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Tax Quote of the Week
"To extinguish a debt which exists and to avoid contracting more are
ideas almost always favored by public feeling and opinion; but to pay taxes
for the one or the other purpose, which are the only means of avoiding the
evil, is always more or less unpopular. These contradictions are in human
nature." -- Alexander Hamilton
White House Budget Changes Taxes
On February 1, 2010, the White House released the budget for fiscal year
2011. The budget projects a spending level of $3.8 trillion and a deficit
of $1.56 trillion.
President Obama spoke in support of the budget. He indicated that the
budget choices were challenging. He stated, "It's time to save what we
can, spend what we must and live within our means."
The budget includes many provisions that will affect taxes. Some provisions
will reduce taxes during the next decade. Others will increase taxes.
Finally, there are some provisions such as the estate tax, which include
both increases and decreases.
Tax Reductions
The most expensive tax reduction is to retain the existing brackets for the
10%, 15%, 25% and 28% rates. These current brackets reduce taxes for
middle-income Americans. The "Making Work Pay" credit is also
proposed to be extended for one year. This credit reduces withholding for
most workers.
The budget also contemplates an expense of $46.7 billion for "tax
extenders." The tax extenders include the teacher's deduction, various
business credits and the IRA charitable rollover.
Tax Increases
Top current tax rates of 33% and 35% will be increased in 2011 to 36% and
39.6%. These increases apply to single persons with incomes over $200,000
and married couples with incomes over $250,000. There will also be an
increase from 15% to 20% in the tax rate on capital gains and dividends,
which will be taxed at ordinary income rates up to 39.6%
During the past three years, the 3% floor on itemized deductions for
upper-income persons and phase out of personal exemptions have been
eliminated. Restoring these provisions will also increase taxes on
higher-income households in 2011.
The White House again made a proposal that was not successful last year in
the United States Senate. The budget proposes that higher-income
individuals be restricted from benefiting from deductions to the extent
that their tax bracket exceeds 28%. If this 28% cap is enacted, major
charitable donors to capital campaigns will lose part of their tax savings.
This proposed limit on tax savings from charitable gifts by higher-income
taxpayers were previously met with strong opposition. The Senate
overwhelmingly passed a 2009 bill by Sen. Robert Bennett (R-UT) that
rejected the concept. Sen. Bennett stated, "The Senate sent a clear
message to the President that we do not support increasing taxes on
charitable contributions."
Sen. Bennett noted that charities "benefit greatly" from
donations made by individuals in high brackets. He suggested that the 28%
cap on itemized deductions would have major negative impact on charities.
Taxes Up and Down
The White House budget proposes an estate tax exemption of $3.5 million and
tax bracket of 45%. In effect, the 2009 estate tax rules will be extended.
The $3.5 million exemption/45% tax rate would be an increase from the
present 0% estate tax rate, but it would be a decrease from the scheduled
55% estate tax rate that is to be effective on January 1, 2011.
Democratic Praise for White House Budget
Democratic Senators and Representatives were supportive of the new White
House budget. Sen. Budget Chair Max Baucus (D-MT) stated, "The job
creation funds allocated in this budget will help rebuild the foundation of
our economy -- the middle class. They will help small businesses hire more
workers and provide assistance to individuals, businesses and families to
get through the recession."
Sen. Baucus also supported the proposed changes and increases on companies
with international operations. He did not comment directly on the income
tax increases.
Sen. Baucus did make reference to the estate tax. In December, 2009, he was
unable to pass an extension of the 2009 estate tax rules because two
Democratic Senators and most Republicans supported a $5 million exemption
and 35% top estate tax rate. Sen. Baucus noted, "Several Members of
this Committee notably Senators Lincoln, Cantwell, and Kyl have been
working hard on their proposals in this area, as well."
Senate Majority Leader Harry Reid (D-NV) was also pleased with the White
House proposal. He indicated that he supported the "middle-class tax
cuts" that will benefit families. He also stated that the budget
"will continue Democrats' efforts to reduce the deficit and restore
fiscal responsibility."
Sen. Kent Conrad (D-ND) is Chair of the Senate Budget Committee. He
believes that the 2010 budget and deficit were essential to save an economy
"on the brink of collapse," but that there need to be changes in
the future. Sen. Conrad indicated that in the future the Senate will need
"to focus on controlling our debt."
Finally, Chair of the House Ways and Means Committee Charles Rangel (D-NY)
stated, "It is abundantly clear that we must find some way to build
confidence in our economy, particularly for small businesses."
Chairman Rangel was generally supportive of the small business credit of
$5,000 per job for hiring new workers. He also hoped that he and the
Ranking Republican Dave Camp (R-MI) could work together to find bipartisan
tax solutions for next year.
Republican Response to White House Budget
Sen. Charles Grassley is the Ranking Republican on the Senate Finance
Committee. He responded that the White House is downplaying "the
effects of raising taxes on small business owners." In his view, the
increase in income tax rates to 36% and 39.6% will impact at least half of
small business owners with 20 or more employees. His staff notes that 20
million workers are employed by these businesses. With the increased tax
rates, Sen. Grassley sees a "real disconnect between the
administration's stated interest in helping small businesses and creating
jobs" and the higher taxes.
Sen. Judd Gregg is the Ranking Member on the Senate Budget Committee. He
and Sen. Conrad have been advocating budget restraint to reduce the
deficit. Sen. Gregg exclaimed, "This country is sinking into a fiscal
quagmire the President's stimulus plan has not resulted in job growth,
this year's deficit is expected to reach $1.6 trillion and Congress just
agreed to extend the federal credit limit to more than $14 trillion."
Sen. Gregg calls the new budget "more spending, more borrowing and
more taxes." His view is that the new budget fails to make significant
progress toward deficit reduction.
Key House Republicans also shared similar concerns. House Minority Leader
John Boehner (R-OH) believes that the budget "spends too much...taxes
too much...and borrows too much." The budget of $3.8 trillion is up
30% in just three years time compared to 2008. There are approximately $2
trillion in tax increases over the next decade that will particularly harm
small business owners. Finally, the $1.6 trillion deficit plus another $9
trillion in estimated deficits over the decade will result in a tripling of
national debt from 2008 to 2019.
Finally, Rep. Dave Camp (R-MI) is the Ranking Republican on the House Ways
and Means Committee. He observes that the stimulus bill was not particularly
successful. He noted, "Instead of creating 3.5 million jobs as
Democrats promised, we have since witnessed the elimination of nearly three
million more jobs." Rep. Camp is also concerned about the increasing
federal debt and the impact of higher taxes on job creation.
Editor's Note: Your editor and this organization take no specific
position on any of the Democratic or Republican comments. We offer a
balanced view of both sides as a service to our readers.
Family Limited Partnership a Bona Fide Sale
In Estate
of Charlene B. Shurtz et al. v. Commissioner; T.C. Memo. 2010-21:
No. 6076-07 (3 Feb 2010), the Tax Court determined that a family limited partnership
(FLP) was properly created and operated. It rejected the IRS claim that
family control over the FLP assets was sufficient to cause the assets
rather than the discounted FLP units to be includable in the estate of Mrs.
Shurtz.
The decedent Mrs. Shurtz married Reverend Richard Shurtz. She had been
raised by Charles and Bonnie Barge in Mississippi. Charles Barge had
acquired and managed timber property and owned 45,197 acres of Mississippi
timberland.
From 1954 to 1986, Pastor and Mrs. Shurtz were missionaries in Brazil and
Mexico. They returned to the United States in 1986 and he became pastor of
a church in Montebello, California.
Mrs. Shurtz and her two siblings inherited interests in the Mississippi
timberland. In 1993, the three children, their mother Bonnie Barge and
trustees of several trusts for grandchildren created Timberland LP to
manage the family property. All of the individuals and trusts contributed
their interests in the property in exchange for limited partnership shares.
Because Mississippi had a reputation for "jackpot justice," many
individuals with substantial resources created FLPs to reduce litigation
risk. On November 15, 1996, Reverend and Mrs. Shurtz created Doulos LP.
Doulos LP was funded with her 16% interest in Timberland LP, her 93.4%
interest in another timber parcel of 748.2 acres and the 6.6% interest in
that same parcel owned by Reverend Shurtz. Doulos LP existed to
"reduce estate tax, provide asset protection, provide for heirs and
provide for the Lord's work."
From 1996 to 2000, Mrs. Shurtz made 26 gifts of 0.4% Doulos LP interests to
various family members. Each gift was valued at $19,700 and qualified for
the annual exclusion. In 2002, Mrs. Shurtz, who had suffered since 1986
with Parkinson's disease, passed away. Her estate was valued at
approximately $8.8 million.
Prior to her demise, Mrs. Shurtz had contacted development staff from the
Dallas Theological Seminary Foundation. They recommended attorney Louis
Wall who prepared her living trust and estate plan. Her estate planning
goals were to create a bypass trust to use any available remaining estate
unified credit, transfer the balance of the estate into a marital deduction
trust to benefit Reverend Shurtz for his lifetime and for the remainder of
the marital trust to be transferred to a charitable annuity lead trust
making a 12% payment for a calculated term of years necessary to achieve a
zero estate tax.
After Mrs. Shurtz passed away and the Form 706 estate tax return was filed,
the IRS contested the marital deduction and issued a deficiency of over
$4.7 million. The IRS claimed that Doulos LP was not a valid FLP and
therefore the assets in Mrs. Shurtz's estate would, under Sec. 2036 or Sec.
2035, be valued at full fair market value rather than the discounted FLP
value. The estate responded with the claim that there was a Sec. 2036 bona
fide sale and therefore the discounts were qualified.
The Tax Court reviewed the requirements for a bona fide sale. Generally
there must be a legitimate nontax reason for the FLP. In the case of
property held in Mississippi, the litigious nature of that state was a
legitimate reason for attempting to protect the family timberland. In
addition, the preservation of a family business is also a legitimate reason
for creating a partnership.
Finally, there were several factors that related to the creation and
operation of Doulos LP. The funding of Doulos LP resulted in proportionate
interests to the contributed property. Assets were reflected properly in
the partner's capital accounts. When distributions were made, there was a
negative adjustment in each capital account. Finally, there was a
"legitimate and significant nontax business reason" for creating
the family limited partnership.
For all of these reasons, the Sec. 2036(a) "bona fide sale"
exception applied. The assets were valued at the discounted level
appropriate for Doulos LP and there was no estate deficiency.
Editor's Note: This was a sparkling taxpayer victory. It is an
excellent road map for a successful family limited partnership. The
contributions and capital accounts were appropriately maintained. There
were annual meetings and correct accounting for all of the withdrawals.
With the documented business purpose and the appropriate management and
operation of the partnership, it easily qualified for FLP discounts.
Applicable Federal Rate of 3.4% for February -- Rev. Rul. 2010-6; 2010-6
IRB 1 (20 Jan. 2010)
The IRS has announced the Applicable Federal Rate (AFR) for February of
2010. The AFR under Sec. 7520 for the month of February will be 3.4%. The
rates for January of 3.0% or December 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 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 had a will with a number of codicils. His final will directed
that real property and cash be held in trust for the benefit of his sole
heir (Son) and Son's wife until their deaths, at which time the proceeds
would be contributed to a charitable trust (Trust). Decedent's will also
contained an in terrorem clause which provided that if any beneficiary
challenged the will, his or her share of the estate would be used to fund
the charitable trust. However, decedent's will was silent as to the
disposition of the residue of his estate. After months of negotiations between
Trust and Son, the parties agreed to a settlement in which Son would
receive $X free and clear of any fee and taxes. The remainder would go to
Trust, after the payment of all fees and taxes (including any fees and
taxes on Son's share). The settlement agreement was approved, without
hearing, by the local court. Both parties anticipated that the amount
passing to the charitable trust would be deducted from Decedent's taxable
estate.
The Service acknowledged that Sec. 2055(c) provides that a taxable estate
is determined after deducting transfers for charitable purposes. However,
in the case of a marital deduction, under Sec. 20.2056(c)-2(d)(2), if as a
result of a controversy involving a decedent's will involving a bequest an
interest is transferred to the surviving spouse, the interest acquired will
be regarded as having passed from the decedent to the surviving spouse only
if the assignment was a bona fide recognition of an enforceable right of
the surviving spouse in the decedent's estate. If the assignment was
pursuant to an agreement not to contest the will, it will not necessarily
be accepted as a bona fide evaluation of the rights of the spouse. The
Service cited Ahmanson Foundation v. United States, 674 F.2d 761 (9th Cir.
1981) in stating that the same rule should apply to cases involving the
settlement of a bona fide controversy not involving a surviving spouse.
Therefore, the question became: Did Trust have an enforceable right under
state law to receive the residuary from the estate?
The estate argued that state law prefers to avoid intestacy where a will
exists. Because the will contained no residuary clause, extrinsic evidence
is needed to demonstrate Decedent's intent. The estate also argued that the
settlement agreement itself demonstrates that Trust would have been
successful in court. Otherwise, Son would have not agreed to the
settlement. The Service disagreed on both accounts, noting first that under
several state court decisions, "...it is error for the court to
consider external evidence tending to impute the intent to the testator
different from that appearing on the face of the will." The Service
cited a state court probate case in stating "although it is true, . .
. that we must construe the will where possible in order to avoid intestacy,
we may not do so by ignoring the testatrix's intent or by ascribing to her
an intent which is nowhere evidenced in the will." Therefore, the
Service denied the estate's claim for an estate tax deduction for the
amounts passing to Trust as a result of the settlement agreement.
Reinsurance of a gift annuity involves
payment of a premium by the charity to a company qualified to issue
annuities in that state.
When a charity receives a gift annuity, it usually has the option to retain
the annuity in a designated reserve fund and invest that fund. The charity
may make payments from the fund or pay a premium to a financial services
company that will then make the required annuity payments. The second
choice is commonly called "reinsurance" of the gift annuity.
Reinsurance involves evaluating the factors that will benefit the charity
with self-insurance, or the favorable factors that might lead to
reinsurance. The primary questions relate to the life expectancy of the
donor, the estimated return of the charity's annuity reserve fund and the
cost of reinsurance.
Bill Russell grew up on the Great Plains. During his youth, he
was a rodeo bull rider and gained fame as "Wild Bill" for his
daring exploits. But Wild Bill was an artist at heart and soon decided to
move on to his artistic pursuits. He traveled throughout America and Europe
and studied all of the great modern and classical artists. In France, he
was greatly impressed by the delicate works of Impressionist painters Monet
and Manet and the bold colors and brush strokes of Van Gogh. Upon his
return to his beloved great plains of the west, Wild Bill combined the
subtlety of the Impressionists, the colors of Van Gogh and his own unique
skills. His Impressionist western landscapes and paintings of cowboys and
life on the ranch became treasured by art collectors nationwide.
Wild Bill was rapidly gaining a national reputation. His western
Impressionist art exhibits would draw art lovers from America and the
world. He was finally selling his paintings for $75,000 or more, and now
had another new experience - paying large income taxes. Bill called his CPA
Helen Swenson and said that he thought there must be a better way. Could
she find a way for Wild Bill to sell his paintings tax-free? After talking
to her friend the gift planner at the Cowboy Western Museum, Helen called
Wild Bill and exclaimed, "I found the answer. We can indeed sell tax
free!"
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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