GiftCharity GiftLaw eNewsletter August 2, 2010

Washington Hotline

Geithner and Reid Support Top Tax Rate Increases

On a national media program on July 25, 2010, Treasury Secretary Timothy Geithner emphasized that the Obama administration plans to increase the tax rates for the top two brackets. When asked whether the 2001/2003 tax reductions should be extended for all brackets, Secretary Geithner stated, "I don't believe they should and I don't believe they will."

In the view of Secretary Geithner, the increase of the top two rates to 36% and 39.6% affects only "2% to 3% of Americans, the highest-earning Americans in the country." He suggested that the increased rates on top earners will not have a "negative effect on growth."

House Majority Leader Steny Hoyer (D-MD) agreed with Secretary Geithner. He advocated extending the tax cuts for middle-income taxpayers and remarked that their taxes are "lower than they were in any single year" when compared to prior administrations. However, in his view, the increase in the top two brackets is necessary to keep America from going "deeper into debt."

Sen. Orrin Hatch (R-UT) is a member of the Senate Finance Committee. He spoke on the floor of the Senate and expressed frustration over the decision by Majority Leader Harry Reid (D-NV) to refuse to allow a vote on the Hatch proposal to extend all of the tax cuts. Sen. Hatch offered a motion to commit the pending small business bill back to the Finance Committee in order to amend it and extend all of the tax cuts.

Sen. Hatch indicated that this "largest tax increase in history" will dramatically impact small businesses. These businesses, with between 20 to 500 workers, are owned by individuals who face substantial tax increases.

In the view of Sen. Hatch, the top bracket tax increases will reduce the ability of small business to perform its normal function during an economic recovery of generating 70% of new jobs. Sen. Hatch noted that new jobs typically have three components.

First, there must be entrepreneurs who are willing to take risks. Second, there must be adequate access to capital. He indicated that the banks and large companies currently hold record amounts of cash reserves, so there certainly is cash available. Third, there must be "reasonable economic certainly" so that the businesses are willing to expand. With the prospect of higher taxes and greater regulations, Sen. Hatch indicates that there is a high level of uncertainly that is directly reducing job growth in America.

BP Strikes $10 Billion Tax Credit "Gusher"

Major oil company British Petroleum (PLC) operated the Deepwater Horizon well that was responsible for a major Gulf of Mexico oil spill. The gushing oil well has now been capped, but the environmental disaster in the Gulf is the largest on record.

The massive quantity of oil in the Gulf is now breaking down as a result of water and wave action. However, there is a major cleanup underway of the beach and wetland areas. BP has promised to pay the expenses of the cleanup.

This week, BP spokesman Robert Wine indicated that the estimated cleanup cost to the company is $32.2 billion. Because U.S. tax law permits a credit for up to 35% of losses, BP plans to take a tax credit of $10 billion. This will reduce the taxes paid by BP to the U.S. Government by that amount.

Rep. Elliott Engel (D-NY) was quite distressed with the BP announcement. He stated, "After being responsible for the worst environmental catastrophe in American history, they have used and abused the system, which has for too long permitted oil companies to treat the environment as their own private playground. Now they are looking to cut their losses at the expense of the American people."

Second Chance for Small Charities

In IR-2010-87 (25 Jul 2010), the IRS announced a one-time filing relief for small and midsize charities.

In the Pension Protection Act of 2006, Congress created a requirement for all tax-exempt organizations to file an annual information return with the IRS. Larger organizations previously were required to file IRS Form 990. Midsize organizations file IRS Form 990-EZ and small charities with gross receipts under $25,000 per year are required to file Form 990-N, Electronic Notice (e-Postcard).

The three year period for filing expired on May 16, 2010. Because approximately one-fourth of the one million plus nonprofits failed to file by that date, they lost their tax exempt status.

However, the IRS determined that it will allow a one-time opportunity from May 17, 2010 through October 15, 2010 for the small and midsize charities to file. Small charities with receipts less than $25,000 per year are permitted to go to www.IRS.gov and file the ePostcard Form 990-N. Midsized organizations who qualify to file Form 990-EZ, Short Form Return of Organization Exempt From Tax, will have until October 15 to file.

Larger charities required to file Form 990 and private foundations required to file Form 990-PF are not covered by the one-time extension of the filing deadline.

Editor's Note: Given the potential for losing exempt status and the cost of refiling IRS Form 1023 to regain status, all board members of small organizations are urged to contact the appropriate leaders of those charities and encourage them to file. Further information is available on www.IRS.gov.

2010 Estate Basis Problems

At a July 27, 2010 conference sponsored by the American Institute of Certified Public Accountants, Treasury Representative Catherine Hughes discussed the basis issues that are arising concerning 2010 decedents.

While the estate tax is repealed during 2010, under Internal Revenue Code Sec. 1022 there are new and complex rules on basis adjustments. For large estates, a majority of the assets will be transferred with a "flow through" of the basis. That is, the heirs will be able to use the basis of the decedent in any future sales for the purpose of reporting capital gain. Because many decedents have few or no records of the basis, it is quite possible that these heirs will pay capital gains tax on the full value of future sales.

However, there are allowances for a basis "step-up" of $1.3 million. In addition, for a surviving spouse, the basis step-up can be $3 million. The step-up in basis cannot be greater than the fair market value of the applicable property.

Determining how to allocate the adjusted basis step-up in an estate has caused great concern among estate planning attorneys and CPAs. Treasurer Representative Hughes stated, "I anticipate there will be a lot of mistakes where there isn't an affirmative allocation" of basis. Treasury is studying the situation and may issue guidance with recommended default allocation rules.

While Congress continues to debate estate tax law and, therefore, has not made any decision on a potential retroactive estate tax, the nonpartisan Tax Policy Center this week released an estimate of the potential number of 2011 taxable estates. If a $1 million exemption is applicable in 2011, there will be an estimated 43,500 estates subject to tax. If the 2009 exemption amount of $3.5 million per decedent is applicable next year, the number of taxable estates is reduced to 6,500.

Editor's Note: The discussion in Washington on the practical aspects of allocating the basis step-up now suggests that there may not be a mandatory retroactive estate tax law. With the pending election, it now seems very likely that Congress will not act on the estate tax before December. The Senate continues to have great difficulty developing a plan acceptable to 60 Senators and to the House of Representatives. However, Senators now recognize that a $1 million exemption and tax on 43,500 estates will impact a large number of middle-class children and other beneficiaries. Therefore, it seems quite likely that a compromise should be passed in December. However, as the AICPA basis adjustment discussion suggests, this compromise is now less likely to mandate an extension of the 2009 exemption for 2010. As a result, attorneys and CPAs will need to address the very complex and uncertain basis adjustment problems for 2010 estates.

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 Letter Ruling

Dance Awards Permitted

ORG is tax-exempt under Sec. 501(c)(3) and classified as a private foundation under Sec. 509(a). ORG proposed a grant-making program that would award grants to individuals to create a new dance work or a partially-created dance work. ORG expects to award one grant annually with the objective of supporting the creation or completion of new dance works and to bring these works into the larger public repertory. By providing needed funding to emerging choreographers, ORG intends to make new dance works available to the general public and raise public awareness and appreciation of the art of dance throughout the country. Grant recipients would be identified based on recommendations by professionals in the field of dance and choreography, as well as artistic and executive directors of performing art institutions. Recipients would be selected by the selection committee based on objective and nondiscriminatory criteria. Each individual grant recipient would be required to submit a report detailing the use of the grant funds and the progress the recipient has made toward achieving the purposes for which the grant was made. ORG requested advance approval for their grant-making program under Sec. 4945(g)(3).

Certain excise taxes are imposed on "taxable expenditures" made by a private foundation under Sec. 4945(a) and Sec. 4945(b). Under Sec. 4945(d)(3), a "taxable expenditure" is defined as any amount paid or incurred by a private foundation as a grant to an individual for travel, study or other similar purposes. However, individual grants awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance will not be treated as taxable expenditures if it is demonstrated that the grant meets the requirements of Sec. 4945(g)(1), (2) or (3). Under Sec. 4945(g)(3) a grant will not be treated as a taxable expenditure if the purpose of the grant is to achieve a specific objective, produce a report or similar product or improve or enhance a literary, artistic, musical, scientific, teaching or other similar capacity, skill or talent of the grantee. The Service determined the ORG's award program would meet the requirements of Sec. 4945(g)(3) and ORG's procedures for granting the awards would not constitute "taxable expenditures" within the meaning of Sec. 4945(d)(3).

Case of the Week

Son's Intentions Paved with Gold, Part 5

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.)

One part of the plan involved Mother's 20-acre rear parcel of land. Specifically, Mother's unitrust would receive the 20-acre rear parcel, which the university intends on eventually developing. To generate the necessary trust income, the university would purchase the land from the trust with a 7% interest-only note. After the payment of the 6% unitrust payout each year and trust expenses, the trust would accumulate any excess income.

Son is the sole owner of Bank Co. Wanting the very best for Mother, Son wants to provide trust and banking services to Mother's unitrust. Son knows Bank Co. would provide excellent services at very reasonable prices. Fortunately, after reviewing the applicable tax rules, Son and Bank Co. may provide trust and banking services to Mother's unitrust without violating the self-dealing rules. (See Case Study "Son's Intentions Paved with Gold, Part 3" for a full explanation.)

With that hurdle cleared, Son now wonders whether there are any investment restrictions or prohibitions in the tax code unique to charitable remainder trusts? If so, should Son and Bank Co. nevertheless serve as trustee for Mother's unitrust?