GiftCharity GiftLaw eNewsletter December 14, 2009

Tax Quote of the Week

"Representation is the ordinary guaranty of fairness in taxation."

-- Robert H. Jackson

House Passes $31 Billion Tax Extenders Bill

On December 9, 2009, the House of Representatives passed the Tax Extenders Act of 2009. The $31 billion bill will extend over 40 tax provisions from 2009 to the end of 2010.

Major tax provisions include extension of the research and development credit, the teachers' supplies deduction and seven charitable provisions.

Chairman of the House Ways and Means Committee Charles Rangel (D-NY) was pleased with the passage and noted, "This bill provides critical tax relief for hardworking families and businesses to help spur economic growth and create jobs."
A controversial part of the bill is the tax offsets. Investment fund managers currently operate as partners and generally pay income tax at the 15% capital gain rate rather than the 35% ordinary rate. Under the bill, the employee of a partnership will pay tax at ordinary rates for services that he or she provides.

This provision was supported by Rep. Sander Levin (D-MI). He stated, "This is a basic issue of fairness. Fund managers are receiving compensation for managing their investors' money. They should not pay the 15% capital gains rate on their compensation when millions of other hardworking Americans, many of whose income is performance-based, pay ordinary rates of up to 35%."

The Ranking Republican on the Ways and Means Committee is Rep. Dave Camp (R-MI). He criticized the tax increase as "nothing short of a new tax on the very investments needed to start a new business and create economic growth."

There are seven charitable provisions in the extenders bill. These are as follows:

IRA Charitable Rollover -- Distributions will be permitted up to $100,000 per year for IRA owners directly from the IRA to charity.
Food Inventory Gifts -- Businesses may give food inventory to charity and receive an enhanced deduction for gifts of apparently wholesome food.
Computer Equipment -- Corporations may receive an enhanced deduction for gifts of computers to educational organizations.
Book Inventory -- Corporations may receive enhanced deductions for gifts of books to elementary and secondary schools.
Subchapter S Corporations -- A Subchapter S corporation may gift appreciated property and the shareholder benefits from the full deduction.
Conservation Property -- Gifts of conservation property qualify for expanded deductions and longer carry-forwards.
Rent Payments to Parent Charities -- Fair value rent payments by subsidiaries will not be unrelated taxable income to the parent charity.

Editor's Note: This list of tax extenders is nearly certain to be passed by both House and Senate. However, because the Senate has in the past objected to these revenue-raising provisions, it may be 2010 before the final extenders bill is passed.

Ten IRS Tax Tips on Year-End Gifts

In a letter published on December 8, 2009, the IRS provided "tax tips on end-of-year donations." These include the following tips:

IRA Charitable Rollover -- While the required minimum distribution for 2009 has been waived, it still is permissible for an IRA owner to transfer up to $100,000 directly to a qualified charity.
Clothing and Household Items -- Gifts of clothing or household items in "good used condition or better" will qualify for a deduction. If the value is over $500, a donor may obtain a qualified appraisal.
Cash Gifts -- Gifts of money now require a bank record or written acknowledgement from the charity. The record must show the name of the charity, the date and the amount of the contribution. Credit card payments are also deductible and should show the name of the charity, the date of the gift and the date the transaction posted. For payroll deductions, a taxpayer should retain a pay stub or a Form W-2.
When Deductible -- Donations are deductible when made. Checks mailed by December 31, 2009 that clear the bank are deductible in 2009.
Qualified Charity -- Not all charities are qualified to receive deductible gifts. On www.IRS.gov, a donor can search for qualified charities in Publication 78 and determine whether a gift qualifies for a deduction. However, gifts to a church, synagogue, temple or mosque qualify even if the charity is not listed in Publication 78.
Itemized Deductions -- If a taxpayer takes the standard deduction, there will be no added benefit from charitable gifts. In order to receive an additional charitable gift deduction, the taxpayer must itemize deductions.
Property Gift Records -- For gifts of clothing, household items or other property, the charity should give a receipt with the name of the charity, date of the gift and a reasonable description of the property.
Car, Boat or RV Gifts -- For vehicle gifts worth over $500 that are sold by the charity, the deduction is limited to the gross proceeds from the sale. The charity will provide IRS Form 1098-C to the donor. It must then be attached to the donor's tax return.
Non-Cash Gifts Over $500 -- If a donor makes non-cash gifts over $500, then IRS Form 8283 must be attached to the tax return.
Gifts of $250 or More -- If a gift of property is valued at $250 or more, then the charity must provide a receipt to the donor. The donor must have the receipt when he or she files IRS Form 1040.

Formula Charitable Gift Upheld

In Estate of Anne Y. Petter et al. v. Commissioner; T.C. Memo. 2009-280; No. 25950-06 (7 Dec 2009), the court upheld a formula clause that transferred a substantial gift to the Seattle Community Foundation.

Anne Petter was a career schoolteacher in Washington State. In 1982, her uncle bequeathed several million dollars of UPS stock to her. Anne continued to live in her own home and made plans to provide substantial gifts to family and charity.

Anne had three children -- Donna Petter Moreland, Terrence Petter and David Petter. She was referred to estate planner Richard LeMaster and together they created a sophisticated estate plan.

LeMaster first created an irrevocable life insurance trust funded with an insurance policy with a face amount of $3.5 million. He then established a charitable remainder unitrust funded with $4 million of UPS stock that made payments to Anne of 5% per year for her lifetime.

The third strategy was to create the Petter Family LLC (PFLLC). In 1998, PFLLC was created and Anne intended to transfer all of her UPS stock to the LLC. However, by November 1999, UPS indicated it was planning to go public and stock could not be transferred until after the initial public offering. Following the offering, the UPS stock owned by Anne was valued at $22.6 million.

PFLLC was created with approximately 452,000 Class A units, 11 million Class D units and 11 million Class T units. The Class D units were intended to be transferred to a trust for Donna and the Class T units were intended to be transferred to a trust for Terrence. Anne retained the Class A units that effectively granted control of PFLLC.

On March 22, 2002, Anne transferred her UPS stock to PFLLC. Previously, LeMaster had created intentionally defective grantor trusts (IDT) for both the Class D units and the Class T units. Anne transferred PFLLC units by gift to the IDTs equal to 10% of the trust assets and then sold units valued at 90% of trust assets in exchange for promissory notes. The notes of approximately $4.1 million from the two IDTs required quarterly payments. All payments were made by distributions from PFLLC to the trusts. As was required under the note terms, quarterly payments were then made by the trusts to Anne.

The 2002 gifts were intended to use the balance of Anne's $1 million gift exclusion. The gift formula indicated that the gifted units to each defective trust were equal to "one-half the minimum dollar amount that can pass free of federal gift tax by reason of transfer's applicable exclusion amount." The excess of the value was to be transferred to "the Seattle Foundation as a gift to the A.Y. Petter Family Advised Fund." If a later valuation dispute with the IRS should arise, the IDGTs were required to transfer additional units to the Seattle Foundation so that the taxable gifts did not exceed the available gift exemption.

The Seattle Foundation gift and a much smaller gift to her local Kipsap Community Foundation were the subject of negotiation with counsel for the Seattle Foundation. The Seattle Foundation specified that it would not bear legal costs in conjunction with the gift and would not be an assignee, but rather would be a substituted member in the PFLLC. This had the impact of creating a fiduciary relationship between the Seattle Foundation and PFLLC.

LeMaster obtained an appraisal by a well-known firm named Moss Adams. The appraisal recommended a 46% discount for non-marketability and a 15.3% discount due to the closed-end fund. Anne filed her gift tax return and reported the gifts, effectively using the balance of her $1 million gift exemption. The IRS audited and claimed a much higher value per unit. The IRS claimed value of $794.39 per unit was later reduced by stipulation to $744.74. This valuation resulted in a dramatic increase in the gift to the Seattle Foundation.

The court faced two questions. First, would the formula valuation which greatly increased the gift to the Seattle Foundation result in a charitable gift? Or, should the formula method be held void as a matter of public policy and the large additional transfer to the Foundation not qualify for a charitable deduction? Second, what would the effective date be for the gift?

The court reviewed various formula and savings clauses. Generally, under Commissioner v. Procter, 142 F. 2d 824 (4th Cir. 1944), a formula clause that results in the recovery of any excess property by the donor is void as a matter of public policy. However, formula clauses that mandate transfer of assets to the charity without a recovery by the donor will be sustained. In Estate of Christensen v. Commissioner, 130T.C. No. 1 (2008), a fairly complex formula clause was used to allocate a transfer to a charitable trust. Because the transfer was effective with only a future determination of actual charitable value, the clause was upheld.

Therefore, the public policy is to "specifically allow formula clauses" if there is a fixed gift that is not "susceptible to abuse." Because the Foundation was substituted and there was a fiduciary relationship with PFLLC, the Foundation could "police the trusts." Therefore, the formula clause was upheld.

With respect to timing, Washington law indicated that a gift is complete when "unconditional and immediate." In this case, there was no condition that would defeat the gift, and it was held effective on the date of transfer on March 22, 2002.

Editor's Note: This is a significant road map for future formula gifts. The skilled estate planner wanted to create a gift that eliminated the risk of paying gift tax. Unquestionably, his goal was to reduce the incentive for the IRS to contest the transaction. The Petter case now shows the path to use for formula clauses to create gifts to charity. However, it is quite probable that charities will also have an interest in insuring that the valuation of such gifts is appropriate because it directly affects their share.

Applicable Federal Rate of 3.2% for December -- Rev. Rul. 2009-38; 2009-49 IRB 1 (17 Nov 2009)

The IRS has announced the Applicable Federal Rate (AFR) for December of 2009. The AFR under Section 7520 for the month of December will be 3.2%. The rates for November of 3.2% or October of 3.2% 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 2009, pooled income funds in existence less than three tax years must use a 4.8% deemed rate of return. Federal rates are available at www.irs.gov/businesses/small/article/0,,id=112482,00.html

Private Letter Ruling

Executor Permitted to Allocate GSTT Exemption to Decedent's Lifetime CRUTs

Donor created three charitable remainder trusts (CRUTs) for his grandchildren during life. Donor relied on Attorney's preparation of Form 709 on which the Attorney reported a taxable gift transfer of the CRUTs, but failed to allocate any of Donor's generation-skipping transfer (GST) exemption to those transfers. Donor also made several generation-skipping transfers to a separate irrevocable trust and properly allocated Donor's GST exemption. Donor subsequently passed away. In preparing IRS Form 706, Executor of Donor's estate learned that the GST exemption had not allocated to the CRUT transfers. Executor requested a time extension to allocate Donor's GST exemption to the lifetime transfers valued at the time of transfer.

The Service granted an extension of time to allocate the exemption under Sec. 2642(g) and Regs. 301.9100-1 and 301.9100-3. Under Sec. 2601, a tax is imposed on every generation-skipping transfer made to a skip person (such as a grandchild). Under Reg. 26.2632-1(b)(2), the allocation for transfers during life is made on Form 709. Sec. 2632(a) provides that any allocation of the GST exemption allowed can be made at any time prior to filing the estate tax return. Sec. 2642(g) gives the Secretary the ability to grant relief to extend the time to make a GST exemption. Reg. 301.9100-1 gives the Service discretion to grant a reasonable time extension and 301.9100-3 provides for granting relief where evidence satisfies the Service that the taxpayer acted reasonably and in good faith and relief will not prejudice governmental interests. Sec. 301.9100-3(b)(1)(v) deems a taxpayer acted reasonably and in good faith in relying reasonably on a qualified tax professional that failed to make or advise taxpayer to make the election.

Article of the Month

New Decade Predictions – Part II

Depression Babies Seek Security – Baby Boomers Move to Retirement

With the massive changes in our financial system the past two years, baby boomers and the depression babies are asking, "What is likely to occur in the future?" While predictions are indeed difficult, by examining the past and the present it is possible to make several projections about the future. Part I of this article discussed the economy and wealth, the impending tax increases on the affluent and the probable boom in financial counseling. Part II will analyze charitable financial planning options for the depression babies group and the baby boomers.

The sections for each will include a prediction, an analysis of the factors surrounding that prediction, and an explanation of the likely impact on major and planned gift donors.

Case of the Week

Lucky Lucy Asks If "Northern Lite Shot" Can Lobby?

Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucky Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucky Lucy was so successful in these markets that she now manages only her mega-mllion-dollar personal portfolio. Somewhat late in life, Lucky Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity, and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a Canadian oil "wildcatter" with the name Northern Long Shot, Inc. This company has been drilling new exploratory wells in the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company with a portion of the successful wells. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot, Inc. After the exchange, Lucy decided to give the Northern Long Shot stock to a private charitable foundation to help those in need.

Lucy has many friends who are active in the oil business in sub-arctic regions. They would like to drill for oil in an Alaska Nature Preserve, and it is possible that their success would also benefit Northern Long Shot, Inc. Lucy discussed options with her attorney. She asked her attorney about the ability of her private foundation to help in the lobbying effort to open up the Nature Preserve for oil development. After all she thought, Northern Long Shot, Inc. would benefit from the drilling for oil and could do more to help the needy. Her attorney noted that private foundations are subject to various rules on self-dealing, minimum distributions and excess business holdings, and taxable distributions. Lobbying by private foundations is not a permitted distribution. Lucy said, "Wow! There are a lot of rules for private foundations. Why would my private foundation have to avoid spending money on lobbying? After all, it could benefit from this oil drilling in the far north."

Thank you for your interest in the Community Foundation of Grant County. To contact us, please call 765.662.0065 or check out our website at www.comfdn.org.

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Thank you for your continued interest in a better quality of life in Grant County.

Yours in Philanthropy,

Elizabeth A. Wright and Dawn M. Brown...
on behalf of the entire Community Foundation Team

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.

The Community Foundation of Grant County, Inc. is a 501(c) (3) charitable organization.