Highway Bill Inches Forward
House Ways and Means Chairman Paul Ryan decided to use various funding strategies known as compliance offsets. The 18.3 cents per gallon federal gas tax will apply to liquid petroleum gas (LPG) and compressed natural gas (CNG). The 24.3 cents per gallon diesel tax would be extended to liquefied natural gas (LNG).
There are other compliance provisions. New mortgage reporting rules will raise revenue. There are changes to the statute of limitations for substantial overstatement of basis. The Sec. 1014 step-up in basis rules require the estate tax basis to be used for income tax purposes if there was an increase in the total estate tax due because of inclusion of the property.
Chairman Ryan’s goal is to find a short-term solution. His longer-term strategy is to combine a six-year highway funding plan with international tax reform. Sen. Chuck Schumer (D-NY) and Sen. Rob Portman (R-OH) recently published a study on proposed international tax reform. Many international tax reform plans permit businesses to return the $2 trillion held overseas to America with a lower tax rate. Ryan’s plan is to use taxes from repatriation of overseas funds to support the highway program.
Senate Finance Committee Chairman Orrin Hatch (R-UT) prefers to not link international tax reform and the highway bill. He is attempting to negotiate with Senate Finance Committee members to agree on various offsets to raise the revenue needed for a longer-term highway bill.
Editor’s Note: While the Senate prefers a longer-term highway bill, both House and Senate are attempting to raise revenue without an unpopular increase in the gas tax. The result of this “raise revenue without raising taxes” strategy may be one more short-term extension of the Highway Fund. In the current political climate, individual and corporate tax reform now are considered by most legislative leaders to be off the table. There still is hope for international tax reform this year.
Conservation Easement Deduction Denied
In Bosque Canyon Ranch LP et al. v. Commissioner; T.C. Memo 2015-130; No. 1067-09, 25946-11 (13 Jul 2015), the Tax Court rejected a 2005 conservation easement deduction of $8.4 million and a 2007 conservation easement deduction of $7.5 million. Both easements permitted boundary changes and multiple types of land use. Therefore, they failed the “in perpetuity” requirement.
In 2003 a Texas limited partnership named BCR I acquired 3,744 acres in Bosque County, Texas. BCR I subsequently marketed five-acre home sites to buyers who initially acquired limited partnership interests. Each limited partnership interest enabled the owner to build on a five-acre identified parcel. BCR I also was required to transfer a conservation easement to the National American Land Trust (NALT), with the charitable deduction flowing through to the limited partners.
On December 29, 2005, BCR I granted a conservation easement to NALT on 1,750 acres. A conservation goal was to protect the habitat of the endangered golden-cheeked warbler. The deed permitted various boundary adjustments for the five-acre parcels. In addition, BCR I retained the right to raise livestock, hunt, fish, trap, harvest timber and build recreational facilities on the land.
The Hirsh Valuation Group completed an appraisal and valued the easement at $8,400,000.
In 2005, a second partnership with the name BCR II was created and received 1,866 acres from BCR I. On September 14, 2007, BCR II transferred a conservation easement to NALT on 1,732 acres. There were similar retained rights for the new easement. The 2007 easement was valued by the appraiser at $7.5 million.
The Tax Court found several faults with the conservation easement deduction. First, the owners did not provide NALT with the appropriate Reg. 1.170A-14(g)(5)(i) documentation. Second, the extensive retained rights for hunting, trapping and construction could very easily impair the rights and interests of the conservation easement. Third, the baseline documentation was “unreliable, incomplete and insufficient to establish the condition of the relevant property.” Fourth, the site survey was completed 15 months after the easement and there was significant construction that changed the character of the property. Finally, the owner was uncertain as to when the acknowledgement of the baseline documentation was signed for either easement.
Because the easements suffered multiple compliance failures, both deductions were denied.
Editor’s Note: The developers were quite creative in attempting to transfer the parcels and flow the charitable deductions through to the buyers. However, conservation easement deductions have produced very significant litigation. It is clear that the Tax Court will require careful compliance with Treasury Regulations to sustain a deduction.
No Personal Deduction for Company Gifts
In Larry Zavadil et ux. v. Commissioner; No. 14.1053 (15 Jul 2015), the Eighth Circuit permitted deductions for notes that had been paid but denied deductions for company gifts that were not proven to be a legal obligation of the taxpayer.
Larry Zavadil organized American Business Forms, Inc. in 1981. It did business as American Solutions for Business. American Solutions sold business supplies and various other promotional products. In 2000, Zavadil sold the business to an employee stock ownership plan in exchange for a $28,760,000 note. The note was to be paid in twenty annual installments with interest.
Zavadil continued to serve as President and CEO and to operate the business. The company had a policy of regularly expending company funds to pay his personal expenses, charitable gifts and some unrelated business expenses. Periodically, Zavadil would use the note payments to repay his obligation to the company.
In 2004 the company made charitable gifts of $358,472. The 2005 gifts were $333,672. The 2004 gift was covered by Zavadil’s payment on June 30, 2005. However, as of December 31, 2005, the company gifts for that year had not been reimbursed.
The tax court determined that the 2004 gift was reimbursed and therefore deductible, but the obligation for 2005 gifts was not paid and therefore no deduction was permitted. It rejected Zavadil’s claim that as of December 31, 2005 there was a “bona fide debt” with respect to that amount that entitled him to take the charitable deduction.
The Eighth Circuit noted that under Reg. 1.170A-1(a) it is permissible to use borrowed money to make a gift. However, the deduction is available only when the taxpayer repays the borrowed amount. Because Zavadil did not pay the company for the 2005 charitable gifts, there is not a qualified deduction unless there was a legal obligation to the company. While Zavadil claimed that there was a “bona fide debt” and the company was obligated to make payments on the $28,760,000 note, there was no written agreement, no specified collateral and no due date for the loan. Therefore, the 2005 contributions were not qualified charitable deductions. Zavadil did not prove that he bore the “economic burden” of the charitable gift.
Editor’s Note: Zavadil did repay the company in 2006. Therefore, he would qualify for a charitable deduction in 2006. The Eighth Circuit decision shows the importance of understanding the timing for gifts. With the rare exception of a transfer that creates a legal obligation, gifts with borrowed money will only be deductible when the actual payments are made by the taxpayer.
Applicable Federal Rate of 2.2% for August — Rev. Rul. 2015-16; 2015-30 IRB 1 (17 July 2015)
The IRS has announced the Applicable Federal Rate (AFR) for August of 2015. The AFR under Section 7520 for the month of August will be 2.2%. The rates for July of 2.2% or June of 2.0% 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 2015, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here