), and is not taxable. Such wording, however, requires caution: if the donee, for example, is also given power to consume, invade or appropriate for his “benefit and comfort,” or for his “comfort and well-being” or words of similar import, the power becomes unrelated to an ascertainable standard and is taxable in the donee’s estate as a general power.

Thus, federal estate tax treatment of assets in a power depends on whether it is general or special; whether it was deemed created before October 22, 1942, or from that date forward, and whether the power continues to be held by the donor or the donee. (BB2036(a)(2), 2038, IRC.) State law determines what substantive rights are held by the donee, but for tax purposes, federal law determines how the power is classified. Morgan v. Commissioner, 309 U.S. 78 (1940).

Disclaimers of Power. As noted above, mere possession of a post October 21, 1942 general power of appointment is sufficient to impose tax consequences in the testator/donee’s estate, unless the power is properly and timely disclaimed. B2041 IRC. “Release” provisions of powers, of appointment, as set out in footnote 3, are contained in BB709.02–709.07, Fla.Stat., and “disclaimer” provisions in BB739.104–739.201, Fla.Stat. In addition, federal “Disclaimer” provisions are in IRC B2518, providing that if a person makes a “qualified disclaimer” regarding any interest in property, it

6 shall apply with respect to such interest as if the interest had never been transferred to such person. B2518(b) defines a “qualified disclaimer” as an irrevocable and unqualified refusal by a person to accept any interest in property, provided the refusal is in writing and received by the transferor, his legal representative, or holder of legal title to such property not later than nine months after the date the transfer was made, or on the date such person attains 21 years of age. It would appear that the above noted Florida statutory provisions for “releases” and “disclaimers” could easily be structured as “qualified disclaimers” within the meaning of B2518(b).4

Should the Donee Attempt to Exercise Unknown Powers?

Returning to the issues of blind exercises of unknown powers, Professor Rabin notes that most modern authorities believe that blanket exercises of unknown powers are usually undesirable. Other commentators suggest, however, that the blanket exercise is desirable. Others straddle the fence and leave it to you and me to make our own decisions. Although Professor Rabin’s reported positions were those circa 1965, they are nevertheless equally applicable today. There can be some advantages to blanket exercises of powers from both a tax and non-tax approach. By the same token, there can also be disadvantages. Since the writer does not like making decisions without knowing all the facts, it is his view, that the disadvantages outweigh any benefits.

Those favoring the blind exercise of unknown powers argue that the testator/donee ordinarily wishes to devise all the property at his disposal, known or unknown, to his beneficiaries to the maximum extent possible. Suppose, for example, the testator has a modest estate (whatever that means today,) a failure to exercise all unknown powers in favor of his family/beneficiaries would appear to be foolish. The failure to dispose of unknown or after-acquired appointive property is as unnatural as failing to dispose of unknown or after-acquired owned property. The writer believes, however, that if the testator possesses a reasonably substantial estate (by today’s standards), and unless members of testator’s family are his sole beneficiaries, such blind exercises in today’s economic climate and

4 Care should be used when employing a disclaimer clause where the spouse’s will creates a general power of appointment intended to qualify for the marital deduction. Depending on the facts, the disclaimer may result in the loss of the marital deduction. B2056(d)(1)(2).

7 uncertainty as to the post-2010 tax laws may be unwise. It is conceivable that the unknown appointive property can be larger or substantially larger than the decedent’s estate; would a blind exercise of the power be prudent?

There are several non-tax reasons against blind exercises of powers of appointment. (1) In many states the creditors of a donee can reach assets subject to a general power not created by the donee only if the donee exercises the power. Thus, it can be argued that known general powers, or unknown powers which might be general, should not be exercised unless the donee’s known assets are sufficient to satisfy all known creditors. (2) A blind exercise, without knowledge of the donor’s creative intentions, may be a careless and ineffective exercise destroying what may have been a well intended carefully worked out plan of disposition in default of the appointment. (3) The blind exercise may be ineffective due to non- compliance with the donor’s specific reference exercise requirements; if ineffective, the property will go to the person who would have taken had there been no exercise, and litigation may be likely. See infra, page 8.

Method of Exercising Power of Appointment.

Statutory or Non-Statutory Exercise. Under statutes in certain states, a will purporting to dispose of a testator’s entire estate (e.g., in the residuary clause) automatically exercises any powers of appointment he may have. However, under the prevailing long-established rule in Florida, such power is not exercised unless the intent to execute the power is so apparent and clear, it is not susceptible to any other interpretation. DePass v. Kansas Masonic Home, 181 So. 410 (Fla. 1938); see Stewart v. United States, 512 F.2d 269 (5th Cir. 1975). It is advisable, in any case, where it is intended to exercise a known power to refer to it specifically by appropriate language in the appointing instrument, particularly if the power was created outside Florida, since the validity of powers over personal property is governed by the law of the donor’s domicile and real property by the situs thereof. If, however, the testator/donee prefers not to exercise the power, he should be cautious to avoid an inadvertent exercise of powers of appointment located outside Florida, of which he is unaware. In such case, the testator’s will can provide language to the effect that:

If, at the time of my death, I have the right to exercise any

8 power of appointment created on or after October 22, 1942, in favor of myself, my estate, my creditors or the creditors of my estate, I hereby declare that nothing in this will shall be deemed or intended to be an exercise of such power, and I further disclaim the right to exercise such power.

SHOULD THE DONOR ATTEMPT TO PREVENT A BLIND EXERCISE BY THE DONEE?

A power of appointment is generally created with the donor’s expectation that it will be exercised intelligently by the donee who is aware of its existence and terms. In today’s economic climate and tax law uncertainties, the donor must also face the possibility that it may not be exercised. For this reason, all well-drafted powers should provide for desired disposition of the appointive assets in case the power is not exercised. In addition, many authorities suggest that the donor should include a clause providing that the power can be exercised only if the donee specifically refers to the power. This would obviously prohibit a blind exercise of unknown powers.

Tax Considerations. Generally speaking, under existing tax law, specific reference clauses inserted by a donor creating the power serves no tax purpose. Since the federal estate tax on powers created after October 21, 1942, is based upon possession of the power, not a subsequent exercise, no federal tax disadvantages result from a careless or inadvertent exercise of the power.

Non-Tax Considerations. Although tax considerations today may, or may not warrant a donor’s imposing a specific reference clause, are there non-tax considerations against such clauses? Professor Rabin, in the tax/economic climate of the 1960s, believed such specific reference clauses to be unwise. He argued that the major problematic non-tax consideration for most donors is that a careless exercise may violate the rule against perpetuities, or it may favor a non-object. He contends, however, that a specific reference requirement is both unwise and increases the possibility that a careless exercise will be ineffective; that if ineffectiveness is to be avoided, a specific reference requirement increases the danger, rather than lessens it.

Secondly, and most importantly, he contends that although legal cases

9 construing specific reference clauses are almost non-existent in America, a specific reference clause may cause wasteful litigation.5 Professor Rabin is correct in his analysis of sparsity of American litigation concerning specific reference clauses.

Although a long-time coming, finally in 2005, one of the few cases, and probably the most recent, construing a specific reference clause in a testamentary power of appointment, and which also had federal estate tax consequences, was instituted by my co-counsel, Christine M. Moreno, Esquire/CPA, and me in Broward County, Florida. Was it the “wasteful litigation” admonished by Professor Rabin? Yes, in the opinion of the writer, but it need not have been.

In the case of Rosoff and Merrill Lynch Trust Company v. Harding, 901 So.2d 1006 (Fla. 4th DCA 2005), Chris and I represented Doreen Harding, the contingent beneficiary of the power of appointment, who was to receive the assets if the power was not exercised. During probate of the decedent’s will, we, on behalf of Harding, objected to decedent’s purported exercise of the specific referenced power in favor of her nephew, Law Professor Arnold Rosoff, the principal beneficiary of decedent’s trust. After several hearings, summary judgment was entered in favor of Harding and Rosoff and Merrill Lynch appealed.

The relevant facts in the case were that in his will dated May 1, 1974, Raymond Molinari created a testamentary trust (“Molinari Trust”) for the benefit of his sister, Teresa Rosoff during her lifetime. The Molinari Trust, created a power of appointment, conditioned upon a precise specific reference clause and clear ascertainable standard for exercising the power, as follows:

(e) The balance remaining in the trust account * * * I give devise and bequeath to such persons or person, or body corporate,

5 Professor Rabin suggests at least three litigation problems he believes are provoked by special reference clauses: 1) Whether existing and new statutes in several states providing that “formalities” imposed by the donor may be disregarded, apply to specific reference clauses? 2) Whether state statutes providing, in effect, that residuary clauses exercise powers in the absence of a manifested intent of the donee, nullify the donor’s specific reference clause? 3) Whether formula clauses exercising “all powers” satisfy the donor’s specific reference requirements? While thought-provoking, his esoteric analysis of these issues are not applicable under Florida law.

10 and for such use and purposes as my sister Teresa M. Rosoff, shall by her Last Will & Testament, or by codicil thereto, in writing, direct, limit and appoint, provided always that any such exercise of her power of appointment that is executed within eighteen months (18 months) of her demise, shall be invalid, unless the same shall have been prepared and executed in the presence of such officers of my corporate trustee as may be delegated to perform in that capacity.

The will further provided that in the event Teresa failed to exercise her power of appointment as therein provided, the balance of the trust would be devised to Harding (the eventual sole surviving contingent beneficiary).

Clarifying his intent, Molinari stated that “[t]his Will has been carefully planned by me and it is my deliberate judgment that all its provisions are wise and just, and that the plan as a whole will be beneficial and satisfactory to all persons concerned.

After Molinari death on January 28, 1982, Teresa executed a will in May, 1982, which provided:

In Paragraph 11(e) of the Will of my late brother, RAYMOND P. MOLINARI, dated May 1, 1974, he provided me with a power of appointment which he required that I exercise by my last Will or a Codicil thereto in writing. He further provided that any such exercise of the power of appointment executed within 18 months of my death shall be invalid unless the exercise shall have been prepared and executed in the presence of officers of the corporate Trustee acting pursuant to his Will. This Will has been prepared and executed in the presence of such officers.

After making several monetary gifts to beneficiaries, she devised the balance of the trust estate to her nephew, Arnold Rosoff. In October, 1983, she republished her 1982 will with a codicil to remove a beneficiary. On June 25, 1991, Teresa executed a second will that expressly revoked all prior wills and codicils. In this 1991 Will she again exercised the power of appointment in the Molinari Trust in accordance with its specific terms, including the presence of the corporate officers, leaving her nephew as the principal beneficiary.

11 On April 28, 2000, Teresa created the Teresa M. Rosoff Revocable Trust. She also executed a third Will, in which she “revoked all prior wills and codicils,” and exercised the power of appointment as follows:

In paragraph 11(e) of the will of my late brother, RAYMOND P. MOLINARI, dated May 1, 1974, he provided me with a power of appointment which he required that I exercise by my last Will or a codicil thereto in writing. I hereby exercise the power of appointment referred to in the Will of RAYMOND P. MOLINARI, dated May 1, 1974, directing that the property which makes up the subject matter of the power of appointment be distributed to the then acting Trustees of the TERESA M. ROSOFF REVOCABLE TRUST dated April 28, 2000.

Teresa’s new Trust did not mention the power of appointment and the gifts therein were not conditioned on anything but Teresa’s death. Most importantly, neither Teresa’s Will nor the Trust were prepared and executed in the presence of corporate officers of the Molinari Trust and Teresa died 13 months (i.e.,within the specified 18 months) after executing the Will and Trust.6

Harding objected to the distribution of the Molinari trust assets to Teresa’s trust and challenged Teresa’s exercise of the specific reference power of appointment in the Will, asserting that the exercise was invalid because Teresa died within 18 months of the Will’s execution, and it was not prepared and executed in the presence of officers of Molinari’s corporate trustee. After the filing of cross-motions by the parties, the trial court, accepting our arguments that Teresa failed to comply with Molinari’s specific reference requirements, entered summary judgment in favor by Harding.

On Arnold’s appeal to the District Court, Harding argued, as in the trial court, that the specific reference requirement was still the controlling law in Florida, and Teresa had failed to comply with the requirements. See Talcott v. Talcott, 423 So.2d 951, 955-956 (Fla. 3d DCA 1982), petition

6 The trial judge raised the interesting rhetorical question as to the purpose of requiring preparation and execution of the power in the presence of the officers of the corporate trustee within 18 months of death. From a conjectural standpoint, Teresa was then in her late 60s, and Molinari apparently thought it less likely that she could be subjected to undue influence if the power was required to be exercised in the presence of the corporate trustee.

12 denied , 431 So.2d 990 (Fla. 1983); Rollins v. Alvarez, 792 So.2d 695, 698 (Fla. 5th DCA 2001); 76 Am. Jur.2d, Trusts Secs. 91, 92, 97; see MacFarlane v. First National Bank of Miami, 203 So.2d 57, 60 (Fla. 3d DCA 1967).

In Talcott, the controlling case in Florida, the appellate court affirmed the summary judgment in favor of the interveners due to the failure to comply with the required method and manner of exercising the power of appointment, by making specific reference to the power in his will. The Court held (423 So.2d at 955-956):

When a method for executing a power of appointment is stated by the donor of a power, the donee must execute the power in the prescribed manner, . . . (cited cases omitted); . . . When the trust defines the manner in which the power must be exercised non-compliance with the donor’s requirements defeats the appointment. In re Estate of Smith, 41 Colo. App. 355, 585 P.2d 319 (1978); Holzbach v. United Virginia Bank, 216 Va. 482, 219 S.E.2d 868 (1975); accord Lednum v. Barnes, 204 Md. 230, 103 A.2d 865 (1954); In re Estate of Schede, 426 Pa. 93, 231 A.2d 135 (1967); see Leidy Chemicals Foundation, Inc. v. First National Bank of Maryland, 276 Md. 689, 351 A.2d 129 (1976); Loring v. Karri-Davies, 371 Mass. 346, 357 N.E.2d 11 (1976); Shine v. Monahan, 354 Mass. 680, 241 N.E. 2d 854 (1968). In Smith, the court stated: Contrary to the ruling of the trial court, the question of whether a power of appointment has been validly exercised depends not on the intent of the donee of the power, but on whether the power was exercised in the manner prescribed by the donor, i.e., by making specific reference in her will to this power. Where the controlling requirements are clearly stated in the donor’s will, the donee’s intent is irrelevant if she fails to comply with those requirements. 41 Colo.App. at 368, 585 P.2d at 321.

The foregoing principles compel the rejection of evidence of intent to exercise the power of appointment because the method employed failed to comply with the donor’s requirements. We therefore hold that the court properly granted appellees’ motion

13 for summary judgment.

In its opinion affirming the lower court, the appellate court, having noted that Teresa had not complied with Molinari’s requirements, implicitly and without comment accepted the holding in Talcott. In lieu thereof, however, the appellate court considered, but rejected, Arnold’s argument that Teresa’s admitted failure to comply with Molinari’s strict requirements was a mere technicality or oversight, and that the doctrine of “dependent relative revocation” (“ DRR”) should apply to give effect to Teresa’s prior intended exercises of the power.

The doctrine of dependent relative revocation provides that when a testator revokes a valid will by an act other than making a new will, and intends that the revoked will be replaced with a new will, and when the new will is not made, or if made, is thereafter found to be invalid, the prior will may be re-established on the theory that the revocation was dependent on the validity of the subsequent will, and that the testator would have preferred the earlier will to intestacy. In the Rosoff case, however, Teresa’s unambiguous and unconditional 2000 will was not, in any manner, invalid and did not give rise either to partial or total intestacy.

In In re Estate of Pratt, 88 So.2d 499 (Fla 1956), the Supreme Court’s thorough analysis of the doctrine of DRR reflects the clear inapplicability of the doctrine of DRR in the Rosoff case. The Court, explaining the doctrine, stated at 88 So.2d at 501-502, 503:

In Stewart v. Johnson, 142 Fla. 425, 194 So. 869, we applied the doctrine to give effect to a prior will when a later will, containing an express revocation clause, failed for lack of sufficient witnesses. ***. Since the second will in the Stewart case attempted to revoke the first but did not comply with the statute, the revocation was ineffective and the first will stood unaltered. The situation in the Stewart case was similar to that in the classic case of Onions v. Tyrer, 2 Vern, 742, 23 Eng.Rep. 1085 (1717) where the dependent relative revocation doctrine was applied to save an earlier will when the later revoking will failed for want of proper attestation. *** Under modern law, codified in F.S. Sec. 731.13, F.S.A., supra, arises for the clause of revocation would like Atkinson gives the following explanation at p. 461:

14 “If * * * invalidity (of a subsequent gift) is due to a defect in execution, no question of dependent relative revocation wise be ineffective since the same formalities are required for a revoking as for a disposing instrument.” * * * The case before us is one wherein the testator, by an unambiguous, complete testamentary instrument, has disposed of all of his property, expressly revoking all prior wills. There is no suggestion of fraud or undue influence. There are no conflicting provisions of testamentary papers necessarily before the court [italics by the court], as in the case of a will and codicils, which might form a basis for the admission of parol evidence for its bearing upon the testamentary intent. We know of no principle of law which would authorize us to look beyond the probated will for testamentary intent in such a case. [7] We do not understand that the “dependent relative revocation” doctrine, useful and salutary as it is in a proper case, carries with it the authority to disregard so well- established a rule as that which forbids us to write a new will for the testator in the face of a clear intent expressed in a proper instrument. (Emphasis added.)

7 Arnold contented that no extrinsic evidence was necessary for application of DRR, because the donee Teresa’s intent to exercise the power in his favor was manifest under her 1982, 1983 and 1991 wills. This was a distortion of applicable law and totally without merit. Initially, as noted, Pratt, id; Talcott, supra (423 So.2d at 955-956), and all the other cited cases, emphasize that the donee’s intent, when she fails to comply with the donor’s requirements, was irrelevant. Secondly, the foundation stone in construction of a will is the testator’s intent, revealed only by what he has written in “the entire instrument from the first letter to the last period.” Luxmoore v. Wallace, 145 Fla. 325, 333, 199 So. 492, 495 (1940); see Diana v. Bentsen, 677 So.2d1374, 1377 (Fla. 1st DCA 1996); In re Estate of Walters, 700 So.2d 434,436 (Fla. 4th DCA 1997); B732.6005(a), Fla. Stat. It is basic that in determining a testator’s intent made necessary because of a situation not anticipated by the testator, “the Court must be confined to the language employed in drafting the will * **.” Luxmoore, supra, 145 Fla. at 325, 337, 199 So.2d at 497; see also Boyle v. Howe, 126 Fla. 662, 674, 171 So. 667, 671-672 (1937). Thus, it is clear that the donee Teresa’s intent, even if it were not irrelevant and inadmissible, could be gleaned only from the four corners of her 2000 Will. Accordingly, “[t]he language employed must control, rather than the language intended to be used or rather than the intention which existed in the mind of the testator.” Boyle v. Howe, supra, 126 Fla. at 674, 171 So. at 672. “Stated another way, the inquiry is not what the testatrix meant to say, but what she meant by what she did say.” In re Estate of Barker, 448 So.2d 28, 32 (Fla. 1st DCA 1984).

15 In the much-cited article to which we have alluded, Warren, Dependent Relative Revocation, the author states in part [33 Harv.L.R. at pp 348-9]:

“A will cannot be set aside for mistake in either the United States or in England where the testator knew and approved its contents. By the same token a revocation absolute on its face, the words of which the testator knows and approves, will not be set aside because the reasons which induced it are found to be based on false assumptions of fact or law. The testator is dead, and it is too dangerous to inquire what motives induced his action. This was to be done for the construction of the document; it should not be resorted to for alteration. (Emphasis.)

The court correctly noted that the doctrine of dependent relative revocation was inapplicable because Teresa’s 2000 will was a valid will which expressly revoked all will and codicil previous made by her. The court, in affirming the summary judgment in favor of Harding, concluded its opinion with the statement that it was unfortunate that Teresa’s intent to leave the trust assets to Arnold had been thwarted by her failure to abide by the terms of the Molinari Trust.

QUERY: DID THE POWER EXIST AT TERESA’S DEATH?

IF SO, WAS TERESA’S POWER OF APPOINTMENT A GENERAL POWER OR NON-GENERAL POWER?

WHAT WAS THE INTERNAL REVENUE SERVICE’S ANSWER?

During administration of Teresa’s Estate proceedings, after belatedly learning of Teresa’s demise and purported exercise of the power of appointment, co-counsel, Christine Moreno, and I conferred with the Estate’s probate and federal tax counsel concerning Harding’s claim to the Molinari assets and the nature of the power of appointment granted to Teresa in the Molinari Trust. The Estate and its reputable team of tax counsel from Palm Beach, Philadelphia and New York, were firm and unmoveable in their

16 collective opinion that it was a “general” power, the assets of which must be included in Teresa’s gross estate. It was our firm belief (1) that since Molinari’s specified pre-conditions had not occurred, the power of appointment ceased to exist precisely at the instance of Teresa’s death; (2) that if, however, such power was otherwise deemed to exist at Teresa’s death, Molinari, at best, granted only a “special” power. Harding further insisted, from the outset, that until a final determination had been made on these issues, the Molinari assets should not be included in Teresa’s gross taxable estate. Over and despite Harding’s continuous objections, Teresa’s tax experts included and reported the Molinari assets on the Estate’s Form 706, substantially increasing the estate tax thereon.

In seeking reversal of the summary judgment, Arnold had argued that Teresa’s admitted failure to comply with Molinari’s strict requirements for exercising the power was a mere technicality or oversight, and that the doctrine of DRR was applicable to effectuate Teresa’s prior intended exercises of the power, as set forth in her prior wills. Harding argued, to the contrary, that not only was Teresa’s intent absolutely irrelevant, but Teresa could not have properly or effectively exercised the power in her 1982, 1983 and 1991 wills and codicil, because the power did not exist therein (i.e., it could only be exercised in her will or codicil – effective, if properly exercised, at her death), and, more significantly, failed to exist or did not come into existence upon her death 13 months from the execution of her 2000 Will.

A power of appointment, whether general or non-general, is not presently exercisable if exercisable only by the donee’s will, or, at the time in question, “is not exercisable until the occurrence of some event or the passage of a specified period of time.” Restatement of Property 2d, Power of Appointment, Section 11.5(2), Comment a.8 And where the power, as required by Molinari, could only be exercised according to its specific terms by Teresa in her 2000 Will, it was “not in existence” or legally operative during

8 Explaining the rule thereto, Comment a provides: a. When power of appointment comes into existence as contrasted with when it becomes exercisable. A power of appointment must come into existence before the issue of whether it is presently exercisable or not presently exercisable can be determined. A power of appointment that is set forth in the will of a living person is not in existence because such person’s will is not legally operative during the lifetime of such person. (Italics in text; emphasis added.)

17 her lifetime. Id. Harding contended that the power failed to come into existence precisely at Teresa’s death, when she died within 13 months of the execution of her 2000 Will, and had not been “prepared” and “exercised” in the presence of Molinari’s corporate trustee. Id. Consequently, the power of appointment in Teresa’s 1982, 1983 and 1991 Wills and Codicil had never come into existence, and could not have been properly and effectively exercised, with or without DRR.

The power of appointment granted by Molinari does not meet the test of a “general” power under either Federal or Florida statutes and law. The classic definition of a “general” power, as noted above, is contained in B2041(b)(1) of the Internal Revenue Code (“IRC”), which provides:

General power of appointment. The term “general power of appointment” means a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate; ***. (Emphasis in italics added.)

The Regulations (Regs. B2041-1(C), promulgated under the IRC, similarly provide and specifically and emphatically clarify what constitutes a general power of appointment as follows:

Definition of “general power of appointment.” (1) . . . The term “general power of appointment” as defined in section 2041(b)(1) means any power of appointment exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate . . . . A power of appointment is not a general power if by its terms it is either — (a) Exercisable only in favor of one or more designated persons or classes other than the decedent or his creditors, or the decedent’s estate or the creditors of his estate, or (b) Expressly not exercisable in favor of the decedent or his creditors, or the decedent’s estate or the creditors of his estate. (Underlining in text, emphasis added.)

The power from Molinari expressly granted to Teresa the power to appoint only to “persons or person, or body corporate.” The power was “expressly not exercisable” in favor of Teresa, or her creditors, or her estate or the creditors of her estate. As such, it was not a general power of appointment. Estate of Stewart v. Caldwell, 271 So.2d 754, 756-757 (Fla. 1972); Keeter v. United States, 461 F.2d 714,

18 717 (5th Cir.1972) (interpreting Florida law); B2041(b)(1), IRC; Regs.B20.2041-1(C). The grant by Molinari to Teresa was a special, non-general power of appointment. Teresa did not have the right to enrich herself or her estate, including her creditors, at the expense of others, an essential feature of a general power of appointment. Cass v. Tomlinson, Director of Internal Revenue, Memorandum Opinion 1913, 1916, U.S. District Court (S.D. Fla. 1957).

As a corollary, Harding argued that the power did not “spring” or come into existence at Teresa’s death. Only the assets subject to a “general”power of appointment existing at a decedent’s death are includible within the decedent’s taxable estate. Where, however, as here, Teresa’s power of appointment failed to exist at the instance of her death, the Molinari assets, according to the IRS, were improperly included in Teresa’s gross taxable Estate/Trust. IRS Regulations, B20.2041-3(b), specifically provides that “a power which by its terms is exercisable only upon the occurrence during the decedent’s lifetime of an event or a contingency which did not in fact take place or occur during such time is not a power in existence on the date of the decedent’s death. For example, if a decedent is given a general power of appointment exercisable only after he reached a certain age, or only if he survived another person, or only if he died without descendants, the power would not be in existence on the date of the decedent’s death if the condition precedent to its exercise had not occurred.” It is clear, therefore, that Molinari’s intended power failed to exist at the instant of Teresa’s death because it was based upon an event and contingency which did not occur: Teresa died within 13 months of making her Will, and it was not prepared and executed in the presence of Molinari’s trustee.

It is likewise clear that Teresa did not receive a general power under Florida statutory and case law. B732.2025(3), Fla.Stat., specifically provides and explains:

Although not the precise terminology of the IRC B2041(b)(1) and Regs. B2041-1(C), the language of the Federal statutes upon which it was patterned, B732.2025(3), is substantively the same. Thus, Teresa did not meet the Florida statutory test of having a “general power of appointment” within the meaning of B732.2025(3)

19 because, as the “holder” of the power, she did not have the power to provide in the present or future an “interest in the holder [herself], the holder’s [her] estate, or the creditors of either [herself or her estate].” Estate of Stewart v. Caldwell, 271 So.2d 754, 756-757 (Fla. 1972); Keeter v. United States, 461 F.2d 714, 717 (5th Cir.1972) (interpreting Florida law); B2041(b)(1), IRC; Regs.B20.2041-1(C). She did not have the “general” power to enrich herself or her estate at the expense of others. Cass v. Tomlinson, supra.

It followed, as Harding contended from the outset, that even had it otherwise existed, Teresa nevertheless did not receive a “general power of appointment” because she was not expressly granted the discretion to appoint the balance of the Molinari trust assets to herself, her estate, her creditors, of the creditors of her estate. She received only a special, non-general power.

The Estate Tax Section of IRS, rejecting the contentions of Teresa’s team of federal estate tax experts, agreed with Harding’s contentions, and granted a full refund of the excess estate taxes erroneously paid by Teresa’s Estate/Trust.

* * * * *

20 Debt Forgiveness: Accounting and Tax Implications

Diane J. Reich, CPA, MBA Barry M. Weins, CPA, JD

21 Diane J. Reich CPA, MBA Assurance and Consulting Services Partner Reich CPA, LLC

Diane J. Reich is an assurance and consulting services partner in Tampa Bay. She has greater than twenty-five years of experience servicing both publicly-traded and privately-held entrepreneurial and middle-market companies. Ms. Reich’s industry experience includes manufacturing, distribution, real estate, construction, biopharmaceuticals, and travel and leisure. She has recently had significant consulting experience addressing the complex accounting and financial reporting issues associated with debt placement and restructuring transactions, derivative instruments, equity and shared-based payment transactions, and accounting for income taxes.

Ms. Reich is a shareholder of a local Tampa Bay accounting firm and was also affiliated with a national firm and other mid-sized firms. Ms. Reich was an instructor of Accounting in Honolulu, Hawaii, where she taught graduate and undergraduate courses in accounting, auditing, business analysis and accounting information systems.

Ms. Reich holds a Master of Business Administration degree and a Bachelor of Science degree in Accounting. She is a Certified Public Accountant and is a member of the American Institute of Certified Public Accountants and the Florida Institute of Certified Public Accountants.

22 Barry M. Weins, CPA Partner Cherry, Bekaert & Holland, L.L.P.

Barry is licensed as Certified Public Accountant in Florida and an attorney with over 23 years of tax experience. As a Tax Partner with CB&H based in the Firm’s Tampa Bay Practice, Barry assists clients in developing income tax planning and compliance strategies.

Barry’s extensive experience includes providing income tax planning and compliance services for S corporations, partnerships, individuals and corporations. Additionally, he has worked with individuals on trust and estate planning and income taxation issues.

Barry also has significant experience in state tax matters, stock basis studies, earnings and profits studies, and mergers and acquisitions. He has represented clients before the Internal Revenue Service at both the examination level and in the Appeals Office.

Prior to joining CB&H through the Firm’s acquisition of Aidman, Piser & Company in 2008, Barry was a principal in the tax department at Aidman, Piser, serving mid-market businesses, entrepreneurs and publicly traded corporations. Prior to that, Barry most recently served as a senior tax manager in the Fort Lauderdale office of a “Big Four” accounting firm.

Barry received his Bachelor of Science degree in Business Administration from the College of Charleston, and his Juris Doctorate from the University of Miami, School of Law.

23 24 What Accounting Applies? Troubled Debt Extinguishment Modification Restructuring Accounting Accounting Yes Is Debtor Was there an experiencing exchange of cash/assets to financial No difficulty? settle Debt obligation? Yes No Has Creditor Contemporaneous Granted a exchange between same Concession? No No debtor & creditor? Yes Yes Substantial Change in Apply Terms of Debt per ASC Modification ASC 470-60 470-50-40 or 470-50-40-21? No Accounting Troubled Debt per Restructuring Yes ASC 470-50-40 Gain/Loss on Extinguishment of Debt

Troubled Debt Restructuring, Extinguishment, or Modification?

y Satisfaction of existing debt obligation?

y How was it satisfied ?

y Issuance of new debt obligation?

y Contemporaneous exchange?

25 Troubled Debt Restructuring, Extinguishment, or Modification? (cont’d)

y Between same debtor and creditor?

y Is transaction troubled debt restructuring?

y Do instruments have substantially different terms?

Is it Troubled Debt Restructuring? yIs debtor experiencing financial difficulties? AND yCreditor deemed to have granted a concession ?

y Apply guidance in ASC 470-60 y Accounting from Debtor’s perspective.

26 Troubled Debt Restructuring May include: yForeclosure / Repossession yIssuance or granting of equity interest to creditor

Troubled Debt Restructuring (cont’d)

May include (cont’d): yModification of terms of following: y Reduction of interest rate y Stated interest rate < current market rate w/ similar risk y Reduction of face or maturity $ of original debt y Reduction of accrued interest.

27 Creditor Concession: Is it Troubled Debt Restructuring? Creditor granted concession if: y New effective borrowing rate < prior . y Effective rate of restructured debt includes: y New or revised sweeteners y Projected cash flows w/ new terms impacting effective rate y Consider recent earlier restructuring

TDR Considerations: Effective Interest Rate & Sweeteners What are sweeteners? yOptions yWarrants yGuarantees yLetters of credit

28 TDR Considerations: Effective Interest Rate & Sweeteners Determining effect of new/revised sweeteners: y Current value of new y Change in FV of revised y Include in day-one cash flows y Consider exercisability of instruments in FV estimate.

Is it Troubled Debt Restructuring? Troubled Debt Extinguishment Modification Restructuring Accounting Accounting

Is Debtor experiencing financial No difficulty? Yes Has Creditor Granted a Concession? No

Yes

ASC 470-60 Troubled Debt Restructuring

29 Accounting for TDR Record gains/losses on:

yRestructuring of Payables y Debt Carrying $ less FV assets given

yTransfer of Assets- y Carrying $ of transferred assets less FV of transferred assets

Do You Apply Extinguishment or Modification Accounting? y Is there an extinguishment or modification for accounting purposes? y If NOT TDR per ASC 470-60. y Apply guidance in: y ASC 405-20-40-1: exchange of cash by debtor to acquire or settle debt obligation y ASC 470-50-40: changes/exchanges non-revolving debt. y ASC 470-50-40-21: changes/exchanges lines-of-credit & revolving debt arrangements

30 Extinguishment of Liability? y Exchange of cash to settle Debt obligation? y Modification/Exchange of debt? y Between same debtor and creditor? y 3rd party principal or agent involved? yExtinguishment accounting y If Obligation Settled with New Creditor y Apply ASC 405-20 Liabilities: Extinguishment of Liabilities

Extinguishment or Modification? yModification/Exchange of new debt obligation? yBetween same debtor and creditor ! ySubstantially different terms? yASC 470-50 Debt: Modification and Extinguishment

31 Extinguishment or Modification? y Debt changes/exchanges “Substantial”? y Substantial = Extinguishment Gain/Loss y Non-substantial = Modification Accounting y More than1 creditor? y ASC 470-50 Debt: Modification and Extinguishment

What is a substantial change?

“Substantial” = - PV of amended/new debt cash flows > 10% different PV of old debt remaining cash flows.

y Use effective interest rate of original debt

32 Components of Substantial Change Analysis Cash flows affected by changes in:

y Principal $

y Interest rates

y Maturity dates

y Fees between debtor & creditor

Components of Substantial Change Analysis (cont’d) y Fees :

y Cash

y Options/warrants

y Stock

y Change in BC feature

y Guarantees

y Other

33 Components of Substantial Change Analysis (cont’d) y Changes to Conversion Features y 2 step approach

y If 10% CF test is “modification”- add step#2

y Step #2-Change in FV of conversion option > 10%= Extinguishment OR

y Substantive conversion option removed=Extinguishment

y Increase in FV charged to debt.

Components of Substantial Change Analysis (cont’d) y Other modifications / changes w/in 1 year y AND not deemed substantially different y Debt terms existing year ago used for 10% test. y Callable (by issuer) or puttable (by holder) y Separate cash flow analyses performed y Cash flow test w/ smaller % change= threshold

34 “Extinguishment” Accounting for Changes/Exchanges of Debt

y “Substantial” change w/ same lender y > 10% change

y Regardless of legal form

y Extinguishment of original debt

y New debt recorded at FV.

Extinguishment Gain or Loss

y Net Carrying Amount of extinguished debt less Reacquisition Price

y Reacquisition price is: y FV of new debt + y Call premium + y Costs paid/given to lenders + y FV of any securities issued

35 Extinguishment Gain or Loss (cont’d)

y Net Carrying Amount is: y Carrying value of debt + y including unamortized discounts/premiums : y extinguished debt y bifurcated derivatives y beneficial conversion feature y allocation due to warrants issued w/ debt y Any bifurcated derivatives -- y Unamortized debt issue costs

What Accounting Applies? Troubled Debt Extinguishment Modification Restructuring Accounting Accounting Yes Is Debtor Was there an experiencing exchange of cash/assets to financial No difficulty? settle Debt obligation? Yes No Has Creditor Contemporaneous Granted a exchange between same Concession? No No debtor & creditor? Yes Yes Substantial Change in Apply Terms of Debt per ASC Modification ASC 470-60 470-50-40 or 470-50-40-21? No Accounting Troubled Debt per Restructuring Yes ASC 470-50-40 Gain/Loss on Extinguishment of Debt

36 Accounting for Debt Modification y Debt is not substantially different y Original debt continues to be outstanding

y New effective interest rate is determined y Consider carrying $ of original debt y Revised cash flows y Sweeteners

yAmortize over new term, (if applicable)

Other Accounting & Tax Issues: Extinguishment & Modification of Debt EXTINGUISHMENT MODIFICATION Income Accounting Tax Accounting IncomeTax Unamortized Extinguishment Deduction Amortize Amortize premium/ Gain(loss)Ǧold (newdebtterm) (newdebtterm) discountǦold debt (includingBCF) Debtissue Amortize Amortize Expensedas Amortize costsǦ3rd (newdebtterm) (newdebt incurred (newdebtterm) parties term) Debtissue Extinguishment Deduction Capitalize& Amortize costsǦ Lender Gain(loss)Ǧold amortize (newdebtterm) debt (newdebtterm) PreǦexisting Extinguishment Deduction Amortize Amortize debtissuecosts Gain(loss)Ǧold (newdebtterm) (newdebtterm) dbt

37 Other Accounting & Tax Issues: Extinguishment & Modification of Debt (cont’d) EXTINGUISHMENT MODIFICATION

Income Income Accounting Tax Accounting Tax Unamortized Gain(loss)on Deduction Amortize Amortize premium/ Extinguishment (newdebt (newdebt discountǦold Ǧ(olddebt) term) term) debt (including BCF)

Other Accounting & Tax Issues: Extinguishment & Modification of Debt (cont’d)

EXTINGUISHMENT MODIFICATION

Income Accounting Tax Accounting IncomeTax Debtissue Amortize Amortize Expensedas Amortize costsǦ3rd (newdebt (newdebt incurred (newdebt parties term) term) term)

38 Other Accounting & Tax Issues: Extinguishment & Modification of Debt (cont’d)

EXTINGUISHMENT MODIFICATION

Income Income Accounting Tax Accounting Tax Debtissue Extinguishment Deduction Capitalize& Amortize costsǦ Gain(loss)Ǧold amortize (newdebt Lender debt (newdebt term) term) PreǦ Extinguishment Deduction Amortize Amortize existing Gain(loss)Ǧold (newdebt (newdebt debtissue debt term) term) costs

39 Modification of Debt Instruments y A significant modification of a debt instrument under Reg. 1.1001-3 results in a deemed exchange of a new debt for the original debt. y Two part analysis: y Is there a modification? y Change in legal rights and obligations

y If so, was the modification a "significant modification"?

40 Modification of Debt Instruments y Step 1 – Is there a modification?

y Is there any alteration in the legal rights or obligations of the borrower or lender under the debt instrument.

y Changes pursuant to the operation of the terms of the debt are generally not modifications

Modification of Debt Instruments y Step 2 – Is the modification significant? y Specific tests y Change in yield y Deferral of payments y Change in obligor y Change in recourse nature of the instrument y Change in accounting/financial covenants y General rule in Treas. Reg. § 1.1001- 3(e)(1) y Economically significant

41 Consequences of Debt Modification

y New debt considered to have been issued in exchange for property (i.e., the old debt).

y Determine issue price of new debt. y IRC § 1274 applies for non-traded debt. y IRC § 1273 applies for traded debt.

Consequences of Debt Modification y If stated interest is at or above the Applicable Federal Rates (AFR), issue price equals principal y If neither the modified nor the original debt is publicly traded and the stated interest rate is equal to or greater than the applicable federal rate (AFR), then there is no COD income unless principal is reduced or made contingent. y Bottom Line for nonpublicly traded debt with inere y If principle stays same

42 Consequences of Debt Modification y Bottom Line y nonpublicly traded debt y interest rate equal to or greater than AFR y principle amount same

y NO COD INCOME

43 Taxation of Cancellation of Debt y Cancellation of debt (COD) is taxable as ordinary income

y Unless Bankrupt

y Or Insolvent

y Or Qualified Real Property Business Indebtedness

Qualified Real Property Indebtedness y Sec 108(a)(1)(D) allows basis in depreciable real property to be reduced in lieu of recognizing COD income. y Applies primarily to rental real estate with a debt restructuring. y Debt must be secured by real estate. y Not available to C Corporations.

44 Homeowners y Qualified Principal Residence Indebtedness – 108(a)(1)(E) y Maximum debt excluded $2,000,000 and must be acquisition indebtedness. y Taxpayer must apply excluded amount to reduce basis of the principal residence but not below zero.

Cancellation of Debt – Bankrupt or Insolvent Taxpayer y Under IRC § 108(a), COD income is excluded from gross income. y In the case of a partnership, the determination is made at partner level. y For corporations, the determination is made without regard to shareholder status.

45 Cancellation of Debt – Bankruptcy y Discharge of debt occurs under the jurisdiction of the court in a case filed under Title 11 of the U.S. Bankruptcy Code. y All discharged debt is excluded from taxable gross income. y Tax attributes of the taxpayer are transferred to the bankruptcy estate.

Bankruptcy Example y Corporation A owns one asset, unencumbered land with a FMV of $500,000

y Corporation A also has unsecured debt of $750,000, which is discharged under a Chapter 7 Bankruptcy case

y How much is included in Corporation A’s gross income upon cancellation of debt?

46 Bankruptcy Example, cont’d

Zero

All discharged debt from bankruptcy is excluded from income under IRC § 108

Cancellation of Debt – Insolvency y COD income is only excluded from taxable gross income to the extent of insolvency before the debt discharge transaction. y Any COD income in excess of insolvency may be taxable. y Insolvency is the excess of total liabilities over the FMV of assets immediately before the debt is discharged.

47 Determining Insolvency y All assets of the entity are included – including assets exempt from creditors at FMV. y Nonrecourse debt is only treated as a liability to the extent of the FMV of the property securing the debt. y Contingent liabilities are only included in the determination of insolvency if “it is more probable than not” that the taxpayer will be called on to pay the liability.

Insolvency Example y Taxpayer owns one asset, unencumbered land with a FMV of $500,000. y Taxpayer has unsecured debt of $750,000. y The bank discharges $350,000 of the debt in a voluntary workout. y How much of the discharge does the taxpayer include in taxable income?

48 Insolvency Example (cont) y The total amount of the discharge excludable under IRC § 108 is:

$250,000

Insolvency Example (cont) y Just before the debt discharge, the taxpayer was insolvent by $250,000 ($750,000 of debt) less land with a FMV of $500,000. y Taxpayer will have $100,000 of ordinary income as a result of the COD income.

49 Deferral of taxable COD income y AJJA added a provision that allows the deferral of COD income arising from the reacquisition of an applicable debt instrument in 2009 or 2010. y When elected, the taxation of the COD income is deferred until 2014, and then included in income ratably between 2014 and 2018.

Deferral of taxable COD income (cont’d) y “Applicable Debt Instrument” is broadly defined.

y “Reacquisition” includes: y The purchase for cash or equity y Exchange or substantial modification of debt instrument y Complete forgiveness of the debt instrument

50 Deferral of taxable COD income (cont’d) Deferred COD income is accelerated: y If the taxpayer dies y Liquidates or substantially sells all of its assets y Ceases to do business

Reduction of Tax Attributes

No Free Lunch y Discharged debt can be excluded from taxable gross income by bankrupt and insolvent taxpayers, certain tax attributes may be lost. y In most cases, tax attributes are reduced dollar for dollar to the extent of excluded COD income.

51 Planning for Attribute Reduction y Taxable income or loss is computed with out regard to excluded COD Income. y All attributes are available for use in year of discharge. y NOL’s & other carryforwards first offset other taxable income before being reduced. y Depreciation is allowed up to time of disposition. y Property sales during year are not subject to basis reductions.

Reporting of Reduction of Tax Attributes Due to Discharge of Indebtedness

Form 982

Under IRC §1017, may elect to reduce basis of depreciable property first

Reduction occurs first day of the tax year following discharge.

52 Ordering of Reduction of Tax Attributes Amounts excluded from income must reduce certain tax attributes in the following order: 1.Current NOL or NOL carryover 2.General business credit allowable under IRC §38 3.Minimum tax credit allowable under IRC §53(b) 4.Capital loss carryover 5.Basis reduction of property 6.PAL and credit carryovers 7.Foreign tax credit carryovers

Ordering of Basis Reductions in Business Property 1. Real property used in trade or business or held for investment that is used to secure debt

2. Personal property used in trade or business or held for investment that secured debt

53 Ordering of Basis Reductions in Business Property (cont’d) 3. Basis of remaining trade or business property, other than inventory, accounts receivable, or notes receivable, to extent discharge exceeds above asset classes.

4. Adjusted basis of inventory (including real property held as inventory), accounts receivable, and notes receivable

5. Any remaining business or investment property

Partnership vs. S Corp Partnership S Corporation

Income inclusion or exclusion Income inclusion or exclusion is determined at the partner is determined at the entity level level

Depends on each individual’s Income excluded does not circumstances increase the basis of any shareholder (See: D.A. Gitlitz Partnership recognizes full v Commissioner) income

Partner can elect to reduce basis in entity’s depreciable property to extent of ownership interest in that property

54 Type of Debt y Recourse y All assets of the entity are subject to claims of the creditor. y Non-Recourse y Creditor can only obtain the collateral subject to the debt. y Guarantee y Does not impact the type of debt.

55 Debt Discharge with Property Transfers - Non - Recourse Debt y There will never be COD income!

y Debt satisfied by a transfer of property is treated as a sale of the property.

y Sales price is amount of outstanding debt.

y Gain or loss is recognized and is not excludible from income.

Debt Discharge with Property Transfers – Recourse Debt y When a transfer and discharge occurs, bifurcation between the debt discharge and the property disposition is required.

y Transfer of property is treated as a sale of the property for FMV.

y Gain or loss is recognized and is not excludible from income.

56 Debt Discharge with Property Transfers – Recourse Debt y If Debt > FMV then COD.

y COD may be excludible under IRC § 108.

y Timing is an issue y Supreme Court ruled that the time for fixing a loss is the foreclosure sale itself. (Helvering v. Hammel, 311 U.S. 504 (1941)) y Other Courts have found exceptions.

COD Income and Importance of Characterization y COD Income is always treated as ordinary income.

y Very important to consider with Recourse Debt.

y Could wind up with capital loss on sale and ordinary income from COD.

y Capital Loss would not offset ordinary income.

57 Foreclosure- Example 1

y S Corporation holds real property as an investment.

y Carrying amount of property is $2,200,000.

y Unpaid principal of debt is $1,800,000.

y Fair market value of property is $1,500,000.

y Taxpayer's adjusted basis in the property is $2,200,000.

58 Foreclosure-Example 1 (cont’d) ACCOUNTING TAXATION Gain(Loss) on Transfer Nonrecourse Debt Property: Amount Realized $1,800,000 Carrying amount ($2,200,000) Less Asset Basis (2,200,000) Fair Value 1,500,000 Realized Loss (400,000) Loss on transfer ($ 700,000) (Capital Loss) Recourse debt Gain on Restructuring of Debt Balance of debt $1,800,000 Debt relieved $1,800,000 FMV (1,500,000) Property FV (1,500,000) COD Income 300,000 $ 300,000 (Ordinary Income Statement Income) Loss on transfer ($ 700,000) FMV $1,500,000 Gain on restructuring 300,000 Less AB (2,200,000) Total Net loss ($ 400,000) Realized Loss (700,000) (Capital

Transfer of Asset/ Extinguishment / COD- Example 2 y XYZ, Inc., an S Corp, holds investment property w/ recourse debt of $1,000,000. y Bank repossesses property with $500,000 FV on 11/1/xx. y Bank later sells property for $600,000 on 12/15/xx. y XYZ pays bank $100,000 cash. y Bank forgives excess recourse debt of $300,000.

*XYZ has not changed ownership since inception

59 Transfer of Asset/ Extinguishment / COD Example 2 (cont’d) At date of discharge, XYZ B/S was as follows: Assets: Cash $ 100,000 Inventory 100,000 Investment property 1,000,000 $ 1,200,000 Total Liabilities $ 1,400,000 Shareholder Deficit $ 200,000 Other taxpayer information: AAA ($ 3,000,000) Capital Stock/APIC $2,800,000

Transfer of Asset/ Extinguishment/ COD Example 2– ACCOUNTING

Gain(Loss) on Transfer Gain on Restructuring of Investment Property: Payables Carrying amount($1,000,000) Debt relieved $ 900,000 Fair Value 500,000 Property FV ( 500,000) Loss on transfer ($ 500,000) $ 400,000

Income Statement Loss on transfer ($ 500,000) Gain on restructuring 400,000 ($ 100,000)

60 Transfer of Asset/ Extinguishment / COD Example 2 – INCOME TAXES

Transfer of Asset/ Extinguishment / COD Example 2 – INCOME TAXES Reduction in Attributes- Suspended loss- $200,000 Capital loss- $400,000 (no basis to take) Inventory -$100,000

61 Debt Modification or Extinguishment?- Example 3 y Modified terms of 2 convertible debentures: y deferral of principal & interest payments, y extension of principal maturity, y increased interest rate to 20% y Issued 6.5 million shares of common stock to lender

Debt Modification or Extinguishment?- Example 3

a Debenture Modification Analysis A B C ((B+C)-A) PRIOR AFTER at $0.10 Modification CF and Principal PV of PV of other Debentures Principal + Accr Cash Cash Stock FV considerati $ New Debt Modified: O/S Interest Flow Flow Issued Stock on Change % FV $1,000,000 Debenture 953,750 1,178,127 1,035,774 1,251,858 2,600,000 260,000 1,511,858 476,084 46% 1,100,000 $1,500,000 Debenture 1,500,000 1,821,873 1,702,957 1,904,588 3,900,000 390,000 2,294,588 591,631 35%1,560,000

2,453,750 3,000,000 2,738,731 3,156,446 6,500,000 650,000 3,806,446 2,660,000

62 Debt Modification or Extinguishment?- Example 3 y What is the Loss on Extinguishment: y $ 310,000 y ($3m CV-$2.66m FV+.65m stock FV)

y How would you record this transaction? Conv Debenture $340,000 Extinguishment loss 310,000 C/S $650,000

y What are the income tax implications?

63 Complex Debt Extinguishment & COD -Exercise Facts: y Deal, Inc., a privately-held C Corp, held: y Assets w/ carrying $ of $25.3m (finance receivables, inventory, minimal other assets) y Liabilities of $ 45.8 million (including collateralized working capital notes payable). y Major lender sold $40 million of operating notes payable plus $2m of accrued interest to 3rd Party Lender.

Complex Debt Extinguishment & COD Exercise (Cont’d) Facts (cont’d): y Deal, Inc. exchanged $15 million note payable to 3rd Party Lender in exchange for 3rd Party Lender’s forgiveness of $25 million of $40 million note purchased from Major Lender plus accrued interest payable y Deal, Inc. has $12 million of NOL carryforwards (including year of debt forgiveness). y Fees: y 10,000,000 warrants w/ FV of $250,000 to 3rd Party Lender. y Fees of $250,000 paid to 3rd Party Lender.

64 Complex Debt Extinguishment & COD Exercise (cont’d) Deal, Inc. Balance Sheet, day of transaction: Total Assets $25,300,000 Total Liabilities 45,800,000 Shareholder Deficit 20,500,000 Other Info: y FV of total assets $18,650,000 y Carrying $ of Old Debt $39,350,000 y ($40m- $.650m) y Face/FV of New Debt $15,000,000 y Additional costs of reacquisition of debt y Modification for leases ($ 7,000,000) y Leased inventory assets $ 1,000,000

Complex Debt Extinguishment & COD Exercise (cont’d) 1.What other information would you need to know? 2.Is Extinguishment Accounting appropriate? Why? 3.What is the Accounting Gain on Extinguishment of Debt? 4.How should Gain be classified in Statement of Operations?

65 Complex Debt Extinguishment & COD Exercise (cont’d)

5. How insolvent was Deal, Inc on date of transaction? 6. Should Deal, Inc. recognize COD Income for Income tax purposes?

7. If so, how much COD income can be excluded?

8. What tax attributes, if any, should Deal, Inc. reduce?

Complex Debt Extinguishment & (cont’d)- DEAL,COD INC. Exercise INSOLVENCY Insolvency Computation Insolvency as of Date of Debt Solvency Subsequent to Debt Forgiveness Forgiveness Balances Consolidated Forgiveness Subsequent to Consolidated Fair Value (Date of Transaction Forgiveness Balances Adjustments Adjusted Forgiveness) Adjustments Transaction Assets Cash 700,000 700,000 700,000 (250,000) 450,000 Financing Receivables 20,000,000 (7,000,000) 13,000,000 20,000,000 (7,000,000) 13,000,000 Deferred fin costs 650,000 (650,000) - 650,000 (650,000) - Inventory 3,000,000 1,000,000 4,000,000 3,000,000 1,000,000 4,000,000 Fixed Assets 600,000 600,000 600,000 600,000 Oth Assets 350,000 350,000 350,000 350,000 25,300,000 (6,650,000) 18,650,000 25,300,000 18,400,000 Liabilities AP/Accruals (3,000,000) (3,000,000) (3,000,000) 2,000,000 (1,000,000) Notes Pay- Old (40,000,000) (40,000,000) (40,000,000) 40,000,000 - Notes Pay-New - - (15,000,000) (15,000,000) Other Notes Payable (2,500,000) (2,500,000) (2,500,000) (2,500,000) Other Liab (300,000) (300,000) (300,000) (300,000) - (45,800,000) (45,800,000) (45,800,000) (18,800,000)

(Equity) Deficit 20,500,000 6,650,000 27,150,000 20,500,000 (20,100,000) 400,000 -

66 Complex Debt Extinguishment & COD Exercise (cont’d) 1.-

2.-

3.-

4.-

5.-

6.-

7.-

8.-

Questions? Questions?

67 Contact Information Barry M. Weins, CPA Cherry, Bekaert, & Holland 813-251-1010 [email protected] Diane J. Reich, CPA Reich CPA, LLC 813-405-6164 [email protected]

68 MEMBERS ADD UP Refer a FRIEND to the FICPA and earn a chance to WIN

Members Add Up is a fun and easy way for you to share the benefits of FICPA membership with your friends and colleagues. Just refer one new member and receive a chance to win a grand prize valued at $2,500!

Reach out to that new person in the office, or encourage a long-time colleague to finally join… just do it before June 30, 2009 for a chance to win! Each member you refer will put your name in the hat for chances for the grand prize, so start today! How Does It Work? HOW? It’s easy. Any FICPA member can participate in Members Add Up. Simply recruit a colleague to join the FICPA, and when he/she processes a new member application with your name as a referral, we’ll credit you with points toward the grand prize. The more points you have, the greater your chances for winning the grand prize. Go to www.ficpa.org for more details about the program or to download a member application. Why Should You Participate? WHY? It’s simple. The more members the FICPA has, the stronger our voice is in the Legislature, where we work hard to promote and protect the CPA designation that is so valuable to you. We need the support of every CPA in Florida to make our message known, and you can help!

It’s fun. The Chapter that has the highest percentage of participation will win funds towards a Chapter event, so joining in today could really pay off!

It’s easy. Just make sure that anyone you refer puts your name on their application and we will take care of the rest. START ADDING UP THOSE MEMBERS TODAY! (850) 224-CPAS • (800) 342-3197 • www.ficpa.org ( 2 7 2 7 ) (within Florida only)

Visit www.ficpa.org and take advantage of your membership benefits, or contact the Member Service Center (MSC) at (800) 342-3197 (within Florida only) or (850) 224-2727, or e-mail [email protected]. NOT SURE WHERE TO START? Remember these benefits when talking to a friend about the FICPA.

1. Networking with other CPA professionals FICPA provides many opportunities to meet peers and share ideas and best practices. 2. Leadership development Joining a committee is a great way to influence the future of the FICPA, as well as gain leadership skills that will boost your resume. The FICPA will help you become a better- rounded professional! 3. Continuing Professional Education We are absolutely committed to providing the highest-quality CPE available in Florida. Stay current with advances in technology, best practices, and timely updates on accounting issues—and save money as a member, too! 4. Join a Section See how others are handling the same challenges you face by just logging on to the Internet. Professional interest Sections provide members the opportunity to ask questions and get advice from colleagues around the state. Each Section has a private members-only Listserv where members share and communicate ideas with each other any time of the day. 5. Stay informed Information is power. As a member you will receive Florida CPA Today magazine and a bi-weekly “Newsflash” electronic newsletter to keep you up to date on industry trends and news. 6. Give back to your profession The FICPA helps to sustain the future of the profession through legislative advocacy and its Educational Foundation, which provides scholarships to accounting students. 7. Safeguard YOUR profession You worked hard to become a CPA, and we work hard to make sure that designation means something. The FICPA represents Florida’s accounting professionals before the state Legislature to protect the CPA license. When you support the FICPA, you support your professional future.

STARTADDING UPTHOSE MEMBERS TODAY! The company that learns together, earns together... Let Us Show You How!

Who We Are Business Learning Institute (BLI) is a one stop shop that helps you to develop a custom learning solution which blends traditional classroom settings with modern tools such as webcasts, webinars and on-line classes.

This combination of traditional and modern training venues will allow your employees – from the highest level to entry-level – the opportunity to participate in programs that cover everything from technical content to leadership, performance skills and technology. What We Do Let us guide you through the process of selecting the right curriculum for your speciﬁc needs –that’s our job! We constantly monitor the profession to identify topics that will be the next hot issue.

Have you heard about XBRL, Lean Accounting, International Financial Reporting Standards? You will – and when you do – we’ll be ready to design the right class for you.

Why Us? When you use BLI, you gain access to our personal service, industry knowledge and guaranteed reliance – we deliver on every promise. Besides gaining CPE and valuable learning tools, you’re supporting your profession. Why? Because we’re part of the Florida Institute of CPAs!

Who Uses Our Services? BLI has coordinated and tailored programs for the following international organizations: • Microsoft • Target Stores • Marriott • Sherwin-Williams • Black & Decker • Northrop Grumman Corporation

For more information

Contact Adam Hebenthal at (800) 342-3197 (within Florida only) or (850) 224-2727, ext. 305 or e-mail hebenthala@ﬁcpa.org.

FLA (PLACE ON YOUR COMPANY’S LETTERHEAD)

Attention: Business Editor Contact: (CONTACT NAME) (CONTACT’S TITLE) (FIRM NAME) For Immediate Release Phone ______E-Mail ______(WEB ADDRESS, IF APPLICABLE)

(MEMBER’S NAME), CPA, Completes course on (SUBJECT AREA)

(MEMBER’S CITY), (DATE), 2008 -- ______(MEMBER’S FULL NAME)______, CPA, of _____(FIRM NAME)______in ______(CITY)______, completed a course, “______(COURSE TITLE)______,” on ____(DATE) ____. This continuing-education course covered the topic of______(SUBJECT AREA)______.

___(MEMBER’S LAST NAME)______is a ______(POSITION TITLE)______practicing in the area of (MEMBER’S AREA OF PRACTICE – TAS, AUDIT, ETC.) with the firm.

In addition to (MEMBER’S LAST NAME)’S professional responsibilities, HE/SHE is also active in (LIST ANY OTHER PROFESSIONAL/CIVIC/ VOLUNTEER/COMMUNITY ACTIVIES – OPTIONAL). HE/SHE is an active member of the Florida Institute of Certified Public Accountants, the professional association representing the interests of more then 18,400 CPAs with over 4,400 offices throughout Florida.

(MEMBER NAME) can be reached by telephone at _____(PHONE NUMBER)____, or via e-mail at ______(E-MAIL ADDRESS)______.

###