Hurricane Wilma!

Due to Hurricane Wilma and extended power outages, we have not been able to do our regular blog posting. We hope to get things back to normal sometime this week. To those of you in South Florida, we wish you a speedy recovery from the storm.

Applicable Federal Rates - Update for November 2005

November 2005 Applicable Federal Rates Summary (Rev.Rul. 2005-71):

-Short Term AFR - Semi-annual Compounding - 4% - (3.89%/Oct. -- 3.9%/Sept.)

-Mid Term AFR - Semi-annual Compounding - 4.19% - (4.08%/Oct. -- 4.19%/Sept.)

-Long Term AFR - Semi-annual Compounding - 4.52% - (4.40%/Oct. -- 4.52%/Sept.)

IRS Guidance for Private Foundations

Does your family operate a private foundation? Are you the CPA or attorney for a private foundation? Are you curious about private foundations? The IRS now has a website on the life cycle of a private foundation, with lots of information regarding setting up, operating, and terminating one.

The link is http://www.irs.gov/charities/charitable
/article/0,,id=127912,00.html.

Spend it Now, Not Later

The remaining months of 2005 may provide a last chance opportunity for taxpayers who itemize deductions to deduct state and local sales taxes in lieu of state and local income taxes.

For tax years beginning in 2005, taxpayers may elect to take state and local general sales and use taxes as an itemized deduction, instead of deducting state and local income taxes. Internal Revenue Code Section 164(b)(5). Electing taxpayers may either (a) deduct their actual sales and use taxes or (b) use IRS-published tables and then add to the amount from those tables the actual amount of their sales tax for certain "big-ticket" items—motor vehicles, boats, aircraft, homes (including mobile and prefabricated homes), and home building materials.

This provision primarily benefits taxpayers who live in states without an income tax, but some taxpayers in other states may benefits if they made major purchases during the year and their state income tax is relatively low.

This option to deduct sales taxes is set to expire at the end of 2005. While it may be extended, there is no way of knowing what Congress may do. Accordingly, individuals who are considering the purchase of a big ticket item (such as an automobile) may want to complete the purchase in 2005 to achieve a higher itemized deduction for sales taxes.

She Should Have Waited Until Mom Died

Joint bank account cases often make for interesting reading. Here is an interesting case from Florida’s 4th District Court of Appeals, issued on October 19, 2005.

Facts:
a. Mom opens a bank account with daughter - the account is held as joint tenants with rights of survivorship.
b. Daughter withdraws money from the account for her own use.
c. Mom does not agree to the withdrawal and asks for the money back.
d. Mom dies, and her estate demands the money back from daughter.
e. Daughter argues that since Florida law says that a bank can pay the assets from a joint account to one of the joint account holders without consulting the other, and that since she would have gotten the funds when mom dies, she can keep the money.

Decision: Daughter owes the money back. The Court held that (i) the above Florida law is for the protection of the bank, and does not create legal entitlements to ownership of assets in a joint account, (ii) that daughter would have gotten the money when mom died is irrelevant to what occurs during lifetime, and (iii) authorization to withdraw the funds is not the same thing as authorization to use the funds for personal benefit.

Observation: If daughter had left the money in mom's account until mom died, there's a good chance she would have gotten all the funds!

Sandler v. Jaffe, 30 Fla. L. Weekly D2446a (4th DCA 2005)

Disregard Entities - A Little Less Disregarded

Under federal tax rules, at times an entity owned by another taxpayer may be "disregarded" for tax purposes. This generally means that all of the tax incidents of the disregarded entity are reported by its owner. The two principal types of disregarded entities are Qualified Subchapter S Subsidiaries and entities that are owned by one owner and are not taxed as a corporation/association under the check-the-box rules (e.g., single member limited liability companies).

The "disregarded" status of such entities may soon disappear for certain tax issues. Under proposed regulations, such entities would cease to be disregarded for employment tax and related reporting purposes, as well as for certain excise tax rules. Since the rules are only proposed, they are not currently applicable. Preamble to Prop Reg 10/17/2005 ; Prop Reg § 1.34-1 ; Prop Reg § 1.1361-4 ; Prop Reg § 301.7701-2.

2006 Indexing Updates

The Social Security Administration has announced that the wage base for computing the Social Security tax in 2006 rises to $94,200 from $90,000 in 2005, an increase of about 4.67%. This means that the amount of wages subject to these taxes has now increased, and thus the total Social Security taxes of a wage earner who earns at or in excess of the maximum will also be increased. The OASDI tax rate for wages paid in 2006 is set by statute at 6.2 percent for employees and employers, each. Thus, an individual with wages equal to or larger than $94,200 would contribute $5,840.40 to the OASDI program in 2006, and his or her employer would contribute the same amount. The OASDI tax rate for self-employment income in 2006 is 12.4 percent. Note that this increase does not impact the Medicare Hospital Insurance program tax - this tax rate is 1.45 percent for employees and employers, each, and 2.90 percent for self-employed persons - this tax, which is in addition to the above OASDI taxes, has no cap and thus is applied to all wages no matter how high.

Also for 2006, the limit on the income tax exclusion for elective deferrals of wages, that is - the maximum amount an employee may defer into 401(k) plans, 403(b) annuities, SEPs, and the federal government's Thrift Savings Plan, increases from $14,000 to $15,000. The limitation on the annual benefit under a defined benefit pension plan increases from $170,000 to $175,000. The limit on annual additions to a participant's defined contribution pension account increases from $42,000 to $44,000.

Year End Tax Planning

Some year end planning considerations to start thinking about -

A deduction for college tuition is scheduled to go off the books unless Congress extends it. You may want to prepay in 2005 tuition not due until early 2006 if that lets you increase your tax savings from the expiring deduction.

The Energy Tax Incentives Act of 2005 provides a new tax credit for making certain energy-saving improvements around the house. But the new credit is not available until 2006, so you may want to hold off on the improvements if possible.

On January 1, 2006, the deduction for buying a hybrid automobile converts to a tax credit that's probably more valuable to auto buyers than the deduction. So if you are thinking about buying a hybrid, you may want to delay your purchase until 2006.

The Katrina Emergency Tax Relief Act of 2005 allows some taxpayers to claim bigger charitable deductions than in the past because the Act lifts restrictions that limited the deductions. But it's only a temporary reprieve; the restrictions return after December 31, 2005. So, if the restrictions apply to you, you may want to consider accelerating your charitable donations from 2006 to 2005.

Contributing Your Car to Charity

A popular method of gifting to charities is to contribute an automobile that would otherwise be sold or traded in. Unfortunately, there was a perception that taxpayers were putting a value on the contributed automobile that was oftentimes much higher than what the charity could get for the car when it sold it.

Under new rules that take effect this year, the deduction for “qualified vehicles” (motor vehicles, boats and planes that aren't inventory or held for sale in the ordinary course of business) contributed to charity for which the claimed value exceeds $500 is dependent on the charity's use of the donated property. If the charity sells the vehicle without any “significant intervening use” or “material improvement,” or transfers it to other than a needy person at a price significantly below fair market value in furtherance of its charitable purpose, the donor's charitable deduction can't exceed the charity's gross proceeds from the sale. The IRS has released new Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes to report such transfers.

No Private Cause of Action Against Section 501(c)(3) Entities

Code Section 501(c)(3) organizations are generally exempt from federal income taxes, and contributors receive a tax deduction for their contributions.

In an interesting case, an individual sued a hospital and related health care entities, claiming damages for failing to provide “mutually affordable medical care” to indigent or uninsured patients without regard to their ability to pay, as purportedly required for the Code Section 501(c)(3) status of the health care entities. The individual alleged that due to the defendants' tax-exempt status under the Internal Revenue Code, the Defendants entered into an express or implied contract with the United States, the Commonwealth of Pennsylvania, and local government bodies and agreed to provide affordable medical care to all hospital patients, to abstain from “humiliating” debt collection practices, and to prevent any private entities from deriving a profit from Defendants' healthcare operations.

While an interesting argument, it was not a good argument, and the case was dismissed. FELICIANO v. THOMAS JEFFERSON UNIVERSITY HOSPITAL, 96 AFTR 2d 2005-XXXX, (DC PA), 09/28/2005.

50% Limit on Charitable Contributions Temporarily Suspended

Generally, individuals making substantial charitable deductions cannot use the charitable income deduction to eliminate all of their taxable income. A 50% limit applies to qualified contributions to the appropriate taxable entity- the maximum charitable deduction allowed is 50% of the adjusted gross income of the taxpayer (without regard to net operating loss carrybacks). Lower percentage limits may apply based on the type of property contributed and the type of entity that receives the contributions.

As part of the Hurricane Katrina Emergency Tax Relief Act of 2005, this 50% limit is suspended for cash contributions made to publicly supported charities. This will apply only for contributions made through December 31, 2005. Interestingly, there is no requirement that the recipient charity be engaged or involved in hurricane relief efforts.

Some recipients will not qualify:

-Section 509(a)(3) "supporting organizations’
-Donor advised funds
-Private nonoperating foundations

Gifts to Foreign Charities

If you would like an income tax deduction for gifts for use abroad, generally gifts cannot be made to organizations organized in a foreign country. Listed below are some general planning arrangements that allow for making tax-deductible gifts that are directed for use abroad:

-gifts to organizations organized in certain countries with tax treaties allowing for the deduction (e.g., Israel, Canada, Mexico)

-gifts to domestic "friends of" organizations that provide financial support to foreign charities (so long as such organizations are not obligated to transfer gifts to a foreign organization)

-gifts to a "donor advised fund" that makes international grants

-gifts through U.S. private foundations that meet specific expenditure rules for grants to foreign organizations

-gifts to domestic organizations that directly expend funds abroad in furtherance of their exempt purpose.

Shareholder Prevails on Loan Characterization

Shareholders of Subchapter C corporations (that is, corporations that have not elected Subchapter S status) are subject to tax on dividends distributed from the corporation (to extent of the undistributed earnings of the corporation). To avoid or defer this tax, shareholders do a lot of things to get access to the money but not pay the tax. One common mechanism is for the shareholder to borrow the money from the corporation so that it is not treated as a dividend distribution. Shareholders that do this need to cross their i's and dot their t's - have a written promissory note, a reasonable rate of interest, have security for the debt, and other evidence of arms-length debt to overcome an IRS that is interested in characterizing the loan as a dividend distribution.

Note, however, that the lack of proper documentation is not always fatal to loan treatment should the IRS contest the issue. In a recent Tax Court case, the IRS's determination that a software developer/consultant had constructive dividends from advances which his closely owned consulting corporation made to him or on his behalf, and which were used for new home purchase and various personal expenses, was rejected - the taxpayer proved that the advances were nontaxable loans. Although advances weren't memorialized in any formal loan documents, weren't subject to any fixed repayment schedule, and weren't secured, loan treatment was still supported by facts taxpayer made reasonable interest payments, repaid a relatively substantial portion of the loan principal, had reasonable prospects of repaying balance, and had expressly agreed with another shareholder to use the funds as loans. Nariman Teymourian v. Commissioner, TC Memo 2005-232, 2005 RIA TC Memo ¶2005-232 (2005).

U.S. Income Taxes Remain Highly Progressive

The IRS has released its latest tax statistics, disclosing date for tax year 2003. Some of the key numbers regarding progressivity:

a. The top 1 percent of U.S. taxpayers, who earn a minimum annual income of at least $300,000, paid more than a third of personal income taxes in 2003.

b. The top half of all U.S. taxpayers accounted for all but 4 percent of the 2003 individual income tax receipts.

c. The top 10 percent of taxpayers, with an income of at least $95,000, were responsible for two-thirds of personal income taxes paid for the year.

The next time you hear that a proposed tax cut will only cut the taxes of the richer half, well that's because they are the only ones paying taxes to begin with!

Mail Rules

All tax systems have deadlines - deadlines for filing items, deadlines for making payments. The taxes under the Internal Revenue Code are no different. Since most items and payments are submitted via mail, when are items deemed filed and how does a taxpayer prove submission?

Certain rules have been developed in regard to these issues, both under the Internal Revenue Code and under common law. As much as you would think these issues have been resolved after so many years, there are still some open questions on these issues. Just this week, the U.S. Supreme Court refused jurisdiction over a case that addressed the issue whether a taxpayer can attempt to prove receipt of an item filed with the IRS if it was not submitted via certified or registered mail.

Below is a general overview of the two key issues (when is an item deemed filed, and how does one prove filing).

1 Proof of Receipt by IRS-------------------------------------------------------------

-1.1 Proof of registered or certified mail and that envelope was properly addressed is prima facie evidence of delivery (Code Sec. 7502)

-1.2 Common Law Mailbox Rule: when mail is properly addressed and deposited in the U.S. mails, with proper postage, there is a rebuttable presumption of receipt by the addressee

---1.2.1 There is a split among the courts whether this can be used absent use of registered or certified mail (that is, whether Sec. 7502 overrides the common law mailbox rule)

-----1.2.1.1 The Supreme Court recently refused to review a recent case that held that Sec. 7502 does not override the common law mailbox rule [Sorrentino, 94 AFTR 2d 2004-5902, cert denied 10/3/2005]

-----1.2.1.2 Prop. Reg. Sec. 301.7502-1(e) provides in effect that Code Sec. 7502 overrides the common law mailbox rule

-1.3 Effect: to avoid any question as to IRS receipt, use certified mail or registered mail

2 Time of Filing or Payment-------------------------------------------------------------

-2.1 When received after a filing date, the IRS will use the postmark date as the mailing/filing date so effectively deemed filed/paid as of the date of mailing (Sec. 7502(a)

---2.1.1 if the postmark date is on or before the due date (Sec. 7502(a)(2))(A))

---2.1.2 if the item was properly addressed and mailed (Sec. 7502(a)(2)(B))

-2.2 When sent by registered or certified mail, the date of registration or certification is treated as the postmark date for this purpose

3 Exceptions-------------------------------------------------------------

-3.1 Court filings, other than Tax Court

-3.2 Currency or other medium of payment unless actually received

-3.3 items requiring by law to be delivered by means other than mailing

Monitoring Insurance Policies In Trusts

Owning life insurance through irrevocable trusts is a common estate planning device to limit exposure to U.S. estate taxes. The trustee of the trust has some standard jobs, including receipt of premium funds and payment of premiums, and Crummey notices. What is often overlooked is the trustee's obligation to exercise oversight of the policy.

While in practice probably not observed by any but the most scrupulous corporate trustees, all life insurance trustees should give due consideration to the following:

• Analysis of the proposed carrier, before the policy is acquired.
• Analysis of the proposed or existing policy.
• Regular monitoring of the insured's health, to determine whether premium payments should be continued and whether a different policy with a different anticipated scope of coverage is advisable.
• Annual consultation with an insurance agent to review the policy and the factual situation.

There are consultants who can be engaged by the trustee to assist in these matters (e.g., Advicon). By engaging in these activities, a trustee will go a long way towards both doing a good for the trust beneficiaries and protecting itself from litigation by disgruntled beneficiaries.

Does the $125,000 Homestead Exemption Cap Apply in Florida?

Inside and outside of bankruptcy, an individual’s homestead is exempt under Florida rule from the reach of his or her creditors (with some exceptions). In the recent Bankruptcy Act, Congress limited this protection in bankruptcy to the first $125,000 of value of a homestead if the debtor has owned the homestead for less than 1,215 days. Or at least, that is what everyone originally thought.

An opinion of an Arizona bankruptcy court (In re McNabb) held that the $125,000 cap did not apply in states such as Arizona (and by implication Florida) where state legislatures have officially "opted out" of the Federal scheme of exemptions found in the Bankruptcy Code. This opinion was based on a literal reading of the statute, which apparently was not well drafted and left the door open for this interpretation.

The bankruptcy courts in Florida have now entered the fray. In a recent ruling, Judge Mark of the Southern District of Florida decided that the cap did apply - the opposite finding of In re McNabb. How this issue will be ultimately resolved is unknown (including resolution through the passage of a Congressional "glitch" bill), but Judge Mark’s ruling is clearly not heartening to Florida debtors who have not owned their homesteads for the requisite 1215 days.

IRS Helps Practitioners with Charitable Remainder Unitrusts Forms

Updating its forms from 15 years ago, the IRS has issued sample charitable remainder unitrust forms for use by practitioners in drafting effective split-interest charitable trusts. Generally, a charitable remainder unitrust is a trust that provides for the payment of a fixed percentage of a trusts assets on an annual or more frequent basis to one or more individuals, followed by the transfer of the remaining trust assets to one or more qualified "charitable" organizations. It allows taxpayers to enjoy the income/cash flow from assets while stil obtaining valuable tax benefits due to its charitable nature.

The particular trusts provided are:

-inter vivos and testamentary trusts for one measuring life
-inter vivos and testamentary trusts for term of years
-inter vivos and testamentary trusts for 2 measuring lives
-inter vivos and testamentary trusts for 2 measuring lives

Rev. Procs. 2005-54 through -59.