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Oil Company Tax Increase to Clean Up Gulf Oil Spill
The oil spill from the Deepwater Horizon rig in the Gulf of Mexico
continues to put the Gulf Coast economy at risk. As a result, President
Obama this week sent a letter to Speaker Nancy Pelosi (D-CA) and proposed
an increase in the excise tax on oil.
The current tax per barrel is eight cents. This excise tax is allocated to
the Oil Spill Liability Trust Fund. President Obama proposes increasing the
tax to nine cents per barrel in 2010 and 10 cents per barrel in 2017.
President Obama stated, "It's absolutely essential that going forward
we put in place every necessary safeguard and protection so that a tragedy
like this oil spill does not happen again." He also indicated that the
government would seek to require British Petroleum (BP), the operator of
the Deepwater Horizon oil rig, to pay for the massive cleanup.
At a hearing this week before a congressional committee, BP, oil rig
operator Transocean and equipment provider Haliburton all testified. The
three companies all blamed the other company for the spill.
While BP claimed that the spill was 5,000 barrels per day, Purdue
University Professor Steve Wereley indicated that his scientific analysis
suggested the leak could be closer to 70,000 barrels per day.
British Petroleum is attempting to insert a tube into the ruptured pipe to
stop the leak. The previous effort to place a four story dome on the leak
was not successful. With an estimated recovery and cleanup cost of $3
billion, BP is attempting to finally cap the leak and end an environmental
and public relations disaster.
Slow, Steady Progress on Estate Tax and Extenders
Senate Finance Chair Max Baucus (D-MT) has been in intensive negotiations
with Sen. Jon Kyl (R-AZ) and Sen. Blanche Lincoln (D-AR) over the estate
tax. Sen. Kyl and Sen. Lincoln have proposed increasing the $3.5 million
exemption that was applicable in 2009 to $5 million per person. In
addition, the previous estate tax rate of 45% would be reduced to 35%.
Negotiations have been ongoing for several weeks. On May 11, 2010, Sen. Kyl
reported, "We have an agreement about how we would like to move
forward and an agreement on many of the offsets." He continued by
observing that the offsets are still subject to discussion. It is estimated
that the offsets will be from $60 billion to $80 billion.
While the details of the proposed compromise have not been released,
several aides suggested that it may include an estate tax option in 2010.
If the option is enacted, estate planners could choose either the repeal of
estate tax and lose part of the step-up in basis under the 2010 rules or
select the new compromise estate exemption and estate tax rate.
It may occur that the tax extenders and the estate tax are combined in one
legislative bill. Senate Budget Chair Kent Conrad (D-ND) observed this week,
"You have got 13 legislative weeks. It seems to me it would be wise to
put all the tax measures together."
The House proposal for the offsets for the tax extenders (including the IRA
charitable rollover) is to change the "carried interests" of
hedge fund managers from being taxed at capital gain rates to ordinary
rates. It now is possible that the change in the law will occur, but it may
be phased in over a number of years.
Editor's Note: The Senate continues to attempt to complete work on
the estate tax and the tax extenders by early June. The estate planning
community and the charitable community are both hopeful that the Senate
will resolve the current great uncertainty in planning by passing
compromise legislation in both areas.
Fortunate Heir Avoids Estate Tax
In Estate
of Robert C. Fortunato et al. v. Commissioner; T.C. Memo. 2010-105;
No. 6937-07 (11 May 2010), the court determined that decedent did not own
the companies that the IRS claimed he possessed. As a result, the IRS
deficiency of $11,662,737 and the Sec. 6663 fraud penalty of $8,649,140
were not applicable.
Robert Fortunato was the third of seven children. His brother Anthony was
the youngest son. Robert was convicted of robbery in 1962 in New Jersey and
served six years in Sing Sing Prison. Following his release, he worked with
other family members and was a co-owner and President of Container Overseas
in New Jersey. Container Overseas failed in 1984. Robert owed $490,000 to
the IRS for employment taxes that had not been properly remitted and also
had debts of several hundred thousand dollars to other creditors.
His younger brother Anthony started St. George Warehousing ("St.
George") in New Jersey in 1984. Between 1984 and 2002 they experienced
many challenges, but eventually Robert moved to California and started the
California and Georgia sections of the warehouse and export company. They
also started a trucking company to ship materials between their locations.
Robert was the principal manager and clearly had excellent business skills.
He served without owning any stock in the companies because the brothers
were concerned about his IRS liens and other creditors. In addition, with
his previous felony conviction there was concern that the business image of
the company would be harmed if he were an owner. However, Robert did have
complete control of the employees, the finances and the business strategy.
In 2001, Anthony discussed sale of the business. Robert was opposed to the
sale. Potential purchaser Edward O'Donnell made an oral offer of $30
million that was contingent upon Robert remaining and operating the
company. However, on November 4, 2002, Robert passed away.
Under his will, which was unsuccessfully contested by his estranged
daughter, Robert's brother Anthony was his sole heir. The IRS audited the
estate, claimed that Robert was entitled to 50% ownership in St. George and
assessed tax and penalties of approximately $20 million.
The court noted that Robert did not own stock. It was probable that because
of his felony conviction and tax liens that the brothers decided he would
not be a formal owner. In response to the claim that Robert had a
"beneficial interest" because he controlled business strategy,
managed the employees and had complete control of the finances, the court
observed that the state law of New Jersey, California and Georgia
recognized an ownership in a corporation based upon actual possession of
stock certificates.
In response to an IRS claim that he had a "right to stock" that
he could exercise at anytime, the court observed that the shareholder must
have the intent to acquire stock plus take some action to effectuate that
intent. Because Robert had no spouse and was estranged from his children,
he did not need to acquire the stock. Robert served as President and yet
was an employee, with no indication of intent to acquire stock. Therefore,
because property rights are determined under state law, Robert was deemed
to hold no stock and the $20 million in estate tax and penalties were not
applicable.
Hawaii QPRT Gifts Close to IRS Value
In Andrew
K. Ludwick et ux. v. Commissioner; T.C. Memo. 2010-104; Nos.
3281-08, 3282-08 (9 May 2010), the Tax Court essentially accepted the IRS
valuation for gifts to two qualified personal residence trusts (QPRTs).
Andrew K. and Worth Z. Ludwick purchased land on the Big Island of Hawaii
in 2000. Two years later they built a home on that property. In 2005, their
home was valued at $7.25 million. Both transferred their respective
one-half interests in the property to QPRTs.
Based on the appraised valuation of their expert Carsten Hoffman, they
claimed a 30% discount and valued each interest at $2,537,500. The IRS
audited their Form 709 Federal Gift Tax Returns and claimed that the
discount should be only 15%, with a gift amount of $3,081,250. On brief,
the IRS reduced the discount to 11% and valued the each transfer at
$3,226,250.
The court reviewed the battle of the appraisers. IRS appraiser Steven
Bethel noted that under Hawaii law, a purchaser is permitted to force a
partition. Because the co-owner could force a partition, the reduction in
value is determined under a formula that reflects that potential partition.
The court determined that the reduction in value would be the fair market
value less costs, and would reflect the length of time for the partition
and the likelihood of partition.
Based on the claims of both parties, the court determined that the
appropriate valuation should use a 10% discount rate, a partition period of
two years, annual operating costs for each half of $175,000, and partition
costs of $36,250 for each of the two years. Finally, the court determined
that there was a 10% probability that partition would be required and a 90%
probability that partition would not be required.
Based on all of these factors, the court then calculated the value of the
property for both the "no partition" and the "partition is
necessary" options. Based on the assumption that there was a 10%
probability of partition, each gift value was determined to be $3,000,089.
Editor's Note: This case is a very good indication of the detailed
analyses that are made with valuations. The court ended up accepting most
of the IRS position, but was required to make numerous assumptions. In
particular, the 10% probability of partition is a very arbitrarily chosen
number and yet essential for the calculation.
Applicable Federal Rate of 3.4% for May -- Rev. Rul. 2010-12; 2010-18
IRB 1 (18 Apr. 2010)
The IRS has announced the Applicable Federal Rate (AFR) for May of 2010.
The AFR under Sec. 7520 for the month of May will be 3.4%. The rates for
April of 3.2% or March 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.
ORG, an acre of dense tropical gardens owned by Chairman, was
a tax-exempt organization under Sec. 501(c)(3) and classified as a private
foundation under Sec. 509. ORG was organized for the specific purpose to
inspire and educate individuals about exotic and tropical ecosystems and
their preservation. CO-1, a boutique hotel and private business owned by
Chairman, created a small tropical jungle resort on ORG. The main
attraction of CO-1 is ORG, which is featured as a part of CO-1 in travel
literature. CO-1's guest rooms and four-star restaurant overlook ORG and,
as a benefit of having access to ORG to enhance and attract business, CO-1
pays ORG $ ** annually in rent. CO-1 uses ORG's gardens to generate income
from weddings, ceremonies and other special events. ORG and CO-1 are
inseparable on the property and, although ORG is open to the public free of
charge, the public is generally unaware of ORG's existence. ORG is mainly
used by CO-1's guests and no effort is made to advertise ORG to the public.
Tucked away behind thick hedges off the main stress, ORG appears to be a
private business.
Sec. 501(c)(3) provides that corporations or foundations must be organized
and operated exclusively for charitable or educational purposes. Reg.
1.501(c)(3)-1(c)(2) states that an organization is not organized
exclusively for exempt purposes if its net earnings inure in whole or in
part the benefit of any private shareholders or individuals. Reg.
1.501(c)(3)-1(d)(ii) provides that an organization fails to operate for
exclusively charitable purposes if it serves a "public rather than a
private interest" and must establish it is not operated for the
benefit of private interests such as designated individuals, the creator or
his family... or persons controlled by such private interests.
The Service held that ORG failed to meet the operational test because it
was not operated exclusively for an exempt purpose. ORG primarily benefits
the interest of CO-1, a for profit business. The Service determined ORG's
sole purpose is to attract business for CO-1. Access to ORG bestows
substantial non-exempt private benefits on CO-1 such that the public
benefits of ORG and any educational activities are incidental and
insubstantial. Also, by leasing ORG, CO-1 essentially determines the
activities carried on at ORG. CO-1 derives substantial income from the use
of ORG for weddings and other events, which inures to the benefit of the
for profit business. Therefore, the Service revoked ORG's tax-exempt
status.
"How can I be sure the real estate sale will be done
properly?"
Donors have been asking this question for many years. If a property is
transferred into a charitable remainder unitrust, the income to the donor
is dependent on the value received from the property. Donors are frequently
very appreciative of the charitable work of their favorite organization,
but may have doubts about the real estate expertise of that same
organization. The "Prearranged Sale," simply put, exists under
state contract law when there is a binding agreement to sell the property.
In effect, there is a identified purchaser, an identified price and a
legally-enforceable agreement to sell the property.
Is there any latitude for creativity? How close to the sale is too close?
It may be possible to have a sale with reasonable safety in a very short period
of time, so long as the rules are followed quite carefully. The key is that
there is no "binding obligation" when the trust is funded. See
Rev. Rul. 78-197, 1978-1 C.B. 83. The three possible options include buyer
waiting in the wings, a contingent oral agreement and a contingent escrow
agreement.
Peter and Sue Olson were raised in the great North Country.
But after college, they were married and Peter accepted a position with one
of the nation's largest discount stores. He rose through the ranks and
finally was promoted to be manager of the New Orleans branch of the store.
Peter and Sue lived in a suburban area of New Orleans and he was quite
successful at managing the store. Each weekend, Peter also enjoyed his
hobby of grilling brat on his barbeque. Peter of course recognized that
brat (short for bratwurst sausage) was a well known delicacy in the north,
but was new to his southern friends. So Peter frequently invited friends
and neighbors over for a brat and sweet iced tea gathering.
Peter and Sue were thinking about branching out, so they started a small
business, the "Southern Brat Deli." To their great surprise and
mutual joy, their southern customers were delighted with brat and sweet
tea. The Southern Brat Deli flourished and Peter soon opened another store.
And then another and another and another, until there were 300 Southern
Brat Deli's stretching across Louisiana and Mississippi. On the advice of
his CPA, Peter incorporated Southern Brat Deli, Inc. as a C corporation. He
was able to operate efficiently and the Southern Brat Deli, Inc. grew and
flourished under his leadership.
When Peter passed away, he transferred the Southern Brat Deli stock to Sue.
About two years ago, she passed away and the Southern Brat Deli C
Corporation was transferred to the Olson Private Foundation for the benefit
of needy children. Under the excess business holding rules of IRS Code Sec.
4943, the Olson Private Foundation had five years to sell the stock in the
Southern Brat Deli. Since this was a company worth tens of millions of
dollars, they needed to find the right buyer. There were two buyers that
were interested and both embarked in the major effort of completing their
due diligence before the sale.
Years two, three and four stretched on and still the sale had not been
completed. In the middle of year five, the last year they could sell
without violating the excess business holdings rules, there was an
unfortunate disaster. A major storm with multiple tornadoes swept through
Louisiana and Mississippi. Over half of the Southern Brat Deli stores were
either flooded or severely damaged by wind. As a result, no buyer is
currently be willing to purchase the Southern Brat Deli. It may take two
years to rebuild the stores and reestablish the brat and sweet tea
business. What action can the Olson Foundation take to avoid penalty taxes?
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.
©
Copyright 1999-2010 Crescendo Interactive, Inc.
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