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Tuesday August 9, 2022

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Time is Short for IRA Charitable Rollover Gifts

As the clock ticks toward December 31, it still may be possible to make an IRA charitable rollover gift this year. The IRA custodian will need to process the gift prior to the December 31 deadline, so it is important to be certain the gift can be completed by then. If you have not yet taken part or all of your required minimum distribution, an IRA charitable rollover, (also called a qualified charitable distribution by the IRS) can fulfill your RMD for 2021.

There are five types of donors who benefit from IRA charitable rollover gifts. The first are the convenience donors who find it a very simple and easy method for an end of year gift. Second, a standard deduction donor benefits from a direct IRA to charity gift. Third, a Social Security recipient may reduce taxes with an IRA charitable rollover gift. Fourth, a generous donor may want to give past the total giving limit. Fifth, a major donor may be looking for a favorable way to make a large gift.
  1. Convenient Gift -- Some IRA owners delay taking IRA withdrawals until December each year. If an IRA owner is actively making gifts to charity during the year, then it may occur to him or her that this is a convenient way to make a gift. Convenience donors contact their IRA custodians to arrange for the IRA charitable rollover. There is no charitable income tax deduction, but also no inclusion in federal taxable income. It is simply a convenient way to help your favorite charity.
  2. Standard Deduction Donor -- Many seniors do not have a mortgage and their medical deductions are modest. They may not have a sufficient level of deductions to itemize and choose instead to use the standard deduction. If this donor withdraws $1,000 from his or her IRA and then gives it to charity, there is $1,000 of increased income with no offsetting charitable deduction, since the standard deduction is taken. Therefore, it is preferable for all donors taking a standard deduction to make IRA charitable rollover gifts directly to charity and avoid additional income tax.
  3. Social Security Donor -- Social Security is generally subject to two levels of taxation. For donors who have income in excess of the first level, 50% of Social Security is taxed. For donors with income in excess of the second level, up to 85% of Social Security income is taxable. A withdrawal from a traditional IRA will potentially cause the recipient's income to increase from the 50% taxable bracket to the 85% Social Security taxable bracket. Even if the withdrawn amount is given to charity and deducted, there still is the higher level of tax on Social Security. By making a transfer directly to charity, many Social Security recipients will stay in the 50% taxable group and save taxes.
  4. Generous Donor -- Some generous individuals are already giving to the maximum deduction limits for cash gifts each year. The excess gifts may be carried forward and deducted over the following five years. Some of these generous donors may also have a large IRA. Since they frequently live at a moderate level in proportion to their income and assets, they may not actually need all of their IRA. If there is a desire to give more, they can make "over and above" gifts from their IRA. Because the IRA charitable rollover is not included in taxable income, it will have no impact on their regular income and other charitable gifts.
  5. Major Donor -- Board members, trustees and other major donors may desire to make large gifts. Because the 2022 IRA required minimum withdrawals have been reduced, large IRAs will continue to grow. For many donors, the IRA may become the majority of an estate. Therefore, it may be desirable for a major donor to give up to $100,000 per year to charity from his or her IRA. This has the advantage of "balancing" the estate assets. In addition, there may be income tax benefits. If the donor were to take the IRA into his or her own personal income, there are several types of exemptions that are phased out at higher income levels. Thus, it may actually be preferable to make the gift directly from the IRA rather than making a charitable gift from regular income.

Build Back Better Act in 2022?

Both the House and Senate have adjourned for the holidays and plan to return in January of 2022. Senate Majority Leader Charles Schumer (D-NY) had hoped to pass the Build Back Better (BBB) Act this year. However, he now pledges to hold a vote on a new BBB Act in January.

Sen. Debbie Stabenow (D-MI) spoke this week on a public media interview. She stated, "We know that this will be done first of the year, not now." The White House and key Senators were not able to come to agreement on major provisions of the bill. A point of contention was the expanded child tax credit (CTC). The expanded child tax credit resulted in payments the last half of 2021 of $300 per month for children under age six and $250 per month for qualified children ages 6 to 17. The balance of the total credits of $3,600 for children under age six and $3,000 for children ages 6 to 17 will be credited on 2021 tax returns.

A group of Senators met prior to the recess in order to discuss strategies for moving forward. Sen. Michael Bennet (D-CO) indicated there was a discussion "about the ways that the current Senate is not working and thinking about how we might be able to change it, make it work better."

Senate Finance Committee Chair Ron Wyden (D-OR) indicated that he plans to create a substantial tax revenue bill in 2022. Wyden believes that the new BBB Act could produce "a revenue menu with more than enough options to permanently pay for these priorities."

While these provisions did not pass in 2021, there are four specific revenue options for potential consideration by the Senate Finance Committee during 2022. These include the millionaire's surcharge, a trust and estate tax surcharge, grantor trust reform or valuation discounts.
  1. Millionaire's Surcharge -- The BBB assessed a 5% surtax on gross income over $10 million and an 8% surtax on income over $25 million.
  2. Trust and Estate Tax Surcharge -- The BBB applied the 5% tax to trust and estate income over $200,000 and an 8% tax to trust and estate income over $500,000.
  3. Grantor Trusts -- A potential tax provision would no longer permit a tax-free sale of assets to grantor trusts. It also may require inclusion of grantor trust assets at fair market value in the estate of the grantor, even if the trust includes a provision that creates a defective grantor trust.
  4. Valuation Discounts -- There have been proposals in Congress to create new rules that reduce the existing valuation discounts for lack of marketability and minority interests.
Editor's Note: It has historically been quite difficult to pass tax increases. A major challenge for Sen. Wyden and the Senate Finance Committee is to develop new tax revenue in a manner that is politically acceptable. The late Sen. Huey Long called this the "Don't tax you, don't tax me, tax the fellow behind the tree" principle.

Timeshare Charitable Donation Promoter Assessed $8.5 Million Penalty

In James Tarpey v. United States; No. 2:17-cv-00094, a promoter of a timeshare donation strategy was subject to a penalty of $8.5 million, based upon the revenue earned by both nonprofit and for-profit related entities that participated in the plan.

Defendant James Tarpey was an attorney in Montana. He created a Section 501(c)(3) nonprofit with the name Project Philanthropy, Inc., d/b/a Donate for a Cause (DFC). He also operated Vacation Property to value the donated timeshares. Timeshare administration and closings were handled by for-profit entities Resort Closings, Charity Marketing and Timeshare Specialist.

In 2015, the federal government obtained an injunction that essentially closed down the donation enterprise. DFC had used "conflicted appraisers who overstated the value of the timeshares" that were donated.

The present action is for the purpose of assessing penalties against Tarpey under Section 6700(a). The IRS must show that Tarpey organized the entity, made false or fraudulent statements about the tax benefits, knew or should have known the statements were false and the false statements pertained to a material matter.

Because Tarpey controlled the preparation of the appraisals, he was in violation of Reg. 1.170A-13(c)(3)(i)(B). He was not an independent and qualified appraiser. In his "Declaration of Appraiser" statements, he failed to acknowledge he was excluded as a qualified appraiser. Therefore, under Section 6700(a), he is subject to a penalty for "50% of the gross income derived from the activity."

The IRS and Tarpey disputed the nature of the "activity" for purposes of the penalty. The IRS claimed the activity should include the nonprofit and related for-profit entities. Tarpey claimed that the federal analysis should have excluded several items.

Government expert Dubinsky determined that total revenue was over $22 million between 2010 and 2013. This would result in a penalty of over $11 million, but the government had requested a penalty of $8.465 million plus interest.

Tarpey claimed that the IRS calculation was not correct because there was an escrow account, the expenses should have been capitalized, there was no reduction for the amounts transferred to qualified charities and Tarpey's wife owned 50% of one of the for-profit entities.

The court noted that there was no true escrow arrangement. An escrow involves a buyer, a seller and an independent escrow agent. Tarpey controlled the entity, Resorts Closings, Inc., that was the escrow agent. Because he controlled the entity, the payments were appropriately included.

DFC was a Section 501(c)(3) organization and therefore could not have been a dealer. Therefore, there was no reason to capitalize the penalty and it was applicable.

Tarpey's entities did transfer $1.5 million to qualified charities. However, even if these gifts were used to reduce the gross revenue, the resulting penalty of $10 million is in excess of the $8.5 million penalty requested by the IRS.

Finally, if the for-profit entity owned in part by Tarpey's wife were considered, there would be an "activity" reduction of $1.2 million. However, because Tarpey exercised complete control over the entities, he is deemed to be sole owner of Timeshare Specialist.

Because the potential reduction of the revenue by $1.5 million in charitable contributions and $1.2 million that could be attributed to his wife's interest would still result in a $9.8 million penalty, the government penalty of $8.465 million was sustained.

Editor's Note: This case emphasizes the importance of obtaining independent qualified appraisals. While the court determined that Tarpey created the nonprofit and manipulated the overvalued appraisals, gifts of nonmarketable assets over $5,000 must comply fully with the appraisal and appraiser requirements.

Applicable Federal Rate of 1.6% for January -- Rev. Rul. 2022-1; 2022-2 IRB 1 (15 Dec 2021)

The IRS has announced the Applicable Federal Rate (AFR) for January of 2022. The AFR under Section 7520 for the month of January is 1.6%. The rates for December of 1.6% or November of 1.4% 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 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.

Published December 24, 2021

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