Washington Hotline – June – Week 4 – 2011

Bipartisan Debt Talks on Hold
Vice President Joseph Biden has been meeting with Republican and Democratic leaders of the House and Senate to develop solutions that reduce the deficit.  The discussions have been moving forward and have “made significant progress on a blueprint for putting American’s fiscal house in order.”

However, this week Majority Leader Eric Cantor (R-VA) and Senate Republican Whip Jon Kyl (R-AZ) stopped attending the meetings.  Both indicated that Democratic negotiators had proposed a combination of both spending reductions and tax increases.  The proposed tax increases were accomplished through reductions in the current tax deductions authorized under the code.  These tax deductions are referred to as “tax expenditures.”

Rep. Cantor and Sen. Kyl indicated they are open to returning to the talks if the Democratic negotiators agree to focus on spending cuts and to not include tax increases in the fiscal solution.

Vice President Biden stated in a press release, “The only way to make sure we begin to live within our means is by coming together behind a balanced approach that finds real savings across a budget – including domestic spending, defense spending, mandatory spending and loopholes in the tax code.  We all need to make sacrifices and that includes the most fortunate among us.”

Senate Majority Leader Harry Reid (D-NV) was asked about the hold on the current negotiations.  He suggested, “With what Kyl and Cantor have done, I think it’s in the hands of the Speaker and the President and sadly, probably me.”

Editor’s Note: Finding appropriate solutions that reduce the deficit is not an easy task.  It is understandable that the negotiators are facing great challenges.  Because there will be very significant decisions on spending reductions, it is likely that the final decisions will be made by President Obama, Majority Leader Reid and Speaker John Boehner.  The Treasury continues to emphasize that a solution must be passed by August 2nd of this year.

White House Supports Patent Reform

The White House again indicated its support for the America Invents Act (H.R. 1249).  The updated bill includes “much needed reforms to the nation’s patent system” and “will speed deployment of innovative products to market and promote job creation, economic growth and US economic competitiveness.”

The White House is pleased that the bill will allow the US Patent and Trademark Office (USPTO) to establish and adjust fees to request the cost of services.  It expects the new bill to improve patent quality and reduce the backlog of patent applications.

The House voted this week to pass the America Invents Act.  The bill bans future tax strategy patents.  The USPTO has already issued 144 patents for tax planning strategies.  Rep. Jarod Polis (D-CO) offered an amendment that would permit issuance of additional tax patents for all of the pending applications.  The amendment failed on a voice vote.

Editor’s Note: The House and the Senate have passed different versions of the America Invents Bill.  Because the House bill exempts financial management software patents from the tax ban and the Senate bill does not, a conference committee will be required to determine final language of the bill.  However, the probability that the tax patent ban will be enacted is now quite high.

Timber Partnership Valued

In Estate of Natale B. Giustina et al. v. Commissioner; T.C. Memo 2011-141; No. 10983-09 (21 Jun 2011), the Tax Court favored the valuation of the IRS in determining the appropriate taxable value of a partnership interest.  The decedent and other family members had been involved in the lumber industry for seven decades.  They had owned and operated several lumber mills and acquired substantial tracts of timberland.

After multiple reorganizations of family businesses, the Giustina Land & Timber Company (GLTC) partnership was created on January 1, 1990.  The decedent passed away on August 13, 2005 with an ownership of 41.128% of GLTC.

The estate valued the ownership interest at $12,678,117.  The IRS valued that same interest at $35,710,000.  It issued a deficiency of $12,657,506 and a Sec. 6662 accuracy-related penalty of $2,531,501.

The Court reviewed the appraised values and the decisions of both the estate and the IRS appraisers.  The IRS appraiser John Thompson valued GLTC estimated cash flows at approximately $65 million.  Estate appraiser Robert Reilly estimated the cash flows to be approximately $33 million.  The IRS reviewed the multiple assumptions and estimated the future cash flows to be approximately $51 million.

As a result of modifications of the future cash flow and determination of the appropriate discounts, the Court valued the total partnership at approximately $76 million.  This was greater than the claimed estate value of $48 million, but below the IRS $123 million value.  Based on the recalculated discounts, the Court determined that the discounted value of the partnership was approximately $66 million.  The 41.128% interest therefore was held to have value of approximately $27.4 million.

While the valuation was deemed to be much closer to the IRS initial number than the estate initial number, the Court determined that the executor (son of the decedent) had obtained legal counsel and a credible appraisal in determining the value.  The appraisal capitalized cash flows, capitalized distributions and compared market values of other companies.  Therefore, the appraisal meets the Sec. 6664(c)(1) reasonable cause for underpayments standard.  The Sec. 6662 penalty was not applicable.

Façade Easement Deductions Permitted

In Commissioner v. Dorothy Jean Simmons; No. 10-1063 (D.C. Cir. 2011), the Court determined that a valuation of façade easements by the Tax Court was correct.

Dorothy Jean Simmons owned two properties in the Logan Circle neighborhood of Washington, DC.  These properties were covered by the District of Columbia’s Historic Landmark and Historic District Protection Act of 1978.

In 2003 and 2004, Simmons executed conservation easement deeds of gift and granted a façade easement to L’Enfant Trust, Inc. The façade easement deeds required her to maintain property in good repair, clean the façades, make changes only in compliance with “applicable federal, state and local governmental laws” and gave L’Enfant the right to inspect the façades.

However, the deeds also permitted the charitable organization “to give its consent (e.g., to changes in a façade) or to abandon some or all of its rights.”

The taxpayer filed timely IRS Forms 1040 and claimed façade deductions of $162,500 in 2003 and $93,000 for 2004.  Appraiser James Donelly valued the property and determined that the reduction in value under a “before and after” test for the 2003 deed was 13% or $162,500 and for the 2004 deed, $93,000 or 11%.

The Tax Court approved the deductions but reduced the amounts to $56,250 and $42,250.

The IRS contested the deductions on two grounds.  First, it claimed the consent provision that permits L’Enfant to abandon the easement is too broad and therefore violates the “exclusive” requirement of a charitable façade easement.  Second, it objected to the use of a percentage method for determining deductions for façade easements.

The Court noted that the easement clearly is perpetual and complies with Sec. 170(h)(5)(A).  It further indicated that it agrees with the amici curiae, the National Trust for Historic Preservation and the Foundation for the Preservation of Historic Georgetown that the “consent to change” provision is valid.  These charitable organizations note that flexibility in the deed is required in order to permit future changes that may be necessary to “make a building livable or usable for future generations.”

The Court stated that the probability that L’Enfant would abandon the easement was a “remote possibility.” Therefore, the provision in the deed allowing changes with permission of the charitable organization is acceptable.

The appraisal by Donelly indicated that there is an approximate 10-15% reduction in value for a façade easement.  He examined various other properties and attempted to determine the “before and after” valuation.  Finally, he concluded that the discounts should be 13% for 2003 and 11% for 2004.  While the Court agreed that his methodology for determining a percentage reduction should have been more comprehensive, the appraisal did meet the required standard.

Editors Note: Appraisals for façade easement or other similar deductions should avoid the use of percentages and instead specify the rationale for a specific dollar amount “before and after” reduction.

Applicable Federal Rate of 2.4% for July – Rev. Rul. 2011-14; 2011-27 IRB 1 (17 Jun 2011)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2011.  The AFR under Section 7520 for the month of July will be 2.4%.  The rates for  June of 2.8% or May 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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