Tax Quote of the Week

"To extinguish a debt which exists and to avoid contracting more are ideas almost always favored by public feeling and opinion; but to pay taxes for the one or the other purpose, which are the only means of avoiding the evil, is always more or less unpopular. These contradictions are in human nature."




White House Budget Changes Taxes

On February 1, 2010, the White House released the budget for fiscal year 2011. The budget projects a spending level of $3.8 trillion and a deficit of $1.56 trillion.

President Obama spoke in support of the budget. He indicated that the budget choices were challenging. He stated, "It's time to save what we can, spend what we must and live within our means."

The budget includes many provisions that will affect taxes. Some provisions will reduce taxes during the next decade. Others will increase taxes. Finally, there are some provisions such as the estate tax, which include both increases and decreases.

Tax Reductions

The most expensive tax reduction is to retain the existing brackets for the 10%, 15%, 25% and 28% rates. These current brackets reduce taxes for middle-income Americans. The "Making Work Pay" credit is also proposed to be extended for one year. This credit reduces withholding for most workers.

The budget also contemplates an expense of $46.7 billion for "tax extenders." The tax extenders include the teacher's deduction, various business credits and the IRA charitable rollover.

Tax Increases

Top current tax rates of 33% and 35% will be increased in 2011 to 36% and 39.6%. These increases apply to single persons with incomes over $200,000 and married couples with incomes over $250,000. There will also be an increase from 15% to 20% in the tax rate on capital gains and dividends, which will be taxed at ordinary income rates up to 39.6%

During the past three years, the 3% floor on itemized deductions for upper-income persons and phase out of personal exemptions have been eliminated. Restoring these provisions will also increase taxes on higher-income households in 2011.

The White House again made a proposal that was not successful last year in the United States Senate. The budget proposes that higher-income individuals be restricted from benefiting from deductions to the extent that their tax bracket exceeds 28%. If this 28% cap is enacted, major charitable donors to capital campaigns will lose part of their tax savings.

This proposed limit on tax savings from charitable gifts by higher-income taxpayers were previously met with strong opposition. The Senate overwhelmingly passed a 2009 bill by Sen. Robert Bennett (R-UT) that rejected the concept. Sen. Bennett stated, "The Senate sent a clear message to the President that we do not support increasing taxes on charitable contributions."

Sen. Bennett noted that charities "benefit greatly" from donations made by individuals in high brackets. He suggested that the 28% cap on itemized deductions would have major negative impact on charities.

Taxes Up and Down

The White House budget proposes an estate tax exemption of $3.5 million and tax bracket of 45%. In effect, the 2009 estate tax rules will be extended.

The $3.5 million exemption/45% tax rate would be an increase from the present 0% estate tax rate, but it would be a decrease from the scheduled 55% estate tax rate that is to be effective on January 1, 2011.


Democratic Praise for White House Budget

Democratic Senators and Representatives were supportive of the new White House budget. Sen. Budget Chair Max Baucus (D-MT) stated, "The job creation funds allocated in this budget will help rebuild the foundation of our economy -- the middle class. They will help small businesses hire more workers and provide assistance to individuals, businesses and families to get through the recession."

Sen. Baucus also supported the proposed changes and increases on companies with international operations. He did not comment directly on the income tax increases.

Sen. Baucus did make reference to the estate tax. In December, 2009, he was unable to pass an extension of the 2009 estate tax rules because two Democratic Senators and most Republicans supported a $5 million exemption and 35% top estate tax rate. Sen. Baucus noted, "Several Members of this Committee – notably Senators Lincoln, Cantwell, and Kyl – have been working hard on their proposals in this area, as well."

Senate Majority Leader Harry Reid (D-NV) was also pleased with the White House proposal. He indicated that he supported the "middle-class tax cuts" that will benefit families. He also stated that the budget "will continue Democrats' efforts to reduce the deficit and restore fiscal responsibility."

Sen. Kent Conrad (D-ND) is Chair of the Senate Budget Committee. He believes that the 2010 budget and deficit were essential to save an economy "on the brink of collapse," but that there need to be changes in the future. Sen. Conrad indicated that in the future the Senate will need "to focus on controlling our debt."

Finally, Chair of the House Ways and Means Committee Charles Rangel (D-NY) stated, "It is abundantly clear that we must find some way to build confidence in our economy, particularly for small businesses." Chairman Rangel was generally supportive of the small business credit of $5,000 per job for hiring new workers. He also hoped that he and the Ranking Republican Dave Camp (R-MI) could work together to find bipartisan tax solutions for next year.


Republican Response to White House Budget

Sen. Charles Grassley is the Ranking Republican on the Senate Finance Committee. He responded that the White House is downplaying "the effects of raising taxes on small business owners." In his view, the increase in income tax rates to 36% and 39.6% will impact at least half of small business owners with 20 or more employees. His staff notes that 20 million workers are employed by these businesses. With the increased tax rates, Sen. Grassley sees a "real disconnect between the administration's stated interest in helping small businesses and creating jobs" and the higher taxes.

Sen. Judd Gregg is the Ranking Member on the Senate Budget Committee. He and Sen. Conrad have been advocating budget restraint to reduce the deficit. Sen. Gregg exclaimed, "This country is sinking into a fiscal quagmire – the President's stimulus plan has not resulted in job growth, this year's deficit is expected to reach $1.6 trillion and Congress just agreed to extend the federal credit limit to more than $14 trillion." Sen. Gregg calls the new budget "more spending, more borrowing and more taxes." His view is that the new budget fails to make significant progress toward deficit reduction.

Key House Republicans also shared similar concerns. House Minority Leader John Boehner (R-OH) believes that the budget "spends too much...taxes too much...and borrows too much." The budget of $3.8 trillion is up 30% in just three years time compared to 2008. There are approximately $2 trillion in tax increases over the next decade that will particularly harm small business owners. Finally, the $1.6 trillion deficit plus another $9 trillion in estimated deficits over the decade will result in a tripling of national debt from 2008 to 2019.

Finally, Rep. Dave Camp (R-MI) is the Ranking Republican on the House Ways and Means Committee. He observes that the stimulus bill was not particularly successful. He noted, "Instead of creating 3.5 million jobs as Democrats promised, we have since witnessed the elimination of nearly three million more jobs." Rep. Camp is also concerned about the increasing federal debt and the impact of higher taxes on job creation.

Editor's Note: Your editor and this organization take no specific position on any of the Democratic or Republican comments. We offer a balanced view of both sides as a service to our readers.


Family Limited Partnership a Bona Fide Sale

In Estate of Charlene B. Shurtz et al. v. Commissioner; T.C. Memo. 2010-21: No. 6076-07 (3 Feb 2010), the Tax Court determined that a family limited partnership (FLP) was properly created and operated. It rejected the IRS claim that family control over the FLP assets was sufficient to cause the assets rather than the discounted FLP units to be includable in the estate of Mrs. Shurtz.

The decedent Mrs. Shurtz married Reverend Richard Shurtz. She had been raised by Charles and Bonnie Barge in Mississippi. Charles Barge had acquired and managed timber property and owned 45,197 acres of Mississippi timberland.

From 1954 to 1986, Pastor and Mrs. Shurtz were missionaries in Brazil and Mexico. They returned to the United States in 1986 and he became pastor of a church in Montebello, California.

Mrs. Shurtz and her two siblings inherited interests in the Mississippi timberland. In 1993, the three children, their mother Bonnie Barge and trustees of several trusts for grandchildren created Timberland LP to manage the family property. All of the individuals and trusts contributed their interests in the property in exchange for limited partnership shares.

Because Mississippi had a reputation for "jackpot justice," many individuals with substantial resources created FLPs to reduce litigation risk. On November 15, 1996, Reverend and Mrs. Shurtz created Doulos LP. Doulos LP was funded with her 16% interest in Timberland LP, her 93.4% interest in another timber parcel of 748.2 acres and the 6.6% interest in that same parcel owned by Reverend Shurtz. Doulos LP existed to "reduce estate tax, provide asset protection, provide for heirs and provide for the Lord's work."

From 1996 to 2000, Mrs. Shurtz made 26 gifts of 0.4% Doulos LP interests to various family members. Each gift was valued at $19,700 and qualified for the annual exclusion. In 2002, Mrs. Shurtz, who had suffered since 1986 with Parkinson's disease, passed away. Her estate was valued at approximately $8.8 million.

Prior to her demise, Mrs. Shurtz had contacted development staff from the Dallas Theological Seminary Foundation. They recommended attorney Louis Wall who prepared her living trust and estate plan. Her estate planning goals were to create a bypass trust to use any available remaining estate unified credit, transfer the balance of the estate into a marital deduction trust to benefit Reverend Shurtz for his lifetime and for the remainder of the marital trust to be transferred to a charitable annuity lead trust making a 12% payment for a calculated term of years necessary to achieve a zero estate tax.

After Mrs. Shurtz passed away and the Form 706 estate tax return was filed, the IRS contested the marital deduction and issued a deficiency of over $4.7 million. The IRS claimed that Doulos LP was not a valid FLP and therefore the assets in Mrs. Shurtz's estate would, under Sec. 2036 or Sec. 2035, be valued at full fair market value rather than the discounted FLP value. The estate responded with the claim that there was a Sec. 2036 bona fide sale and therefore the discounts were qualified.

The Tax Court reviewed the requirements for a bona fide sale. Generally there must be a legitimate nontax reason for the FLP. In the case of property held in Mississippi, the litigious nature of that state was a legitimate reason for attempting to protect the family timberland. In addition, the preservation of a family business is also a legitimate reason for creating a partnership.

Finally, there were several factors that related to the creation and operation of Doulos LP. The funding of Doulos LP resulted in proportionate interests to the contributed property. Assets were reflected properly in the partner's capital accounts. When distributions were made, there was a negative adjustment in each capital account. Finally, there was a "legitimate and significant nontax business reason" for creating the family limited partnership.

For all of these reasons, the Sec. 2036(a) "bona fide sale" exception applied. The assets were valued at the discounted level appropriate for Doulos LP and there was no estate deficiency.

Editor's Note: This was a sparkling taxpayer victory. It is an excellent road map for a successful family limited partnership. The contributions and capital accounts were appropriately maintained. There were annual meetings and correct accounting for all of the withdrawals. With the documented business purpose and the appropriate management and operation of the partnership, it easily qualified for FLP discounts.


Applicable Federal Rate of 3.4% for February -- Rev. Rul. 2010-6; 2010-6 IRB 1 (20 Jan. 2010)

The IRS has announced the Applicable Federal Rate (AFR) for February of 2010. The AFR under Sec. 7520 for the month of February will be 3.4%. The rates for January of 3.0% or December 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.