As Americans are enjoying the 4th of July holiday, the House Ways and Means Committee staff published a summary of efforts to improve the tax code. These efforts highlight the potential changes in three areas of taxation.

1. Permanent Tax Extenders - There are 55 tax provisions that are extended for one or two years at a time. Unfortunately, the extension in 2014 occurred in mid-December. It is very difficult for people to plan or use provisions such as the IRA charitable rollover when the bills are passed so late in the year. Therefore, Ways and Means Committee staff believe that several of the tax extenders should be made permanent. The committee has passed bills to make permanent the charitable IRA rollover, enhanced deductions for gifts of food to relief organizations, state sales tax deductions and business deductions that create jobs. These bills await Senate action.
2. Highways - America needs better roads, safe bridges, airport improvements and municipal facilities. Select Revenue Measures Subcommittee Chairman Dave Reichert (R-WA) has been seeking “permanent, sustainable funding sources” for the Highway Bill. After 33 short-term extensions of the Highway Bill, Reichert desires to find a permanent solution to fund the much needed infrastructure.
3. Comprehensive Tax Reform - Members of both parties agree that the tax-code is antiquated and needs to be reformed. Most tax reform proposals involve a combination of lower tax rates and a broader tax base with fewer deductions. Committee staff suggest “the goal of tax reform should be to create a fairer, flatter code that makes America more competitive, creating new growth and jobs.”

Editor’s Note: Both the House and Senate tax-writing committees will continue hearings on tax reform this year and in 2016. The probable legislation for tax reform will be deferred until 2017. It is likely that a comprehensive tax reform bill will be 1000 or more pages. The last major reform in 1986 was the product of two years of detailed effort. To write this comprehensive tax change will require extensive work and negotiation between the House, Senate and White House.

The Missing Trilobite Appraisals

In James J. Issacs v. Commissioner; T.C. Memo. 2015-121; No. 29303-11 (29 Jun 2015), the Tax Court denied deductions for gifts of trilobite fossils.

Dr. James Isaacs is a veterinarian who also collects trilobite fossils. A trilobite fossil is from a group of extinct marine arthropods. They roamed the ocean 250-500 million years ago.

On December 29, 2006, Dr. Issacs donated four trilobite fossils to the California Academy of Science (CAS). Letters from CAS confirmed receipt of the gifts but did not contain the “no goods or services were provided in exchange for the gifts” statement.

Dr. Isaacs included IRS Forms 8283 for tax years 2006 and 2007. CAS signed both forms as the donee. Fossil expert Jeffrey R. Marshall’s signature appeared on both forms. There was a letter supposedly signed by Marshall with each form that valued the deductions at $136,500 in 2006 and $109,800 in 2007.

At trial Jeffrey Marshall did not recall signing the forms 8283 and stated that he did not prepare the claimed letter “appraisals.” The court noted that there are three requirements for qualified charitable deductions.

First, Sec. 170(f)(8)(A) requires a contemporaneous written acknowledgement for gifts of $250 or more. Second, Sec. 170(f)(11)(A) requires reliable written records for noncash gifts of $500 or more. These records must include the date and manner of acquisition, a reasonable description of the property, acquisition cost, current fair market value and the method for determining that value. Third, Sec. 170(f)(11)(C) requires a qualified appraisal and submission of IRS Form 8283 if the non-cash charitable gift has a value of $5,000 or more.

Dr. Issacs failed all three tests. There was no qualified appraisal as required under Sec. 170(f)(11)(C). Because he did not indicate his cost basis and there was no method stated for determining the fair market value, he failed the Sec. 170(f)(11)(A) requirement for non-cash gifts over $500.

Finally, because the CAS letter did not contain the required “no goods or services were provided” statement, he failed the Sec. 170(f)(8)(A) requirement. Therefore, there was no charitable deduction for the gift of the trilobite fossils.

Exemption Revoked for Family Scholarship Foundation

In Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts Inc. v. United States; No. 1:11-cv-01573 (30 Jun 2015), the United States District Court for the District of Columbia revoked the exemption of the foundation under the private benefit test.

Decedent Julius Schaller passed away in December 2003. Co-executors Barrett Weinberger and Frances Odza incorporated the Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts, Inc. (“Foundation”). They appointed Solomon Zieger as the third Director. All three directors are descendants of Julius Schaller.

The foundation received tax-exempt status in 2004 and was funded with $2,595,847. In December 2004 the foundation authorized scholarships totaling $146,325 to Michael Chase Weinberger and Adam Zieger. In 2005, the scholarships to Weinberger and Zieger were again funded and Avraham Wachs also received a scholarship. All three are descendants of Julius Schaller.

The IRS audited the foundation and determined it was not qualified for exempt status because it “did not operate exclusively for exempt purpose and served private interests to a more than an insubstantial degree.” Because there was a misstatement of material fact in the application for exemption, the revocation of exempt status was retroactive to inception.

The foundation bought the present action and sought a declaratory judgment from the federal court that it qualified for exempt status.

The court noted that exempt status is available for public rather than private purposes. Reg. 1.501(c)(3)-1(d)(1)(ii). Example (ii) under that regulation indicates that “educational activities primarily serve the private interests of members of a single family.” Therefore, that organization failed the private benefit test and could not qualify for exempt status.

The foundation provided five scholarships for individuals who all were descendants of Julius Schaller. While the foundation noted that it was created for the purpose of benefiting all Hungarian immigrants and there was a qualified panel of three independent experts to award the scholarships, the court noted that a qualified foundation must meet both the organizational and operational tests. Because the independent panel was not convened to award the scholarships and the decision was made by the family members to grant scholarships to students who were also part of one family, the foundation was not exclusively operated for an exempt public purpose. It failed the private benefit test and the exemption was revoked.

While the documents indicated an intent to benefit a broad category of Hungarian immigrants and stated that an independent panel of qualified academic individuals would be convened to select recipients, the operation of the foundation indicated that the three directors did not intend to serve the public purpose. Therefore, there was a misstatement of material fact in the exemption application and the IRS could appropriately revoke the exemption retroactive to inception.

Editor’s Note: Scholarship funds are required to fulfill a broad public purpose. The group may be specific and limited if it is reasonably broad in scope. If scholarships are limited to a particular city, county or state, family members are permissible recipients if there is a reasonably broad class and an independent board to select recipients. However, some groups may not be sufficiently large. Nonprofit counsel should carefully examine the breadth of the qualified potential recipients. If a college or university were to create a scholarship fund for grandchildren of trustees or major donors, that may not pass the operational test.

Applicable Federal Rate of 2.2% for July—Rev. Rul. 2015-15; 2015-27 IRB 1 (18 June 2015)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2015. The AFR under Section 7520 for the month of July will be 2.2%. The rates for June of 2.0% or May of 1.8% 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 2015, 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.