Washington Hotline – November – Week 5 – 2010

President Pardons Turkeys

A Thanksgiving tradition since the days of President Harry Truman is that two turkeys receive a Presidential pardon.

Two California-born turkeys named Apple and Cider were at the White House this week to receive the official Presidential pardon. The turkeys were 21 weeks old and the names Apple and Cider were selected in a contest of California school children.

President Obama issued the pardon and noted, “It’s like a turkey version of Dancing with the Stars. Except the stakes for the contestants were much higher. Only one pair wins the prize: life, and an all-expenses trip to Washington.”

Following the pardon ceremony, Apple and Cider will live out their lives on the Mount Vernon Estate of President George Washington.

There was another turkey issue in Washington this week. The National Turkey Federation, an organization with members that include Perdue Farms and Butterball Turkey LLC, lobbied for the expiration of an ethanol tax break. The turkey raisers are hoping that Congress will reduce the Volumetric Ethanol Excise Tax Credit (VEETC).

House Ways and Means Chair Sander M. Levin (D-MI) introduced an energy tax bill earlier this year that would reduce the excise credit from 45 cents per gallon to 36 cents per gallon. If Congress takes no action, the credit could lapse.

The credit is very popular in the Midwestern states that raise corn. Lobbyists for those states continue to support the ethanol credit. However, because much of the feed for turkeys is developed from corn, the companies raising turkeys would prefer that the credit lapse or be reduced. A lapse or reduction of the ethanol credit will be likely to reduce the cost of corn.

CBO Director Urges Fiscal Restraint

Congressional Budget Office Director Douglas Elmendorf spoke on November 19^th at the National Tax Association Annual Conference in Chicago. He responded to inquires about the economic recovery and the potential for additional stimulus.

Elmendorf stated, “To avoid a worsening of fiscal outlook, any policies that widen the budget deficits in the near term would need to be accompanied by specific policies to reduce spending or increase revenue over time.”

The CBO Director noted that there is a basic disconnect between the amount of taxes that are being paid and the government services that are being rendered. He continued, “A permanent extension of the tax cuts combined with the budgetary pressures posed by the aging of the population and rising costs for healthcare would put federal debt on an unsustainable path.”

Elmendorf continued to suggest that it is important for Congress to face the deficit issues and begin to enact specific laws to resolve the problem.

Editor’s Note: The deficit and taxes will be foremost on the minds of everyone in Washington next week. On November 30^th there will be a meeting between President Obama and leaders of both parties in Congress. They will need to discuss the potential for a compromise on extending the tax cuts. The President and Democratic leaders continue to advocate extension of middle-class tax cuts and an increase in tax rates for the top two brackets. Republican leaders from the House and Senate prefer a two-year extension of all of the existing tax rates.

Baucus Proposes Repeal of $600 Form 1099 Requirement

During the 2009 negotiations for the Patient Protection and Affordable Care Act, there was an obvious need for revenue offsets. After an extensive search for ways for the government to increase tax collection, Congress decided to extend the Form 1099 requirement to all payments for goods and services to a single business that total more than $600 in a year. The requirement is effective starting in the year 2012.

Previously, the requirement existed for corporations to file Form 1099 if they made payments for services more than that amount, but they were not required to file the form for all payments for goods. The reaction to the proposed rule has been overwhelmingly negative. Many mid-size and small businesses have stated that they will be required to file hundreds of Forms 1099. The accounting and administrative burden in their view, is much greater than the potential tax revenue to be gained.

Following a firestorm of criticism by advocates for a small business, Senate Finance Committee Chair Max Baucus (D-MT) attached an amendment to the FDA Food Safety Modernization Act of 2010. This amendment would repeal the $600 Form 1099 requirement for payments by corporations for goods.

Applicable Federal Rate of 1.8% for December – Rev. Rul. 2010-29; 2010-50 IRB 1 (16 Nov. 2010)

The IRS has announced the Applicable Federal Rate (AFR) for December of 2010. The AFR under Sec. 7520 for the month of December will be 1.8%. The rates for November of 2.0% or October of 2.0% 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.

Washington Hotline – September – Week 4 – 2010

 

Small Business Jobs Bill Passes

A week after the Senate passed the Small Business Jobs Bill, the House passed the same legislation by a vote of 237-187. President Obama is expected to sign the bill on Monday, September 27, 2010.

The White House issued a statement and noted, “The Small Business Jobs Bill passed today will help provide loans and cut taxes for millions of small business owners.”

House Minority Leader John Boehner (R-OH) expressed concern about the bill. He noted that the bill does not “end the uncertainty that is crippling job creation and hurting small businesses.”

The bill includes seven separate strategies to facilitate hiring of employees by small businesses. Since small businesses are responsible for 70% of new job creation, the hope is that the bill will increase employment by up to 500,000 new jobs.

1. Bank Fund of $30 Billion – The principal expenditure is a fund of $30 billion that will be distributed to community banks with less than $10 billion in assets. Because community banks make a large percentage of all loans to small businesses, these funds are intended to increase the available credit. If small businesses have greater borrowing power, they may be able to increase employment.

2. State Lending Fund – A fund of $1.5 billion will be distributed to the states. Many states have programs with loans to small businesses. With the state funding deficits, these programs have been sharply curtailed. This $1.5 billion fund will restore some of these state programs.

3. Small Business Administration Loans – There will be easier access to loans and lower costs for small businesses that use this funding option.

4. Zero Capital Gains Tax Rate – There will be no tax on the sale of a limited category of stock in C corporations that is held for five years. The corporations must have less than $50 million in business assets.

5. Equipment Expensing – The current expensing limit for small businesses is $250,000 per year. This will be increased to $500,000 for purchases of equipment in 2010.

6. Bonus Depreciation – Business will benefit from the ability to depreciate up to 50% of newly-acquired equipment in 2010.

7. Start-Up Businesses – If there is $60,000 or less in start-up costs, then up to $10,000 may be deducted this year.

Editor’s Note: While it is not likely that there will be substantial impact on jobs prior to the election in November, the hope of the House and Senate members in Washington is that this bill will start to produce recovery in the small business sector.

Façade Easement Charitable Deduction Denied

In Billy L. Evans et ux. v. Commissioner; T.C. Memo. 2010-207; No. 8309-08 (21 Sep 2010), the Tax Court disallowed a deduction for two façade easements transferred to charity.

Billy and Renetta Evans acquired townhomes in the Capital Hill Historic District in 1995 and 2004. On December 29, 2004, they transferred two façade conservation easements to the Capital Historic Trust, Inc.

Based upon a list of appraisers recommended by Capital Historic Trust, the Evans employed Mr. Wood and Mr. Keegan to provide an appraisal of the two façade conservation easements. The appraised value used a percentage method and the total contribution deduction was $154,350. The taxpayers attached page two of Form 8283 for each conservation easement to their Form 1040 and claimed that deduction amount. The IRS audited the return and denied the entire deduction.

Before the Tax Court, the taxpayers noted that because they had filed Form 8283 with an appraised value, the burden of proving the deduction value had shifted to the IRS. However, the Court determined that the appraisal failed to present “credible evidence of fair market value” and required the taxpayers to sustain the burden of proof.

The taxpayers called as a witness Sandy Lassere, a certified residential appraiser in the District of Columbia. She indicated that she had previously completed 30 conservation easement appraisals and had also appraised the two façade conservation easements.

However, the Court noted that there were numerous mistakes in her appraisal. She incorrectly described restrictions, was in error on size adjustments for comparables, did not review deeds for other conservation easements, was not familiar with the IRS regulations on appraisals and the appraisal was completed four years after the gift. This appraisal, therefore, was not within the required window of 60 days before the gift to the date the tax return was due (potentially extended if a valid extension was approved).

Therefore, the Court determined that the appraisal by Lassere was not valid. Because taxpayers did not call Wood or Keegan to defend their appraisal, the court determined that the taxpayers had failed to support the deduction and it was denied.

In its answer, the IRS also applied a Sec. 6662(a) penalty of 20% on the underpayment due to the denied deduction. The Court noted that there is a reasonable cause exception for the penalty. Because the taxpayers did obtain a qualified appraisal, they had reasonable cause that negated the penalty.

Finally, the IRS asserted that the Wood and Keegan appraisal was not qualified under Reg. 1.170A-13(c)(3). While it was completed on January 6 and 7, 2005 and, therefore, was timely, the appraisal did not include required information. It failed to list the qualifications of the appraiser, did not have a sufficient description of the property, failed to identify the method of valuation and did not describe the specific basis for evaluation. The appraisal appeared to use an 11% discount factor to determine the value of the façade conservation easement. The Court agreed that the appraisal did omit several items, but the IRS was not able to show that these failures disqualified the appraisal.

Editor’s Note: For appraisals of conservation easement gifts, the IRS has vigorously opposed a flat percentage deduction method. The appraiser must consider all relevant factors in a “before and after” method. If the appraiser uses a simple percentage, the IRS will oppose the charitable deduction. It was somewhat unusual in the Evans case that the Wood/Keegan appraisal was deemed valid to avoid a penalty, but invalid to substantiate the charitable deduction.

No Appraisal – No Timeshare Gift Deduction

In Maria Elena Towell v. Commissioner; T.C. Summ. Op. 2010-141; No. 8002-09S (20 Sep 2010), the Tax Court affirmed an IRS denial of a deduction for a gift of a timeshare.

Maria Towell acquired a timeshare in 2001 from Westgate Miami Beach, Limited Ltd. for $12,396. After completing payments on the timeshare in 2004, she deeded the timeshare to an agent for the Tracets Foundation on November 30, 2006. The Tracets Foundation claimed to be a Sec. 501(c)(3) that was involved in lake and stream preservation.

The taxpayer filed Form 8283 and claimed a charitable deduction of $12,900. The IRS audited taxpayer and denied the deduction.

The Tax Court noted that a noncash contribution greater than $5,000 must be supported by filing IRS Form 8283 and a qualified appraisal. A real estate appraisal must be done by an independent appraiser who is appropriately certified. The appraisal must be not earlier than 60 days prior to the gift and must be completed by the due date for the return (including potential extensions). If the appraisal is not completed on time, it may be excused if there is reasonable cause and not willful neglect.

Ms. Towell did not present any evidence of the claimed appraisal to the Court. Because she did not actually obtain an appraisal, the Form 8283 was not valid and the deduction was denied.

Editor’s Note: While this deduction was denied for failure to obtain an appraisal, it is quite possible that the actual timeshare fair market value was less than the $5,000 threshold. If this were the case, then Form 8283 would still be required because the noncash asset is over $500 in value. However, through stating a reasonable method for valuation less than $5,000, Ms. Towell could have filed Form 8283 without an appraisal and obtained a charitable deduction.

Applicable Federal Rate of 2.0% for October – Rev. Rul. 2010-24; 2010-40 IRB 1 (17 Sept. 2010)

The IRS has announced the Applicable Federal Rate (AFR) for October of 2010. The AFR under Sec. 7520 for the month of October will be 2.0%. The rates for September of 2.4% or August of 2.6% 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.

Washington Hotline September Week 3 – 2010

Washington Hotline

September – Week 3 – 2010

Small Business Bill Nears Passage

On September 16, 2010, the Senate passed the Small Business Jobs Act by a vote of 61 to 38. The bill passed after retiring Senator George Voinovich (R-OH) decided to vote in favor of the bill. Democratic leaders hope that the bill will enable small businesses to create as many as 500,000 new jobs.

The House of Representatives passed a similar bill earlier this year. Speaker Nancy Pelosi (D-CA) indicated that she plans to submit the Senate bill for a vote by the House. If the House passes the bill, it will be sent to President Obama for his signature.

Senate Finance Committee Chairman Max Baucus (D-MT) was very please that the bill passed. He stated, “When we help small businesses, we help to get Americans back to work. This bill creates the right conditions right now to help small businesses create jobs by spurring investments and entrepreneurs helped with tax cuts and improved access to capital.”

There are several provisions in the bill that are designed to assist small businesses in hiring new employees. These include the following sections.

1. $30 billion loan fund – The funds will be transferred to small and mid-size banks. These banks will be encouraged to make loans to small businesses. Compared with mid-2008, loans to businesses are down approximately 18%. It is hoped that this fund will increase lending to small businesses who then will hire new employees.
2. Small Business Administration loans – There will be reduced fees on SBA loans. In addition, the loan down payments for some types of loans may be reduced from 25% to 10%.
3. Various tax reductions – For new corporations, if investors hold the stock for five years, it may be sold with no capital gains tax. Assets purchased this year may be expensed up to $250,000 for real estate or $500,000 for equipment. There is also a one year extension on bonused appreciation.

A point of controversy was a Republican amendment that failed by a vote of 46-52. The amendment would have repealed the healthcare act requirement that businesses report all payments of $600 or more on Form 1099. Small businesses have objected strenuously to this requirement on the grounds that it will be very burdensome and expensive to implement.

Ranking Member on the Senate Finance Committee, Charles Grassley (R-IA), was generally supportive of the bill even though he voted against it. Sen. Grassley complimented his “friend, Chairman Baucus, for diligently pressing the tax proposals in this bill.” However, he did express concern about the $30 billion bailout. Sen. Grassley was concerned that the bailout fund might be mismanaged as he believes the Troubled Assets Recovery Plan (TARP) funds were mismanaged. He quoted Professor Elizabeth Warren, head of the TARP Congressional Oversight Panel, who noted that the fund “runs the risk of creating moral hazard by encouraging banks to make loans to borrowers who are not credit-worthy.” Sen. Grassley is concerned that the new loan fund may create incentives for banks to make bad loans to overextended small businesses.

Estate Requests to Value Tax Bill Denied

In Marshall Naify Revocable Trust et. V. United States; No. 3:09-cv-01-604 (8 Sep 2010) the District Court refused to permit a deduction based on an estimated cost of California State capital gains tax.

The decedent, Marshall Naify, created a revocable trust on February 3, 1997. On December 18, 1998, he also created the Mimosa Delaware Investment Corporation with initial offices in Delaware and subsequent offices in Reno, NV. Mimosa was intended to be a C Corporation under California law and was created in the hopes that it would avoid payment of California Income Tax.

Mr. Naify owned a large block of convertible notes in Telecommunications, Inc. (TCI). He transferred the stock to Mimosa and converted the notes into stock in 1999. There was a gain of approximately $835 million on the conversion; however, he claimed that the California tax was only $629 million because the corporation was claimed to be a Delaware Corporation with offices in Reno, Nevada.

Mr. Naify passed away on October 12, 2000. The estate filed the final IRS Form 1040 and reported federal income of $835 million and state income of $629 million. The state of California audited the return and contested the lower valuation for the California tax.

On July 18, 2001, the estate filed IRS Form 706 estate tax return. The state valued the potential tax payable to California at $62 million. In February of 2004, after extended negotiation, the estate and the state of California settled the tax debt for $26 million. On March 29 of 2004, the IRS allowed the $26 million deduction and assessed the tax. The estate sought a refund of $11 million based on the claimed deduction of $62 million and the IRS refused the claim. The estate then paid approximately $12 million in additional tax and sued for a refund.

The court reviewed the factual background and then applied the applicable law. Under Sec. 2053, claims and expenses are deductible. Reg. 20.2053-1(b) (3) indicates that “estimated amounts” may be deducted if the claim is “ascertainable with reasonable certainly and will be paid.”

It was obvious that the creation of the Mimosa Corporation was an attempt to avoid the California tax. By claiming a $62 million deduction for the value of the potential California tax, the estate was essentially claiming that the detailed plan to avoid tax was going to fail and, therefore, and the amount payable was ascertainable.

The IRS countered that the $62 million potential tax bill paid to California was ascertainable with reasonable certainty. The amount payable to the Franchise Tax Board could have been anywhere from $0 to $61 million. Subsequently, the estate claimed that the appropriate valuation and deduction should be $47 million.

However, the claim was quite uncertain. No one could be certain that the Mimosa tax strategy would work.

In addition, the reasonably ascertainable bill must also have a certainly that it “will be paid.” Given the protracted litigation with the California Franchise Tax Board, there was no certainty as to the amount that would be paid.

The fact that the claim was both disputed and disputable by the estate and that there was negotiation over a period for 7 years indicates that there was not an ascertainable amount. As a result, post-death events are a permissible factor in determining the appropriate amount of tax.

Therefore, the claim by the state of California was not certain. After the settlement for $26 million, it was appropriate for the IRS to allow deduction for the actual amount. The resulting tax bill, as stated by the IRS, was affirmed.

Estate Refund of Late Filing Penalties Denied

In Estate of Robert M. Cederloff v. United States; No. 8:08-cv-02863 (9 Sep 2010), the District Court denied an estate petition to wave penalties for late filing of IRS Form 706.

The decedent, Robert M. Cederloff, passed away on August 15, 1999. Attorney Garland Lowe was appointed as personal representative. Mr. Lowe had previously been employed as an IRS attorney.

On May 15, 2000, Lowe filed Form 4768 and obtained an automatic six-month extension for filing the tax return. The extension gave Mr. Lowe until November 15, 2000 to file. On January 30, 2001, he requested an additional extension which the IRS denied. The IRS required him to “file IRS Form 706 immediately.” Mr. Lowe waited until October 31, 2001 to file Form 706.

With that filing, Mr. Lowe indicated four reasons why the late-filing penalties should be abated.

First, Mr. Lowe observed that the decedent had purchased a home in Las Vegas and placed both his name and his brother’s name on the home. After the death of Mr. Cederloff, the brother claimed the entire home and there was litigation to resolve the issue.

Second, the decedent resided in Maryland and maintained records in both Maryland and Las Vegas. However, he passed away in his daughter’s home in Lake Oswego, OR and also had records there.

Third, the decedent was separated from his wife but not divorced. She predeceased him and her estate needed to be probated to determine the total assets.

Fourth, at the due date with extension, it appeared that there were other unknown assets in the estate. In fact, the other assets were discovered and subsequently reported in the estate.

For all of these reasons, Mr. Lowe claimed that he could not file the return and requested that the penalties be abated. The IRS refused to abate the penalties and noted that an IRS Form 706 must be filed within the required deadlines.

Before the District Court, the estate observed that the four reasons given constitute the reasonable cause for the failure as defined under Sec. 6651(a). In addition, the personal representative noted that the IRS had waived the penalties on late filing of the final income tax return and claimed that a refusal to similarly waive the penalties on the estate tax return was arbitrary and capricious behavior by the IRS.

The court noted that the Internal Revenue Code creates strict deadlines for Form 706. The form is due nine months after the date of death, but there is an automatic six month permitted extension if Form 4768 is filed. However, no further extensions are permitted unless the executor is abroad. Reg. 20.6081-1(b).

While Sec. 6651(a)(1), (a)(2) permits waiver of late filing if there is no “willful neglect” and there is “reasonable cause,” the actions cannot be within the control of the personal representative. Only if there are events such as the death of an immediate family member or a mistake of a competent tax advisor is there an event that is “beyond the executor’s control” that permits delay.

The intent of the statutes is to require filing of the return “as complete as possible” prior to the applicable deadline. The fact that Mr. Lowe paid the estimated tax payments suggested that he had sufficient data to file. The court noted that the taxpayer may file based on the available information.

While the form does require a statement by the personal representative that it has been filed under penalty of perjury and “to the best of his or her knowledge and belief,” Mr. Lowe could have and should have filed the return. It is not permitted to amend the return, but Mr. Lowe could have later provided supplementary information that would have assisted in the final tax calculations. Therefore, because Mr. Lowe had the ability to file, even though some information was incomplete, the penalties were correctly levied and are applicable.

Applicable Federal Rate of 2.0% for October

The IRS has announced the Applicable Federal Rate (AFR) for October of 2010. The AFR under Sec. 7520 for the month of October will be 2.0%. The rates for September of 2.4% or August of 2.6% 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.