Washington News

In the State of the Union Address, the President suggested that there should be a 30% minimum tax for those with incomes over $1 million per year. This 30% minimum tax has been called the "Buffet Rule" tax after statements in support of this plan by businessman Warren Buffet.

This week, Sen. Sheldon Whitehouse (D-RI) introduced the Paying a Fair Share Act. This act creates a 30% tax rate on incomes over $2 million per year. For those with incomes from $1 million to $2 million, the tax is phased in.

Whitehouse stated, "As we continue working to restore our economy, it's more important than ever to make sure all Americans are paying their fair share toward our nation's success." He suggested that upper-income taxpayers should pay a fair rate and that his tax will help "fix" potential unfairness in the system.

Fortunately for philanthropy, the act includes a "modified charitable contribution deduction." For individuals who are subject to this higher minimum tax, their charitable itemized deductions will be adjusted upward so they save the same percentage of tax at the higher rate than they would have saved at their lower rate. In effect, the modified charitable contribution deduction is intended to protect the savings of their charitable gifts.

The Alliance for Charitable Reform (ACR) published a statement in support of this provision. ACR stated, "We appreciate the wide recognition that the charitable deduction is different from all other deductions in that it is an incentive for Americans to give away their money as compared to other deductions and credit incentives." ACR is a group of volunteer nonprofit leaders who support philanthropic freedom and increased giving.

Editor's Note: The inclusion of the modified charitable contribution deduction is very positive for philanthropy. While the proposals for taxing higher incomes may not be enacted this year, it is possible that one or more could be enacted in future years as the government attempts to address the deficit. It is a breakthrough for philanthropy that this bill recognizes the importance of charitable deductions and creates a separate category from all other types of itemized deductions. Hopefully, this principle will be followed in future legislation.

Tax Extenders – Repealed or Made Permanent?

At a hearing on the tax extenders by the Senate Finance Committee on January 31, Chair Max Baucus (D-MT) indicated that most of the 150 potential tax extenders are likely to be passed by November of 2012. However, he held the hearing in order to prepare for a major tax bill in 2013. Sen. Baucus suggested that the tax extenders should be first reduced and then the remaining made permanent.

Baucus stated, "We need to address these tax extenders to provide long-term certainty. And through tax reform we should evaluate each and every extender and determine whether it should be allowed to expire or made permanent."

The Ranking Member of the Senate Finance Committee is Sen. Orrin Hatch (R-UT). He agreed with Baucus that action needed to be taken on the extenders. Hatch stated, "The number of temporary tax provisions has grown from 42 in 1998 to 154 in 2011. Even those tax extenders that are sound tax policy lose much of their power due to their temporary character."

Hatch noted that he and Baucus agreed that there is a need for a comprehensive revision of the tax code in 2013. Presumably, this hearing and others will be the basis for action on tax extenders at that time.

One of the four witnesses at the hearing was Professor Calvin Johnson of Austin, Texas. He reviewed many of the tax extenders with larger revenue impact and created three categories. Johnson suggested repealing 13 of the extenders, modifying nine and was uncertain about three.

Several of the extenders he reviewed were in the charitable giving area. Johnson recommended the repeal of the increased deduction for corporate contributions of computer equipment for educational purposes, the enhanced deduction for contributions of food inventory, the enhanced deduction for gifts of book inventories of public schools, the basis flow-through benefit for appreciated deductions by Subchapter S corporations and conservation easement deductions.

Johnson proposed that the popular IRA Charitable Rollover should be continued but that it should be counted in the 50% of adjusted gross income contribution limit.

Editor's Note: Sen. Baucus has indicated that he believes the tax extenders, including the IRA Charitable Rollover, will be passed by the end of November. If this occurs, the effective date for the IRA Charitable Rollover and other provisions is likely to be January 1, 2012. The good news is that the IRA Charitable Rollover seems to be on the safe list. The challenge is that while both Chairman Baucus and Ranking Member Hatch are quite positive toward philanthropy, many of the 154 tax extenders will not be in the final 2013 tax bill. All friends of philanthropy need to support the charitable tax extenders.

Gift Tax Fraud a Potential Jury Option

In Thomas W. Gaughen v. United States; No. 1:09-cv-02488 (31 Jan 2012), a U.S. District Court ruled on a motion for partial summary judgment. Taxpayer Gaughen sought to have an IRS claim for fraud removed from the action. The motion was denied.

Gaughen owned multiple real estate properties. On December 31, 2004 he transferred seven parcels of real property to family members and filed IRS Form 709 United States Gift Tax Return. The IRS contested the valuation of three parcels. These parcels in Cumberland County, Pennsylvania totaled approximately 205 acres and were valued at a cumulative $857,000 on his Form 709.

The IRS audited the return and assigned a value of $5,730,000 to the three parcels. The tax on the deficiency was $1,055,228.78. A 75% civil fraud penalty under Sec. 6663(a) was levied in the amount of $781,429.59. With $493,676.67 of interest, the total was $2,340,327.04. Gaughen paid the deficiency plus fraud and interest and filed an action for refund. The current motion for partial summary judgment by Gaughen sought to remove the fraud claim from the case.

The U.S. District Court noted that under Sec. 6663(a) the government was required to prove by "clear and convincing evidence that the taxpayer intentionally underpaid his or her taxes" in order to collect the 75% civil fraud penalty. The three issues surrounding the fraud claim are the level of underpayment, assessments by the Cumberland County on the three parcels involved and contracts for sale on two of the three parcels.

The first issue was the underpayments. Gaughen noted that a mere difference in valuation is not an indication of fraud. The Court agreed that it was not determinative that there are different valuations. However, the Court noted that if the valuation claimed by the IRS (which had been reduced to $2,688,000 at trial) was accurate, the jury could determine that there was fraud.

Second, the Cumberland County, Pennsylvania tax assessments for the three parcels equaled $1.53 million. The IRS claimed that this known valuation could be considered as evidence that the reported valuation of $853,000 was understood by Gaughen to be insufficient.

Gaughen stated that the IRS regulations preclude a reliance on the local assessment. However, the Court noted that this regulation indicates the county value will not be determinative "unless that value represents the fair market value thereof on the date of the gift."

Finally, Gaughen indicated that the county values were closer to the taxpayer value then the government value and therefore show a lack of intent to defraud. However, the Court indicated that the county values were subject to a "weight of the evidence" test by the jury and therefore the fraud claim could proceed.

Third, there were two sale contracts on parcels. One contract was signed on May 21, 2004 for $5 million. A second contract was signed four months after gifting the property. The two contracts together were approximately $7 million.

The IRS claimed that the existence of the contracts with value on the two parcels subject to sale of approximately 10 times the respective Form 709 amounts showed intent to commit fraud. The taxpayer pointed out that the second contract was created following the gift and that both contracts had multiple real estate contingencies.

The Court noted that a valuation of 10 times over the claimed value could be interpreted by the jury as intent to commit fraud. While all real estate contracts have contingencies, there was no material change during the four months between the gift and signing the second contract. Therefore, a reasonable jury could find intent to commit fraud.

Finally, Gaughen noted that he relied on an "independent" appraiser. However, the record indicated that Gaughen had written letters to the appraiser directing him to set the value at specific low numbers. Therefore, the independence of the appraiser is subject to evaluation by the jury. The court held that a reasonable jury could consider the valuation difference, the county assessments and the sale contracts and may apply the 75% Sec. 6663(a) civil fraud penalty.

Applicable Federal Rate of 1.4% for February – Rev. Rul. 2012-7; 2012-6 IRB 1 (19 Jan. 2012)

The IRS has announced the Applicable Federal Rate (AFR) for February of 2012. The AFR under Sec. 7520 for the month of February will be 1.4%. The rates for January of 1.4% or December of 1.6% 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 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return. Federal rates are available by clicking here.