Tax Planning

Article excerpt

Execution and Documentation Are Critical to Success

It has long been recognized that tax planning is a legitimate and valuable service pn)vided by tax advisors. Tax advisors, after years of training and experience, enjoy developing well-reasoned, technically sound strategies, arrangements, and structures designed to legally minimize their clients' tax liabilities. Tax planning by taxpayers and their advisors is both legal and ethical, as was recognized by courts early in the development of the federal income tax [Wood v. Comm'r, 33 B.T.A. 806, 820 (1935)]. The characteristics, rewanis, and pitfalls of tax planning are well known.

Successful tax advisors are typically adept at-and enjoy the challenges of-the technical aspects of tax planning, but they often fail to follow through with the execution of the planning transaction or structure. Ensuring that the plan is properly executed and documented may seem mundane, but it is necessary to secure the intended benefits. Practitioners often see the execution of a tax plan as the client's responsibility, but this is a recipe for failure and, more importantly, is not in the advisors's best interest. Clients rarely understand the technical nuances of the transactions, agreements, or structures involved in the plan. They also rarely appreciate the importance of adhering to the advisor's detailed instructions. Even relatively sophisticated clients typically have little time or inclination to follow the practitioner's carefully crafted structures.

Leaving execution to the client is hazardous and is poor professional practice. Working with a client to ensure that a plan is properly executed and documented significantly increases the plan's probability of success. Such diligence, moreover, helps a tax advisor foster a stronger client relationship and generate additional fees.

Case Study

A recent Tax Court case demonstrates the consequences of leaving a client in charge of executing a well-crafted tax strategy [Magassy v. Comm'r., TC Memo 2004-4, afl'd, 140 Fed. Appx. 450(4th Cm 2005)]. Csaba L. Magassy was a plastic surgeon who operated a successful medical practice in the Washington, D.C., metropolitan area. In 1990, apparently on the advice of his brother-in-law, Magassy puivhased a 108-foot yacht Magassy had been told by his brother-in-law that the yacht was being offered for sale under distress conditions and could be restored and resold at a substantial profit. Magassy did not inspect the yacht before signing an agreement to purehase it, nor did he attend the sale closing.

Upon his first inspection of the yacht in Florida, Magassy discovezud that the interior and exterior wem both in exu~me1y poor condition. As a result, Magassy spent a significant amount of money to have the yacht restored over the next several years. In the spring of 1992, on the advice of his acasmtant, Magassy obtained tax advice from a Washington, D.C., law finn reganuing the tax implications of selling the yacht. Apparently, by this time it was a foregone conclusion that any sale of the yacht would result in a loss. It is unclear whether Magassy or his accountant viewed the yacht as personal-use property or as investment property. In either case, any loss realized on the sale of the yacht would have been a capital loss [IRC sections 1221(a) and 1222]. For personal use, the loss would have been wholly nondeductible [IRC section 165(c)]. In contrast, for investment use, the loss would have been deductible, but limited in amount-generally, to the extent of the taxpayer's recognized capital gains for the tax year plus $3,000 [IRC section 1211(b)].

The law firm advised Magassy that, if he wanted to deduct an ordinary loss on the sale of the yacht, he should establish a chartering operation with the yacht prior to its sale. The law flim presumably reasoned that establishing the chartering operation would demonstrate the use of the yacht in a trade or business under IRC section 1231. …