Washington News

On March 29, the Senate voted down the Repeal Big Oil Tax Subsidies Act (S. 2204). The bill was introduced by Sen. Robert Menendez (D-NJ) and would change several tax benefits for large oil companies.

The bill would have limited the deductibility of foreign tax credits, reduce the Sec. 199 manufacturing deduction and change from percentage to cost depletion. It also would repeal expensing of intangible drilling costs and require those items to be amortized.

While big oil companies would pay approximately $24 billion in additional taxes over 10 years with these changes, approximately $11.7 billion of that amount would be allocated to energy tax extenders. These had previously been proposed by Sen. Debbie Stabenow (D-MI). They include credits for energy-efficient homes, for biodiesel and for cellulosic biofuel.

President Obama supported the bill to require major oil companies to pay additional tax. He stated, "With record profits and rising production, I'm not worried about the big oil companies. That's why I think it's time they got by without more help from taxpayers who are already having a tough enough time paying the bills and filling up their gas tank."

Sen. Menendez supported the bill on the Senate floor and stated, "People I talk to in New Jersey want to know why they are stuck paying close to $4 for a gallon of gasoline while these companies rake in billions of dollars of subsidies and record profits. And they want to know why these oil companies should continue to enjoy billions of dollars in subsidies when we could be using that savings to invest in alternatives to oil and lower the deficit."

Senate Republican Leader Mitch McConnell (R-KY) responded to Sen. Menendez. He pointed out that taxes on energy would not result in lower gas prices. McConnell commented, "As Americans filled up their cars with gas this weekend, I'm sure a lot of them wondered how much higher gas prices could get. Well, today, the Democratic-controlled Senate plans to send these folks a message: If they had their way, gas prices would be even higher."

Editor's Note: Your editor and this organization take no specific position on the above comments. This information is offered as a service to readers because the cost of gasoline impacts all Americans.

Formula Gifts Do Not Violate Public Policy

In Joanne M. Wandry et al. v. Commissioner; T.C. Memo. 2012-88; Nos. 10751-09, 10808-09 (26 Mar 2012), the Tax Court permitted gifts of specific dollar amounts through a formula that reduced the number of gifted shares based on final IRS or Tax Court valuation.

In 1998 Joanne and her husband formed the Wandry Family Limited Partnership, a Colorado limited liability limited partnership (WFLP). The Wandry's transferred cash and securities to the partnership. They planned to use their $11,000 per donee annual exclusions and their $1 million lifetime gift exclusions to transfer partnership interests to family members.

In April of 2001, they started a new family business, Norseman Capital, LLC. All WFLP assets were transferred to Norseman.

On January 1, 2004, the Wandry's transferred gifts of $261,000 to each of their four children and $11,000 to five grandchildren. The gifts were determined based on a formula that stated the "number of gifted units shall be adjusted accordingly so that the value of the number of units gifted to each person equals the amount set forth above, in the same manner as a federal estate tax formula marital deduction amount would be adjusted for a valuation redetermination by the IRS and/or a court of law."

Taxpayers hired Kreisman & Williams, P.C. (K&W) to value the Norseman interests. K&W valued a 1% Norseman interest at $109,000. Based upon this value, the Norseman capital accounts were adjusted and Form 709 was filed for each petitioner. The two petitioners reported total gifts of $1,099,000, an $11,000 annual exclusion gift for each of the nine beneficiaries and transfer of their respective $1 million lifetime gift exclusion amounts. This equated to a transfer of Norseman interests to each child of 2.39% and to each grandchild of .101%.

In 2006, the IRS audited the returns and valued the respective interests at $366,000 and $15,400. Prior to trial, the parties stipulated to value the children's interest at $315,800 and the grandchildren's at $13,346.

The IRS claimed that completed gifts of these respective interests were in excess of the exclusion amounts and gift tax plus interest was payable. The IRS pointed to the gift descriptions stating 2.39% and .101%, the changes in the Norseman Capital accounts to reflect these gift descriptions and the fact that the specific gift documents referenced these percentage interests. The IRS also stated that the adjustment clause was a "condition subsequent" that did not reduce the gift value to the applicable exclusion limit under Commissioner v. Procter, 142 F.2d 824, 827-828 (4th Cir. 1944).

The Court reviewed each of the IRS issues. First, the descriptions of the gifts did not show a specific intent to give a percentage of Norseman. Rather, the descriptions showed a specific intent to make a gift of $261,000 to each child and $11,000 to each grandchild.

Second, the capital accounts were "unofficial and unreliable." Because the capital accounts and the K1 were not clear and did not control the gifted items, they were deemed not material.

Third, the gift documents did state the specific percentages. However, under Estate of Petter v. Commissioner, T.C. Memo. 2009-280, a formula clause of that specified a specific value to family with a gift over to charity of excess amounts was upheld.

In this case, there is no gift of excess value to charity, but the formula clause does not create a condition subsequent "to take property back" based on the valuation. The formula simply has one unknown - the value of an LLC unit at the time of the transfer. This is similar to the Petter formula and therefore should not violate public policy. The Court continued that "it is inconsequential that the adjustment clause reallocates membership units among petitioners and the donees rather than a charitable organization because the reallocations do not alter the transfers."

Therefore, because there is a fixed set of interests transferred, the formula adjusts the number of units transferred rather than subjecting the transfer to gift tax.

Editor's Note: This was a very carefully and expertly crafted formula. It transferred a specific dollar value and adjusted the percentage of units transferred. If this method is upheld by appellate courts, the Petter formula method will be extended to an entirely new level.

No Marital Deduction for Sec. 2036 Included Assets

In Estate of Clyde W. Turner Sr. et al. v. Commissioner; 138 T.C. No. 14; No. 18911-08 (28 Mar 2012), the Tax Court considered a request for reconsideration of a prior decision including FLP assets in the estate under Sec. 2036(a). The Tax Court determined that the assets remained includable at full market value and did not qualify for a marital deduction.

In the initial case on the Turner estate, the Tax Court determined that assets in the Turner & Co. family limited partnership (TFLP) would be includable at fair market value in the estate. They were includable because there was no legitimate and significant nontax reason for TFLP formation, Clyde Sr. retained an interest in the transferred assets and the purpose of Turner & Co. was primarily testamentary.

After reviewing estate requests for reconsideration, the court determined that no new substantive evidence indicated that there was a significant nontax reason for creation of Turner & Co. Therefore, even though the family had potential tax savings and a grandson had a history of substance abuse, the court determined that there was no manifest error of fact and Sec. 2036(a) inclusion was applicable.

The estate then claimed that the transfers should qualify for a marital deduction under a pecuniary formula clause. Clyde and Jewell Turner had jointly transferred $8.67 million to TFLP. Each held a 0.5% general partnership interest and a 49.5% limited partnership interests. Clyde had transferred 21.7446% of his limited partnership interests to various family members and passed away with his 0.5% general partnership interests and 27.7554% limited partnership interests.

Clyde's estate transferred 18.8525% limited partnership interests to a marital deduction trust and 8.9029% limited partnership interests to a bypass trust.

The marital deduction formula provision of the will indicated that a pecuniary amount would be transferred that "will result in the smallest, if any, federal estate tax being imposed on my estate." The estate claimed that proper interpretation of this marital deduction language enables the estate to deduct the transfer of the previously-gifted limited partnership interests.

The court noted that a Section 2036(a) revaluation creates potential calculation issues in an estate. In this case, the IRS permitted the marital deduction trust to reflect the actual increase in value of the assets. However, the IRS denied a marital deduction for the increased value of the gifts to other family members.

The court observed that a marital deduction is permitted for property that passes to a spouse under Sec. 2056(c). Under Reg. 20.2056(c)-1, the marital deduction qualifies "only if it passes to the spouse as beneficial owner."

In this case, Clyde's gifts could not qualify because spouse Jewell did not actually receive the property. The gifted items were transferred to other family members.

The marital deduction is also based on the principle that the assets transferred to any qualified marital deduction trust or other entity will be taxable in the spousal estate. For example, a transfer of assets to a qualified terminable interest property trust (QTIP) permits the use of the marital deduction, but trust assets will be includable in the estate of the surviving spouse under Sec. 2044.

The requested interpretation by the estate was rejected. If the gifted assets were granted a marital deduction, they would not be taxed in the estate of the surviving spouse because they are held by other family members.

GRIT Income Beneficiary Pays Gift Tax

In United States v. Robert S. MacIntyre et al.; No. 4:10-cv-02812 (28 Mar 2012), a District Court held that the income beneficiary of a grantor retained income trust (GRIT) was subject to gift tax on a transfer created by a below-fair-market-value sale of stock by her former husband.

J. Howard Marshall and Eleanor Pierce Stephens were married from 1931 to 1961. As part of the divorce settlement, Eleanor Stephens received 47,623 shares of Marshall Petroleum, Inc. (MPI) stock. In 1984 she transferred her shares to the Eleanor Pierce Stephens living trust, an irrevocable trust. In 1988 and 1989, this trust was divided into three charitable remainder annuity trusts and one grantor retained income trust (GRIT). The charitable remainder trusts sold their shares back to MPI, while the GRIT retained 22,798 MPI shares. In 1995, J. Howard Marshall sold a substantial block of MPI stock back to the corporation in a below-market-value sale. Later that year, he passed away.

The IRS audited the estate and determined that there was an indirect gift to all other shareholders as a result of the below-fair-market-value sale. Following a stipulation in 2002 and a United States Tax Court decision in 2008, the gift to the GRIT was valued at approximately $36.28 million. The Marshall estate refused to pay the gift tax and the IRS proceeded in an action against the Stephens estate for recovery of the gift tax.

The Stephens estate contended that it did not own any MPI stock in 1995 and therefore could not be assessed a gift tax. The IRS responded that under the 2002 stipulation, the estate could not relitigate the amount or recipient of the gift. The estate also claimed the stipulation was hearsay and therefore was not admissible.

The Court determined that the three CRATs had sold their stock before 1995, but the GRIT had retained its ownership. The stipulation was a matter of record and therefore could be considered by the court. The estate contended that under the Kansas law applicable to the GRIT, Stephens was the income beneficiary and the gift enhanced the corpus. Therefore, the transfer of value benefited remainder recipient E. Pierce Marshall, who should pay the gift tax.

First, the Court determined that a beneficiary of a gift may be subject to payment of gift tax. Because Stephens was a beneficiary of the trust, her estate could be subject to gift tax. Under the terms of the GRIT, Stephens was the income recipient and Marshall was the remainder recipient. However, a donee of a trust that benefits from a present interest is the appropriate person to pay a gift tax. Because Stephens was the income beneficiary and the GRIT paid all income every quarter to her, she and her estate are the donee of the gift and must make payment of the applicable gift tax.

Applicable Federal Rate of 1.4% for April – Rev. Rul. 2012-11; 2012-14 IRB 1 (16 Mar 2012)

The IRS has announced the Applicable Federal Rate (AFR) for April of 2012. The AFR under Section 7520 for the month of April will be 1.4%. The rates for March of 1.4% or February of 1.4% 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 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return. Federal rates are available by clicking here.