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Saturday October 3, 2015

Washington News

Washington Hotline

Clinton and Fiorina on Taxes

With the presidential campaign at full speed, candidates Hillary Clinton and Carly Fiorina recently published several tax proposals.

Clinton focused on healthcare. Many individuals are now making substantial out-of-pocket payments for healthcare costs that are not covered by insurance. To assist individuals with substantial costs, Clinton proposes a healthcare tax credit. If you have healthcare expenses that exceed 5% of income, there would be a $2,500 credit for single persons or a $5,000 credit per family.

The Clinton campaign stated, “This refundable, progressive credit will help middle-class Americans who may not benefit as much from currently available deductions for medical expenses.”

While the Clinton campaign was not specific on how the credit costs would be covered, it indicated that there will be higher taxes on upper-income persons and new fees paid by medical companies.

Fiorina was conducting an online media presentation this week and was asked about the income tax code. She commented, “Our tax code is now 70,000 pages long. Only big companies and wealthy, powerful, well-connected people can understand that tax code and hire the accountants and lawyers to take advantage of all that complexity. So we need to go from a 70,000-page tax code to about a three-page tax code.”

The 70,000 pages referred to by Fiorina include the Internal Revenue Code, Treasury Regulations and the Congressional legislative history. The Fiorina campaign has not yet published specifics on how the tax code could be reduced to three pages.

Editor’s Note: As a public service to our readers, your editor will periodically share tax proposals from candidates of both parties.

Litigation Blocks Estate Charitable Deduction

In Estate of John D. DiMarco v. Commissioner; T.C. Memo. 2015-184; No. 1132-14 (24 Sep 2015), the Tax Court denied a charitable income tax deduction of $314,942 due to ongoing estate litigation.

Decedent John DiMarco passed away on December 16, 2008. His will required payment of all estate cost and taxes, with 100% of the residuary transferred to his church.

Seven cousins secured the services of attorney Fredrick Killeen and intervened in the probate on February 3, 2010. There were court proceedings in 2010 and 2011. During 2011, Killeen proposed a settlement between the seven cousins and the nonprofit. In the initial settlement agreement on April 26, 2012, the seven cousins and two charities each received a 1/3 share, or $173,250. The final settlement was established on January 28, 2013.

The estate filed its 2010 IRS Form 1041 Income Tax Return. Because a substantial qualified plan was distributed to the estate, it reported $335,854 of income. However, under Sec. 642(c)(2) the estate claimed a charitable income tax deduction of $314,942. While the estate claimed those funds were “permanently set aside” for the charity, the IRS rejected the deduction and assessed a deficiency of $108,588.

The Court noted that Sec. 642(c)(2) permits an income tax charitable deduction if the funds are permanently set aside. However, under Reg. 1.642(c)-2(d), the amount may not be qualified if there is a risk it will not be permanently set aside. The set-aside amount must pass the not “so remote as to be negligible” test and fail to be distributed to the charity.

The estate was in litigation until 2012. The estate claimed that the deduction should be permitted because by March 22, 2012 there was a settlement conference and it could determine all potential expenses.

However, the IRS rejected the claim by the estate because there was litigation for a period of three years. The IRS factors included the known litigation, a will contest involving cousins and potentially other heirs, multiple attempts to locate the witnesses for the will and the uncertainty of administrative expenses. Based on these factors, there was a “not so remote as to be negligible” risk that the funds will not go to charity.

Because the litigation continued over a period of three years, the Tax Court determined that the funds are not permanently set aside and denied the charitable income tax deduction.

Editor’s Note: The decedent made a costly error by not selecting the charity as his designated beneficiary. Generally, an IRA or other income in respect of a decedent (IRD) should not be transferred to an estate because it opens the potential for income taxation. The IRA or other qualified plan should always be transferred directly to the charity through a beneficiary designation. If DiMarco had selected the charity as his designated beneficiary, it would have saved all of the administrative fees on the IRA transferred to the estate and would also have avoided the risk of a very substantial income tax payment.

Final Regulations on Private Foundation Foreign Grants

In T.D. 9740 the IRS published final regulations explaining how foreign grants may be qualified distributions.

Under Rev. Proc. 92-94 and prior regulations, private foundations were able to rely solely on affidavits by foreign charities. If the private foundation had an affidavit, it qualified for a “special rule” exception to the taxable expenditure provisions.

The final regulations change the “solely an affidavit” rule and require a written opinion by a qualified tax practitioner. Based upon a “facts and circumstances test,” the CPA or attorney may opine that the foreign charity could be qualified as a U.S. nonprofit. An update to Rev. Proc. 92-94 is expected later this year.

The tax practitioner may use the affidavit of the foreign charity, rely on an opinion by counsel for the foreign charity and gather additional factual data. He or she must provide the IRS with sufficient facts to demonstrate potential qualification for U.S. nonprofit status.

The new tax practitioner written opinion rule applies after September 25, 2015. There is a 90 day grace period, but if a written grant is approved on or before that date, payments may be made for up to five years.

Applicable Federal Rate of 2.0% for October -- Rev. Rul. 2015-21; 2015-40 IRB 1 (17 September 2015)

The IRS has announced the Applicable Federal Rate (AFR) for October of 2015. The AFR under Section 7520 for the month of October will be 2.0%. The rates for September of 2.2% or August of 2.2% 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 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.

Published September 25, 2015
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