NO CHANGE IN 2011 ANNUAL EXCLUSION AMOUNT

While we are on the subject of 2011 inflation adjustments, due to a lack of significant inflation in 2010 the annual exclusion amount for gifts for federal gift taxes will remain at $13,000. This is the amount that a donor can gift to any given recipient in a calendar year that is not treated as a taxable gift.

The current official rate of inflation is in the neighborhood of 2-3%. If that doesn’t square with your perception of inflation and rising prices, don’t judge yourself too harshly. Go ahead and visit the charts at www.shadowstats.com/alternate_data/inflation-charts. This website compiles its own inflation statistics, inlarge  part by ignoring changes made by the government in the CPI rules that now act to depress the “official” rate of inflation. According to Shadowstats, inflation is currently at around 8%.

2011 INFLATION ADJUSTMENTS FOR INTERNATIONAL PROVISIONS

The IRS has announced the following 2011 inflation adjustment amounts that relate to international issues:

1. EXPATRIATION. An individual with “average annual net income tax” of more than $147,000 for the five taxable years ending before the date of the loss of United States citizenship under  §877(a)(2)(A) is a covered expatriate for purposes of   §877A(g)(1). Also, for taxable years beginning in 2011, the amount that would be includible in the gross income of a covered expatriate by reason of §877A(a)(1) is reduced (but not below zero) by $636,000.

2. FOREIGN EARNED INCOME EXCLUSION. The foreign earned income exclusion amount under §911(b)(2)(D)(i) is $92,900.

3. ANNUAL EXCLUSION GIFTS TO NONCITIZEN SPOUSES. The first $136,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under §§2503 and  2523(i)(2) made during that year.

4. NOTICE OF LARGE GIFTS RECEIVED FROM FOREIGN PERSONS. Recipients of gifts from certain foreign persons may be required to report these gifts under §6039F if the aggregate value of gifts received in a taxable year exceeds $14,375.

5. TAX ON ARROW SHAFTS. The tax imposed under §4161(b)(2)(A) on the first sale by the manufacturer, producer, or importer of any shaft of a type used in the manufacture of certain arrows is $0.45 per shaft. 

Okay, the last one has nothing to do with international taxes – it is in here just to see if you are paying attention. Did you know there was a special tax on “arrow shafts?” No, I didn’t think so. but then again, neither did I until about five minutes ago.

Rev.Proc. 2010-40

THIRD PARTY CAPITAL CONTRIBUTIONS

A basic tenet of federal income tax is that all accessions to wealth are income to the recipient, absent a statutory exclusion. What happens if a for-profit corporation receives funds by the government – is that income? It would seem silly – the government giving money away with one hand, and then taking some of it back in tax with the other. However, it happens all the time. For example, Social Security payments can be taxable to recipients.

This issue came up in regard to grants to broadband communications companies under the American Recovery and Reinvestment Act of 2009, and reminds us of an advantageous characterization of such payments if the recipient is a corporation. Revenue Procedure 2010-34 recently provided a safe harbor interpretation for the communications companies, using Code Section 118.

Code Section 118 permits corporations to receive contributions to capital in a nontaxable manner. Most capital contributions come from shareholders of a corporation, and the Code Section 118 clearly avoids income to the corporation on its receipt. Further, Code Section 118 will also apply to contributions received from non-shareholders. However, in that situation, the corporation must reduce its tax basis in assets acquired within 12 months of the contribution (or other property of the taxpayer if such assets are not purchased in that period), pursuant to the rules of Code Section 362(c)(2)(B).  Thus, the reduction in basis does impose a tax cost to the recipient corporation by way of reduced depreciation or increased gains/reduced losses in regard to corporate property.

The Revenue Procedure confirmed the application of these provisions to most of the grants, but did not apply them to reimbursement for pre-application expenses and certain specified grants. The Procedure is silent as to why some of the grants do not qualify.

Code Section 118 only applies to corporations. The Revenue Procedure confirms this when it excludes noncorporate taxpayers from the coverage of the Procedure.

An interesting question is what happens if the recipient corporation does not acquire enough property within 12 months of a grant, and has insufficient basis in its other property, to apply a full basis reduction equal to the capital contribution.

Revenue Procedure 2010-34

APPLICABLE FEDERAL RATES – NOVEMBER 2010

IRS RULES FAVORABLY ON RESIDENCE INTEREST DEDUCTIONS

Generally, interest paid by a taxpayer on personal items is not deductible. However, the Code allows an interest deduction for "acquisition indebtedness" for a qualified residence of a taxpayer for up to $1 million of indebtedness. A taxpayer may also deduct interest on up to $100,000 of "home equity indebtedness."

If a taxpayer incurs a mortgage debt on a qualified residence of over $1 million when he buys the residence, clearly he can deduct interest on the first million dollars of debt. Can he use the "home equity indebtedness" provisions to obtain an interest deduction on the first $100,000 over the first million dollars of debt? Until now, the answer was no, at least according to 2 Tax Court Memo decisions and a 2009 Chief Council Advice.

Happily for taxpayers (or at least for those that can afford to take on mortgages in excess of $1 million), the IRS has reversed its position and will now allow the use of the "home equity indebtedness" provisions for interest on the first $100,000 of acquisition indebtedness in excess of $1 million already allowed. The IRS based its decision on the fact that there is no provision in the Code that restricts "home equity indebtedness" to indebtedness not incurred in acquiring, constructing, or substantially improving the residence.

It is not often that the IRS reverses both itself and the Tax Court in a manner favorable to taxpayers. This is something of an early holiday gift for sure.

For any taxpayers that are eligible for additional interest deductions under these rules for prior open tax years, they should consider filing an amended tax return to obtain the benefit of this ruling.

Revenue Ruling 2010-25

FRAUDULENT HOMESTEAD CONVEYANCE AND INCOME TAXES

Florida’s Uniform Fraudulent Transfer Act will allow a creditor to reach an asset transferred from a debtor to a third party if the transfer is found to constitute a fraudulent transfer. However, Fla.Stats. §726.102(2)(b) will exempt transfers of assets that are generally exempt from creditors under nonbankruptcy law from the fraudulent conveyance rules.

In Scott E. Rubenstein et al. v. Comm., an insolvent father transferred his exempt homestead to his son. The IRS sought to set aside the homestead transfer as a fraudulent conveyance so as to assist in collecting the father’s income tax liabilities. The son argued that under the above Florida statute, the homestead was an exempt asset and thus the fraudulent conveyance rules could not apply to it.

That may be true for other creditors, but not the U.S. The IRS is not bound by the exempt status under Florida law as to homestead property in collection matters, and thus as to the U.S. the homestead was NOT generally exempt from creditors under nonbankruptcy law. As such, it was likewise not exempt from the application of the Fraudulent Transfer Act.

Scott E. Rubenstein et al. v. Comm., 134 TC No. 13 (6/7/10)

NO ONE EVER SAID THE CODE IS A TWO WAY STREET

On May 6, the stock market fell victim to the “flash crash.” In a short period of time, the market took a major dive, and then quickly recovered. Experts are still looking for what triggered the unusual movement.

Many taxpayers who had standing stop-loss orders on their securities had their securities sold for a gain or loss due to the large percentage swing that occurred.

Under the wash sale rules, those taxpayers who repurchased the same securities within 30 days cannot deduct any losses from such sales – instead, the losses will be figured into their basis on the subsequent sale of the securities.

Essentially arguing that since losses from the flash crash are deferred, some taxpayers sought a special dispensation from the IRS Commissioner that in regard to securities that were sold for a gain, the taxpayers would be allowed to repurchase their sold securities and avoid having to recognize their gains.

Not surprisingly, the Commissioner declined, per their being no authority in the Internal Revenue Code for such a deferral. Beyond the lack of specific authority, additionally there is no constitutional or statutory requirement that gains and losses be treated in the same manner under law. Indeed, the Code is rife with provisions that limit the use of losses (e.g, the $3,000 capital loss limitation, passive loss limitations, etc.) that have no corollary deferral of gain. The Code is not the place to go looking for fair and balanced provisions that impact the taxpayers and the government in equal measure.

Information Letter 2010-0188