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Sunday August 2, 2015

Washington News

Washington Hotline

34th Highway Fund Extension

On July 30, by a vote of 91-4, the Senate passed a three-month extension for the Highway Trust Fund. The House had previously approved The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (H. R. 3236). The bill extends highway funding for 3 months and is the 34th short-term extension of the Highway Trust Fund.

The Senate also passed a 6-year act to fund highways, bridges and other infrastructure. The DRIVE Act would be the first multi-year highway bill since 2005.

Sen. Jim Inhofe (R-OK) was the lead sponsor for the bill. He stated, “The DRIVE Act is a solution, it’s the solution – a bipartisan solution. It provides the needed long-term funding certainty so that the major construction projects can get off the ground – projects that are not possible with short-term extensions. And it will signal to job creators that America’s economy is not only going to grow, but it’s going to be sustained because the infrastructure will exist to support it.”

The DRIVE Act includes fairly complicated revenue-raising provisions. It was necessary to assemble seven different revenue provisions in order to pay for construction over six years.

1. Estates – More comprehensive reporting rules on the basis of assets. With an accurate basis, when heirs sell appreciated property there will be a larger capital gains tax.

2. Passport – Any person owing over $50,000 in tax will be subject to passport revocation or denial of his or her renewal request.

3. Overstated Basis – If a taxpayer claims too high of basis on sale of an asset, the IRS will have six years to discover the error and collect more tax.

4. Mortgages – Comprehensive reporting requirements will lead to more accurate home interest deductions.

5. Corporations and Partnerships – There will be changes in some of the filing deadlines.

6. Tax Debt – Private collectors will be hired to obtain payments from taxpayers who owe back taxes.

7. Pension Plans – Certain funding requirements may be satisfied with surplus assets until year 2025.

The House will review the Senate bill in September and is likely to pass its own version of the long-term bill. The three-month extension is designed to permit the House and the Senate to agree on a six-year bill by the end of October.

Editor’s Note: The complexity of the tax revenue provisions shows how challenging it was for the Senate to find six years of funding. However, if the Senate and House can develop a six-year plan by October, that is clearly very helpful for states and cities who are attempting new highway, bridge and other infrastructure projects.

NIMCRUT Valued Using IRS Tables


In Estate of Arthur E. Schaefer v. Commissioner; 145 T.C. No. 4; No. 13183-11 (28 Jul 2015), the estate desired to value two net income plus makeup unitrusts based upon the Sec. 7520 Applicable Federal Rate (AFR) rather than the stated payout percentages. The Tax Court determined that legislative history and IRS rulings require use of the actual 11% and 10% payout rates for the unitrust. Because the trusts with higher rates fail the Sec. 664(d)(2)(D) 10% minimum deduction interest tests, there was no estate charitable deduction.

Arthur Schaefer funded two NIMCRUTs on February 21, 2006. Trust I paid 11% to Arthur for life, then to son Ronald for his lifetime, with a maximum term of twenty years. Trust II paid 10% to Arthur for life, then to son Benjamin for life, also with a maximum term of twenty years. Because both trusts used the net income plus makeup methodology, they paid the lesser of the stated percentage or the actual income earned each year.

Arthur passed away March 9, 2007. The Applicable Federal Rate under Sec. 7520 for that month was 5.8%.

When the estate filed IRS Form 706 on April 16, 2008, it did not claim a charitable deduction under Sec. 2055 for the two unitrusts. However, it reduced the estate value by the calculated charitable value of the trust using the March 2007 AFR.

The IRS audited and assessed a deficiency on March 7, 2011. The IRS denied all charitable deductions because the two trusts did not pass the 10% minimum deduction interest test.

The Tax Court noted that the question was the interest rate that was required to be used under Sec. 664 (d)(2)(D) to determine the charitable remainder value. If the 5.8% AFR was permitted, then the trusts would pass. However, the 11% and 10% trust rates failed the 10% minimum deduction interest test.

The estate noted that Sec. 7520 mandates an estimated return number of 5.8% for the month of the demise of Arthur. Therefore, that number is the “return expectation” and should be used to calculate the deduction.

However, the IRS noted that the requirement under Sec. 664(d)(2)(D) was to use the stated trust payout. The legislative history indicated that for a net income plus makeup unitrust, the deduction “is to be computed on the basis that the income beneficiary of the trust will receive the higher of 5% of the net fair market value of the trust assets or the payment” specified in the trust instrument.”

Because the IRS and Congress have indicated that the deduction must be completed using the stated 11% and 10% trust rates, the unitrusts do not qualify. Therefore, there is no charitable deduction.

Editor’s Note: With a gift of an income interest from a NIMCRUT to charity, the IRS requires using the lesser of the AFR or the trust payout percentage for valuation. However, because it is possible that a NIMCRUT may earn and pay out a higher amount, the IRS requires the use of the trust payout to calculate the remainder interest value for both income and estate tax purposes.

IRS Settlement Final Even With Subsequent Estate Litigation


In Marcia Billhartz v.Commissioner; No. 14-1216 (7th Cir., 2015) the Court held that a subsequent state court action did not change a settlement between the IRS and an estate.

Decedent Warren Billhartz had a Marital Settlement Agreement with first wife Norma. Under this agreement, one-half of his estate at death must pass to the four children of his first marriage. Billhartz subsequently married his second wife, Marcia, and he passed away in 2006.

The estate assets were held either in joint tenancy or in a trust. The successor co-trustees were wife Marcia and son Ward.

Following a negotiation between Marcia and the four children, each of the three daughters received $3.5 million from the estate and son Ward received $9.5 million.

While the distribution to the four children was $20 million, on IRS Form 706 the estate claimed a Sec. 2053(a)(3) deduction for a debt of $14 million. The IRS contested the deduction and issued a deficiency. In April of 2012, the estate and the IRS settled, with a permitted deduction for 52.5% of the $14 million amount.

In June of 2012, the three daughters sued the estate in state court. The estate asked the Tax Court to reopen the estate if the daughters obtained a favorable settlement. Subsequently, each daughter did obtain an additional $1.45 million from the estate. The IRS opposed reopening the estate and asked the court to affirm the original settlement.

The Court noted that the estate claimed there was mutual mistake of fact and potential fraudulent withholding of information by the IRS. While there was a question during the settlement negotiations with respect to the total payments, the Court observed that even with the existing $20 million payment to the children, the estate only claimed a qualified debt for $14 million. Therefore, there still was uncertainty as to the appropriate amount of the estate deduction. A negotiated settlement is different from a “mutual mistake as to material fact.”

In addition, one daughter had indicated to the IRS that she may sue the estate in state court. The Circuit Court determined that it is not at all surprising that an heir who believes they potentially could recover $1 million or more might bring an action. Therefore, the potential existence of the suit was obvious to both the IRS and to the estate. The estate settlement with the IRS was upheld and there was no additional deduction for the estate payments to the three daughters.

Applicable Federal Rate of 2.2% for August -- Rev. Rul. 2015-16; 2015-31 IRB 1 (17 July 2015)


The IRS has announced the Applicable Federal Rate (AFR) for August of 2015. The AFR under Section 7520 for the month of August will be 2.2%. The rates for July of 2.2% or June of 2.0% 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 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 July 31, 2015
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