Washington Hotline – March – Week 3 – 2011

House Debates Top Tax Rates
Both parties entered the debate this week on the appropriate top income tax rate. House Ways and Means Chair Dave Camp (R-MI) suggested that it would be important to “jump-start” tax reform by picking a top rate. His preference for a top individual and corporate tax rate is 25%.

Washington tax commentators noted that this low tax rate would require very substantial changes if the tax bill is revenue-neutral. That is, in order to reduce the top rate from 35% to 25%, there would be very substantial changes in all of the major tax deductions.

Former Congressional Budget Office Director Alice Rivlin commented on the 25% rate. She stated, “It’s feasible to bring rates down, but only if you get rid of a lot of – almost all of – the loopholes and special provisions.”

The Ranking Member on the House Ways and Means Committee is Sander M. Levin (D-MI). He expressed great concern about the proposal. Levin noted, “It’s one thing to conceive a goal of a top tax rate of 25% for individuals and corporations – which would reduce revenues by $2 trillion over a decade.” But he continued that it would be very difficult to understand “how it would work” when actually modifying the tax deductions.

House Member Jan Schakwkowsky (D-IL) was a member of the Fiscal Commission appointed by President Obama. She introduced the Fairness in Taxation Act. This bill creates high tax brackets for individuals with very large incomes. For those with incomes over $1 million per year, the tax rate would be 45%. The small number of persons with incomes over $1 billion per year would pay 49%.

Rep. Schakwkowsky quotes a number of individuals with incomes over a million dollars per year who believe that there should be higher taxes for very-high income persons. Kathryn Myers is a millionaire from Pennsylvania. She stated, “I think very wealthy people like me should pay substantially higher taxes, since we have done exceedingly well in the last few decades.”

Editor’s Note: Your editor and this organization do not take a specific position on the appropriate tax rates. It is important to note that reducing tax rates and keeping a new tax bill revenue-neutral will require major changes in deductions for healthcare, retirement plans, state and local taxes, mortgage interest and charitable gifts.

Taxes Are Too Complex

In a bipartisan statement, Senate Finance Chair Max Baucus (D-MT) and House Ways and Means Committee Chair Dave Camp (R-MI) agreed that taxes are in need of simplification.

Both taxwriters serve on the Joint Committee on Taxation (JCT). At the latest meeting of the Joint Committee, Chairman Camp stated, “There is no doubt that today’s tax code is too complex, too costly and takes too much time to comply with.” He indicated that it is now time to take a “comprehensive approach to tax reform” that will help to increase the number of jobs in America.

Sen. Baucus agreed and stated, “Our tax code should maximize job creation and widespread economic growth. As we work together to simplify the tax code and make it more fair and competitive, we need to be armed with the data showing the impact of potential changes to the code.”

Both taxwriters are responding to the proposal by President Obama to pass a revenue-neutral tax reform for corporations. Treasury Secretary Tim Geithner testified before the House Committee on Appropriations and indicated that the White House looks forward to working with members of Congress and the business committee to design “a comprehensive, revenue-neutral reform of the corporate tax system.” The goal will be to lower tax rates by reducing federal deductions.

Editor’s Note: Both the Senate Finance Committee and the House Ways and Means Committee are embarked on a series of tax reform hearings. Sen. Baucus and Rep. Camp are striving to prepare legislation that would reform both corporate and personal taxes. The perennial problem in lowering tax rates is that when any deductions are limited, there is strong opposition. However, both leaders are seriously pursuing major reform in 2011.

QPRT Excludes Home from Estate

In Estate of Sylvia Riese et al. v. Commissioner; T.C. Memo. 2011-60; No. 5388-08 (14 Mar 2011), the Tax Court determined that a QPRT did exclude a valuable residence from an estate. The decedent survived six months after the termination of a three-year QPRT. Even though she failed to pay rent, the court determined that her intent and actions discussing payment of rent had created an obligation under the law of New York.

Decedent was a resident of 35 Tideway in Kings Point, New York. She inherited the residence in 1990 when her husband passed away. The decedent regularly communicated with daughters Ellen Grimes and Judith Zipp.

Ms. Grimes had discussions in 2000 with the decedent’s estate attorney Stefan F. Tucker. Following discussions between Grimes and Tucker, they proposed to decedent that she create a qualified personal residence trust (QPRT). On April 19, 2000, the decedent transferred her residence into a three-year QPRT. When the QPRT terminated on April 19, 2003, there was discussion of the amount of rent that should be paid. Ms. Grimes called attorney Tucker and inquired about the proper amount of rent to be paid for the balance of 2003. Mr. Tucker indicated that the rent should be at fair market value and could be determined by the rents charged for similar residences in that area. He also suggested that the rent could be determined and paid by December 31, 2003.

Ms. Riese unexpectedly had a stroke and quickly passed away on October 26, 2003. As a result, the rent payments were not determined and paid prior to her demise. When the IRS Form 706 Estate Tax Return was filed, the estate determined the rent payable for the six month period following termination of the QPRT to be $46,298. It excluded the residence from the taxable estate and claimed a debt obligation of the estate in that amount. The IRS rejected the estate claim and determined a deficiency based on inclusion of the $6,138,000 residence in the estate.

The court noted that Reg. 20.2036-1(c)(1)(i) states that there is inclusion of a retained interest if “there was an understanding, express or implied, that the interest or right would later be conferred.” In a number of cases, the IRS has successfully contended that attempted agreements to transfer a family residence through a life estate or QPRT were not effective because the decedent lived in the home until death without formally making payments for rent or otherwise treating the home as the property of heirs.

After reviewing the applicable law, the court noted that the factual basis existed for upholding the agreement to pay rent. The key factors include the following:

1. Rent Discussions – On several occasions the decedent, daughters and counsel discussed rent.

2. Decedent’s Agreement – Ms. Riese had indicated that she was willing to pay rent at the appropriate rate.

3. Discussion with Counsel – Ms. Grimes called attorney Tucker and inquired about the appropriate method for determining a fair rent.

The court did note that Mr. Tucker’s plan to determine the appropriate amount and make a rent payment by December 31 of that year was “not the most prudent course of action.”

However, in the view of the court, there “was an agreement among the parties for decedent to pay fair market rent” and this good-faith intent created an obligation. The factual circumstances are different from cases in which there was no documentation and no expressed intention to pay rent.

Therefore, the QPRT was valid and there was sufficient expression of intent to pay rent. The rent obligation existed and the estate is permitted to exclude the home from the taxable estate and to consider the rent owed in the amount of $46,298 as a valid Sec. 2053 debt.

Editor’s Note: This case shows the importance of a lease agreement that takes effect upon termination of the QPRT. There should be in place an agreement that immediately requires payment of a fair market value rent from the parent to the children.

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.

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