House Majority Leader Steny Hoyer (D-MD) stated on August 3^rd that he hopes the House will act to extend the 2001/2003 tax cuts before adjourning on October 8, 2010. House Democrats generally agree with the White House proposal that tax cuts should be extended for individuals making less than $200,000 ($250,000 for married couples).

In response to suggestions that the tax cuts should also be extended for the taxpayers in the top two brackets, Leader Hoyer opposed the concept. He stated, "Almost every economist indicates that those tax cuts will not serve to grow the economy or encourage investment or consumer spending."

Speaking at a Washington conference this week, Treasury Secretary Timothy Geithner also emphasized the importance of extending the middle-class tax cuts and raising taxes for the top two brackets. He stated, "There is no credible argument to be made that the purpose of government is to borrow from future generations of Americans to finance an extension of tax cuts for the top 2%."

Two prominent Democratic senators have suggested that the tax cuts should be extended for upper-income earners. Sen. Evan Bayh (D-IN) and Budget Committee Chair Kent Conrad (D-ND) have both supported an extension of all the tax cuts for the next year.

When asked whether the tax system should be modified this year, Sen. Conrad noted, "It is a losing strategy to try to rejigger the current tax code." He prefers to wait for a November proposal from the National Commission on Fiscal Responsibility and Reform. If 14 of the 18 members of the fiscal commission agree on a proposed strategy, House and Senate leaders have promised to submit that strategy for a vote. Sen. Conrad suggests not making changes until comprehensive new tax and spending policies are determined.


Schumer Proposes Permanent IRA Rollover

Senator Schumer and 15 co-sponsors of the Currency Exchange Rate Oversight Reform Act of 2010 included provisions that would make four charitable deductions permanent. The bill is designed to modify the laws on currency transactions but it provided a platform to add in the four charitable provisions.

The senators propose making permanent the IRA Charitable Rollover, the deduction for gifts of food inventory, the deduction for gifts of book inventory to public schools and the enhanced deduction for gifts of computers for educational purposes.

Editor's Note: While there may not be prompt action on this bill, it is very encouraging that these 16 senators believe it is important to extend these four charitable provisions permanently. The IRA Charitable Rollover was the first of the four in the bill. That suggests that there is strong support in the Senate for permanent status for the rollover. Please note: As of the date of this publication, the House has passed the tax extenders including the Charitable IRA Rollover but the Senate has been unable to come to agreement on a bill. It is possible that the Senate may act in September to attach the 40 tax extenders to legislation. While that is the earliest possible date for passage of the IRA Charitable Rollover for 2010, it is still probable that the rollover will pass with an effective date of January 1, 2010.


Costs and Taxes Decimate Inheritance

In Carl M. Upchurch et al. v. Commissioner; T.C. Memo. 2010-169; Nos. 14827-07, 14959-07 (1 Aug 2010), the Tax Court held that two estate beneficiaries were liable for taxes and interest on their bequests.

Tasker M. and Judith D. Upchurch were both in their second marriage. The blended family included children Bruce and Carl from Tasker's first marriage and children Rodney, Ronald and Robin from Judith's first marriage.

Tasker passed away in 1994. Judith executed her will on June 7, 1999 and passed away on August 20, 2000.

Under Judith's will, her tangible personal property was divided among the five children. Her cash and securities were transferred to her natural-born children and grandchildren. Her will also directed that the family residence would be divided equally among the five children.

However, after executing the will she divided the lot into two parcels. The lot with no residence was transferred to son Ronald and his wife Laura through a quitclaim deed. Ronald subsequently built a home on that property. The residence and remaining property was transferred by quitclaim deed to daughter Robin. After the demise of Judith, Tasker's sons, Bruce and Carl, brought an action against the estate claiming constructive trusts of the two parcels on behalf of the estate or requesting that the court invalidate the quitclaim deeds. In a settlement by all parties, $53,500 was distributed to Bruce and $53,500 was paid to Carl.

The estate deducted both payments as debts on the IRS Form 706. The IRS disallowed the deductions because the debts were to family members and issued a deficiency of $46,758.12 with interest of $7,162.53. Subsequently, the IRS also issued a "failure to pay penalty" of $11,727.32 against the estate.

Bruce and Carl claimed that they were exempt from the IRS claim because they received the property from the children rather than from the estate. The Tax Court noted that the payments were made directly from the estate and that the estate was a party to the action. Second, Bruce and Carl stated that their potential obligation should be limited to the two-thirds of the payouts and the one-third that was transferred to their attorneys should reduce their obligation. However, the court noted that they were the legal recipients of the full $53,500 and, therefore, their liability extended to that amount. Finally, the court determined that interest was properly calculated using the federal law.

Editor's Note: With a blended family, there is a higher probability of conflict. As the Upchurch estate teaches, it is important to have agreement on the inheritance while both spouses are living. In some cases, it may be appropriate to have a revocable trust with an independent trustee to reduce the risk of a future estate contest. In this case, Bruce and Carl lost nearly all of their inheritance as a result of payment of taxes, interest and attorney fees.


Executor Relieved of Accuracy Penalty

In Estate of Ralph Robinson v. Commissioner; T.C. Memo. 2010-168; No. 20941-07 (1 Aug 2010), the Tax Court allowed an executor to escape liability for an accuracy-related penalty. The decedent, Ralph Robinson, was a residence of Washington State and had acquired a number of real estate properties. In his late 80's, he suffered from Alzheimer's disease. In 1999, he gave his daughter Carol a durable power of attorney to manage his assets. At the request of his sister Carol, James Robinson became co-personal representative and managed Ralph Robinson's estate planning.

James is a computer programmer with no college degree and has obtained assistance from enrolled agent John Schlabach on his personal income tax returns. James discussed the estate planning for his father Ralph with Mr. Schlabach. Schlabach recommended that they create a living trust and transfer the Robinson home and brokerage accounts to that trust. Schlabach also recommended a "pure trust" that was funded with six residential lots in Everett, Washington. James understood that the "pure trust" was a means of avoiding federal estate tax on the lots.

Following the death of Mr. Robinson, Schlabach recommended that a portion of the estate be transferred to a charitable trust to eliminate the federal estate tax. James and Carol created the Robinson Foundation and transferred $941,000 from the estate to the foundation.

The IRS disallowed the charitable deduction because the charitable trust did not exist on the date of death. In addition, the IRS required all of the lots in the "pure trust" to be included in the estate and accessed a deficiency of $380,514 and a $76,103 accuracy-related penalty under Sec. 6662(a). The estate paid the deficiency and James now contests the accuracy-related penalty.

The Tax Court noted that the accuracy penalty is applicable unless James had good faith reliance on an independent competent professional. The good faith reliance must be "demonstrably reasonable." Because James is unsophisticated and relied on Mr. Schlabach in good faith, the Tax Court determined that the accuracy penalty was not applicable.

Editor's Note: It was a good decision to fund the revocable living trust. An individual with a chronic disease such as Alzheimer is well served by transfer of assets into a living trust. This may avoid a very expensive and cumbersome conservatorship. However, the "pure trust" was an obvious sham and should never have been recommended by an enrolled agent. It is a flag that merits attention from the IRS in the estate tax review process. Finally, the charitable foundation should have been created during life. When counsel creates durable powers of attorney, if a charitable plan is contemplated there should be specific language in the durable power to so indicate. While it may be appropriate to obtain a ruling from the probate court to approve funding a foundation, with a solid indication of charitable intent it should have been possible to do so during the life of Mr. Robinson.


Applicable Federal Rate of 2.6% for August – Rev. Rul. 2010-19; 2010-31 IRB 1 (18 July 2010)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2010. The AFR under Sec. 7520 for the month of August will be 2.6%. The rates for July of 2.8% or June of 3.2% 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 2010, pooled income funds in existence less than three tax years must use a 4.6% deemed rate of return. Federal rates are available by clicking here.