The House Appropriations Committee met and passed the tentative budget for next year for the IRS. The White House had requested $13.3 billion. The House Appropriations Committee released its Fiscal 2012 Financial Services and General Government Appropriations Bill. It included $11.5 billion for the IRS. That represents a cut from the current year of over $606 million.
The IRS cut would be approximately 5.5% of the budget. IRS Commissioner Douglas Shulman spoke to a Senate Appropriations Subcommittee earlier in the month. He stated that a cut in the IRS budget would reduce revenue collections and therefore increase the deficit.
The House Appropriations Committee Chair is Harold Rogers (R-KY). He published a release indicating that the IRS cut in the bill shows "the commitment of the Republican majority to reduce spending, dig our nation out of record deficits and rein in unnecessary agency regulation interference that obstructs economic growth."
The ranking member on the House Appropriations Committee is Rep. Norm Dicks (D-WA). He opposed the cut and noted, "At this level, enforcement and customer assistance of the IRS would be adversely affected. The agency estimates that as many as 4,100 employees would have to be furloughed. The IRS estimates that this cut will end up costing $4 billion per year due to the lack of enforcement on tax cheats."
National Treasury Employees Union (NTEU) President Colleen Kelley was very critical of the cut. She commented, "It simply makes no sense to slash the budget of the agency that generates 93% of the government's revenue."
Editor's Note: The House Budget will eventually be modified in a conference with the Senate. It seems quite possible that a portion of the IRS budget may be restored. However, it is clear that the IRS and other governmental organizations will operate with leaner budgets in the future.
Two Trillion in Deficit Reduction?
Vice President Joe Biden continues to lead a group of House and Senate Leaders from both parties in deficit reduction negotiations. Vice President Biden has increased the number of meetings each week as the group now seeks to build a compromise budget before the August 2 deadline.
Members of the committee have not been willing to release specifics on the budget proposals. However, House Majority Leader Eric Cantor (R-VA) did speak to the press this week and shared some of the discussion.
He noted that the House Republicans still "have to see more than the $2.4 trillion amount that matches the debt ceiling increase in terms of cuts." Speaker John Boehner (R-OH) previously indicated that the requested debt increase of $2.2 trillion would be matched by the same amount in spending reductions.
While Secretary of the Treasury Timothy Geithner did not release details, it was reported that he included a number of tax increases in White House proposals submitted during the past week. Rep. Cantor indicated that he remains "straightforward in my opposition" to any tax increases.
House Budget Committee Ranking Member Chris Van Hollen (D-MD) is a member of the negotiating group. He suggested there was "satisfactory progress" toward a compromise. He stated, "We'll have a much better idea by the end of this week whether we're in striking distance" of the budget [compromise].
Life Insurance Incidents of Ownership
In Estate of Edward Thomas Coaxum et al. v. Commissioner; T.C. Memo. 2011-135; No. 27783-08 (15 Jun 2011), the Tax Court held that decedent held incidents of ownership in six life insurance policies. The policies and several annuities were included in his estate.
Decedent Edward Thomas Coaxum owned seven insurance policies when he passed away. One of the policies was deemed to have no value, but the other six had a cumulative value of $1,283,184. Mr. Coaxum held the right to select the beneficiaries on all six policies as of the date of his death. He also owned a number of commercial annuities. The beneficiary of the annuities was his brother Lonnie Coaxum.
The decedent passed away on October 15, 2003. IRS Form 706 was filed approximately 28 months later on February 27, 2006. The estate did not report the value of the insurance policies or the annuities in the estate. The IRS audited the estate and issued a deficiency.
The estate conceded that there were various errors in Form 706. The value of the real property was understated by $50,402. The funeral and administrative expenses were $5,780, rather than the reported $288,923. Finally, the insurance policies and annuities were not included.
The court noted that insurance is includable in the estate if there is an incident of ownership. Reg. 20.2042-1(c)(2) indicates that the power to change the beneficiary is a retained incident of ownership. Therefore, all six policies are includable in the estate.
Sec. 2039(a) requires annuities owned by the decedent to be included in the estate. The estate noted that the annuities had been transferred to brother Lonnie Coaxum and he had reported those amounts for federal income tax purposes in his 2005 return. The Tax Court included the annuities in the estate under Sec. 2039(a), but noted that there might be a potential Sec. 691(c) deduction on the income tax return of brother Lonnie Coaxum for estate tax paid on the annuities. However, the Tax Court did not have jurisdiction to determine that deduction.
Finally, the estate tax return was over five months late and there was no demonstration of "reasonable cause" or a lack of "willful neglect." Therefore, the 25% penalty of Sec. 6651(a)(1) was applicable.
Gift Formula Clause is Upheld
In John H. Hendrix et ux. v. Commissioner; T.C. Memo. 2011-133; No. 10503-03 (15 Jun 2011), the Tax Court upheld formula clauses that included gifts to trusts for children and transfers to a qualified charity.
John H. and Carolyn Hendrix were the owners of the John H. Hendrix Corp. (JHHC). They created a Texas "C" corporation on December 16, 1976. In 1997, they engaged in discussions with attorney Stephen Dyer. At his recommendation, they redeemed their preferred stock and issued common nonvoting and voting stock. In 1998, they elected Subchapter S status for JHHC.
After consultation with attorney Dyer, they created a generation skipping trust and also an issue trust. Both intended to make substantial gifts to the trust. Because they also wanted to benefit various charitable organizations within the state of Texas, they contacted the Greater Houston Community Foundation. After discussion, they decided to create a donor advised fund with the Foundation.
The Hendrixs' agreed to make two gifts to their donor advised fund – $20,000 of cash and a block of JHHC nonvoting stock.
The plan for the transfers was for each donor to give approximately $10.5 million in value to the GST trust, $4.2 million in value to the issue trust and $50,000 in nonvoting stock to the donor advised fund. The two trusts would pledge to pay any gift taxes on the transfer and sign notes of obligation back to donors. The note values were just under 90% of the stock values transferred to the trusts.
On December 30, 1999, John and Carolyn each held 403,241.88 shares of JHHC stock. On December 31 of that year, they each transferred 287,619.64 shares to the GST trust and 115,622.21 shares to the issue trust.
The transfer to the GST trust was through a formula clause that transferred $10,519,136.12 in value to the trust, returned a note of $9,090,000 to each donor and transferred the balance of the stock value with an estimated gift of $50,000 to each donor advised fund with the Greater Houston Foundation.
There also was the gift of shares to the issue trust. This was valued at $4,213,710.10, with a note back to each donor of $3,641,233.
IRS Form 709 was timely filed. Each donor reported a charitable contribution of $50,000 and a taxable gift of $1,414,581.37. Appraiser Howard Frazier determined that the per share value of the stock on the date of the transfer was $36.66. The IRS audited the gift tax return and issued a deficiency of $6,939,597.53 for each donor.
The court noted that there was a stipulation that if the valuation of $36.66 were not accepted, then there would be a per share valuation of $48.60.
The IRS claimed two grounds for the deficiency. First, the formula clauses were not valid because they were not negotiated at arms length. Second, the formula clauses were invalid as a matter of public policy.
The court noted that a taxpayer "may structure a transaction in a manner that minimizes or avoids taxes." The fact that the negotiation lacks adverse interest or is not thoroughly negotiated doesn't mean that it fails the arms-length test. Furthermore, there was nothing in the trial record to show that this was the case. In addition, the daughter's trusts were at risk concerning the valuation of the stock because they continued to be subject to payments on the notes. Therefore, the court determined that the transaction did not fail the arms-length test.
The IRS claim that this formula violates public policy is based on Commissioner v. Proctor, 142 F.2d 824 (4th Cir. 1944). Proctor indicated that a gift that would fail as a result of a disallowance of a formula clause is invalid based on public policy.
However, this formula clause does not cause a gift to fail. The formula clause merely may change the value of the charitable transfer based on the determined final value of each share of stock. Because the court determined that the appraised value of $36.66 was appropriate, the transaction functioned as intended by taxpayers. Each taxpayer was permitted a charitable deduction for $50,000.
Applicable Federal Rate of 2.8% for June – Rev. Rul. 2011-13; 2011-23 IRB 1 (18 May 2011)
The IRS has announced the Applicable Federal Rate (AFR) for June of 2011. The AFR under Section 7520 for the month of June will be 2.8%. The rates for May of 3.0% or April of 3.0% 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 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.
