Following the introduction of another deficit reduction plan this month by House Budget Chairman Paul Ryan (R-WI), there has been extensive bipartisan discussion of potential options for deficit reduction. On April 13, 2011, President Barack Obama spoke in Washington. He set forth a plan that is designed to reduce the deficit by $4 trillion over 12 years.
The Obama plan included several specific provisions. The plan components are as follows:
1. Deficit Reduction – $4 trillion over a period of 12 years in order to strengthen the economy and encourage employment.
2. Debt Trigger – If the national debt is not on a declining path, there would be automatic across-the-board spending reductions starting in 2014.
3. Spending Cuts and Tax Increases – There would be a balance between the reductions in spending and increases in taxes.
4. Shared Sacrifice – There would be budget cuts, but also increased taxes for upper-income Americans.
5. Bipartisan Commission – Vice President Biden would chair a commission with two appointed members from each committee. The commission would negotiate deficit reduction measures.
6. Medicare – The expenditure would be eventually limited to the growth in the economy per person plus 0.5% per year. There would be no block grants to states.
7. Income Tax Rates – The top tax brackets would increase to 36% and 39.6% for upper income taxpayers. Tax savings on itemized deductions for charitable gifts and mortgage interest would be limited to the savings of a taxpayer in the 28% bracket.
Several Washington organizations commented on the address by President Obama. Maya MacGuineas, President of the Committee for a Responsible Federal Budget, was pleased that “the President laid out a broad proposal for bringing down deficits and debt.” She noted that the President had officially joined the deficit discussion.
However, she also continued, “But the plan itself contains less in savings than the White House Fiscal Commission recommended, which we look at as the minimum of what is needed to reassure credit markets and get our debt levels back on track.”
Ms. MacGuineas thought that the “trigger mechanism to help enforce a declining debt path” was a good concept. She believes that Congress needs to be aggressive in acting. She concludes, “The luxury of time is not on our side.”
Both Parties Join Budget Debate
Following the speech by President Obama on deficit reduction, there was a lively bipartisan debate in Washington.
Senate Majority Leader Harry Reid (D-NV) supported the President. He noted, “We believe that the responsible approach is to make sure the wealthiest Americans contribute their fair share as we try to bring our fiscal situation back into balance.”
Senator Reid promptly appointed the two members of the Fiscal Commission to be chaired by Vice President Biden. His appointments are Sen. Daniel Inouye (D-HI), Chairman of the Senate Appropriations Committee, and Sen. Max Baucus (D-MT), Chairman of the Senate Finance Committee.
Sen. Mitch McConnell, the Minority Leader, held a rather different perspective. He stated, “From my point of view, taxes are not on the table, because we don’t have a revenue problem. We have a spending problem.” Sen. McConnell continues to support the budget reductions that are under discussion as the House Budget Committee votes on the deficit plan by Rep. Paul Ryan.
A group of three Democratic and three Republican Senators continue to develop a bipartisan plan that they will soon introduce in the Senate. The “Gang of Six” Senators claim their plan will be quite similar to the proposal by the President’s Fiscal Commission.
Editor’s Note: Your editor and this organization do not take specific positions on any of the above comments. This information is offered as a service to our readers because the deficit solution will have great impact on both your taxes and benefits in the future.
Einstein Quote on Tax Code Complexity
At an April 13 hearing on the tax code before the Ways and Means Committee, witnesses noted that there is a general consensus on the complexity of the tax code.
One witness quoted Albert Einstein, recipient of 1921 Nobel Prize in Physics. While he was the world expert on the Theory of Relativity, Mr. Einstein also commented that “the hardest thing in the world is to understand the income tax.”
At the hearing, Chairman Dave Camp (R-MI) noted there are “nearly 4,500 changes in the last decade – 579 of them in 2010 alone – the code is too complex.” Other representatives and witnesses agreed that the sheer size and complexity of the Internal Revenue Code make compliance very challenging.
Annette Nellen represented the American Institute of Certified Public Accountants in the hearing. She indicated that there are five specific steps that could be taken to substantially reduce the complexity and cost of complying with the code. These include the following actions.
1. Higher Education Deductions and Credits – Reduce the Hope Credit, American Opportunity Credit, Lifetime Learning Credit, the tuition and fees deduction and other benefits into one simple credit.
2. Education Phase Out – Create one definition for qualified education expenses and eliminate the multiple phase outs under the current system.
3. Kiddie Tax – For children with unearned income under age 18 or students under age 24, simplify the current method where they pay tax at their parents’ rate.
4. Mileage Rates – Create the same mileage rate for business purposes, medical purposes and qualified charitable travel.
5. Alternative Minimum Tax – Repeal the tax because it is too complicated to modify.
Financial Planner Mark Johannessen is a CFP and Managing Director of a McLean, Virginia financial firm. He was President of the Financial Planning Association in 2008 and suggested that there are a number of Internal Revenue Code issues that make financial planning difficult.
First, there are temporary provisions. For example, the 2011 tax rate on dividends is 15%, but the scheduled tax rate on dividends in 2013 is 43.4%. While it’s possible that Congress could change the law between now and 2013, it makes investment planning very difficult.
Second, many changes are temporary and Congress tends to act very late in the year. Congress passed the IRA Charitable Rollover for 2010 on December 17. By that date, most individuals had already taken their required minimum distribution. Johannessen indicated that the late date “negatively impacted both the individuals’ planned charitable giving” and also the charities who received fewer gifts.
Third, the uncertainty in estate tax law continues to make planning quite difficult. While the current exemption is $5 million and there now is portability for couples, the current law only applies for 2011 and 2012. To do good planning, it is essential to know what the law will be in future years.
Facade Easement Deduction Denied on NYC Townhouse
In 1982 East LLC et al. v. Commissioner; T.C. Memo. 2011-84; No. 30052-08 (12 Apr 2011), the Tax Court determined that a limited liability company would not receive a charitable deduction for the grant of a facade easement.
Solomon D. Asser is the tax matters partner for a New York City LLC that acquired real estate at 19 East 82nd Street in New York City. In 2002 the LLC acquired the five story townhouse with approximately 10,375 square feet.
The LLC planned to renovate the property and convert it into a single dwelling. After making a down payment of $2 million in cash and then eventually acquiring a $9.35 million mortgage with First Republic Bank, the LLC proceeded to renovate the property.
The property is within the New York Metropolitan Museum Historic District. Because it is in the Special Madison Avenue Preservation District, it is subject to specific New York City landmark and zoning laws.
Mr. Asser was contacted by the National Architectural Trust (NAT) and, following extensive discussions, the LLC decided to grant a facade easement to NAT. There was an initial appraisal on June 7, 2004 and the facade easement transaction was completed on December 30, 2004.
The deed of easement granted NAT the right to enforce a “Protected Facade” easement and also relinquished rights for upper level development (UDRs).
Under the easement, First Republic Bank subordinated its rights in the subject property to NAT in order to permit the charity to enforce the conservation easement. However, the lender agreement also granted First Republic Bank a “prior claim to all insurance proceeds” and the right to take “title to the property by foreclosure.”
An appraisal was obtained from a qualified appraiser on February 8, 2005. The facade easement was valued at $2,690,000 and the relinquishment of UDRs was valued at $3,880,000 for a total of $6,570,000. The LLC filed the tax return for 2004 and allocated the deduction to the respective partners.
The IRS audited the partnership tax return and denied the charitable deduction. While the IRS acknowledged that under Sec. 170(h)(1) there was a “qualified real property interest” and a “qualified organization,” the IRS claimed that the facade easement failed the “exclusively for conservation purposes” requirement. In the event of a foreclosure by First Republic Bank, then the facade easement would not be protected in perpetuity. Therefore, the facade easement fails the “exclusive” test and there is no charitable deduction.
The court noted that Congress had specifically required a perpetual easement with “legally and enforceable restrictions on the interest in the property.” In Reg. 1.70A-14(g)(2), the IRS explained the relationship that could still be permitted with a mortgage. Under that regulation, “the mortgagee must subordinate its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.” Because the First Republic Bank right was prior and it could foreclose on the property, the facade easement failed this test.
In addition, Sec. 170(h)(4)(A)(iv) requires that a facade easement preserve a historically important land area. Because this property was within the Metropolitan Museum Historic District, it could not be altered without permission of the appropriate New York body. Therefore, the facade easement was not effective because the New York City rules would require the owners to “preserve the subject property.” The deduction failed to qualify because the property was protected by New York law and the easement added no further restrictions.
Because Mr. Asser reasonably relied on professional advisors and demonstrated good faith in his efforts to comply with the law, there was no accuracy-related penalty under Sec. 6662(a).
Applicable Federal Rate of 3.0% for April – Rev. Rul. 2011-10; 2011-14 IRB 1 (17 Mar 2011)
The IRS has announced the Applicable Federal Rate (AFR) for April of 2011. The AFR under Sec. 7520 for the month of April will be 3.0%. The rates for March of 3.0% or February of 2.8% 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 2011, pooled income funds in existence less than three tax years must use a 2.8% deemed rate of return. Federal rates are available by clicking here.