Washington Hotline – July 24, 2012

Bipartisan “Fix the Debt” Campaign

On July 17, a group of civic leaders, CEOs and budget experts met to organize a new effort to encourage a budget compromise.  Erskine Bowles, co-founder of “The Campaign to Fix the Debt” stated, “We need our leaders to make these hard choices, these politically difficult choices.”  He indicated that it was time to set partisanship aside and work together for the future of the country.  If the nation faces the debt problem there will be a “bright future,” but if it fails to move forward, the entire nation faces serious economic challenges.
The co-chairs of the group are former Senator Judd Gregg and former Pennsylvania Governor Ed Rendell.  Sen. Gregg stated, “Without significant, fundamental and comprehensive reforms, the debt will reach 90% of the economy within 10 years and exceed 250% by the early 2040s.  These crippling levels of debt threaten the strength of our economy, our standard of living and the prosperity of the future generations.”
Governor Rendell continued, “We simply cannot afford all the promises we’ve made.  But, if we do this right, we can make reforms in a way that protects the most vulnerable, prioritizes important investment scenarios like infrastructure and education, and enhances economic growth.”
Several members of the group emphasize that it will be important to have a proactive and thoughtful solution.  Honeywell’s Chairman Dave Cote suggested that a bipartisan solution can resolve the problem before a future increase in bond market interest rates creates another financial crisis.
Former President of the World Bank Robert Zoellick stated, “Australia’s Foreign Minister Bob Carr hit the nail on the head when he said, ‘The U.S. is one budget deal away from restoring its global pre-eminence.'” Zoellick indicated that the U.S. could restore its world leadership position through a budget compromise.
Finally, Former Senator Sam Nunn suggested, “On fiscal matters, neither political party can impose its will on the other, nor it is not likely to change after the election.  Successfully tackling our fiscal challenges requires members of Congress to come together across party lines with a balanced plan.”
Editor’s Note:  Leaders of both parties have united to urge the current Congressional and White House leadership to move forward on a budget compromise.  Mr. Bowles has suggested that a “$4 trillion solution” is the minimum that will restore the financial strength of the nation.  The Campaign to Fix the Debt leaders will continue to urge Washington in November to seek a large-scale solution that has bipartisan support.

Estate Tax Debate

The Senate this week has been discussing action on tax bills by both parties.  The Middle-Class Tax Relief Act of 2012 (S. 3412) is supported by Senate Majority Leader Harry Reid (D-NV).  Minority Leader Mitch McConnell (R-KY) and Senate Finance Committee Member Orrin Hatch (R-UT) support the Tax Hike Prevention Act of 2012 (S. 3413).
The Middle-Class Tax Relief Act would extend most of the 2001-2003 tax cuts.  Tax rates will increase to 36% and 39.6% for single persons with incomes over $200,000 and married couples with incomes over $250,000.  For those individuals, the capital gain rate would increase from 15% to 20%.  Most other provisions of the 2001-2003 tax cuts will be extended for the balance of taxpayers.
Sen. Reid stated, “Right now, we have a very clear picture of what we want to do: make sure that people making less than $250,000 don’t get a tax increase.”
McConnell responded, “There’s some uncertainty we could remove by indicating sooner rather than later that we’re not going to let anybody’s taxes go up at the end of the year.”  His Tax Hike Prevention Act would generally extend the provisions of the 2001 and 2003 tax bill.
The estate tax provisions of both bills are also under discussion.  The original White House budget proposed a $3.5 million estate exemption and 45% estate tax rate for 2013.  The initial draft of the Middle-Class Tax Relief Act followed the White House model.  However, in an apparent effort to increase total revenue from the bill, that provision was deleted.  If no provision passes, then the estate tax exemption returns to $1 million (with indexed increases) and the top estate rate would be 55%.
The Tax Hike Prevention Act supported by Sen. McConnell extends the $5 million exemption (with indexed increases) and 35% estate tax rate.
Editor’s Note:  Your editor and this organization take no specific position on these comments.  The probability is that neither bill will pass prior to the election.  Both parties are now creating negotiating positions for the November tax bill.  These efforts to introduce specific legislation are useful in understanding the negotiating positions of both parties.

Façade Easement Deduction with Mortgage

In Gordon Kaufman et ux. v. Commissioner; Nos. 11-2017 (18 Jul 2012), the First Circuit determined that a façade easement deduction was not explicitly precluded by the existence of a mortgage, but they remanded the case to the Tax Court and noted that the local zoning requirements of the historic district may eliminate most of the charitable deduction.
In 1999, Lorna Kaufman purchased a $1,050,000 row house in the historic district of Boston.  After discussions with the Trust for Architectural Easements (TAE), on December 22, 2003, the taxpayers signed a deed that created a façade easement and granted rights of enforcement to TAE.  Prior to signing the deed, the Kaufmans had corresponded with their mortgage lender, Washington Mutual Bank, and requested that it subordinate its rights to the easement granted to TAE.  Washington Mutual did sign a subordination document, but the agreement included the stipulation that it “shall have a prior claim to all insurance proceeds” resulting from destruction or condemnation of the property.
The Kaufmans obtained the services of certified appraiser Timothy Hanlon who estimated the value of the donated easement to be $220,800.
The IRS reviewed the transaction and denied the deduction both for the easement and for an accompanying cash gift of $16,840.  The position of the Service was that the provision in the lender agreement requiring insurance proceeds to accrue first to the lender violated the “in perpetuity” requirement for a valid conservation easement.
The Tax Court in Kaufman v. Commissioner, 134T.C. 182 (2010), held that under Reg. 1.170A-14(g)(6) the charity must have a proportionate right to insurance proceeds and that, failing that test, the deduction was denied.  However, the Tax Court agreed that the cash gift of $16,840 was a qualified charitable deduction.
The 1st Circuit noted that Sec. 170(h)(2)(C) creates a requirement for the restriction to be “in perpetuity.”   While the court agreed that the regulation created a requirement for the charitable easement grantee to receive a proportionate interest, it indicated that this is not an absolute right.  For example, all properties could be subject to future tax liens, and those claims generally have “super-priority” over other interests.  If the the charitable interest must be absolute, the existence of a potential tax lien would under the IRS reading “doom practically all donations of easements, which is surely contrary to the purpose of Congress.”
Therefore, the court determined that a remote possibility of abandonment of the easement by the charity or a remote possibility of the loss of the charitable interest is permissible.
In addition, the IRS objected to several entries on IRS Form 8283.  The court determined that the Form 8283 could have included additional information, but held that the omissions were not material.
While the court did reject the absolute requirement for certainty as part of the charitable deduction, it noted that the key issue for this easement is valuation.  The Kaufmans’ appraiser referred to the overlap in restrictions of the easement with the pre-existing requirements of local ordinances.  The IRS position may have been too aggressive in creating a bar to the potential deduction, but the Tax Court will need to determine the value, if any, of the actual easement under the existing ordinances.  Therefore, the court remanded the case to the Tax Court to determine the valuation of the façade easement.

Applicable Federal Rate of 1.0% for August — Rev. Rul. 2012-21; 2012-32 IRB 1 (18 July 2012)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2012.  The AFR under Section 7520 for the month of August will be 1.0%.  The rates for July of 1.2% or June of 1.2% 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 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return. Federal rates are available by clicking here.

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