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Senate Extenders Compromise on Hedge Fund Taxes
The Senate continues to move forward on the American Jobs and Closing Tax
Loopholes Act of 2010 (H.R. 4213). Following passage of the bill by the
House on May 28, 2010, the Senate has taken up the legislation.
The House bill's principal offset is a tax increase on hedge fund managers.
Under existing law, their "carried interests" are taxed at the
15% capital gain rate. The House bill would tax 75% of carried interests at
ordinary income rates and 25% at the capital gain rate. Because the capital
gains rate is scheduled to increase from 15% to 20% next January, the
combined rate under the House bill will be 34.9%. This is more than double
the current tax rate for hedge fund managers.
The Senate this week released its version of the extenders bill. The Senate
proposes taxing income of most hedge fund managers' carried interests as
65% ordinary income and 35% capital gain. However, if the hedge fund holds
the asset for seven years, then the ordinary rate portion is 55% and the
capital gain part is 45%.
The Senate bill also increases the oil-spill-cleanup tax. While the House
would increase the tax from eight cents to 33 cents per barrel, the Senate
plan is to increase the "oil spill" tax from eight cents to 41
cents per barrel. The existing oil spill fund of $1.5 billion is now
inadequate to clean up the Deepwater Horizon spill that has done great
damage in the Gulf of Mexico.
Sen. David Vitter (R-LA) expressed concern about the oil spill tax. He
suggested that this tax is an obvious effort to use the outrage over the
Gulf of Mexico oil spill as a "gimmick" to raise taxes on the oil
industry.
The Senate bill also includes the House provision on Subchapter S
corporation payroll taxes. The House bill does not permit the current
practice by many Subchapter S corporations to pay nominal salaries. These
Sub S corporations still pay the same income to owners, but avoid payroll
taxes on the majority of income by classifying it as dividends. For
individuals who are in most service partnerships, the full amount of future
Subchapter S earnings will be subject to payroll taxes.
The American Institute of Architects sent a letter this week to Senate
Majority Leader Harry Reid (D-NV) and opposed the Subchapter S payroll tax
increase. The architects and engineers indicated that the bill will
"sweep in many legitimate and tax compliant small architectural and
engineering firms" into the new tax. It will increase payroll taxes
and reduce potential ability to hire unemployed workers.
Sen. Reid indicated that he plans to start voting on the new bill and
potential amendments within the next few days.
Editor's Note: The House and Senate are nearing agreement on the tax
increases for the extenders bill. The ongoing debate shows how difficult it
is to come to agreement on tax increases. As the Federal Fiscal Commission
continues to prepare for the report due December 1, 2010, it is becoming
quite evident that the tax increases they are certain to propose will be
quite controversial.
Independent Sector Supports IRA Rollover in Extenders Bill
Diana Aviv, President of Independent Sector, sent a letter this week to
Chairman Sander Levin (D-MI). She expressed "strong support" for
many of the provisions in the tax extenders bill. She was
"particularly pleased that this legislation would extend the IRA
rollover provision."
Ms. Aviv notes that the rollover provision during the past four years has
"generated millions of dollars in new contributions" that have
enabled charities to "build cancer centers, develop programs for
counseling at-risk youth, support housing for homeless families, conserve
wilderness areas and provide art therapy for people with developmental
disabilities."
The other provision in the bill that Independent Sector noted is the
enhanced deduction for gifts of "apparently wholesome" food
inventory. This is particularly important because of the number of people
in economic need during the downturn.
Editor's Note: Both the House and Senate tax extenders bills include
the IRA charitable rollover effective from January 1, 2010 to December 31,
2010. After the compromise on offsets is finalized, the bill should pass by
the end of June.
Bernanke Predicts 3.5% Growth for USA
Federal Reserve Chairman Ben Bernanke spoke on June 9, 2010 to the House
Budget Committee. He gave a fairly complete briefing on the economy. Chairman
Bernanke indicated that he expects real gross domestic product (GDP) growth
this year and next of 3.5%.
There was both good news and bad news in his briefing. The good news was
that business profits are up and corporations have record levels of cash
accumulation. This cash is likely to be invested in new equipment and
software during the next year. In addition, inflation has been very low for
the past year. Because the world economy is still quite slow, Chairman
Bernanke anticipates low inflation rates for the foreseeable future.
However, there also was bad news. Housing continues to be in recession.
There is a "large inventory of distressed or vacant existing
homes" that continues to depress prices. The unsold homes also reduce
incentives for contractors to build new homes.
Unemployment remains just below 10%. The U.S. economy lost 8.5 million jobs
during the past two years. While an average of 140,000 new private sector
jobs are being added per month, it may take three to five years to replace
the lost jobs.
There is also concern over the problems in Greece and other nations in
Europe. As a result of large government debt and massive budget deficits,
Greece and several other European nations have been forced to take dramatic
austerity measures. They have substantially reduced budgets and increased
taxes in the middle of a major recession. These actions will lead to a
sustained period of below-normal economic growth.
The U.S. fiscal position has "deteriorated appreciably" since the
2008 financial crises. Chairman Bernanke considers the current budget trend
"unsustainable" and urged Congress to address the structural
budget deficit.
Editor's Note: While Chairman Bernanke did not explicitly make this
statement, it is clear that his presentation is intended to pave the way
for the 2011 tax increases. Even with the recovering economy, the need to
address the budget deficit makes very likely the increase in the top income
tax rate to 39.6% and the capital gain rate from 15% to 20%.
Small Business Bill Offset by 10 Year GRAT
The House is preparing to vote on the Small Business Jobs Tax Relief Act of
2010 (H.R. 5486). The major tax provision of this bill is a forgiveness of
capital gains tax on sales of stock for qualifying small businesses that
issue new stock between March 15, 2010 and January 1, 2012.
The White House supported the bill provisions and recognized the importance
of new jobs created by small businesses. Information from the Small
Business Administration (SBA) indicates that between 1995 and 2010, 64% of
net new jobs were created by small business.
President Obama praised the bill and stated, "Insuring that small
businesses can thrive is about more than our economic success. It's about
who we are as a people. It's about a nation where anybody with a good idea
and a willingness to work can succeed. That's the promise of America."
Because under the "pay-go" rules a reduction in taxes requires an
offsetting tax increase, the House bill necessarily includes several tax
increases. One proposed tax increase is to change the minimum term for
grantor retained annuity trusts (GRATs) to a minimum of 10 years. This
concept was included earlier this year in the proposed White House Budget
for 2011.
Editor's Note: A GRAT is frequently created for a term of two years
under current law. With a very high two-year payment back to the grantor,
the assets transferred to the GRAT are frequently returned. However, if the
assets appreciate during the two years, then the appreciation may be
transferred to family with little or no gift taxation. If the minimum GRAT
term is 10 years rather than the current two years, it still will be
possible to create a GRAT. However, the attractiveness will be
substantially reduced with a ten-year term. The Congressional estimate is
that the increase in the GRAT term would save $5.3 billion in taxes over
the next decade.
Applicable Federal Rate of 3.2% for June – Rev. Rul. 2010-15; 2010-23
IRB 1 (18 May 2010)
The IRS has announced the Applicable Federal Rate (AFR) for June of 2010.
The AFR under Sec. 7520 for the month of June will be 3.2%. The rates for
May of 3.4% or April 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 died testate, leaving a bequest to A and B, if
living, of certain automobiles and X amount per month for life. The residue
and remainder of Decedent's property was to be transferred to co-trustees,
A and C, in trust (Trust). The terms of Trust directed co-trustees to use
funds to build buildings for Town, pay for upkeep of said buildings and
benefit listed charities and "any other charitable organization"
as determined by co-trustees. Decedent's executor filed proceedings with
the Court to resolve ambiguity with regards to setting aside funds for the
lifetime payments to A and B, while also timely establishing Trust with all
the residue and remainder of Decedent's property.
The Court concluded that Decedent intended to create a charitable trust
that would qualify for a charitable deduction under Sec. 2055. Court
ordered A and B be paid Y amount in full satisfaction of their general
legacies and for executor to fund Trust with the remainder of the estate. Further,
Court added an additional article to Decedent's will, clarifying the
definition of "charitable organization" to mean an organization
defined under Secs. 501(c)(3) and 2055. Executor filed Decedent's Form 706
and requested that an estate tax charitable deduction (under Sec. 2055) be
permitted for the value of the trust.
Section 2055 provides that the value of the taxable estate is determined by
deducting from the value of the gross estate the amount of all bequests,
legacies, devises and transfers to or for...organizations organized and
operated exclusively for an exempt purpose. Here, because the Court ordered
that Decedent's will be clarified to define "charitable
organization" as an organization described in Sec. 2055, the IRS ruled
that the Trust will qualify for an estate tax charitable deduction.
Note: At publication date the House and Senate are close to
agreement on the provisions of the tax extenders bill. It is very likely to
be passed and enacted, but has not yet been signed by the President.
In The American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213),
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.
Several years ago Mother and Father built a very 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, a wonderful
four part solution was suggested 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.)
This solution seemed like the perfect fit until Mother's attorney, Paul
Weiss, discovered that Mother had discussed selling the 45 acre family lot
to Billy Joe Jackson, an adjacent landowner, for $2.5 million several
months ago.
If the discussions between Mother and Billy Joe are deemed a prearranged
sale, Paul stated that Mother's four-part solution would surely crumble.
What are the tax consequences if a prearranged sale is found? What are the
rules governing prearranged sales?
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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