On February 22, Treasury Secretary Timothy Geithner spoke to Congress and outlined the White House proposal for corporate tax reform.  Geithner noted that there has not been a comprehensive corporate tax reform for 25 years.  Since the last major corporate tax reform, there have been many significant events.  These include the following changes.

1. Internet is widely used.

2. Cell phones are now commonplace.

3. China and India have become significant economies.

4. Global trade has greatly expanded.

5. Nearly all other industrial societies have lowered their corporate rates.

There are five major elements in the White House proposed reform.

1. Reduced Rates – The elimination of tax loopholes and subsidies will permit a reduction of the corporate tax rate from 35% to 28%.

2. Manufacturing Incentives – The effective tax rate for manufacturing companies will be reduced to 25% through incentives.

3. International Taxation System – Companies could pay penalties for shifting income overseas.

4. Simplification – Small businesses would benefit from reduced complexity in the Tax Code.

5. Revenue Neutrality – The reduced rates are achieved through eliminating various tax deductions.

Treasury Secretary Geithner indicated that he plans to meet with Senate Finance Chair Max Baucus (D-MT) and House Ways and Means Chair Dave Camp (R-MI).  He hopes that it will be possible to build a bipartisan consensus for corporate tax reform.

Editor's Note: Sen. Baucus and Chairman Camp have been holding hearings and proposing corporate tax reform for the past year.  With the White House announcement, that the President, the House and the Senate agree that there should be simplification and a lower corporate top rate.  The challenge will come when the government grapples with the question of which major corporate deductions (such as bonus depreciation) will actually be removed in order to lower rates.  Because of the magnitude of major tax reform, it is not likely that an actual bill could be passed before 2013.

Congress Welcomes Debate on Tax Reform

In response to the White House, many members of Congress welcomed the debate on tax reform.

Both the House Ways and Means Committee and the Senate Finance Committee have held multiple hearings on tax reform.  At the hearings, witnesses observed that the United States has an average state and local tax rate on corporations of up to 39%.  This is approximately 15% higher than the average rate of other industrial countries.

Since 2000, most of the other major industrial countries have reduced tax rates from 5% to 15%.  The reduced rates are designed to make the companies competitive in a global economy and to retain jobs at home.  Because the U.S. has a high corporate tax rate, there is an incentive for companies to move jobs overseas.

Democratic leaders were supportive of the President.  Rep. Nancy Pelosi (D-CA) stated, "President Obama's proposal presents a clear opportunity to work in a bipartisan manner to lower tax rates on American businesses and corporations while closing loopholes for Big Oil and companies that ship jobs overseas."

The Ranking Member on the House Ways and Means Committee is Rep. Sander Levin (D-MI).  He "applauded" the President for setting forth a series of goals for corporate tax reform.  Levin noted, "The Administration has put the focus of corporate tax reform where it needs to be: on promoting investment, job creation and especially manufacturing in the United States, not overseas."

Republican leaders were generally pleased that the White House had issued a proposal.  However, they expressed hope that there would be more specifics to the Treasury plan.  Ranking Member of the Senate Finance Committee Orin Hatch (R-UT) noted that the major tax overhaul signed by President Reagan in 1986 was the result of "three long years" of effort.  The actual major overhaul of corporate and personal taxes together is a huge undertaking.

Hatch stated, "America's tax system is broken to the point that it's putting our nation at a competitive disadvantage around the world.  I'd hoped the White House would recognize the severity of the problem with a real plan and real leadership."  Sen. Hatch called the proposal "profoundly disappointing in its lack of detail."  He hopes that the White House and Treasury Secretary Geithner will work with the Republicans on a meaningful tax reform.  He indicated that this level of effort would find "willing and able partners in Congress."

A key member of Congress for tax reform is the Chairman of the House Ways and Means Committee, this committee is required to initiate all major tax legislation.  Chairman Dave Camp (R-MI) noted that he appreciated the White House proposal.  Camp stated, "There is a clear and growing consensus that our outdated tax code is hindering the job creation this country needs to get Americans back to work and it must be reformed so that the United States would be a more attractive place to invest and hire."

Camp and Sen. Ron Wyden (D-OR) also expressed a bipartisan concern that it is not possible to have major corporate tax reform without also reforming personal income taxes.  Camp noted, "More than half of all business income is taxed at the individual (rather than corporate) tax rates and a corporate-only proposal does not address the needs of those job creators."

Wyden has previously been involved in bipartisan tax proposals.  He agreed and stated, "Right now, more than 80% of all U.S. businesses are filing their taxes through the individual tax code, not the corporate tax code.  Those businesses would see little benefit from this proposal."

Editor's Note: It is positive that the House and Senate tax writers and the White House have all published proposals.  If Sen. Wyden and Chairman Camp persuade Congress that tax reform must include both corporate taxes and personal taxes, then the process will be quite extensive.  However, there is general agreement that broadening the tax base through reducing deductions and reducing rates at the same time will be beneficial.

Marital Portability Guidelines

Catherine Hughes is the Attorney Advisor in Treasury's office of Tax Policy.  She spoke to the Estate and Gift Tax meeting of the American Bar Association Section on Taxation on February 17.  Many of the estate attorneys present expressed strong interest in the Treasury position on martial portability and recently-issued Notice 2012-21.

Attorney Hughes explained five specific requirements for the Notice.  The Notice is designed to enable executors for individuals who passed away the first half of 2011 to benefit from marital portability.  The five requirements include the following:

1. Estate Size – $5 million or less.
2. Decedent – Who is survived by a spouse.
3. IRS Forms – No filing of IRS Form 706 or IRS Form 4768, "Application for Extension of Time to File a Return and/or Pay United States Estate (and Generation-skipping Transfer) Taxes."
4. Date of Death – January 1 to June 30 of 2011.
5. Filing Deadline – Forms 706 and 4768 filed within 15 months of date of death.

Hughes also commented that Treasury is developing regulations to clarify the specifics of marital portability.  The regulations will address statute of limitations questions, application of indexed applicable exclusion amounts and specific requirements for information on Form 706.

FLP Assets Excluded from Estate

In Estate of Joanne Harrison Stone et al. v. Commissioner; T.C. Memo. 2012-48; No. 23290-09 (22 Feb 2012), the Tax Court held that family limited partnership assets were excluded from the estate because there was qualification as a bona fide sale for adequate and full consideration.

The decedent and her husband Roy Stone were long-term residents of Tennessee.  They had six adult children and numerous grandchildren at the time of her death.  The Stones held approximately 30 parcels of real property and operated a family publishing business.

Cumberland County constructed a dam in the 1990s and parts of the Stone property became water frontage on that reservoir.  Other parcels were woodland lots that were in the vicinity of the lake.  After discussion with attorney Harry Sabine, decedent and Mr. Stone created the Stone Family Limited Partnership of Cumberland County (SFLP) on December 29, 1997.

SFLP was created for the purpose of holding and managing lakefront and adjacent woodland property for the Stone family.  Decedent and Mr. Stone each held a 1% general partner interest and 49% limited partnership interests.  The appraised value of the property was $1,565,600.  During the years 1997 through 2000, the Stones gifted limited partnership interests to 21 family members and spouses. By the end of 2000, the 98% limited interests were held by the family members and the 2% general partner interests by Mr. and Mrs. Stone.

Two family members were involved in divorce proceedings in 1999 and 2000.  The daughter and granddaughter entered into settlement negotiations with spouses that involved transfer of property interests in woodland parcels held within SFLP.

The decedent passed away July 2, 2005 at the age of 81.  Roy Stone was still alive and age 95 at the time of the trial.  There was no consideration provided by family members for transfers of SFLP interests.

The IRS audited the estate, claimed that SFLP assets were included in decedent's estate and issued a notice of deficiency on August 27, 2009 in the amount of $2,563,290.

The Tax Court noted that Section 2036 requires asset inclusion if there were an inter vivos transfer of property, the transfer was not a bona fide sale for adequate and full consideration and the decedent retained an interest or right in the property.  The IRS position was that there was not a bona fide sale and therefore the property should be included at its date of death value in the estate.

The Court indicated that the primary question is whether the nontax reasons for creating an estate were "a significant factor that motivated the partnership's creation."  The considerations include six different specific issues.

1. Control – Do taxpayers stand on both sides of the transaction?
2. Dependence – Is the taxpayer dependent on partnership assets for financial support?
3. Comingling – Does taxpayer exercise caution to keep personal bills and expenditures separate from the partnership?
4. Transfer – Are all of the legal formalities followed in transferring property and is the partnership actually deeding or transferring real property?
5. Discounts – Are the gifts when transferred to family members subject to substantial discounts?
6. Imminent Death – Is the family limited partnership created when the transferor is in poor health or at a very senior age?

The estate noted that it had two legitimate nontax purposes.  First, the plan was to create a family asset and permit the development and sale of homes around the lake for the benefit of children and grandchildren.  Second, the woodland parcels would be protected from division through partition.  Finally, SFLP would also facilitate gifts to family members.

The Court noted that the goal to manage the woodland and lake frontage parcels for the benefit of family "constituted a legitimate nontax motive."  The IRS continued and observed that Mr. and Mrs. Stone were on "both sides of the transaction."  However, the Court noted that it is permissible for the donors to be on both sides if there is a legitimate nontax purpose.

Finally, the IRS claimed that SFLP did not always follow partnership rules.  During divorce proceedings, there was a transfer of actual real estate parcels rather than limited partnership units.  SFLP interests were transferred with a bill of sale and Mr. Stone paid property taxes from personal funds rather than SFLP funds.

However, the Court noted that there were five positive factors.  There were no personal distributions to pay expenses from SFLP, the Stones did make a legal transfer of the parcels to SFLP, there was no comingling of assets, there was no discounting of SFLP units upon the transfer and both Mr. and Mrs. Stones were in good health at the time of the transfer.

Therefore, the Court held that there was a legitimate and actual nontax motive for transfers to SFLP.  The transfer qualifies as a bona fide sale for adequate and full consideration.  The date of death asset value was not includable and the deficiency was denied.

Editor's Note: This case is a very cogent and clear explanation of favorable FLP factors.  It forms a useful checklist for all FLPs to follow in order to insure qualification and avoid including assets at date of death value in the taxable estate.

Applicable Federal Rate of 1.4% for March – Rev. Rul. 2012-9; 2012-11 IRB 1 (20 Feb 2012)

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

Key Terms and Definitions

Face  Value -- The original death benefit amount. Convertibility -- Option to convert from one type of policy (term) to another (whole life), usually without a physical examination. Cash  Value -- The savings portion of a policy that can be borrowed against or cashed in. Premiums -- Monthly, quarterly, or yearly payments required to maintain coverage. Beneficiary -- The individual(s) or entity (e.g., trust) that is designated as benefit recipient. Paid  Up -- A policy requiring no further premium payments due to prepayment or earnings.