The new budget proposes spending $3.7 trillion next year. With an estimated total federal revenue of $2.6 trillion, the deficit is estimated to be $1.1 trillion.
The Congressional Budget Office (CBO) also projects revenue, deficit levels and tax provisions for the next decade. With the basic projections, the 10 year deficit will be $7.2 trillion.
However, with several "realistic" assumptions, the probable deficit increases over 10 years to $9.4 trillion. These "realistic" assumptions include a permanent increase in the exemption for alternative minimum tax, permanent extension of the 35% top income tax rate and 15% capital gain rate, and permanent extension of the $5 million applicable exclusion amount for estate taxes (plus indexed increases) and the 35% gift and estate rate.
There are several revenue raisers in the proposed budget. First, itemized deductions for high-income taxpayers would be capped at 28%. Higher-income persons who have deductions for home mortgages, charitable giving and state and local taxes would not receive the full benefit of those deductions. This proposal was also in the previous budget and was soundly rejected by the Senate.
Second, there are changes in international taxes designed to create more revenue for multi-national corporations. Third, a number of the deductions permitted to coal and gas companies would be limited.
Treasury Secretary Timothy Geithner testified before the Budget and Tax Committees of both the House and the Senate this week. In his comments before the House Ways and Means Committee on February 15, Secretary Geithner claimed that the budget was both fiscally responsible and invested in the future of the nation.
Mr. Geithner noted that the budget "stabilizes" the national debt. By 2016, the deficit declines to 3% of the economy. There is also a five year freeze on non-security discretionary domestic spending. Finally, while there are limits on spending, there are continued investments in research and development, education and clean energy.
Editor's Note: The budget debate will surely continue for most of this year. The "realistic" White House assumptions are a reasonable indicator of the probable direction of those discussions. The White House may be suggesting a willingness to hold the top income tax rate at 35%, the top capital gain rate at 15% and the estate tax applicable exclusion amount at $5 million ( plus indexed increases) for next year and perhaps even the next decade. However, in Washington, the winds of change blow quickly and may change directions in the next week.
House and Senate Join Budget Debate
Following a release by the White House Office of Management and Budget (OMB) of the proposed budget for fiscal year 2012, OMB Director Jacob Lew testified before the House Budget Committee.
House Budget Chair Paul Ryan (R-WI) expressed concern about the direction of spending in the budget. He stated, "Instead of confronting our debt head on, the President has presented us with a budget that spends too much, borrows too much and taxes too much. His budget would double the amount of debt held by the public by the end of his term – and triple it by the 10th anniversary of his inauguration."
In the view of Rep. Ryan, President Obama did not follow the advice of Erskine Bowles, the Democratic Chairman of the White House Fiscal Commission. According to Mr. Bowles, the new budget goes "nowhere near where they have to go to resolve our fiscal nightmare."
The Ranking Member of the House Budget Committee is Chris Van Hollen (D-MD). He thanked Budget Director Lew for his service to the nation and noted, "I want to commend the President for submitting a budget that reduces our deficit, while also investing in our future. This is a tough love budget. It cuts non-security discretionary spending by $400 billion over the next decade – taking that category of spending to the lowest share of GDP since the Eisenhower Administration."
Rep. Van Hollen was pleased that the budget also included investments in research and development, education and clean energy. He further noted that it is not possible to "balance the budget with domestic discretionary spending" because cuts to that area could only impact 12% of the budget. His preference for deficit reduction focused on increasing taxes on oil companies.
Senators also offered opinions on the new budget. Sen. Kent Conrad (D-ND) was the prime motivator behind creation of the fiscal commission last year. He suggested that "the President's budget gets it about right in the first year."
However, Sen. Conrad expressed major concern about future debt and deficit reduction. He continued, "A debt that is too high acts like an anchor on the economy, reduces future economic growth, reduces opportunity for the American people, reduces job prospects for those seeking employment." Sen. Conrad noted that the spending levels are the highest percentage of the economy in 60 years and revenue is currently at the lowest percentage of the economy in 60 years. He suggested that some of the fiscal commission solutions were not perfect, but were a major potential step in the right direction.
Sen. Orrin Hatch (R-UT) also expressed concern about the deficit and future taxes. Sen. Hatch quoted American Poet Ogden Nash. Mr. Nash once wrote, "The more you earn, the less you keep. And now I lay me down to sleep. I pray the Lord my soul to take, if the tax collector hasn't got it before I wake."
Sen. Hatch indicated that it is important to "restrain spending" or there will be a "monstrous tax hike" in the future."
Charitable Contribution Denied
In Setty Gundanna Viralam et ux. v. Commissioner; 136 T.C. No. 8; No. 21355-03 (13 Feb 2011), the Tax Court denied a deduction for a charitable gift to an organization maintaining donor advised funds for doctors. In addition to not receiving the charitable deduction, the doctor was subject to capital gains tax on sale of the stock and an accuracy-related penalty.
Dr. Viralam is a medical practitioner. In 1998, Dr. Viralam sold his 50% interest in a medical practice for $2,262,500, producing a taxable gain of $2,261,750. Dr. Viralam had joined a membership organization of doctors named Xelan. He paid a $975 membership fee for the "Xelan tax reduction plan."
Based upon promotional materials that promised "a tax reduction" program, Dr. Viralam transferred appreciated stock to the Xelan Foundation ("Foundation") in 1998. The Foundation indicated that Dr. Viralam could create an account described variously as a "donor advised fund" or "family public charity." The fund was available for "charitable giving, income tax reduction planning, estate tax reduction, educational funding and future retirement planning."
The Xelan Foundation had been recognized by the IRS as a public charity and was included in IRS Publication 78. In addition, the Foundation had obtained an opinion letter from the Conner & Winters law firm on deductibility of gifts. In their opinion letter, Conner & Winters suggested that gifts to the Foundation were more likely than not to be deductible. However, the opinion letter declined to issue an opinion on the specific grants or educational programs of the Foundation donor advised funds.
Following Dr. Viralam's gift of stock with fair market value of $262,433 and cost basis of $131,360, the Foundation sold the gifted stock and provided him with a receipt. The receipt included the Sec. 170(f)(8) statement that "no goods or services" were transferred in exchange for the gift.
At the recommendation of Dr. Viralam, the Foundation accountant distributed $15,500 to religious organizations for the next two years. However, his Foundation account also made distributions to the University of Pennsylvania of $70,299. Dr. Viralam's son Vinay was at that time a student at that university. The IRS audited Dr. Viralam and issued a notice of deficiency for 1998. The IRS denied the charitable deduction, assessed a tax on the sale of the appreciated stock by Xelan Corporation and also accessed an accuracy-related penalty under Sec. 6662.
The court noted that under Sec. 170(c)(2), a charitable contribution is permitted if it is given to "a foundation organized and operated exclusively for charitable or educational purposes."
The IRS claimed that the supposed "student loan" to Vinay showed that Dr. Viralam had "never surrendered dominion and control" over the fund. When Dr. Viralam created the fund in 1998, he anticipated that his three children would receive most of the fund for their college expenses. The initial distributions for the benefit of Vinay were made and "the Foundation's approval of petitioner's son as a student loan beneficiary was perfunctory."
While it was true that the Foundation had been granted exempt status and was listed in Publication 78, the issue of the operation exclusively for the benefit of charitable purposes remained. Even though the purported donor advised fund was supposedly for charitable purposes, the facts indicated that Dr. Viralam had retained dominion and control.
The Sec. 170(f)(8)(A) receipt issued by Xelan Foundation indicated that there were no "goods or services" provided in consideration of the gift. However, the "student loans" were clearly within the regulatory definition of "cash, property, services, benefits and privileges." Because the student loans were contemplated as part of the fund benefits, the gift failed the "no goods or services" test. Under Sec. 170(f)(8), there is "no deduction" if that test is failed.
Because there was no charitable deduction, Dr. Viralam is also taxable on the long-term capital gain produced by sale of the stock in 1998. In addition, the penalty under Sec. 6662 applied. Dr. Viralam pointed to the legal opinion by the law firm Connor & Winters. However, that legal opinion explicitly excepted a potential student loan program. In the view of the court, the arrangement fails the "too good to be true" test. In the view of a reasonable person, a taxpayer should realize that this gift to provide university-level educations for children would not be deductible.
Applicable Federal Rate of 3.0% for March – Rev. Rul. 2011-6; 2011-10 IRB 1 (17 Feb. 2011)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2011. The AFR under Section 7520 for the month of March will be 3.0%. The rates for February of 2.8% or January of 2.4% 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 2011, pooled income funds in existence less than three tax years must use a 2.8% deemed rate of return. Federal rates are available by clicking here.
