MSBA Probate & Trust Law Section

Federal Tax Committee Monthly Update 2008

     December 2008

     2009 Standard Mileage Rates.  The IRS announced the new 2009 optional standard mileage rates for the use of a car starting January 1, 2009. They will be $0.55 per mile for business mileage, $0.24 per mile for medical or moving mileage, and $0.14 per mile for charitable purposes. 2008 was $0.50.5 per mile for the first half and $0.58.5 for the second half. The medical and moving rate was $0.19 per mile and $0.27 per mile. Revenue Procedure 2008-72.

     Income Tax Deduction—Bundle Fees for Trusts and Estates.  The IRS announced in Notice 2008-116 that for tax years beginning before January 1, 2009, that trusts and estates will not be required to divide bundled fees paid to a fiduciary between those expenses that are fully deductible and those that are subject to the two (2%) percent exclusion. Instead, taxpayers may deduct the full amount of such fees; however, payments to third-parties for expenses subject to the two (2%) percent rule must be reported separately on the appropriate line.

     Tax-preparer Penalty Guidance Issued.  The IRS has issued a series of items regarding the new tax return preparer penalties. Amended IRC Section 6694 now divides the definition of "unreasonable position" into a general category, a disclosed positions category and a tax shelter/reportable transactions category, each with its own standard to determine whether or not a penalty applies. Final regulations are announced in T.D. 9436, and updated interim guidance is issued in Notice 2009-5. Rev. Proc. 2009-11 identifies the categories and the returns that fall within the different categories.

     Required Minimum Distributions Suspended for 2009.  The Worker, Retiree, and Employer Recovery Act of 2008 was approved by Congress on December 11, 2008, and suspends the required minimum distributions requirements for 2009. The Act also delays changes and suspends other requirements to ease retirement plan funding burdens on employers for 2008 and 2009.

     The Act clarifies that all employer plans must permit rollovers of decedents' accounts out of the plan for non-spouse beneficiaries, giving us the benefit which everyone except the IRS understood was included in the Pension and Protection Act of 2006. This provision is effective for plan years beginning after December 31, 2009.

     The Act also clarifies that all reimbursements from a state or local government-sponsored health plan under IRC Section 105 payable to either the participant or a deceased participant's beneficiaries shall be income tax free.

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     November 2008

     Inflation adjustment increases gift tax exclusion and other tax thresholds.  The IRS reported in Revenue Procedure 2008-66 that the gift tax exclusion will increase from $12,000 to $13,000 per person starting in calendar year 2009. Additionally, the exclusion for gifts to a non-citizen spouse increased to $133,000 per year pursuant to I.R.C. sections 2503 and 2523. This Revenue Procedure lists more than 3 dozen inflation adjustments taking effect this coming January 1.

     More from the EESA: some easing of the new tax preparer penalties.  In addition to the financial markets rescue, the Emergency Economic Stabilization Act of 2008 includes over 100 tax provisions, but little effecting estate and gift taxation. It does make the return preparer penalty standard more favorable for preparers by replacing the "more likely than not" test by a "substantial authority" standard in IRC Section 6694(a).

     Sale of Conservation Easement triggers recapture.  The IRS ruled that a sale of a qualified conservation easement on a family farm to a public charity would be a disqualifying disposition triggering the recapture tax for property that qualified for special use valuation rules under Code Section 2032A. While Section 2032A(c)(8) provides for an exception for gifts of qualified conservation easements, the IRS said that the exception did not include a sale of such an easement. Private Letter Ruling 200840018.

     Charitable deduction for a non-qualifying modification of a testamentary CRT denied because modification was done solely to receive the charitable tax deduction.  In TAM 200840008, the IRS concluded that an estate was not entitled to an estate tax charitable deduction because the sole reason for the modification made to the terms of a testamentary trust was to gain the charitable deduction under Section 2055(a). Although the trust beneficiaries were qualifying charities, the testamentary trust as written would not qualify for the deduction. The non-judicial modification was not made according to Section 2055(e), but would have otherwise qualified the trust for the deduction had the modification been required for some reason other than solely for the purpose of avoiding estate tax through a charitable deduction. TAM 200840008 (6/10/2008).

     Valuation of façade conservation contribution reduced; penalty imposed.  The Tax Court rejected two elements of the taxpayer's appraisal of the taxpayer's qualified conservation contribution of a building façade. The court disallowed the reconstruction cost method as inappropriate as the historic building would unlikely be reconstructed if it was ever destroyed and it also rejected the income method as too speculative. Instead, the court relied on the comparable sales method to fix a value of the conservation contribution (based on the difference of the value of the building before and after the easement). The court also rejected the taxpayer's claim that the contribution also diminished the value of taxpayer's adjacent property. Gross valuation misstatement penalty was imposed. Whitehouse Hotel Limited Partnership v. Commissioner, 131 TC 10, Decision No. 57,572.

     IRS identifies new transaction of interest involving CRTs.  The IRS has identified a new "transaction of interest" for purposes of the reportable transaction rules. Specifically, the IRS is concerned about the manipulation of the Uniform Basis Rules to avoid tax on gain from the sale of appreciated assets contributed to a CRT. After the typical establishment of the CRT, the contribution of appreciated assets to the trust and sale of those appreciated assets, the proceeds are then reinvested in liquid or readily marketable securities. The income beneficiary and the charity then sell their respective interests to an unrelated third-party for an amount equal to the value of the new assets in the CRT. The third-party terminates the trust and collects the assets. Taxpayer then claims the cost-basis of the new assets as his/her basis for the sale under the Uniform Basis Rules of Reg. Sections 1.1014-5 and 1.1015-1(b) and Code Section 1001(e)(3). Notice 2008-99.

     Heard on the Street: Retirement plan required minimum distribution requirements and early withdrawal penalties may be temporarily suspended.  CCH reports that a growing number of lawmakers from both parties are now supporting a temporary suspension of the RMD rules, a suggestion that President-elect Obama also made on the campaign trail.

     Also suggested is a temporary one or two year suspension of the 10% early withdrawal penalty for distributions from IRAs and other retirement accounts. (CCH also reports that major tax bills in the last 30+ years have all passed in the year immediately following a presidential election.)

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     October 2008

     Income Tax Deduction for interest on Estate Tax Dependent upon basis of deferral.  The IRS ruled in Chief Council Memo 2008 36027 that interest accrued during an approved extension period for paying estate tax was non-deductible personal interest. The extension was granted under IRC Section 6161 for economic hardship. The Chief Council's Office advised that this interest is the equivalent to non-deductible personal interest and is non-deductible under Section 163. It distinguished this situation from extensions granted under Section 6163 which is specifically given the deduction in Section 163(h)(2)(E). NOTE: this solely addresses the income tax question, might this interest be deductible as an administration expense on the estate tax return?

     IRS proposes 2008-2009 Guidance Projects.  The Treasury Department and IRS have released their 2008-2009 priority guidance plan which identifies 314 areas to be addressed between July 2008 and June 2009. Included are much anticipated revisions to Circular 230 rules. Joint Statement Regarding the 2008-2009 Priority Guidance Plan, 2008 Fed, paragraph 46, 565.

     Repair of unintended charitable consequences from the Pension Protection Act of 2006 in the works.  The House passed HR 7083, the Charity Enhancement Bill of 2008, and sent it on to the Senate for consideration. This bill is designed to address certain objections to unintended restrictions resulting from the PPA such as restrictions on distributions from donor advised funds awarding scholarships approved by the charitable organization through a carefully monitored process, lifting excess benefit restrictions in reimbursement of reasonable and necessary expenses to certain contributors, etc. The fate of the bill in the Senate before adjournment is uncertain.

     Emergency Economic Stabilization Act of 2008.  Much of the "sweetener" added to the financial market recue plan are tax provisions, including tax incentives, energy incentives, and the alternative minimum tax patch for 2008. (In a sense this is odd, as the "sweetener's" were added to obtain the House of Representatives approval to the rescue plan that the Senate had already passed. Prior to the financial crises, the House and Senate were bickering over these same provisions with the House insisting on revenue offsets —PAY-GO provisions— vs. the Senate's refusal to fully pay for these extenders. Most of these provisions are now included in the EESA with minimal revenue offset.) Included in the provisions of interest to probate and trust practitioners are the following:

• Charitable IRA rollovers, which expired 12/31/2007, are reinstated for 2008 and 2009, subject to the same limitations of only those over age 70½ qualify and $100,000 per person (husband and wife are considered separately) per year. Rollover amounts satisfy RMDs, can be used to satisfy an outstanding pledge to the charity, applies only to taxable distributions (not tax free amounts in Roth IRAs) and do not give rise to charitable income tax deduction in addition to the exclusion.
• A current benefit for non-residents is extended relating to regulated investment company stock and estate taxes.
• Charitable contribution deduction is extended/enhanced for qualified farmers and ranchers contributing food and for C and S corporations for contributions of food, books and computer equipment to specified charities.
• Stockbrokers will be required to maintain and report adjusted basis in the future. Brokers will use FIFO or the average cost basis method to determine basis unless the taxpayer specifies the security sold specifically. This is effective for stock acquired in 2011, mutual fund shares acquired in 2012 and other securities acquired in 2013. This is considered a revenue raiser.
• Of interest only because it would affect so many taxpayers: the AMT exemption is again raised for 2008. This "patch" is only for calendar year 2008 with a revenue cost of almost $62 Billion dollars. Query: will Congress look for a permanent solution in 2009?

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     September 2008

     Charitable Organizations—Filing Requirements.  The IRS revised Publication 557, Tax Exempt Status for Your Organization (Rev. June 2008) to reflect changes made by the Pension Protection Act of 2006. New filing requirements such as the reporting of $1,000 or more of gross unrelated business income by any exempt organization are explained. New filing requirements for exempt organizations with gross receipts of less than $25,000 are also explained, as well as some of the exceptions to the filing requirements and mandatory electronic filing requirements now imposed.

     Automatic Extension Requests starting with tax returns due on or after January 1, 2009.  The IRS has announced that it will reduce automatic extension periods from six to five months for forms 1041, 1065, and 8804. Notice 2008-084.

     CRT UBTI Reg. 1.664-1.  This Reg. was finalized to implement the change enacted in the Tax Relief and Healthcare Act of 2006. Total loss of exempt status for a CRT that has UBTI is now changed to imposing a 100% excise tax on such income.

     Tax Court rejects IRS indirect and step transaction theories.  Taxpayers set up a FLP, transferred stock to the FLP and then made limited partnership interest gifts to their children. The gift tax returns claimed significant discounts on the valuation of the shares transferred. The IRS disallowed the discounts under both an indirect transfer and under step-transaction theories. Although the US Tax Court rejected both arguments, the Court found that the FLP had no business purpose and reduced the discounts. This, however, is a good case to read to get the issues involved in both the indirect transfer and step transaction arguments and for business purpose analyses. Holman, Jr. v. Comm., 130 T.C. 12 (5/27/2008).

     Musings on the Street: Estate tax reform.  The Kiplinger Tax Letter reports that Obama supports a $3.5 Million Dollar exemption and a tax rate of 45% and McCain favors a $5 Million Dollar exemption with a maximum rate of 15%. It predicts new legislation to set the exemption some where within that range, a top rate at the higher end of the two preferences, and the lifetime gift tax exemption raised to the same exemption level as for estate taxes. Kiplinger Tax Letter also predicts a repeal of the carryover basis provisions, but failure to revive the estate tax credit.

     Prorata Division of Charitable Remainder Trusts okayed.  The IRS approved prorata divisions of CRTs in Rev. Rul. 2008-41.

     IRS rejects discount for Restricted Management Accounts.   In Rev. Rul. 2008-35 the IRS rejected any discount on assets owned by a decedent which were held in an account with a bank where withdrawals were restricted for several years for management purposes.

     Tax Court confirms no deduction without separate written receipt.  The US Tax Court showed no mercy to a couple who made substantial charitable contributions to their church, but failed to get written confirmation of the gifts prior to the filing of their income tax return. The fact of the contributions was not contested. The cancelled checks were produced and written acknowledgment was received from the Church, but after the filing of their income tax return, but the Court ruled that those items did not meet the substantiation requirements required by the Code. Gomez v. Commissioner, T.C. Summary 2008-93 (7/30/08).

     Alternate Estate Valuation.  The IRS announced a proposed regulation in 73 Fed. Reg. 22,300 (42508) in response to their loss in Kohler v. Commissioner, T.C. Memo. 2006-152, to limit the benefit taxpayers may obtain from using the alternate valuation date. In Kohler, the Tax Court allowed the taxpayer to benefit from a reduction in stock price that resulted from restrictions imposed upon closely-held corporate stock under a post-death reorganization. The proposed Reg would limit any reduction in value from the alternative valuation date to strictly marketplace reductions in value.

     Charitable Lead Trusts.  The IRS has published sample Charitable Lead Unitrust agreements in Rev. Proc. 2008-45 and 2008-46 for inter vivos and testamentary situations.

     Substantiation of Charitable Gifts.  The IRS issued proposed Reg. 1.170A-15 discussing the substantiation of reporting requirements for cash and non-cash charitable contributions which were added by the American Jobs Creation Act of 2004 and the Pension Protection Act of 2006. This Reg. discusses the written substantiation requirements now of all charitable gifts, including the need for a canceled check or receipt for gifts under $250, written acknowledgment by the charity for gifts over $250, and qualified appraisals for donated property of over $5,000. A very limited reasonable cause exception is included, but replaces the good faith omission exception. Comments are being accepted through November 5, 2008.

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     June 2008

     Declaratory Judgment for Gift.  The IRS has issued proposed regulations that would provide a procedure for filing petitions with the Tax Court for a declaratory judgment on gift tax values. This applies in limited cases, where the IRS is proposing an adjustment to the value of the gift, but there is no gift tax owing because, for example, it is offset by the applicable gift tax credit under IRC §2505(a). Previously the taxpayer would not have been able to petition the court, but the increased value would have been binding for purposes of calculating the cumulative gift tax on all future gifts and in figuring the taxpayer's estate tax liability. Prop. Treas. Reg. §301-7477-1.

     Estate and Trust Charitable Donations.  The IRS has published proposed regulations that require charitable contributions from an estate or trust to have "economic effect" independent of the income tax consequences in order to be respected for Federal tax purposes. An example includes a charitable lead trust provision that requires charitable contributions to be made first from ordinary income, then from other sources of income. The regulation says this allocation does not have economic effect independent of the tax consequences because the amount to be paid to charity is not dependent upon the type of income from which it is to be paid. In that case the distribution is considered to be generated from each class of income in proportion to the total each class bears to the total of all classes. Prop. Treas. Reg. §1.642(c)-3.

     Contribution to Donor-Advised Fund and Repurchase.   If a taxpayer makes a contribution with a prearranged sale of the assets, the taxpayer can be considered to sell the asset first, with a charitable contribution of the proceeds. In PLR 200821036, the Service determined there was no prearranged sale when the taxpayer donated closely-held stock to a donor-advised fund, because the community foundation where the DAF was set up was under no legal obligation to sell the stock after the contribution. The taxpayer was one of the Board of Directors for the closely-held company, although there were no other family members acting as Directors at the time.

     New Expatriate Tax Rules.  In the Heroes Earnings Assistance and Relief Tax Act of 2008, signed into law in early June, a new tax is imposed on long-term residents and U.S. citizens who expatriate. The Act uses a mark-to-market regime and treats all property owned by the expatriate as if it was sold on the date of expatriation. Any gain in excess of $600,000 (to be adjusted for inflation) will be taxed. Also, a gift tax is imposed on U.S. citizens or residents who receive qualifying gifts or bequests from an expatriated individual, and there is a 30% withholding tax on qualifying deferred compensation paid to a covered expatriate. The provisions are found in IRC §877A.

     Charitable Contribution Guidance.  The IRS has revised Publication 1771, Charitable Contributions—Substantiation and Disclosure Requirements, which cover the federal tax law for organizations such as charities and churches that receive tax-deductible charitable contributions and for taxpayers that make contributions. The IRS also revised Publication 4303, A Donor's Guide to Vehicle Donations. This is a companion guide to Publication 4302, A Charity's Guide to Vehicle Donations.

     Charitable Remainder Trusts/UBTI.  Final regulations have been issued to reflect the Tax Relief and Health Care Act of 2006 change easing the tax consequences for charitable remainder trusts that have unrelated business taxable income. The regulations apply for tax years beginning after December 31, 2006. Treas. Reg. §1.664-1.

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     May 2008

     Family Partnerships (LLC).  The Decedent, Anna Mirowski, had transferred significant assets to an LLC she initially owned, and then made gifts of 16% interests to three trusts set up for her children. She unexpectedly died four days later, and the Tax Court (8th Circuit) upheld the gifts and determined that IRC §2036(a) and §2038(a) did not apply. It found that the assets were exchanged for adequate and full consideration, the assets were properly credited to her capital account, and she would have right to distribution in the event of liquidation or dissolution, in accordance with her capital account. Even though she continued as manager of the LLC, the court found that she did not retain the possession or enjoyment of, or the right to the income from, the three 16% interests that she gave to the daughter's trusts. Estate of Anna Mirowski, TC Memo 2008-74.

     Intentionally Defective Trusts.  In Rev. Rul. 2008-22, the IRS determined that the power, in a nonfiduciary capacity, to substitute assets of equivalent value for assets held by an irrevocable trust will cause the trust to be a grantor trust under IRC §675(4). This means that the trust is taxable to the grantor for income tax purposes, but it does not cause the trust to be included in the grantor's estate for transfer tax purposes, under IRC §2036 or §2038. Although the grantor retains this power, they usually are prohibited from serving as trustee. The trustee has the duty to make sure that the properties exchanged are of equal value.

     Alternate Valuation.   The IRS has published proposed regulations that would disallow valuation discounts based on actions taken by the executor, instead requiring that the discounts be a result of "market conditions." The regulations are a reaction to the Kohler (T.C. Memo 2006-152) decision, where the Court allowed discounts that resulted from a corporate reorganization that took place after the decedent's death but before the 6-month alternate valuation date. The IRS did not acquiesce to the decision. The regulations contain several examples that deny discounts for actions by the executor. Prop. Reg §20.2032-1.

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     April 2008

     Transfer Tax Reform.  The staff of the Joint Committee on Taxation has released JCX-23-08, Taxation of Wealth Transfers Within A Family: A Discussion of Selected Areas for Possible Reform. The document was prepared in conjunction with a Senate Finance Committee hearing on April 3, 2008, explaining the estate and gift tax system's current state of flux and ways to reform it. The report can be found at www.house.gov/.

     Charitable Remainder Trust discretion.  In PLR 200813023 and 200813006, the IRS has ruled that a special independent CRT trustee can have discretion to allocate a portion of the annual unitrust amount to the income recipients or to qualified charities. In addition, the trustor can retain the power to substitute the charitable remainderpersons, provided that at least one-third of the remainder interest is distributed to public charities, and can retain the power to substitute the special independent trustee.

     Tax-exempt status.  The IRS has issued final regulations, Treas. Reg. §1.501(ac)(3)-1, clarifying the substantive requirements for tax exemption under IRC §501(c)(3) and the relationship between those requirements and the imposition of IRC §4958 excise taxes. The final regulations add several examples to illustrate the requirement that an organization serve a public rather than a private interest.

     Federal Estate Tax liens.  IRC §6324(a)(1) creates a special estate tax lien that attaches to the gross estate of a decedent for ten years from the date of death. The gross estate is divested of the special estate tax lien to the extent that the gross estate is "used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof." IRC §6324(a)(1). In First American Title Insurance Co v U.S., 101 AFTR 2d ¶ 2008-622 (CA 9, 03/27/08), the 9th Circuit ruled that the liens survived the sale of the real estate to third parties, although the additional estate tax was not assessed until a later audit of the estate tax return. The plaintiffs also conceded that the personal representative did not obtain a discharge of liability under IRC §2204 before selling the properties.

     Public Inspection of 501(c)(3) Form 990-T.  IRS Announcement 2008-21 explains the procedures the public may use to request the inspection and copying of a 501(c)(3)'s annual return reporting §511 unrelated business taxable income (Form 990-t). This provision is effective for returns filed after August 17, 2006. Form 4506-A is currently used to request a copy of an exempt or political organization's return, report, or notice under §6104(b)., and the form will be revised to allow a request for the Form 990-T. In the meantime, the Form 4506-A should still be filed to get a copy of the Form 990-t by writing "Form 990-T" on line 7. The charges for copies are listed on the Form.

     Extension of Time for GST elections.   New proposed regulations would provide guidance on how to obtain more time under §2642(g)(1) to make various generation-skipping transfer (GST) tax elections. Prop. Reg. §26.2642-7.

     Charitable Contributions of Intellectual Property.  The IRS has issued final regulations explaining the information reporting requirements for donees (charitable organizations) receiving net income from qualified intellectual property contributions made after June 3, 2004. If the charitable organization receives income from the intellectual property during the year ("Qualified Donee Income"), the charity is required to file Form 8899, and the donor may receive additional charitable deductions for QDI in excess of basis for 10 years after the gift. The deduction in the year of initial donation is limited to fair market value or basis, whichever is lower (usually a very low basis).

     Intentionally Defective Trusts.  Such trusts are typically structured so that the grantor pays the income tax on the trust's income, but the trust assets are not included in the grantor's taxable estate upon death. One method for doing this is giving the grantor, in a nonfiduciary capacity, the right to acquire property held by the trust by substituting other property of equivalent value. In Rev. Rul. 2008-22, the IRS ruled that this power retained by the grantor did not cause the trust property to be included in the grantor's taxable estate under IRC §§2036 or 2038.

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     March 2008

     Bundled Fees/Knight.  In IRS Notice 2008-32, the IRS has stated that for tax years beginning before January 1, 2008, nongrantor trusts and estates will not have to "unbundle" a fiduciary fee into costs that are fully deductible and those that are subject to the 2% Floor. Instead, you can deduct the full amount of the bundled fiduciary fee without regard to the 2% floor. This can be relied upon until the IRS issues final regulations consistent with the Supreme Court's holding in Knight, which requires that the fees "be uncommon (or unusual or unlikely) for an individual to incur" in order to not be subject to the 2% of AGI limitation.

     §7520 Annuity Tables.  The tables are generally used for valuing annuity interests at death. In Anthony v. U.S. (5th Cir, 03/04/08), the Court determined that the Estate must use the tables to value structured settlement payments (such as you typically see for a personal injury settlement). The case points out that the statute does allow deviation from the tables if (1) an annuity is expected to exhaust the fund before the last possible payment is made, (2) where the trust corpus may be invaded without the beneficiary's consent, or (3) where an individual who is a measuring life is terminally ill.

     UBTI on CRTs.  The IRS issued proposed regulations on the tax effect of unrelated business taxable income recognized by a charitable remainder trust. These changes were made as part of the Tax Relief and Health Care Act of 2006. The regulations would be effective for UBTI recognized in tax years beginning in 2007. The proposed regulations clarify that, consistent with Treas. Reg. §1.664-1(d)(2), the 100% excise tax imposed upon a CRT with UBTI is treated as paid from corpus, and the UBTI is income of the trust for purposes of determining the character of the distribution made to the beneficiary. Prop. Treas. Reg. §1.664-1(c). This is still somewhat better than the old rules that would have disqualified the tax-exempt status of the trust altogether.

     Post-death stock restrictions.  In IRB 2008-9, the IRS issued a nonacquiescence in the case of Herbert Kohler Jr . (TC Memo 2006-152), in which the court had said that post-death restrictions on stock as part of a tax-free reorganization could be considered when valuing the stock under §2032 (alternate valuation). The restrictions were placed on the stock between the date of death and the six-month alternate valuation date, and the Court decided that the stock should not be treated as "sold" on the date of the reorganization (about 2 months after the date of death) because of its tax-free design.

     E-Postcard for Small Tax-Exempts.  The IRS has announced a simple online filing system that small tax-exempt organizations can use to comply with a new law. Tax-exempt organizations that normally have annual gross receipts of $25,000 or less must file an electronic Form 990-N, "Electronic Notice (e-Postcard) for Tax-Exempt Organizations not Required to File Form 990- or 990-EZ," for tax years beginning in 2007.The Service has also launched a disclosure website where the public can view an organization's e-Postcard, located at www.irs.gov/.

     Private Foundations.  In Ltr. Ruls. 200808042 and 200808043, the Service has ruled privately that a transfer of assets from one private foundation to another pursuant to a court-approved settlement agreement will not jeopardize the tax-exempt status of either foundation, will not subject the transferring foundation to a private foundation termination tax under section 507, and will not violate any of the private foundation excise tax rules under sections 4941 - 4945.

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     February 2008

     Split-Interest Trusts.  The IRS has released new Form 5227, Split-Interest Trust Information Return, for 2007. The form replaces the additional Form 1041-A previously required, but the new Form 5227 used for charitable remainder and lead trusts is much more lengthy.

     Investment Advisory Fees.  The Supreme Court affirmed that investment advisory fees are subject to the 2% of AGI limitation for deduction under IRC §67(e). In Knight v. Commissioner, S.Ct. Docket No. 06-1286 (Jan. 16, 2008), which affirms the 2nd Circuit Rudkin decision, the Court determined that the fees would have been incurred even if the property were not held in the trust. Under the Court's analysis, fees will only be fully deductible (not subject to the 2% floor) if the taxpayer (i.e. trustee) can show that the costs "would be uncommon (or unusual, or unlikely) for the taxpayer" if an individual. The trustee must substantiate that it would be unusual for an individual who owned the same property to have incurred the same cost. The cost of the fiduciary tax return should be deductible under this standard, but other fees will have to be tested against the Court's language above. The Supreme Court decision is the law to be followed for all fiduciary returns, with IRS proposed regulation §1.67-4 (which also deals with this issue) not becoming effective until it is released as a final regulation, and then only for payments made after that date. That proposed regulation would require trustees to unbundle their fees.

     Nonqualified Partial Disclaimer.  In Estate of Christiansen, 130 T.C. No. 1 (2008), the Decedent had set up the estate to pass entirely to her daughter. However, any portion disclaimed was to be transferred 1/4 to the Decedent's foundation, and 3/4 to her testamentary, 20-year, charitable lead trust. The daughter disclaimed the portion of the estate in excess of $6,350,000, and the Estate was initially valued at $6.5 million. The IRS audited and adjusted the total value to $9.6 million, and the Estate claimed that it was still entitled to a deduction for the excess passing to the foundation ($800,000) and the present value of the charitable interest in the CLAT ($140,000), with a total contribution of about $2.4 million. The IRS only allowed the initial deduction for the foundation's interest of $40,000, claiming that the formula clause of the disclaimer was void as a violation of public policy. The Tax Court disagreed that there was a public policy against the formula, and found that the charitable deduction could be easily determined once the value of the Estate was finally determined. However, the full deduction for the CLAT was disallowed because Treas. Reg. §25.2518-3(a)(1)(ii) requires that the disclaimer of a partial interest also requires disclaimer of the remainder interest.

     §6166 Tax Lien.  In Internal Legal Memorandum 200803016 the IRS explains the circumstances under which a Decedent's LLC interest must be accepted as security for the deferred tax payments under IRC §6166. The deferred estate tax payment option is available for an estate if (1) a closely held business interest is included in the gross estate of a decedent who was a U.S. citizen or resident at the time of his death; and (2) the value of the business interest is more than 35% of the decedent's adjusted gross estate.

     Life Insurance Exchange.   In PLR 200801001 the IRS has privately ruled that the proposed exchanges of employer-owned life insurance will qualify as a tax-free exchange under IRC §1035. The basis and the investment in the contract of the newly issued contracts will be the same as that of the contract for which they are exchanged. In this case the taxpayer making the exchanges was the corporate employer and its subsidiary.

     Charitable deduction for series fractional contributions.  The Technical Corrections Act of 2007 (enacted Dec. 29, 2007) has retroactively repealed stringent limits on estate and gift tax charitable deductions that would have applied where an individual made a series of fractional contributions of tangible personal property. The common example is giving a fractional interest in art work to a museum, giving the museum the right to display the property for a fractional part of the year. When subsequent fractional interests are contributed, the deduction for income tax purposes is still based on the fair market value at the time of the original contribution (i.e. you do not get a deduction for appreciation that occurred after the initial contribution), but if a remaining fractional share is given at death, the estate will get a deduction based on the full fair market value of the fractional interest at death.

     Like-Kind Exchanges.  In Rev. Proc. 2008-16, the IRS has issued a safe harbor allowing limited personal use of a property without impacting its qualification for like-kind exchange treatment of business or investment property. The safe harbor applies if (1) the taxpayer owns both properties for the qualifying use period (24 months before the exchange for the old property, and 24 months after for the new property), and (2) within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange (a) the taxpayer rents the dwelling unit to another person(s) at a fair rental for 14 days or more, and (b) the period of the taxpayer's personal use of the dwelling unit doesn't exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.

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     January 2008

     Home sale exclusion for surviving spouse.  The Mortgage Forgiveness Debt Relief Act of 2007 provides that the surviving spouse, even if filing as a single taxpayer, can exclude up to $500,000 of taxable gain on the sale of the homestead if the home is sold within two years of the decedent's date of death, and if (1) the requirements for the exclusion were met immediately before the date of death, and (2) the surviving spouse has not remarried. The full exclusion otherwise applies only if (1) the spouse's file a joint return, (2) either spouse owned the home for at least 2 of the 5 years before the sale, (3) both spouses used the home as a principal residence for at least 2 of the 5 years before the sale, and (4) neither spouse is ineligible for the full exclusion because of the once-every-2-year limit on the exclusion.

     Forgiven Mortgage Debt Relief.  The same Act provides that a taxpayer does not have to pay income tax on up to $2 million of debt forgiven for a qualifying loan secured by a qualified principal residence (e.g. one to buy or renovate a residence). The change applies to debts discharged from Jan. 1, 2007 to Dec. 31, 2009.

     Type III Supporting Organizations.  As of August 17, 2007, trusts that previously qualified as Type III supporting organizations may be classified as private foundations as a result of the Pension Protection Act of 2006. Because of the need for affected charitable trusts to adjust record-keeping systems to reflect private foundation status, and the administrative difficulties in processing returns reflecting a mid-year change of status, trusts that became private foundations during 2007 by virtue of the PPA change may continue to file Form 990, Return of Organization Exempt from Income Tax, for tax years beginning before January 1, 2008. In addition, they will not be required to file an information return on Form 990-PF or pay excise tax on investment income under IRC §4940 until the first tax year beginning on or after January 1, 2008.

     United Way charitable giving.  The IRS has issued Notice 2008-16 providing interim guidance on substantiating charitable contributions to pass-through organizations such as the United Way. Starting in 2008, taxpayers are required to substantiate all charitable contributions, regardless of amount. The taxpayer should maintain bank records or a written communication from the donee showing the name of the donee organization, the date of he contribution and the amount of the contribution. Until new regulations are issued, contributions to a "CFC" (Combined Federal Program, or a similar program like the United Way) will be properly documented by a communication from the CFC or by the payroll documentation if a payroll deduction, even if the funds flow through to another charitable organization.

     Zero capital gains tax.  For 2008, there is no tax on capital gains and qualifying dividends if the taxpayer's total income is less than $32,550 for single taxpayers and married taxpayers filing separate returns, $65,100 for married taxpayers filing joint returns and surviving spouses; and $43,650 for heads of households. However, most children who are subject to the kiddie tax won't benefit from the 0% tax rate if their parents are in the higher brackets. For 2008, a child subject to the kiddie tax pays tax at his or her parents' highest marginal rate on the child's unearned income over $1,800 if that tax is higher than the tax the child would otherwise pay on it. Under stricter rules that apply beginning this year, a child is subject to the kiddie tax if (a) he or she has not attained age 18 before the close of the tax year; or (b) is age 18, or is a full time student over age 18 but under age 24, and his or her earned income doesn't exceed one-half of the amount of their support.

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