Washington Hotline – April – Week 4 – 2011

President Obama’s Tax Return
Each April the President and Vice President release their tax returns. President and Michelle Obama filed a joint return for 2010. With the Presidential salary and approximately $1.38 million in book royalties, their total income was $1.8 million.

The President created a Simplified Employee Pension account and funded that with $49,000 from his book royalties. President and Mrs. Obama’s itemized deductions totaled $373,289. The majority of the itemized deductions were charitable gifts totaling $245,075.

The major charitable gift was $131,075 transferred to the Fisher House Foundation. This foundation maintains residential facilities and provides free or low-cost housing to families of veterans who are receiving treatment at VA Medical Centers.

President and Mrs. Obama also made a $10,000 gift to the Boys and Girls Club of America and a $15,000 gift to the Clinton-Bush Haiti Fund.

Vice President and Mrs. Biden also released their 2010 tax returns. Their income was from his Vice Presidential salary, the teaching appointment of Dr. Jill Biden at an area college, a pension and Social Security.

With an adjusted gross income of $379,179, their itemized deductions were $67,038. Most of the itemized deductions were taxes and mortgage interest. Their charitable gifts were $5,350.

Five separate gifts totaling $950 were transfers of clothing to Good Will. There was a $1,400 gift to the Northern Virginia Community College where Mrs. Biden is an adjunct professor of English. They also made a gift of $1,000 to Westminster Presbyterian Church.

E-Filing Passes 100 Million Returns

The IRS reported a surge of e-Filing the past weekend just before the tax deadline. With all of the latest returns that have been filed electronically, the IRS reported that 101 million taxpayers now used the e-Filing system resulting in 8.8% growth this year.

The IRS noted that some taxpayers have filed for the automatic six-month extension and will need to complete their tax returns by October of 2011. The IRS will continue to permit e-Filing of returns that are on a proper extension.

The movement toward e-Filing reflects a general increase in Internet use in America. The Pew Research Center studies the movement of Americans to the Internet. The latest statistics show that 80% of all Americans are using the Internet. Over 60% of those users now have broadband at home.

The Pew Internet surveys also give details about online Internet usage. Over 95% of those ages 18 to 29 use the Internet. For age 30-49, the percentage is 87%. Baby boomers age 50-64 are at 78%. Finally, 42% of those over age 65 use the Internet.

As might be expected, individuals with moderate and higher incomes are more likely to use the Internet. Over 90% of those with incomes of $50,000 are now using the Internet. College graduates use the Internet at a 96% rate. Finally the increase in e-Filing is also reflected by a movement to online banking and online giving. Total online giving in 2010 increased to nearly 8% of all charitable gifts.

Unseen Art Gift Deductions Limited

In Joseph B. Williams III v. Commissioner; T.C. Memo. 2011-89; No. 2202-08 (21 Apr 2011), the court upheld an IRS assessment against an individual who had unreported overseas income and gifts of appreciated art.

Joseph Williams was employed by Mobil Oil from 1993 to 1998, the tax years in question. He also engaged in a side business as an oil industry consultant to a number of the former Soviet Republics. Without disclosure to Mobil Oil, he pursued various business transactions. Through this consulting, he received $8.86 million in compensation between 1993 and 2000. All payments were transferred to a Swiss bank account. In 1993, Mr. Williams had created a corporation called “ALQI” in the British Virgin Islands. ALQI created a Swiss bank account that received the consulting payments.

Various personal and business expenses were paid from this bank account during these years. Mr. Williams did not report the consulting income on his tax returns.

Subsequently, Mr. Williams was audited and the IRS accessed deficiencies and penalties for the unreported income. He also was the subject of a criminal action by Treasury in 2003 and convicted of tax evasion. He was sentenced to 46 months incarceration.

In 1996, Mr. Williams contacted Abby Art Consultants, Inc. (“Abby”), a corporation in New York City. Following negotiations, Mr. Williams and Abby signed an agreement. He agreed to purchase art that could later be gifted to charity. Williams made an initial payment of $3,600 and agreed to purchase art at a rate equal to 24% of fair market value.

The anticipated first year total payment would be $72,000 for art worth approximately four times that amount. Mr. Williams would pay the balance of the amount due when Abby had received the art. He could then either take possession of the art or direct its donation to an appropriate charitable organization. Abby agreed to obtain an appraisal with the valuation approximately four times the amount that Mr. Williams was to pay for the art items.

In late 1997, Abby acquired art with a valuation of $425,625. Mr. Williams paid $98,400, for a total payment of $102,000 which represented 24% of the claimed fair market value. On December 23, 1997, Mr. Williams signed a deed of gift and transferred the art to a university.

In late 1999, Abby acquired art valued at $250,825. Mr. Williams paid $57,500. On December 21, 1999, he signed a deed of gift to transfer that art to a second university.

In late 2000, Abby acquired art with a value of $102,825. Mr. Williams wrote a check for $4,600 and a second check for $17,158 to Abby. That art was transferred to a third charity with a deed of gift on December 15, 2000.

The IRS accessed a deficiency for the full amount of the unreported overseas consulting income. In addition, it denied the charitable deduction, with the exception of the basis in the art. The IRS also accessed an accuracy penalty for the excessive charitable deduction.

The court initially considered the IRS claim on consulting income. Mr. Williams claimed that ALQI was a valid foreign corporation and, therefore, that he was taxable only on the interest on the $8.86 million and not on the full amount of the consulting income. However, the court determined that ALQI was merely the “receptacle into which Mr. Williams diverted his consulting income” and he was therefore taxable on the full amount.

With respect to the charitable gifts, Mr. Williams indicated that he had committed to making purchases of the approximately $800,000 in claimed fair market value for the art that Abby acquired over the next four years. Because he had committed to that acquisition, the acquisition date should relate back to the 1996 contract for purchase.

The IRS noted that charitable deductions for appreciated property are limited under Sec. 170(e)(1)(A) to fair market value for assets that have been held for over one year (long-term capital gain). Because he did not own the assets for the required holding period, Mr. Williams qualified only for a deduction for cost basis. He also should be required to pay the Sec. 6662(a) accuracy penalty.

The court reviewed the basic requirements for long-term capital gain status. Under the agreement with Abby, Mr. Williams had the option, but not the obligation, to purchase art. As a result, he owned an option to buy art. When the option was exercised by the actual acquisition of art, the holding period then commenced. It appears that the art was purchased by Abby and then held in the New York warehouse with no personal viewing at any time by Mr. Williams. He merely made payment for the 24% of fair market value. The art was then promptly given to a charitable organization.

Because Mr. Williams had acquired an option to purchase additional art for $3,600, the holding periods for the art in 1997, 1999 and 2000 were less than one year. Therefore, his deductions were limited to cost basis.

The Sec. 6662(a) penalty applies if the transaction in the view of a reasonable person is “too good to be true.” Because the implausible plan was to purchase art for 24% of the claimed value and quickly give it to a qualified charity, the accuracy penalty applied.

Editor’s Note: This and similar appreciated art cases have led to much more restrictive rules on these gifts. For gifts of art, there must now be a qualified appraiser with certification or two years of college level courses in the type of art gifted. The appraiser is now potentially subject to personal penalties. If the claimed deduction is over $20,000, the appraisal and a photo or colored transparency must be attached to the return. There are quite restrictive rules on gifts of partial interests of art. Finally, the IRS Art Advisory Panel meets periodically to review and value art gifts. The Advisory Panel values gifts for both gift and income tax deduction purposes, without knowing which type of gift is involved. Its valuations are deemed quite objective by courts.

Primer on Charitable Deductions Substantiation

In Bridgett Jeanette Bell v. Commissioner; T.C. Summ. Op. 2011-54; No. 8048-08S (17 Apr 2011), the Tax Court in a summary opinion denied several charitable deductions, but permitted some on the basis that there was sufficient substantiation.

In 2001 Ms. Bell organized the Holistic Opportunities for Mental Empowerment (HOME), a qualified Sec. 501(c)(3) organization. The five member Board of Directors included her mother, another family member and two other individuals. During 2004, HOME conducted literacy classes at Good Shepherd Missionary Baptist Church (Good Shepherd) in Houston, Texas. The programs were conducted by volunteers from the church.

Good Shepherd owned a house on the adjacent property and desired to remove the house and use the property for a parking lot. Ms. Bell determined that it would be beneficial to move the home to a lot in Cleveland, Texas, a town approximately 50 miles away. Following the moving of the home and expending funds for repairs and renovations after it had been transported to Cleveland, Ms. Bell filed her 2004 Federal Tax Return. She claimed charitable contribution deductions of $37,274. These deductions included cash donations to Good Shepherd or to HOME. The IRS did not dispute those gifts. There also was a claimed deduction for the value of the lot in Cleveland, the cost of moving the relocated house, the cost of repairing and renovating the house, travel expenses for various conferences and cell phone expenses.

The IRS denied deduction for all of the claimed gifts except the cash contributions, citing insufficient substantiation.

Ms. Bell claimed that the lot and the home with improvements in Cleveland had been transferred to HOME during 2004. However, she was unable to produce a recorded deed or even the original warranty deed for the transfer. The court noted that a transfer under Texas law requires delivery of the deed. Because Ms. Bell was unable to show the delivery, the claimed deduction for the lot was denied.

The expense for removing and renovating the home could be determined to be an unreimbursed expenditure that would benefit Good Shepherd Church. Good Shepherd would have had to pay the expense of tearing down the building in order to construct the parking lot. While the cost of the residence and renovations were not deductible as a gift to HOME, they were deemed deductible to the extent that they saved Good Shepherd the cost of razing the property.

Travel related expenses are a charitable deduction under Reg.1.170(A-1)(g). The deductions must be “away from home” and there can be no significant element of personal pleasure or gratification on the trip. Because the taxpayer demonstrated that these trips were for appropriate conventions, board meetings and conferences, they were permitted.

Office supplies purchased for the literary program are permitted as deductions if substantiated. The receipts and cancelled checks for these items were sufficient.

However, a cell phone can be deducted only under Sec. 280(F)(d)(4)(A)(v) because Ms. Bell did not have a detailed list of business use and an allocation between personal use and business use, that deduction was denied.

Applicable Federal Rate of 3.0% for May — Rev. Rul. 2011-11; 2011-19 IRB 1 (18 Apr 2011)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2011. The AFR under Section 7520 for the month of May will be 3.0%. The rates for April of 3.0% or March of 3.0% 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.

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