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Tax Quote of the Week
"The federal income tax is a complete mess. It's not efficient. It's
not fair. It's not simple. It's not comprehensible. It fosters tax
avoidance and cheating. It costs billions of dollars to administer. It
costs taxpayers billions of dollars in time spent filling out tax forms and
other forms of compliance. It costs the economy billions of dollars in lost
output of goods and services from investments being made for tax rather
than for economic purposes."
- Robert E. Hall and
Alvin Rabushka
Volcker Suggests Value Added Tax (VAT)
Former Chairman of the Federal Reserve and current White House Advisor Paul
Volcker spoke to the New York Historical Society on April 6, 2010. In
response to a question about potential additional taxes to address the
budget deficit, Chairman Volcker indicated that the VAT "was not as
toxic an idea" as previously thought. He suggested that either a VAT
or an energy tax maybe necessary to address the deficit.
The White House promptly noted that Chairman Volcker was speaking not on
behalf of official White House policy, but for himself as an individual.
Sen. Charles Grassley (R-IA) is the Ranking Member of the Senate Finance
Committee. He published a press release on April 7, 2010, in response to
the suggestion by Chairman Volcker that the federal government consider a
VAT or national sales tax.
Sen. Grassley stated, "Chairman Volcker is giving an unvarnished
assessment of where the administration feels it must go. To make up for the
largest levels of spending and deficits in modern history, the
administration is laying the foundation for a large, misguided new tax, a
first-time American VAT."
Editors Note: Your editor and this organization take no position on
the comments by Chairman Volcker or Sen. Grassley. This information is offered
as a service to our readers.
FLP Reduced Discounts Affirmed
In Thomas
H. Holman Jr. et ux. v. Commissioner; No. 08-3774 (7 Apr 2010), the
Court of Appeals for the 8th Circuit affirmed the Tax Court decision. In Thomas
H. Holman, Jr. et ux v. Commissioner; 130 TC No. 12; No. 7581-04 the
Tax Court reduced claimed 49% family limited partnership (FLP) discounts to
approximately 24%.
Thomas H. Holman, Jr. and Kim D. Holman are the parents of four children.
During the Internet boom in the late 1990's, Mr. Holman was employed by
Dell Computer Corporation in Texas and acquired a substantial block of Dell
stock. The Holman's moved to Minnesota in 1997 and created the Holman
Family Limited Partnership (HFLP) on November 3, 1999. The Holman's
transferred 70,000 shares of Dell stock to the HFLP on that date. Five days
later on November 8, 1999, they transferred limited partnership interests
to trusts for their four daughters. Similar FLP gifts to their daughters'
trusts were made in 2000 and 2001. With additional transfers of Dell stock,
HFLP owned 111,100 shares of stock by 2001.
The four goals of HFLP were long-term growth, asset preservation, asset
protection and education. The Holman's filed IRS Form 709 Gift Tax Returns
and claimed discounts for lack of marketability and minority interests of
approximately 49%.
The IRS contested the valuation discounts with four arguments. First, the
IRS claimed that there was a gift not of FLP interests but actually a gift
of Dell shares to the daughters under the theory of Senda v.
Commissioner; T.C. Memo. 2004-160, affd. 433 F.3d 1044 (8th Cir. 2006).
Second, the IRS claimed that there was no operating business and so the
valuation should be based on a trust and not an active business. Third, the
restrictions on transfers within the partnership agreement should be
disregarded under Sec. 2703(a). Fourth, the valuation discounts should be
reduced to 28%.
The Tax Court considered the IRS and taxpayer positions and made three main
findings. First, there was no "Senda" indirect gift. The FLP was
created, the stock was transferred to the FLP and five days later the FLP
units were gifted. There was no simultaneous gift on creation and there was
a change in valuation during the intervening five days.
Second, the Sec. 2703(a) restrictions are not to be considered for
evaluation purposes. HFLP is solely an entity to hold the Dell stock and
therefore not a bona fide business. It is also merely a device to
facilitate asset transfers to the family members.
Third, taxpayer appraiser Ingham argued for minority discounts and lack of
marketability, with a total discount of approximately 49%. IRS Appraiser
Burns generally agreed with the minority interest discounts, but
recommended reducing the claimed 35% marketability discount to 12.5%, since
the Dell stock was readily tradable. The Tax Court accepted the 12.5%
discount. The resulting discount from net asset value for the total gifts was
approximately 24%.
In a 2-1 decision, the appellate court determined that the Tax Court was
correct. The HFLP was not a "bona-fide business arrangement" and
was instead primarily an estate planning device.
Because the underlying assets of Dell stock were highly liquid and readily
saleable, there was no "operating business nexus."
As a result, the IRS was correct in disregarding the discounts that would
have been applicable for an FLP that met the bona-fide business test. In
addition, because the Dell stock was highly liquid, easily priced and
readily saleable, a new buyer would realize there was little economic risk.
Therefore, the reduced discounts authorized by the Tax Court were affirmed.
Dissenting Judge Beam stated that "maintaining family control" is
a "legitimate business purpose" for the HFLP. As a result, he
would have reviewed and reconsidered the tax court discounts.
S Corp. Bargain Sale Deductions Upheld
In William
R. Klauer et al. v. Commissioner; T.C. Memo. 2010-65; Nos.
18181-07, 15147-08, 15148-08, 15149-08, 15150-08, 15151-08, 15152-08,
15153-08, (4 Apr 2010), the Tax Court determined that the S Corp.
charitable deductions were qualified and flowed through to shareholders.
The Klauer family owned an Iowa Subchapter S corporation named Klauer
Manufacturing. Between 1919 and 2001, Klauer Manufacturing acquired land
adjacent to Taos, New Mexico. In 1999, the Trust for Public Land (TPL) approached
the Klauer family and indicated an interest in purchasing approximately
2,581 acres that were locally described as the "Taos Overlook."
Because TPL had no funding and was not able to enter into a legally binding
contract to purchase the property, on January 23, 2001, TPL and Klauer
signed three options to permit transfer of approximately one-third of the
property each year over a period of three years. The options permitted
acquisition of Phase I for $4 million, the Phase II property for $5 million
and the Phase III land for $5.5 million. All of the sales would be
dependent upon TPL obtaining federal funding for the purchases.
TPL was able to obtain funding from Congress each year and the purchases
were completed in 2001, 2002 and 2003. Klauer Manufacturing obtained an
appraisal for the fair market values for the three years. Total value each
year was substantially in access of each sale price. Klauer then issued a
K-1 to each shareholders and they claimed their pro-rata charitable
deductions for the 2001, 2002 and 2003 bargain sales.
The IRS audited all shareholders and denied the deductions. The IRS
contended that the option agreement had created a binding sale contract
that fixed the value at the sale price. Because there was a binding sale
contract and an "interdependent transaction," the IRS denied the
deductions.
The Tax Court considered the questions of fact regarding the IRS binding
transaction claim. The Tax Court noted that the initial pricing was not
based on fair market value, but was an assumed potential funding level that
TPL could obtain from Congress. Because TPL "was not in a financial
position to be contractually and thus legally bound" under the
contract, the options were contingent upon Congressional funding.
A binding agreement exists when there is a legal obligation. TPL did not
have legal obligation. Therefore, there was no binding agreement and no
step transaction.
The second claim of the IRS was that the transfer of the three parcels was
"interdependent" and therefore the charitable deductions for the
bargain sales failed under the interdependence test. The court determined
that there was no binding requirement for TPL to acquire all three parcels.
Any of the three options could have been exercised separately depending upon
the funding provided by Congress. Therefore, the interdependence test was
not applicable and the deductions were permitted.
Applicable Federal Rate of 3.2% for April – Rev. Rul. 2010-11; 2010-14
IRB 1 (18 Mar. 2010)
The IRS has announced the Applicable Federal Rate (AFR) for April of 2010.
The AFR under Sec. 7520 for the month of April will be 3.2%. The rates for
March of 3.2% or February of 3.4% also may be used. The highest AFR is
beneficial for charitable deductions of remainder interests. The lowest AFR
is best for lead trusts and life estate reserved agreements. With a gift
annuity, if the annuitant desires greater tax-free payments the lowest AFR
is preferable. During 2010, pooled income funds in existence less than
three tax years must use a 4.6% deemed rate of return. Federal rates are
available by clicking
here.
Decedent died owning an IRA without a beneficiary designation.
Under state law, the IRA passed to decedent's estate. Decedent's will
provided that assets in the estate be paid over to Trust. Article IV of
Trust provides that Charity will receive X% of the residue and various
other charities will receive the remaining residue of the estate. Article
VI of Trust granted the trustee power to make allocations, divisions and
distributions of Trusts assets among beneficiaries. The Estate desired to
transfer the IRA to Trust and, in turn, Trust will distribute the IRA to
the residual charitable beneficiaries. Estate represented that it had
sufficient assets to satisfy the bequests to the non-charitable
beneficiaries. Estate requested a ruling that under Sec. 691 proposed
transfer of the IRA will not be a transfer within the meaning of Sec.
691(a)(2).
Sec. 691(a)(1) provides that the amount of all items of gross income in
respect of a decedent (IRD) shall be included in the gross income, for the
taxable year when received, of: (A) the estate of the decedent; (B) the
person who acquires the right to receive the amount; or (C) the person who
acquires from the decedent the right to receive the amount by bequest,
devise, or inheritance. Sec. 691(a)(2) provides that if a right, described
in Sec. 691(a)(1), to receive an amount is transferred by the estate or a
person who received such right by reason of the death of the decedent or by
bequest from the decedent, the IRD asset will be included in the income of
the estate or such person. For purposes of Sec. 691(a)(2), the term
"transfer" includes sale, exchange or other disposition, or the
satisfaction of an installment obligation at other than face value, but
does not include transmission at death to the estate or a transfer to a
person by bequest, devise, or inheritance from the decedent. The Service
determined that the transfer to Trust and, in turn to the charity was not a
transfer within the meaning of Sec. 691(a)(2). Therefore, neither the
estate nor Trust was responsible for the IRD income tax.
In PLR 200152018, a donor requested a ruling on converting the
income interest from a charitable remainder unitrust into a charitable gift
annuity. The PLR had four specific requests. First, that the donor would
receive an income tax deduction for a portion of the value of the income
stream transferred to charity for the gift annuity. Second, that there would
be a charitable gift tax deduction for the same portion. Third, that the
transfer of the unitrust income interest for a gift annuity would not
accelerate underlying capital gain in the income interest. Finally, that
the percentage of capital gain and basis as of the date of creation of the
trust could be utilized for calculating the tax-free portion of the gift
annuity payouts.
In the ruling, the IRS found that there was an income tax deduction
allowable for the present value of the remainder interest in the charitable
gift annuity. It also found that there would similarly be a gift tax
deduction and the transfer of the unitrust income interest in exchange for
the gift annuity would not accelerate the underlying capital gain. On the
last issue, the IRS found that a prorated basis would not be allowed and
all payouts to the annuitant would be ordinary income and capital gain.
Mac Swenson loved the great outdoors. He grew up in the Big
Sky country of Montana. As soon as he could walk, Mac was on a pony. By his
teen years, Mac was riding horses every day. On weekends, he watched with
admiration as the older cowboys practiced riding bucking broncos at the
local rodeo grounds.
By age twenty, Mac was riding the rodeo circuit. He soon moved up to the
most exciting event at the rodeo - bareback riding on the wild and powerful
Brahma bulls. Mac was lean and tough and soon gained a national reputation
as a skilled and fearless Brahma bull rider. At a rodeo in Burwell,
Nebraska, Mac watched with great interest as a lovely and charming young
lady named Glenda Olson was crowned the rodeo queen. Mac was head over
heels in love. They soon married and he used the rest of his rodeo winnings
to buy a small ranch near the Beartooth Mountains in Montana. Over the
years, Mac and Glenda raised four children and steadily built up the ranch.
Both loved the great Big Sky country and planned to spend the rest of their
days watching the sun set over the Beartooth Mountains.
As Mac and Glenda reached their sunset years, the ranch was now more than
7,000 acres. One day a new neighbor moved in to the ranch next door. Glenda
said, "You know Mac, our four children have left for the city, and no
one is here to manage the ranch. I know we both love it here, but
eventually you may need to think about selling." A few weeks later,
their neighbor Bob Brown stopped in for a visit. He and Mac enjoyed talking
about cattle, the weather and the hay crop. After hearing how Mac and
Glenda had built up their ranch over the years, Bob mentioned that he was
looking for a way to expand the size of his ranch.
Five years ago, Mac and Glenda used a sale and unitrust to sell the ranch
tax free. They transferred half of the ranch to a unitrust and half to a
revocable trust. Their neighbor Bob Brown paid $1,000,000 to the unitrust
and $1,000,000 to a revocable trust for the entire ranch except the home
quarter section. Since that 160 acres included their home, the barn and
other buildings, it now has a value of $400,000.
Mac and Glenda want to live in their home for life. But they are now 75 and
receiving good income from their unitrust and the revocable trust. Mac
called their CPA and asked if there was a way to reduce their taxes. The
CPA noted that Bob Brown had bought the rest of the ranch and thought,
"Maybe he would also want the home quarter. But how can Mac and Glenda
live on that home quarter, sell to Bob and get a deduction?"
Note: Case studies, articles, commentary and other materials in the
GiftLaw system are included solely as educational information. Articles and
editorial comments are offered as an educational service to friends of this
organization, and may not always reflect our official position on any
issue. Since case studies or articles may not always reflect the current
AFR or tax law, it may be necessary to run any illustration with a current
version of Crescendo to obtain updated information. If professional
services are required, all persons shall consult with their qualified
professional advisors. Tax Quotes are courtesy of Jeffery L. Yablon,
Washington, D.C.
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Copyright 1999-2010 Crescendo Interactive, Inc.
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