Senator Max Baucus (D-MT) is continuing his series of tax reform hearings as Chairman of the Senate Finance Committee.  On June 19, former Sen. Pete Domenici (R-NM) and Alice Rivlin, former Director of the Congressional Budget Office and the Office of Management and Budget, described their solution.  Domenici and Rivlin are the Co-Chairs of the Bipartisan Policy Center Debt Reduction Task Force.

Domenici emphasized that there are two essential parts of the potential 2013 financial reform.  He stated, "Healthcare reform and tax reform that raises additional revenue are essential pieces of any serious plan."

Rivlin continued to describe the basic principles for tax reform.  She commented, "Assume that all income from whatever source is taxable, which would enable you to raise more revenue from much lower rates, and then go back to decide which modifications are absolutely essential, even though they would raise the rates."

The Domenici-Rivlin plan starts with a modification of Medicare.  They propose two major changes.

1.  Federal Medicare Exchanges. Private companies could offer fee-for-service and other comprehensive Medicare plans.  All Medicare beneficiaries could choose their plan.

2.  Competitive Pricing. The private plans and traditional fee-for-service Medicare plans would receive federal support at the level of the second-lowest-cost plan.  This pricing method encourages plan providers to economize and reduce overall costs.

Domenici and Rivlin also offered very specific proposals for comprehensive tax reform.

1.  Tax Brackets. Their personal tax system has brackets of 28% and 15%.  The corporate rate is 28%.

2.  Capital Gains. All gains from capital asset sales are taxed at ordinary income rates.  Most taxpayers would pay 28% capital gains rates.

3.  Child Credit. The credit per child would be $1,600.

4.  Itemized Deductions. None, except miscellaneous deductions that exceed 5% of adjusted gross income.

5.  Mortgage Deduction. A 15% credit on interest paid with a limit of $25,000 per year.

6.  Charitable Gifts. A 15% credit on deductible gifts.

7.  State and Local Taxes. Not deductible.

8.  IRAs and Retirement Plans. A 15% tax credit or deductions up to $20,000 per year.

Ms. Rivlin concluded her discussion by observing that the plan under discussion was similar to the Bowles-Simpson plan approved by the National Commission on Fiscal Responsibility and Reform.  She observed, "The basic structure is the same.  You can't get there any other way."

Editor's Note: Sen. Baucus and House Ways and Means Chairman Dave Camp (R-MI) are steadily moving toward major tax reform in 2013.  The two bipartisan groups advocating reform have agreed on general principles.  However, there still remains a major political discussion at the end of this year before broad-based reform can commence.  Your editor and this organization take no specific position on these recommendations.  This information is offered because it will have major impact on all Americans.

Stock of Decedent Wife Not In Taxable Estate

In Estate of Alfred J. Richard et al. v. Commissioner; T.C. Memo. 2012-173; No. 9876-09 (19 Jun 2012), the Tax Court determined that stock in the estate of a decedent wife was not included in the husband's taxable estate.

Decedent Alfred J. Richard incorporated the family business A. J. Richard & Sons (AJRS) in 1977.  At his death, he owned 1,311 shares of the company.  His spouse Victoria passed away October 15, 1997.  She owned 140 shares of Class A preferred stock.  Alfred's estate filed IRS Form 706 and valued his 740 preferred shares of AJRS stock at $740,000.  The IRS audited the estate and assigned a value of $142,203,000 for the stock and assessed taxes and penalties of approximately $95 million.

The will for the Estate of Victoria Richard had not been probated following her 1997 death.  In 2010, the will was submitted to probate and the local court determined that under Florida law, her 140 shares of AJRS stock passed to a credit shelter trust.

The IRS claimed that the decedent's husband had conducted his affairs as though he had ownership of the 140 shares of AJRS stock.  Because of his acts of dominion and control, the IRS claimed that his actions were "sufficient to require assigning the shares to decedent's estate."

The court determined that under Florida law the stock had never been retitled and still was in Ms. Richard's name in 2010.  Under Florida law, the title was transferred in 2010 from Mrs. Richard to the credit shelter trust and this ownership related back to her death in 1997.  Therefore, the 140 shares of preferred stock were not taxable in the husband's estate.

No Façade Easement Deduction on Mortgaged Home

In Frederick M. Wall v. Commissioner; T.C. Memo. 2012-169; No. 17209-09 (18 Jun 2012), the Tax Court determined that a façade easement on a mortgaged home would not qualify for a charitable deduction.

Mr. Wall owned a residence in the historic district of Evanston, Illinois.  On December 10, 2003, he granted the Landmarks Preservation Council of Illinois (LPCI) a conservation easement that protected the façade of his historic home.  Based upon an appraisal of the "before and after" value, he claimed a $400,000 non-cash charitable contribution on Form 8283.

The IRS disallowed the conservation deduction.  Under Reg.1.170A-14(g)(6), the charitable organization must be entitled to a share of proceeds if there is any subsequent sale, exchange or involuntary conversion.  While the agreement attempted to achieve this result, mortgage-holders Bank of America and First Bank & Trust both had first claim to insurance or condemnation proceeds.

Because LPCI may not receive any share of future proceeds after payments are made to one or both banks, the façade easement fails to comply with the requirement that it be enforceable in perpetuity.  The deduction was denied.

Façade Easement Percentage Method Permitted

In Huda T. Scheidelman v. Commissioner; No. 10-358 (15 Jun 2012), the 2nd Circuit reversed a Tax Court decision denying a charitable deduction for a façade easement with an appraisal based upon a percentage of value method.

Taxpayer Scheidelman granted a façade easement in her Brooklyn historic home to a qualified conservation nonprofit in 2003.  Appraiser Michael Drazner valued the initial property at $1,015,000.  He estimated an 11.33% reduction in value based upon various factors.  Because that discount produced a value after the easement of $900,000, Scheidelman reported a deductible gift of $115,000 on Form 8283.

The Tax Court determined that the use of a percentage deduction was not a qualified appraisal under Reg. 1.170A-13(c)(2) and denied the deduction.

The IRS maintained that a percentage method for the charitable deduction was merely a general guideline and not sufficient to meet the required standards for an appraisal.  However, the 2nd Circuit noted that a method could be "sloppy or inaccurate, or haphazardly applied - it remains a method."  Therefore, while the Service may not prefer the percentage reduction method, there was sufficient supporting data in the Drazner appraisal to determine that it could be an acceptable method.  The Circuit Court remanded the case to the Tax Court to determine whether or not the appraisal complied with other requirements, but permitted the use of the percentage reduction method.

An additional issue concerned the cash gift mandated by the conservation nonprofit.  The $9,275 additional charitable gift deduction was permitted because there was no "quid pro quo" involved.

Editor's Note: The IRS has won most of the percentage method façade appraisal cases.  It is important for all conservation easement appraisers to use an appropriate "before and after" method.

Regulations on Marital Portability

In T.D. 9593; 77 F.R. 36150-36163 and REG 141832-11; 77 F.R. 36229-36231 (17 Jun 2012), the IRS published temporary and proposed regulations on marital portability and the deceased spouse unused exclusion (DSUE).

During 2011 and 2012, Sec. 2010 permits "marital portability" that enables a deceased spouse to pass his or her unused applicable exclusion amount to a surviving spouse.  In Notice 2011-42, the IRS stated that an executor of the deceased spouse must file IRS Form 706 and elect marital portability.

In the temporary and proposed regulations, the IRS expanded on prior guidance.

Portability will require an IRS Form 706 that is timely filed and the executor must make the marital portability election.  The regulations state that valuation may be estimated for marital or charitable deduction property in the deceased spouse estate.  This will substantially simplify the Form 706 return for small and moderate estates.

The calculation of the DSUE under Sec. 2010(c)(4)(b) was initially stated in the statute to require use of the "basic exclusion," but the regulations clarify that the example in the accompanying legislative materials will be followed and will use the applicable exclusion amount.

There also are provisions that exclude gifts for which gift tax was paid in computing the DSUE.  If a spouse remarries and divorces, he or she will not lose the DSUE of the last deceased spouse.

Applicable Federal Rate of 1.2% for July -- Rev. Rul. 2012-20; 2012-27 IRB 1 (17 June 2012)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2012.  The AFR under Section 7520 for the month of July will be 1.2%.  The rates for June of 1.2% or May 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.