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Saturday, November 27, 2010


The Internal Revenue Code allows nonprofit educational organizations to be exempt from income tax under Code §501(c)(3). In making a determination whether an organization is “educational,” the IRS will determine whether an organization actually is engaged in educational activities. While this is an appropriate line of inquiry, inquiries into the substance and political correctness of the items that the organization intends to teach should not be relevant.

According to pleadings filed in a civil action, Z Street is a nonprofit organization which educates the public about Zionism, and about the State of Israel and its battle with terror.  As a nonprofit educational organization, Z STREET has applied for certification that donations made to it are charitable, and therefore exempt from federal income tax, under Code §501(c)(3).

Z Street is contending that the IRS is asking improper questions and unduly delaying its exempt organization application. As part of its court filing, Z Street has indicated that an IRS agent has informed it that the IRS is “carefully scrutinizing organizations that are in any way connected with Israel,” and that there are such “cases… being sent to a special unit in the D.C. office to determine whether the organization’s activities contradict the Administration’s public policies.”

If true, such inquiries by the IRS should not be permitted (as not relevant to the “educational” aspects of the organization). Further, it raises that the specter that the IRS may be denying exempt organization status because an organization’s activities are not in accord with the Administration’s policies – an improper, if not unconstitutional, politicization of what should be a policy-neutral exempt organization review.

To support its claim, Z Street has indicated that another Jewish organization applicant has been asked questions such as (1) [d]oes your organization support the existence of the land of Israel, and (2) describe your organization’s religious belief system towards the land of Israel.

It is true that an institution's purpose must not be so at odds with the common community conscience as to undermine any public benefit that might otherwise be conferred. Bob Jones Univ. v. U.S., 461 U.S. 574 (1983). In Bob Jones Univ., Code §501(c)(3) status was denied to a school that imposed racial discrimination. However, in that case, the U.S. Supreme Court noted that “[w]e are bound to approach these questions with full awareness that determinations of public benefit and public policy are sensitive matters with serious implications for the institutions affected; a declaration that a given institution is not “charitable” should be made only where there can be no doubt that the activity involved is contrary to a fundamental public policy.” Merely disagreeing with the Administration on foreign or religious policy should not give rise to a clash with fundamental public policy justifying  denial of Code §501(c)(3) status.

Just because Z Street has made these factual allegations in its court filings does not mean they are true. However, if they are, it is hoped that further judicial attention will be focused on the appropriateness of the questions being asked and whether the IRS is improperly basing exempt organization determinations on whether an organization’s activities are in concert with Administration policies.


Monday, November 22, 2010


Owners of investment real property in Florida often rent out their property to farmers - not so much for the rent but to obtain an agricultural classification for ad valorem tax purposes. The agricultural classification will typically result in much lower taxes.

Florida law now expressly provides that the agricultural classification can continue even if the real property is listed for sale. The Florida legislature had previously passed this law, but it was vetoed by Governor Charlie Crist. The legislature voted to override the veto and thus is now law (effective July 1, 2010).

The classification applies based on the use of the property on January 1 of the tax year. Thus, owners who put their property up for sale during a period that includes January 1 can now squeeze out at least one more year of lower ad valorem taxes.

Wednesday, November 17, 2010


Mr. and Mrs. Au erroneously deducted gambling losses to offset other income, in violation of Code §165(d). Code §165(d) only allows gambling losses to be deducted to the extent of gambling winnings.

The IRS sought to impose the 20% accuracy-related penalty under Code §6662 for the understatement of tax. The taxpayers objected, claiming that they deducted the losses only because their tax preparation software allowed them to do it – thus, they had reasonable cause which is an exception to the 20% penalty.

The Tax Court rejected the reasonable cause claim. This is not the first time it has done so. See, for example, Parker v. Comm., T.C. Memo 2010-78 (June 21, 2010).  That case involved the TurboTax tax preparation software, and this defense is often referred to as the “TurboTax Defense.”

In the Au’s case, the Court found that the taxpayers did not provide evidence of a mistake in the software instructions, nor of a thorough effort by the taxpayers to determine their correct tax liability. This seemingly leaves the door open to the successful use of the TurboTax Defense if a taxpayer can actually prove up a mistake in tax preparation software or its instructions.

To be fair (to TurboTax), the opinion did not indicate whether the software used was TurboTax or some other company’s software. I am sure that TurboTax does not appreciate the colloquial use of the term “TurboTax Defense” since it implies that their tax preparation software makes mistakes. Perhaps they may take some comfort in the credo that there is no such thing as bad publicity, or does that only apply to celebrities?

Au v. Commissioner, T.C. Memo. 2010-247

Sunday, November 14, 2010


There are a lot of people in Washington D.C. that believe there are massive numbers of U.S. taxpayers who are avoiding U.S income taxes through offshore accounts and entities. To attack this avoidance, as part of the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147, 3/18/2010) the Foreign Account Tax Compliance Act (FATCA) installed a new withholding tax and reporting regime on various payments to offshore entities. In October, the IRS issued Notice 2010-60 to provide some guidance on how the new provisions will apply (the new provisions commence operation in 2013).

The new provisions and the IRS’ planned implementation rules boarder on the incomprehensible. They are the height of “bureacracyspeak.” Rules exist, subject to exceptions, which are themselves subject to additional exceptions. The rules contain definitions, which to determine their application, require the application of other definitions. Payors and offshore financial institutions have to run through a gauntlet of determinations regarding the status of accounts, payees, and various categories of taxpayers.

Those seeking to apply the rules will have to master the following new terms and definitions:

-Financial Account. Code §1471(d)(2).
-Financial Institution (FI). Code §1471(d)(5).
-Foreign Financial Institution (FFI). Code §1471(d)(4).
-Non-Financial Foreign Entity (NFFE).
-Recalcitrant Account Holder. Code §1471(d)(6).
-Specified United States Person (Code §1473(3)).
-Substantial United States Owner. (Section 1473(2))
-United States Account. Code §1471(d)(1).
-United States Owned Foreign Entity. Code §1471(d)(3).
-Withholdable Payment (Code §1473(1)):
-Withholding Agent (Code §1473(4).

A payor of a payment that may be subject to withholding will have to make determinations place the payee and/or the payment into one of the following 9 categories:

- U.S. Entity Payee (no withholding).
- Participating FFI (no withholding).
- Code §1471(f) entity (no withholding).
- Deemed compliant FFI (no withholding & will not be a NFFE).
- Nonparticipating FFI (withholding).
- NFFE Payee.
- Excepted NFFE (no withholding).
- Code §1472(c)(2) low risk entity (no withholding).
- Other NFFE (withholding).

Undoubtably, there will be a number of offshore entities that legitimately invest in the U.S. that will say to heck with this, and cease to invest in the U.S. or in its securities markets, rather than attempt to comply with this monster or be burdened by its withholding taxes. Yet there has been hardly a mention in the financial press of the potential deleterious effects of these new provisions – both as to compliance costs and the loss of capital investment in the U.S. Ah, for the good old days when Congress considered the impact of its legislation on the U.S. economy.

Wednesday, November 10, 2010


The end of 2010 brings unique opportunities and problems relating to gifting. There is a strong interest in making gifts in 2010 since the maximum federal gift tax rate is 35%, and generation-skipping taxes do not apply. Absent a change in the law, come January 1, 2011 the maximum federal gift tax rate will increase to 55%, and generation-skipping taxes (at 55%) are again in effect.

Therefore, in many circumstances it may make sense to make a gift in 2010 to take advantage of the lower rate. However, there are some important considerations in undertaking such planning.

First, in many circumstances it is desirable to delay the gifts until as close as possible to (but before) January 1, 2011. This is because if the transferor dies in 2010 there will be no estate tax. Therefore, death allows for a tax-free transfer (if the gift recipient would also be the recipient at the transferor’s death), while a taxable gift incurs up to a 35% gift tax. To avoid an unnecessary gift tax, the gift should be delayed to as close as possible to the end of the year to avoid the situation of the gift being made and then the transferor dying in 2010. Also, deferring the gift will allow for consideration of any changes that may occur in the law prior to January 1, 2011 that may impact on the tax planning.

Second, if the gift involves a transfer to a trust, there are some uncertainties regarding the application of the generation-skipping tax in future years. More particularly, if the gift in 2010 is effectively a "direct skip" because it is a transfer to a trust for which all of the beneficiaries are skip beneficiaries (i.e., they are all two or more generations removed from the transferor), future distributions from that skip trust to skip beneficiaries may still incur generation-skipping tax. In normal circumstances, such a direct skip funding would change the generation levels for a generation-skipping trust. That is, if grandfather made a gift to a generation-skipping trust, as a direct skip, future distributions to grandchildren from the trust (but not great grandchildren or more remote descendents) will not be subject to generation-skipping tax. However, since generation-skipping taxes do not apply in 2010, it is unknown if this generation exemption will apply to post-2010 distributions to a grandchild from such a trust that is funded in 2010.

Further, if the transferor to a trust involved a transferor with unused generation-skipping tax exemption, there is a fair amount of uncertainty how or if to apply that exemption to the trust for purposes of computing the inclusion ratio and applicable generation-skipping taxes for future distributions out of that trust.

Third, the common understanding is that the maximum gift tax rate in 2010 is 35%. This is correct, but there are two important considerations to paying gift tax in 2010. Accelerating transfer taxes to 2010 means you are paying taxes sooner than you might otherwise. This deprives the transferor and his family unit from the ability to invest and earn from such transfer taxes. It is a maxim of tax planning that, all other things being equal, it is better to pay a tax tomorrow than today from a financial standpoint.  Also, if the transferor dies within three years, estate taxes will be payable on the gift tax amount paid to the IRS. Since the maximum estate tax rate is 55% starting in 2011, the combined 35% gift tax rate and a 55% estate tax rate on gift taxes paid can result in a combined maximum rate of approximately 54%, which is barely better than the maximum 55% rate which would apply 2011 and beyond on gifts.

Therefore, it is advisable to consider making gifts in 2010, but the above considerations, among others, need to enter into the analysis.

Sunday, November 07, 2010


In a recent Florida case, a separated husband and wife each had their own homesteads (although the wife’s was situated in New York). The local property appraiser denied granting a homestead exemption to the husband for his Florida residence.

CONSTITUTIONAL PROVISIONS.  Article VII, Section 6(a) of the Florida Constitution provides that a homestead exemption extends to “[e]very person who has the legal or equitable title to real estate and maintains thereon the permanent residence of the owner, or another legally or naturally dependent upon the owner.” However, section 6(b) directs that “[n]ot more than one exemption shall be allowed any individual or family unit or with respect to any residential unit” (emphasis added). There is no constitutional or statutory definition of the term “family unit” nor is there case law interpreting the term in context of the tax exemption.

REGULATORY RULE. However, this a regulatory provision on the issue. Florida Administrative Code Rule 12D-7.007(7), provides as follows: “If it is determined by the property appraiser that separate permanent residences and separate “family units” have been established by the husband and wife, and they are otherwise qualified, each may be granted homestead exemption from ad valorem taxation under Article VII, Section 6, 1968 State Constitution. The fact that both residences may be owned by both husband and wife as tenants by the entireties will not defeat the grant of homestead ad valorem tax exemption to the permanent residence of each.”

There is also case law that recognizes separate homestead exemptions for creditor protection purposes under similar facts.

The property appraiser argued that the application of the FAC rule would make his job in reviewing homestead exemptions virtually administratively unworkable, because no property appraiser has the staff or resources to verify whether a married couple is, in fact, maintaining two separate permanent residences and family units.

The court was not impressed. It held that in circumstances when a husband and wife have established two separate permanent residences in good faith and have no financial connection with and do not provide benefits, income, or support to each other, each may be granted a homestead exemption if they otherwise qualify.

Wells v. Haldeos, 2D09-4250, 2010 WL 4137581 (Fla. Dist. Ct. App. Oct. 22, 2010)