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Members of both Parties joined the debate this week on income
taxes. Without action by Congress, all of the tax reductions in the
2001/2003 tax acts will be phased out on January 1, 2011.
The White House has steadfastly maintained that the reductions for lower
and middle-income brackets should be retained, while the reductions for the
top brackets must be phased out. Under the White House proposal,
individuals with incomes over $200,000 ($250,000 for married couples) would
pay higher taxes. The top two brackets will increase to 36% and 39.6%. In
addition, the White House proposes that the capital gains tax rate returns
to 20%.
Senator Ben Nelson (D-NE) has expressed concern about the increase in taxes
on upper income individuals. He is joined by Sen. Charles Grassley (R-IA),
who has consistently supported extending all of the 2001/2003 tax brackets.
Sen. Grassley suggested that it would be important to continue the tax
reductions in order to encourage small business owners to hire new
employees and reduce unemployment.
A long-term deficit hawk on the Democratic side is Senate Budget Committee
Chair Kent Conrad (D-ND). He stated for the first time this week that he
may be open to a temporary extension of the top brackets at the current 33%
and 35% rate. Senator Conrad indicated that at some future time it will be
necessary to "pivot" and move aggressively toward deficit
reduction. However, he questioned whether the economy is strong enough to
start the process of tax increases this year.
House Speaker Nancy Pelosi (D-CA) joined the debate with a strong
affirmation of the White House position. She stated, "Our position has
been that we support middle-income tax cuts. The tax cuts at the high end
have increased the deficit enormously and they have not created jobs in the
eight years."
Editor's Note: With Congress soon turning to the fall election, it
is highly probable that action on income taxes will be deferred until after
the election. With bipartisan concern about unemployment and the economy,
it is quite likely that the tax reductions at the lower and middle brackets
will be extended. The result for upper-income individuals is still
uncertain.
Senate Refuses to Repeal Estate Tax
On July 21, 2010, Sen. Jim DeMint (R-SC) offered an amendment to the
unemployment bill that would repeal the estate tax. Sen. DeMint noted that
the White House is creating a difficult environment for "small
businesses that are already facing higher income taxes and higher
investment taxes."
The proposed amendment was defeated on a vote of 39-59. Democratic Senators
Blanche Lincoln (D-AR) and Ben Nelson (D-NE) supported the abolition of the
estate tax. Republican Senators Olympia Snowe (R-ME), Susan Collins (R-ME)
and George Voinovich (R-OH) opposed the abolition of estate tax.
Sen. Lincoln and Sen. Jon Kyl (R-AZ) continue to advocate an estate tax
compromise. Under the compromise, the $3.5 million exemption from 2009
would be increased over 10 years to $5 million and the top 45% estate tax
rate would be reduced to 35% over that same time frame.
Editor's Note: The political pressure on the Senate continues to
rise. Following the March death of Houston oilman Dan Duncan with a $9
billion estate, the news media noted that the government had lost $2 to $3
billion on that estate alone. When New York Yankees owner George Steinbrenner
passed away with an estimated $1.1 billion estate, news media suggested
that he hit a "home run" by dying in 2010 with no estate tax.
While action is not likely before the election, there now seem to be two
general patterns to a potential Senate compromise. First, the estate tax
exemption will start at $3.5 million and increase to a higher number over
ten years. Second, the estate tax rate will begin at 45% and decrease again
over that same decade. The House majority has held strongly to a $3.5 million
exemption and 45% top tax rate, so the final compromise would also need to
reflect their preferences.
Donor Couple "Burned" by Denial of Deduction
In James
Hendrix et al. v. United States; No. 2:09 cv.00132 (20 Jul 2010), a
District Court denied a charitable deduction for a home given to a fire
department that was destroyed as part of the fire training process.
In 2000, taxpayers James and Lori Hendrix bought a property at 2580 Sherwin
Road in Upper Arlington, Ohio. In 2004, the couple decided to demolish the
home and rebuild a new home on the lot. The estimated cost of demolition
was $10,000.
Mr. and Mrs. Hendrix then had a creative idea. Rather than tear down the
house, they would give the home to the local fire department for training
and allow them to burn the house down. Following the destruction of the
house, they would then rebuild a new home and would save the cost of
demolition.
However, they also thought that they might receive a charitable deduction
for the value of the destroyed structure. On June 11, 2004, they obtained
an appraisal of the home and lot from appraiser Ann Ciardelli. She valued
the home at $520,000. They transferred the home on June 29, 2004 to the
local fire department. After the home was burned down by the fire
department, it was returned to them on October 29, 2004. They then
constructed the new home on the existing foundation.
Taxpayers claimed a charitable deduction in 2004 of $287,400. The IRS
denied the deduction and assessed a deficiency of $100,590.
The court noted that under Sec. 170(f)(11)(C), the deduction needed to be
supported by a qualified appraisal that is conducted by a qualified
appraiser. The Ciardelli appraisal did not indicate the anticipated date of
contribution, failed to disclose the terms between taxpayers and the fire
department, failed to include the required qualifications of the appraiser
and did not include the required statement that the appraisal was prepared
for income tax purposes.
Taxpayers acknowledged the failings of the appraisal but claimed
substantial compliance. The court indicated that the appraisal "wholly
lacks even a modicum of content in critical areas to say that it
substantially complies." While the court was not even willing to state
that substantial compliance was a permissible ground for a deduction, it
noted that the appraisal failed completely to meet the standard of
substantial compliance.
Second, a deduction for a gift over $250 requires a contemporaneous written
acknowledgement. Because there was no contemporaneous written
acknowledgement under Sec. 170(f)(8)(A), the deduction was denied.
Editor's Note: The court did not reach the Sec. 170(f) partial
interest issue. Even if the appraisal and contemporaneous written
acknowledgement were appropriate, the gift of the home for fire training
would fail to produce a deduction. A qualified deduction for a transfer of
a home is permitted for an undivided interest to a charitable remainder
unitrust, charitable remainder annuity trust or a gift of remainder
interest. The gift of the home for fire department training is a
nondeductible partial interest. As a result of the appraisal failure, the
Hendrix' charitable deduction went up in flames.
Charitable Deduction Permitted But No Court Costs
In Consolidated
Investors Group et al.v. Commissioner; T.C. Memo. 2010-158; No.
23703-06 (21 Jul 2010), the Tax Court refused to allow a partnership that
had been awarded a charitable deduction for the litigation costs of that
effort.
Consolidated Investors Group owned a property that was sought by the Ohio
Transportation Commission (OTC) in an eminent domain proceeding. After
negotiation between the parties, they settled for a payment of $950,000
from OTC to the partnership. However, the partnership valued the property
through an appraisal at $1,591,000 and therefore claimed a $641,000 charitable
contribution deduction.
The IRS and taxpayers contested the issue and the Tax Court determined that
the deduction did qualify. Taxpayer now sues under Sec. 7430 to recover
litigation costs.
The court noted that IRS appraiser Mr. Richard G. Racek valued the property
at $953,671. While the court determined that the appraisal value was highly
subjective and had accepted the taxpayers' higher appraisal, the IRS was
reasonably entitled to rely on the Racek appraisal.
The partnership did present sufficient evidence to show an intention to
create a part-charitable deduction and part-sale transaction. The
partnership appraisal failed in several respects. It was not prepared
within this 60-day period, did not show the date of the contribution, did
not indicate the fair market value of the property on that date and did not
contain a statement that it was prepared for income tax purposes. The court
determined, under a substantial compliance theory, that the appraisal would
be accepted.
However, with the reasonableness of the Racek appraised value and the
obvious failures of the partnership to comply with appraisal formalities,
the IRS position was justified. No litigation costs were awarded to the
partnership.
Applicable Federal Rate of 2.6% for August – Rev. Rul. 2010-19; 2010-31
IRB 1 (18 July 2010)
The IRS has announced the Applicable Federal Rate (AFR) for August of 2010.
The AFR under Sec. 7520 for the month of August will be 2.6%. The rates for
July of 2.8% or June 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.
Private Foundation (PF) was the beneficiary of a charitable
lead trust created by one of its founders. As a result, PF received a large
amount of shares in a publicly traded U.S. corporation (X). When first
received, the amount of shares was less than 20% of the total number of
outstanding shares in X. In later years, X began to repurchase outstanding
shares of its stock. As a result, PF was left holding more than 20% of the
outstanding shares. In recognition of its increasing excess business
holdings, PF's governing board approved a plan to dispose of a sufficient
percentage of shares to avoid the excise tax under Sec. 4943. However, with
the market crash in 2007 and SEC rules limiting the number of shares
permitted to be sold within one year, PF was unable to sell a sufficient
number of shares. After four years of owning more than 20% of the
outstanding shares, PF requested an additional five years to dispose of its
excess business holdings.
Section 4943 imposes an excise tax on the excess business holding of a
private foundation. Sec. 4943 defines "excess business holdings"
as the amount of stock or other interest that a foundation holds in excess
of 20% of the outstanding shares in a business enterprise. Sec.
4943(C)(6)(A) essentially provides a foundation five years to dispose of
excess business holdings before the imposition of the excise tax. Sec.
4943(c)(7) allows the IRS to extend the initial five year holding period by
another five years if the foundation demonstrates that: The foundation made
diligent effort to dispose of the shares; disposition was not possible
(except at a substantially reduced value); a plan for disposition is
submitted to the Service and the state attorney general before the end of
the initial five year period; and the plan is likely to achieve its goal.
The Service determined that PF met the requirements of Sec. 4943(c)(7) and
was, therefore, granted a five year extension to dispose of its excess
business holdings in X.
Note: At publication date the House and Senate are still not
in agreement on the provisions of the tax extenders bill. It is very likely
to be passed and enacted by the end of 2010, but has not yet been signed by
the President.
In The American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213),
which is still in negotiations in the Senate, Congress permits a 2010
rollover directly from an IRA to a qualified public charity.
This act enables an IRA owner age 70½ or older to make a direct transfer
to charity. The transfer may be up to $100,000 in one year. See Sec.
408(d)(8)(A). The IRA rollover first created by the Pension Protection Act
(PPA) of 2006 is (after enactment of H.R. 4213) extended to the end of
2010.
Donor
Profiles
There are five donor profiles for IRA rollover gifts. First are the
convenience donor who finds it a very simple and easy method for an end of
year gift. The second is the generous donor, who wants to give past the 50%
of AGI limit. The third is a major donor. This person may be a board member
or trustee who is looking for a favorable opportunity to make a major gift.
Fourth, the Social Security recipient may reduce taxes with an IRA rollover
gift. Finally, a standard deduction donor will benefit from a direct IRA to
charity gift.
Several years ago Mother and Father built a unique home on 45 acres
of beautiful rolling hills and woods. Father passed away three years ago
and Mother now solely owns the 45-acre parcel and home.
She enjoys the peaceful country view out her front window. However, the
university adjacent to the property is very interested in acquiring the
property for eventual future growth. Not surprisingly, Mother is concerned.
She does not want a new dormitory filled with college students in her front
yard. In fact, she enjoys the peace and protection of her lovely home in
the wooded countryside. However, at age 80, she recognizes that eventually
some planning will have to be accomplished.
After a thorough understanding of Mother's needs and desires, her advisor
suggested a wonderful four-part solution which incorporated an outright
sale, a unitrust, a gift annuity and a gift of a remainder interest in a
home. (See Case Study "Peace in the Countryside" for a full
explanation.)
In addition, another component of the plan involves the potential sale of
the home to Son after Mother's death. Specifically, Son enters into an
option agreement with the university. It is a contingent agreement that
permits Son to purchase the home from the university. This transaction is
not an act of self-dealing, (See Case Study "Son's Intentions Paved with
Gold, Part 1.") so, naturally, it is part of the final plan.
However, Son wants an additional option contract with Mother's unitrust.
Specifically, Mother's unitrust will receive the 20-acre rear parcel, which
university intends on developing. In the event university does not develop
the land itself, Son wants the right to purchase back the "family
land" from the unitrust. However, Son's potential transaction with
Mother's unitrust is a prohibited act of self-dealing. (See Case Study
"Son's Intentions Paved with Gold, Part 2.") Accordingly, the
university and Mother's advisors strongly discourage such a transaction.
Never liking to hear he cannot do something, Son retains his own counsel.
Despite the prohibition on self-dealing, may Son nevertheless purchase the
20-acre rear parcel from the unitrust? What types of penalties may be
imposed on Son?
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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1999-2010 Crescendo Interactive, Inc.
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