Oil Company Tax Increase to Clean Up Gulf Oil Spill
The oil spill from the Deepwater Horizon rig in the Gulf of Mexico continues to put the Gulf Coast economy at risk. As a result, President Obama this week sent a letter to Speaker Nancy Pelosi (D-CA) and proposed an increase in the excise tax on oil.
The current tax per barrel is eight cents. This excise tax is allocated to the Oil Spill Liability Trust Fund. President Obama proposes increasing the tax to nine cents per barrel in 2010 and 10 cents per barrel in 2017.
President Obama stated, “It’s absolutely essential that going forward we put in place every necessary safeguard and protection so that a tragedy like this oil spill does not happen again.” He also indicated that the government would seek to require British Petroleum (BP), the operator of the Deepwater Horizon oil rig, to pay for the massive cleanup.
At a hearing this week before a congressional committee, BP, oil rig operator Transocean and equipment provider Haliburton all testified. The three companies all blamed the other company for the spill.
While BP claimed that the spill was 5,000 barrels per day, Purdue University Professor Steve Wereley indicated that his scientific analysis suggested the leak could be closer to 70,000 barrels per day.
British Petroleum is attempting to insert a tube into the ruptured pipe to stop the leak. The previous effort to place a four story dome on the leak was not successful. With an estimated recovery and cleanup cost of $3 billion, BP is attempting to finally cap the leak and end an environmental and public relations disaster.
Slow, Steady Progress on Estate Tax and Extenders
Senate Finance Chair Max Baucus (D-MT) has been in intensive negotiations with Sen. Jon Kyl (R-AZ) and Sen. Blanche Lincoln (D-AR) over the estate tax. Sen. Kyl and Sen. Lincoln have proposed increasing the $3.5 million exemption that was applicable in 2009 to $5 million per person. In addition, the previous estate tax rate of 45% would be reduced to 35%.
Negotiations have been ongoing for several weeks. On May 11, 2010, Sen. Kyl reported, “We have an agreement about how we would like to move forward and an agreement on many of the offsets.” He continued by observing that the offsets are still subject to discussion. It is estimated that the offsets will be from $60 billion to $80 billion.
While the details of the proposed compromise have not been released, several aides suggested that it may include an estate tax option in 2010. If the option is enacted, estate planners could choose either the repeal of estate tax and lose part of the step-up in basis under the 2010 rules or select the new compromise estate exemption and estate tax rate.
It may occur that the tax extenders and the estate tax are combined in one legislative bill. Senate Budget Chair Kent Conrad (D-ND) observed this week, “You have got 13 legislative weeks. It seems to me it would be wise to put all the tax measures together.”
The House proposal for the offsets for the tax extenders (including the IRA charitable rollover) is to change the “carried interests” of hedge fund managers from being taxed at capital gain rates to ordinary rates. It now is possible that the change in the law will occur, but it may be phased in over a number of years.
Editor’s Note: The Senate continues to attempt to complete work on the estate tax and the tax extenders by early June. The estate planning community and the charitable community are both hopeful that the Senate will resolve the current great uncertainty in planning by passing compromise legislation in both areas.
Fortunate Heir Avoids Estate Tax
In Estate of Robert C. Fortunato et al. v. Commissioner; T.C. Memo. 2010-105; No. 6937-07 (11 May 2010), the court determined that decedent did not own the companies that the IRS claimed he possessed. As a result, the IRS deficiency of $11,662,737 and the Sec. 6663 fraud penalty of $8,649,140 were not applicable.
Robert Fortunato was the third of seven children. His brother Anthony was the youngest son. Robert was convicted of robbery in 1962 in New Jersey and served six years in Sing Sing Prison. Following his release, he worked with other family members and was a co-owner and President of Container Overseas in New Jersey. Container Overseas failed in 1984. Robert owed $490,000 to the IRS for employment taxes that had not been properly remitted and also had debts of several hundred thousand dollars to other creditors.
His younger brother Anthony started St. George Warehousing (“St. George”) in New Jersey in 1984. Between 1984 and 2002 they experienced many challenges, but eventually Robert moved to California and started the California and Georgia sections of the warehouse and export company. They also started a trucking company to ship materials between their locations.
Robert was the principal manager and clearly had excellent business skills. He served without owning any stock in the companies because the brothers were concerned about his IRS liens and other creditors. In addition, with his previous felony conviction there was concern that the business image of the company would be harmed if he were an owner. However, Robert did have complete control of the employees, the finances and the business strategy.
In 2001, Anthony discussed sale of the business. Robert was opposed to the sale. Potential purchaser Edward O’Donnell made an oral offer of $30 million that was contingent upon Robert remaining and operating the company. However, on November 4, 2002, Robert passed away.
Under his will, which was unsuccessfully contested by his estranged daughter, Robert’s brother Anthony was his sole heir. The IRS audited the estate, claimed that Robert was entitled to 50% ownership in St. George and assessed tax and penalties of approximately $20 million.
The court noted that Robert did not own stock. It was probable that because of his felony conviction and tax liens that the brothers decided he would not be a formal owner. In response to the claim that Robert had a “beneficial interest” because he controlled business strategy, managed the employees and had complete control of the finances, the court observed that the state law of New Jersey, California and Georgia recognized an ownership in a corporation based upon actual possession of stock certificates.
In response to an IRS claim that he had a “right to stock” that he could exercise at anytime, the court observed that the shareholder must have the intent to acquire stock plus take some action to effectuate that intent. Because Robert had no spouse and was estranged from his children, he did not need to acquire the stock. Robert served as President and yet was an employee, with no indication of intent to acquire stock. Therefore, because property rights are determined under state law, Robert was deemed to hold no stock and the $20 million in estate tax and penalties were not applicable.
Hawaii QPRT Gifts Close to IRS Value
In Andrew K. Ludwick et ux. v. Commissioner; T.C. Memo. 2010-104; Nos. 3281-08, 3282-08 (9 May 2010), the Tax Court essentially accepted the IRS valuation for gifts to two qualified personal residence trusts (QPRTs).
Andrew K. and Worth Z. Ludwick purchased land on the Big Island of Hawaii in 2000. Two years later they built a home on that property. In 2005, their home was valued at $7.25 million. Both transferred their respective one-half interests in the property to QPRTs.
Based on the appraised valuation of their expert Carsten Hoffman, they claimed a 30% discount and valued each interest at $2,537,500. The IRS audited their Form 709 Federal Gift Tax Returns and claimed that the discount should be only 15%, with a gift amount of $3,081,250. On brief, the IRS reduced the discount to 11% and valued the each transfer at $3,226,250.
The court reviewed the battle of the appraisers. IRS appraiser Steven Bethel noted that under Hawaii law, a purchaser is permitted to force a partition. Because the co-owner could force a partition, the reduction in value is determined under a formula that reflects that potential partition. The court determined that the reduction in value would be the fair market value less costs, and would reflect the length of time for the partition and the likelihood of partition.
Based on the claims of both parties, the court determined that the appropriate valuation should use a 10% discount rate, a partition period of two years, annual operating costs for each half of $175,000, and partition costs of $36,250 for each of the two years. Finally, the court determined that there was a 10% probability that partition would be required and a 90% probability that partition would not be required.
Based on all of these factors, the court then calculated the value of the property for both the “no partition” and the “partition is necessary” options. Based on the assumption that there was a 10% probability of partition, each gift value was determined to be $3,000,089.
Editor’s Note: This case is a very good indication of the detailed analyses that are made with valuations. The court ended up accepting most of the IRS position, but was required to make numerous assumptions. In particular, the 10% probability of partition is a very arbitrarily chosen number and yet essential for the calculation.