Tax Reform in 2016?

With the new year, optimism for tax reform again breaks forth in Washington. In January the Senate Finance Committee and the House Ways and Means Committee will embark on a journey toward major tax reform.

But what is the realistic potential in an election year? The 2016 tax reform may reflect changes in international, corporate, personal and estate taxes.

International taxes were the focus of one of the five groups created in early 2015 by the Senate Finance Committee Chair Orrin Hatch (R-UT). He created these five tax working groups to develop specific proposals in each area.

The international group was led by Sen. Rob Portman (R–OH) and Sen. Chuck Schumer (D–NY). They had made substantial progress by the middle of 2015. At that time Schumer began negotiations with then House Ways and Means Chairman Paul Ryan (R–WI).

The two taxwriters attempted to combine international tax reform with the highway bill. When they were unable to bring those negotiations to completion, Congress passed a highway bill in the fall of 2015.

However, international tax reform remains a high priority. The United States has the highest corporate tax rate in the industrialized world. This high rate leads to inversions – a U.S. corporation moves its tax headquarters overseas to reduce corporate taxes.

Corporate tax reform is often paired together with international reform. Senate Finance Committee and House Ways and Means Committee members have discussed reducing the top corporate rate from 35% to 25% by limiting deductions. Current Ways and Means Chairman Kevin Brady (R–TX) prefers a 20% corporate rate. Reducing the top rate to that level would require a very broad–based elimination of corporate tax deductions.

Personal taxes are the third potential area of negotiation. There is general agreement that the tax code should be broadened by reducing deductions and tax rates. The obvious political challenge for lowering rates is that state and local tax deductions would have to be eliminated and there must be substantial limits on deductions for mortgage interest. These changes will be politically challenging.

There is a relatively low level of interest in modification of the estate and gift taxes. The applicable exclusion amount of $5.45 million for 2016 means that only 0.2% of estates are taxable. Very few Americans now pay gift or estate tax.

Editor’s Note: Will there be tax reform in 2016? International reform is possible, but other changes are likely to wait until after the November election.

LLC Asset Transfer Is a Bona Fide Sale

In Estate of Barbara M. Purdue et al. v. Commissioner; T.C. Memo. 2015–249; Nos. 12994–12, 29829–12 (27 Dec 2015), the Tax Court held that the transfer of assets to an LLC was a bona fide sale for full and adequate consideration. In addition, gifts of LLC units qualified for the annual exclusion. Finally, an estate loan was necessary and therefore the interest was deductible.

Attorney Robert A. Purdue and decedent Barbara M. Purdue were residents of Washington. During the 1960s, they invested in cable company TeleView Systems, Inc. The cable company was purchased in a stock-for-stock exchange in 1969 by Columbia Broadcasting Company.

The Purdues retained their public shares and stock dividends. By 2000 the estate had grown to $24 million in marketable securities, their home and realty in Hawaii.

In 2000 estate attorney Alan Montgomery recommended creation of the Purdue Family LLC (PFLLC), the Purdue Family Trust (PFT) and the Purdue Family Residence Trust (PFRT).

In a 2000 memo, Montgomery suggested that the nontax reasons for creating the PFLLC included limitation of liability, creating a passthrough entity for tax purposes, minimum formalities and the ability to hold real estate.

The Purdues funded PFLLC with $22 million in public securities. PFRT was funded with the family residence. Between 2001 and 2007, they gifted PFLLC units to PFT. Because PFT included Crummey withdrawal rights, the Purdues utilized annual exclusions for these gifts.

Mr. Purdue passed away on August 3, 2001. Mrs. Purdue passed away on November 27, 2007. Her executor timely filed IRS Form 706. The IRS audited the estate and assessed deficiencies for estate tax of $3,121,959 and gift tax of $776,767.

At trial the estate maintained that the non-tax reasons for PFLLC included providing for management of the assets, consolidating the investments and educating their five children on managing an investment portfolio.

The IRS contended there were no valid nontax reasons because the family controlled the entire transaction.

The Tax Court determined that transfer of assets in exchange for the PFLLC units was a bona fide sale for full and valid consideration. The Purdues were not dependent on PFLLC because they retained sufficient assets. They were in good health in 2001 when the entity was created. Finally, the LLC formalities were respected with appropriate meetings and bank accounts.

A gift is a qualified present interest if there is a right to use the property. Reg. 25.2503–3(a). In order to demonstrate this right of use, the estate must show that there was income, distribution of income each year and a method for readily ascertaining the amount of available income. Because PFLLC made substantial distributions of income each year, the present interest was qualified.

Finally, the estate was deadlocked on the methods for making payments of the estate tax and therefore required a loan. The $20,891 of interest payable on that loan was a qualified Sec. 2053(a)(2) deduction.

Affordable Care Act Reporting Delayed

Each year there are increased coverage and reporting requirements for the Affordable Care Act (ACA). In 2015 large employers have new requirements. They must provide employees with IRS Form 1095–B, “Health Coverage,” and Form 1095–C, “Employer – Provided Health Insurance Offer and Coverage.”

In Notice 2016–4; 2016-3 IRB 1, the Service changed due dates for employer reporting to employees from February 1, 2016 to March 31, 2016.

Employers also must file reporting forms with the IRS for the “Transmittal of Health Coverage Information Returns.” These reporting forms are also delayed from March 31, 2016 to June 30, 2016, if filing electronically. If not filing electronically, the due date is May 31, 2016.

Applicable Federal Rate of 2.2% for January—Rev. Rul. 2016-1; 2016-2 IRB 1 (21 Dec 2015)

The IRS has announced the Applicable Federal Rate (AFR) for January of 2016. The AFR under Section 7520 for the month of January will be 2.2%. The rates for December of 2.0% or November 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 2016, 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.