Washington Hotline – April – Week 2 – 2012

Tax Freedom Day is April 17

Each year, The Tax Foundation publishes the “Tax Freedom Day.”   For this year, Tax Freedom Day will be on April 17.

Based on averages of incomes and taxes, Americans will work 107 days from January 1 to April 17 to pay the combined 29.2% tax bill for federal, state and local taxes.  If the budget deficit amount were paid for through taxes, Tax Freedom Day would be extended to May 14, an additional 27 days.

Tax Freedom Day has typically arrived earlier during the past five years.  The latest Tax Freedom Day was May 1, 2000, when the total tax revenue was 33%.  Generally, because of the downturn in the economy and reductions in the stimulus bill enacted in 2008, Tax Freedom Day has come earlier during the past four years.

Several states collect lower taxes and have an earlier Tax Freedom Day.  These states’ Tax Freedom Day include Tennessee on March 31, Louisiana and Mississippi on April 1 and South Carolina on April 3.

The highest tax state is Connecticut, with Tax Freedom Day on May 5.  However, New Jersey and New York both celebrate Tax Freedom Day on May 1.

The Tax Foundation also estimates the number of days that you work to pay taxes in these separate categories.

Tax Category Days
Federal Income 32
State/Local Income 8
Fed. Social Insurance 23
State Social Insurance 1
Fed. Sales 2
State Sales 12
Property Taxes 12
Fed. Corporation 9
Other Fed. 3
State Corporation 1
Other State 4

Editor’s Note: The Tax Foundation publishes these calculations each year.  They are based on overall tax payment averages.  Other publications have observed that the dates would change if the numbers were calculated based upon taxpayer income tiers.  However, no other publication calculates Tax Freedom Days for low-income, mid income and high-income taxpayers.

IRS Help for Last-Minute Tax Filing

The IRS published information letters this week to assist taxpayers who are filing their taxes before the April 17, 2012 deadline.

The IRS YouTube channel is the fourth most popular government channel.  It receives about 1 million views per year.  Taxpayers may find several YouTube programs helpful.  They are available in English, Spanish and American Sign Language.

IRS YouTube Programs

  • Need more time to file your tax return?
  • Last-Minute Tax Tips
  • IRS Tax Payment Options
  • Owe Taxes but can’t pay?
  • When will I get my refund?

The IRS YouTube videos are also available on iPhone or Android through the IRS2Go application that may be downloaded through the App Store or Android Marketplace.

For individuals who need extra time to file, it is possible to request an extension with Form 4868 (either electronically or by paper).  This extension filing requires that you estimate and pay the correct tax, but your time to file is extended to October 15th.

If you do not pay the correct tax, there is interest of 3% per year and a late penalty of 0.5% per month on the balance.

There are three exceptions to the filing date.  If you live and work abroad or are on military duty outside the U.S., you may pay on April 17 and file by June 15.  Military members serving in Iraq or Afghanistan may file 180 days after departing the combat zone.  Finally, several federal disaster areas in the Midwest are permitted to file and pay on May 31.

Some taxpayers may need more time to pay.  If your tax, penalties and interest are $50,000 or less, you may request a payment agreement from the IRS with Form 9465-FS.  If you are unemployed or self-employed with a 25% reduction in income for 2011, you may file Form 1127-A to request permission to pay by October 15, 2012.  You still must pay the tax plus interest at that time.  Finally, if you have a substantial overdue tax obligation, you may be able to negotiate an “offer-in-compromise” with the IRS.  This will require the IRS to review all of your income and assets to make a determination as to the correct tax payment.

Mortgaged Land – Conservation Easement Deduction Denied

In Ramona L. Mitchell v. Commissioner; 138 T.C. No. 16; No. 10891-10 (3 Apr 2012), the Tax Court denied a conservation easement charitable deduction due to a mortgage on the property with no subordination agreement.

Charles and Ramona Mitchell bought 105 acres in the Mancos Valley of Southern Colorado in 1998.  Their son Blake and his wife Melody built a home on that parcel in 2000.  During 2000, Charles and Ramona purchased the remaining 351 acres in the parcel from owner Clyde Sheek.  The property was purchased on a land contract with $83,000 down and 10 payments of $60,000 per year plus interest.

The Mitchells then owned a full 456 acre parcel adjacent to Mesa Verde National Park.  Charles and Ramona also built a home on the ranch.

In December of 2002, they transferred the property to the C.L. Mitchell Properties, L.L.L.P., a family limited partnership (MFLP).  On December 31, 2003, MFLP deeded a conservation easement on the south 180 acres to the Montezuma Land Conservancy.  On December 22, 2005, Clyde Sheek signed a subordination agreement.  In 2006, Charles passed away and Ramona gained sole title to the property.

Following the 2003 MFLP deed for the conservation easement, the Mitchells hired William B. Love Appraisals, Inc. to value that easement.  Love placed a market value on the conservation easement of $504,000.  The Mitchells claimed that deduction on their 2003 and 2004 tax returns.

The IRS issued a notice of deficiency on February 23, 2010 and disallowed the 2003 deduction.  Alternatively, the IRS determined that the value of the deduction should be reduced to $100,100.

The Court noted that there are three requirements for a conservation easement charitable deduction.  The qualified real property must be given to a qualified organization exclusively for conservation purposes.  The IRS agreed that the property was a qualified interest and that Montezuma Land Conservancy was a qualified charity.  It disputed that the gift was exclusively for charitable purposes.

Sec. 170(h)(5)(a) indicates that the deduction is only qualified if the property is “protected in perpetuity.”  Reg. 1.170A-14(g)(2) states that if there is a mortgage on the property, the mortgagee must agree to “subordinate its rights in the property to the right of the” charitable conservation organization.  Subparagraph (g)(3) of that section also creates a “so remote as to be negligible” test for easements.

The IRS contended that the subordination agreement on December 22, 2005 did not save the charitable deduction for the deed on December 31, 2003.

The taxpayer claimed that the subordination agreement was sufficient because all of the payments had been made in the intervening period.  Second, the taxpayer observed that the “so remote as to be negligible” test was met because there was minimal risk of default.

The court determined that the subsequent subordination agreement was not sufficient to qualify for a charitable deduction.  Because there could have been a default and failure of the conservation easement interest during the nearly two years from the date of the deed to the subordination agreement, the easement did not qualify.  A subordination agreement must be effective as of the date of the conservation easement deed.

Second, the Court determined that the “so remote as to be negligible” standard did not apply to the subordination agreement.  Because a conservation easement frequently involves potential issues with respect to property and the possible termination of existence of the conservation organization, the statute drafters needed to create a standard that did not require certainty with respect to all issues.  However, the “so remote as to be negligible” standard is not to be applied to the subordination agreement.  Therefore, the conservation easement charitable deduction fails.

Finally, because Ramona Mitchell acted with reasonable cause and in good faith, the Sec. 6662(a) penalty is not applicable.

No Attorney Fees to Estate

In Estate of Antonio J. Palumbo et al. v. United States; No. 11-2371 (2 Apr 2012), the 3rd Circuit of the United States Court of Appeals determined that an estate with remainder to be transferred entirely to a charitable trust did not qualify for recovery of attorneys’ fees.

Decedent Antonio Palumbo created a charitable trust in 1974.  His various wills transferred the residue of his estate to the charitable trust, with the exception of the last will executed on July 6, 1999.  That document failed to include a provision for distribution of the residue to the charitable trust.  It subsequently was determined that the omission of the residuary provision to the charitable trust was a scrivener’s error.  Following the death of Palumbo in 2002, his son contested the will and claimed to be the beneficiary of the estate residue.  The son and the executor reached a settlement for payment of $5.6 million to the son.  This amount was exclusive of costs and taxes, which were to be paid from the residue.  The balance of the residue was transferred to the charitable trust.

The IRS contested the charitable deduction for the $11,721,141 transferred to the charitable trust because it was subject to the settlement.  Following litigation in the United States District Court for the Western District of Pennsylvania, the estate charitable deduction was deemed qualified under Sec. 2055.  However, the district court judge ruled that the IRS position was “substantially justified” and did not grant attorneys’ fees to the estate.  The estate appealed.

The 3rd Circuit noted that the payment of fees to the prevailing party under Sec. 7430(c)(4) is permitted when the taxpayer has substantially prevailed and the estate does not meet the net worth restrictions of the Equal Access to Justice Act (EAJA).  The applicable limit for net worth under the combined provisions is $2 million, and the Palumbo estate clearly exceeded that amount.

However, the estate claimed that since the charitable trust was the sole recipient of the estate and would bear the cost of attorney’s fees, the exception to the net worth requirements for charitable trusts should apply.

The Court noted that it is bound by the plain language of the statute.  In this case, the estate was legally responsible for payment of the taxes.  In addition, the agreement with the Palumbo son indicated that “the residuary estate will be solely responsible for payment of all inheritance in estate taxes.”

While the charitable trust would suffer an “indirect pecuniary consequence” due to payment of fees from the estate, it is not the real party in interest.  There is no language in the statute that permits the court to “look through” the will to the charitable trust as final beneficiary.  While the charitable trust will be impacted, it is not legally responsible.  Therefore, the attorney fee recovery was denied.

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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