Washington Hotline – April 17, 2012

Tax Facts for Taxpayers

The Tax Foundation, a nonpartisan research organization, monitors the taxes paid by Americans each year.  On April 11, 2012, they released their report for the past year.  As Americans prepare to file before the April 17 deadline this year, many may be interested in the impact of taxes on their daily lives.

In tax year 2010, the total federal income taxes paid were $945 billion.  143 million families filed tax returns.  85 million paid taxes and 58 million were not required to make tax payments.  The taxpayers with more modest incomes received refundable credits of $105 billion.

The following table shows the income, effective tax rates and percent of the total tax paid by three groups of taxpayers.

Effective Tax Rates and Payments

Income Effective Tax Rate Percent of Taxes Paid
$0 – $50,000 3.5% 6.7%
$50,000 – $250,000 14.1% 47.6%
$250,000+ 23.4% 45.7%

About one-third of taxpayers chose to itemize deductions.  Twenty-five percent of taxpayers deducted mortgage interest and saved approximately $381 billion.  Charitable gifts were reported by 27% of taxpayers.  These gifts produced a tax savings of $158 billion.

The tax code continues to grow in size and complexity.  It now has expanded to 3.8 million words.  For the past decade, there has been an average of one change to the tax code every day.  What is the time required to complete taxes this year?  Over seven billion hours will be devoted to complying with the tax code.

Editor’s Note: There is great debate on many aspects of tax law.  However, there is a general agreement by Americans from all walks of life that a tax code with 3.8 million words is too long and too complicated.  When Congress turns its efforts toward major tax reform in 2013, it hopefully will be able to reduce the size and complexity.  By working diligently, perhaps Congress might be able to reduce the Internal Revenue Code to only 3.7 million words.

IRS Tweets as Some Taxpayers Extend

As the April 17 filing date approaches, taxpayers can receive the latest updates from the IRS through Twitter.  These Twitter notes are available on http://twitter.com/IRSnews.   If you have an Apple or Android smartphone, you may choose to load the free IRS2Go app.  It includes the handy “Where’s My Refund” function and also permits you to follow the IRS on Twitter.

Professionals may choose to follow specific tax advice for CPAs, attorneys and other tax preparers on http://twitter.com/IRStaxpros.

Many of the tweets offer explanations on how to pay taxes and some of the most common tax deductions and rules.

The IRS also has its own YouTube channel.  The official IRS YouTube channel includes five separate sections.  These cover “Tax Tips, Do Your Taxes for Free, Small Business, IRS Tax Pros and Uploaded Videos.”

If you need to extend, you may watch the YouTube video on filing IRS Form 4868.  Filing an extension requires you to estimate and pay your taxes, but you may delay filing until October 15.  The payment can be made through the Electronic Federal Tax Payment System (EFTPS) or by credit or debit card.

A few taxpayers are given special extensions.  Citizens outside the U.S. and military on duty outside America may file and pay on June 15.  They will need to pay interest from April 17 through June 15 on those payments.  Military serving in combat zones in Iraq or Afghanistan have 180 days after departing the combat zone to file and pay tax.  Finally, several Midwestern areas affected by the tornadoes and other natural disasters are permitted to file and pay on May 31.

Final Regulations on Charitable Lead Trust Income

In TD 9582, the Department of the Treasury published final regulations for the rules on charitable trust income distributions.

Generally, charitable lead trusts and other charitable trusts may make distributions of income to qualified exempt charities and are permitted charitable deductions under Sec. 642(c).  Some counsel have used ordering provisions for distribution of income to charities through charitable lead trusts in an effort to reduce the potential tax paid by the family members who eventually receive distribution of trust principal.

In Reg-101258-08, Treasury published proposed regulations on June 18, 2008 that indicated this ordering would not be respected for lead trusts because there was not “economic effect independent of income tax consequences.”  All distributions would follow the general provision under Subchapter J, Sec. 652(b) that the payments must come pro rata from all of the various classes of income.

Commentators observed that because there was an impact on the value of the trust remainder for the family beneficiaries, the IRS might consider this to be an independent economic effect.  Treasury rejected that argument, stating that the attempt to minimize liabilities of the remainder beneficiaries was not a present economic effect.  The annuity payment from a charitable lead annuity trust must be paid to the charity regardless of the ordering methods specified in the trust document.

A second commentator suggested that there is a public policy to encourage charitable giving and the ordering should be respected for these policy reasons.  However, Treasury determined that this general policy does not permit creation of a special rule for charitable lead trusts.

Therefore, Reg. 1.642 (c)-3(b)(2) states, “In the absence of such specific provisions in the governing instrument or in local law, the amount to which Section 642(c) applies is deemed to consist of the same proportion of each class of the items of the income or of the estate or trust as the total of each class bears to the total of all classes.”

An example states that a lead trust may include a provision that deems distributions to charity “to come first from ordinary income, second from short-term capital gain, third from 50% of the unrelated business income, fourth from long-term capital gain, fifth from the balance of unrelated business taxable, sixth from tax-exempt income and seventh from principal.”  The provision will not be respected under the regulation and all distributions will be “of the same proportion of each class of the items of income of the trust.”

In a second example, a trust pays all income to charity with remainder to a family member.  This allocation is permitted because the amount of income has direct economic effect.  It is not a fixed unitrust or annuity amount and therefore an allocation of all income is permitted.

Applicable Federal Rate of 1.4% for April – Rev. Rul. 2012-11; 2012-14 IRB 1 (16 Mar 2012)

The IRS has announced the Applicable Federal Rate (AFR) for April of 2012.  The AFR under Section 7520 for the month of April will be 1.4%.  The rates for March of 1.4% or February 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. Federal rates are available by clicking here.

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