|
Washington Report
November 1999
IRS Memo Determines Taxation
Of Preneed Funeral Contract Income
by Robert M. Fells, Esq., General Counsel
The Internal Revenue Service has issued a Technical Advice Memorandum (TAM) that determines when the proceeds from a preneed installment contract must be reported for federal income tax purposes. Previously, IRS agents auditing industry members would often maintain that except for amounts placed in trust pursuant to state law, preneed sales proceeds were taxable in the year the contract was signed, regardless of when the funds are actually received by the seller. The new TAM makes clear that under certain circumstances preneed sales proceeds are taxable only when due or when received by the seller, whichever is earlier.
The IRS Memo, identified as TAM120109-98, was issued to a taxpayer owning a cemetery mortuary combination and, technically, cannot be cited as authority by other taxpayers. However, TAMs are important because they show the thinking of IRS on selected issues and can be influential during an audit. According to the facts, the taxpayer here used the accrual method of accounting and sold burial rights (defined as real property consisting of cemetery lots, mausoleum crypts and niches, and lawn crypts), merchandise (defined as personal property and consisting of caskets, vaults, urns, memorials, acknowledgment cards, register books, flowers, etc.) and services (including preparation of the body, use of the taxpayer's facilities and staff for funeral services, and opening and closing of the burial sites).
On preneed installment contracts, the taxpayer charges interest on the balance due only when the installment period is more than three years and the customer pays less than 20 percent down or less than $100 per month. The customer cannot take possession or modify the selected burial site in any way prior to payment in full. In the event of a balance remaining at the time of the customer's death, the contract price must be paid by the estate or the survivors before the taxpayer will provide the burial.
State law provides a right for the purchaser to cancel within 30 days from the date of purchase and receive a full refund. Cancellation for services may be made at any time prior to the services being provided. A refund for merchandise is provided only if the taxpayer is unable to perform under the contract. Under no circumstances does the taxpayer refund amounts received for real property. In the event of customer default, the taxpayer may terminate the contract and withdraw all funds in trust allocable to merchandise and keep all payments as liquidated damages. However, the taxpayer must refund all funds for services, facilities and cash advances.
During an audit of the taxpayer, the IRS agent held that, under the "all-events" test, income from preneed sales of real property, personal property and services must be reported when the sale is made, and that point occurs when the contract is executed (signed). The taxpayer contended that the sale does not occur until all payments due under the contract have been received.
According to the TAM, "The determination of when a sale occurs is essentially a question that requires consideration of all the facts and circumstances of a particular situation. (Cases). One important factor to consider...is whether under the contract the seller has an unqualified right to receive the contract price. (Case). Due in large part to applicable State A law (the unnamed state is apparently Florida), taxpayer does not have an unqualified right to receive income attributable to real and personal property at the time the preneed contract is executed. At the time the contract is executed, the customer is expected to make regular payments...but has no duty under the contract to make any future payments.
"If the customer fails to pay the entire contract price, taxpayer does not have the right to legally enforce the contract and cannot require the customer to pay the balance of any installments or interest due. Taxpayer may only terminate the contract, keeping certain amounts the customer has already paid as liquidated damages. Other factors to be considered in determining when a sale is complete for tax purposes are the transfer of legal title and the shift of benefits and burdens of ownership of the property. (Cases).
"Under taxpayer's preneed contracts, legal title to the real and personal property is not transferred at the time the contract is executed; instead, title is transferred only after the customer has paid the entire contract price. Further, the benefits and burdens of ownership of the real and personal property do not pass to the customer at the time the preneed contract is executed.... A customer has no right to possess or use the property prior to full payment of the contract price, even in the event of the customer's death."
The TAM concluded that based on the particular facts and circumstances, "the sale of real and personal property occurs for tax purposes only when all amounts under the contract are received from the customer. Thus, we do not agree with the agent.... Therefore, income from services must be included in (taxable) income when payment is due under the preneed contract or payment is made, whichever happens earlier. With regard to real and personal property, the required performance does not take place until the property is sold...(and) must be included in income at the earlier of when payment is made or when payment is due under the contract."
The Memo's rationale echoes a number of points made earlier by the ICFA in comments filed with IRS on the issue of income recognition for preneed installment lot sales. Tax attorney Leslie J. Schneider, a member of the ICFA Government and Legal Affairs Tax Subcommittee, observed, "Every company should review their preneed contracts in light of this TAM. If the contract either states outright, or leaves open the possibility, that the seller can sue the purchaser to recover the outstanding balance, then the IRS could likely rule that the entire tax is due in the year the contract is executed, regardless of when the proceeds are actually received. In such circumstances, an industry member would need to make appropriate changes in its contract in order to obtain the results provided in this TAM."
Members who would like a copy of the TAM should call the ICFA offices at 1-800-645-7700.
Copyright ICFA 1999.
|
