Washington Hotline – February – Week 2 – 2011

Fed Chair Bernanke Defends Bond Purchases
Federal Reserve Chair Ben Bernanke appeared on February 9 before the House Budget Committee. He defended the plan by the Federal Reserve to purchase another $600 billion of government bonds. This would bring the total holdings of the Federal Reserve to approximately $2.6 trillion. Previously, the Federal Reserve lowered interest rates close to zero and purchased $1 trillion of bonds to support the financial markets.

Chairman Bernanke pointed to four factors that in his view justified the additional bond purchases. First, the unemployment level continues to be approximately 9%. Second, he expects unemployment to remain high and inflation to remain low “for some time.”

Third, it is likely the federal funds rate will remain quite low as long as there is high unemployment and low inflation.

Fourth, the initial purchase of $1 trillion of bonds and the proposed additional $600 billion bond purchase are both appropriate and manageable. He suggests that there will be opportunity “to tighten monetary policy when needed.” The Federal Reserve has sufficient capability to sell the bonds and reduce its holdings as needed.

Chairman Bernanke also addressed fiscal policy. He noted that it is important “to put the budget on a sustainable trajectory.” Chairman Bernanke spoke approvingly of the plans advocated by the National Commission on Fiscal Responsibility and Reform. He suggested that there is now a “much-needed conversation” on the deficit.

House Budget Chair Paul Ryan (R-WI) agreed that it is important to address the deficit. He observed that the projected $1.5 trillion deficit this year would increase the publicly-held debt. That public debt was 40% of the economy in 2008 and will rise to 69% of the economy by the end of the year.

Chairman Ryan stated, “Endless borrowing is not a strategy. We must restore the foundations of economic growth – low taxes, spending restraint, reasonable regulations and sound money – to help restart the engines of economic growth and job creation.”

The Ranking Member of the House Budget Committee is Rep. Chris Van Hollen (D-MD). He indicated to Chairman Bernanke, “I commend you and your colleagues at the Fed for using various forms of monetary policy to promote maximum employment and stable prices.”

However, Rep. Van Hollen also agreed that it is important to create “a responsible plan to bring down and then eliminate the primary budget deficit.”

CBO Director Elmendorf Discusses Budget Deficits

On February 10 the House Budget Committee held a hearing and Congressional Budget Office (CBO) Director Douglas Elmendorf discussed the federal budget deficit. Director Elmendorf emphasized the importance of addressing the deficit and also noted that the Fiscal Commission recommendations are a useful addition to the current discussion.

Chairman Paul Ryan noted that there still is a major problem with unemployment. According to Chairman Ryan, the recession ended in June of 2009 and between that time and December of 2010, “payroll employment rose by a mere 6/100 of 1% (0.06%).”

Chairman Ryan noted that it is essential to restore growth in America. He advocated “low taxes, reasonable regulations sound money and spending restraint.”

Ranking Member Chris Van Hollen (D-MD) also responded to Director Elmendorf. He indicated a willingness to address the deficit. Rep. Van Hollen suggested that “Democrats and Republicans must work together now to put our nation on a fiscally sustainable path and we stand ready to do that.”

However, Rep. Lloyd Doggett (D-TX) expressed concern that Chairman Ryan was focusing excessively on spending rather than on tax deductions. Rep. Doggett noted, “Dollar for dollar, cutting funding for cancer research or local law enforcement has the same effect on the deficit as closing a tax loophole that allows a Wall Street corporation to benefit by stashing their tax dollars offshore.” Rep. Doggett suggests that tax deductions will need to be reduced in order to address the deficit challenge.

Musical Composers and Capital Assets

In T.D. 9514; 76 F.R. 6553-6554 (7 Feb 2011), Treasury published final regulations on the capital gain election by composers of musical works.

In the Tax Increase Prevention and Reconciliation Act of 2005 and the Tax Relief and Healthcare Act of 2006, a provision was passed that permits creators of musical works to elect capital gain treatment. Under Sec. 1221(a)(3), musical works in the hands of the creator are normally denied capital gain treatment and sale requires payment of ordinary income tax.

However, in the two tax bills an exception was created that permits composers of musical works to elect to be taxed at capital gain rates. Under current tax rates, the reduction is from a top ordinary rate of 35% to a top capital gain rate of 15%. The final regulations make clear the rules on the timing and method of the election.

Reg. 1.221-3(a) indicates that the election will create a capital gain or loss. Subparagraph (b) notes that the election applies to any musical composition “sold or exchanged” during the year. It must be elected on Schedule D, “Capital Gains and Losses” of IRS Form 1040. Under Subparagraph (c), the election may be revoked with the consent of the IRS Commissioner. The election is applicable after May 17, 2006.

Applicable Federal Rate of 2.8% for February – Rev. Rul. 2011-4; 2011-6 IRB 1 (18 Jan. 2011)

The IRS has announced the Applicable Federal Rate (AFR) for February of 2011. The AFR under Section 7520 for the month of February will be 2.8%. The rates for January of 2.4% or December of 1.8% 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.

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