Washington News

The Senate voted this week on payroll tax plans by both the Democratic and Republican members. The Democratic plan introduced by Sen. Robert Casey Jr., (D-PA) was modified. The new plan proposes a reduction in the 2012 Social Security payroll taxes from 6.2% to 3.1%. It does not include a reduction for employers and the surtax on incomes over $1 million is reduced to 1.9%. The plan also proposes increased fees on mortgage lenders who work with Fannie Mae and Freddie Mac. The Democratic proposal accepted the Republican suggestion to limit unemployment benefits for those with incomes over $1 million.

The Republican plan is the Temporary Tax Holiday and Government Reduction Act. It proposes a reduction in Social Security payroll taxes from 6.2% to 4.2% for employees in 2012. The plan is paid for by a 10% reduction in the federal work force through attrition, by freezing salaries next year for Congress and federal workers and by limiting unemployment benefits for those with $1 million in income.

On Thursday the Republican leadership of the House published their proposed plan. It includes the 2% reduced payment for employees. The Republicans propose paying for the plan with a freeze on salaries of Congress and federal workers. In addition, parents would need to include a Social Security number to claim the child tax credit.

The White House continued to press leaders in Congress to pass a bill. President Obama stated, "I expect that it's going to get done before Congress leaves. Otherwise, Congress may not be leaving, and we can all spend Christmas here together."

Editor's Note: While the debate over payment continues, it now seems likely that a compromise plan with a 2% reduction and some method of offsets through other types of savings will be passed this month.

Insurance Trust May Include Asset Substitution Right

In Rev. Rul. 2011-28; 2011-49 IRB 830 (4 Dec 2011), the IRS determined that a right of asset substitution is not an incident of ownership under Sec. 2042.

The ruling assumes that D, a U.S. citizen, funds an irrevocable trust with cash. The trust purchases a life insurance policy on D. The beneficiaries of the trust are D's heirs.

There is an independent trustee of the trust and D is prohibited from serving as trustee. D makes gifts annually to the irrevocable trust and they are used to pay premiums. When D passes away, the insurance proceeds will be received by the trust for the benefit of D's heirs.

Under Sec. 2042(2) the gross estate includes all assets and insurance if there are any retained "incidents of ownership" in the policies. Reg. 20.2042-1(c)(2) indicates that the incidents of ownership are primarily those powers that grant economic benefit or control to the insured. These include the right to change the beneficiary, to surrender or cancel the policy, to assign the policy, to pledge the policy for a loan or to obtain a loan against the surrender value.

Reg. 20.2042-1(c)(4) expands the incidents of ownership provision by noting that the ability to change beneficial ownership or control proceeds will trigger estate inclusion.

In Rev. Rul. 84-179, 1984-2 C.B. 195, the taxpayer purchased a policy and created an irrevocable trust for his spouse with no retained incidents of ownership. However, the spouse died and the insured became trustee of the trust for the benefit of a child. Even though the trustee powers included various rights over the policy, the indirect method of acquiring those rights through a successor trusteeship enabled the individual to avoid the categorization of an incident of ownership that would require estate inclusion.

However, the ruling noted that where powers are held in a fiduciary capacity and the taxpayer creates the policy and then serves as trustee, those incidents of ownership will require inclusion.

In Estate of Jordahl v. Commissioner; 65(T.C. 92) 1975, the decedent created an irrevocable trust and reserved the power to substitute securities or other assets of equal value to the property replaced. The Tax Court determined that the decedent was bound by fiduciary standards and that the substitution power was not a power of economic control under Sec. 2038.

In Rev. Rul. 2008-22, 2008-16 I.R.B. 796, a grantor also created an irrevocable trust for heirs with a retained power to substitute other assets of equivalent value for trust property. The retained power was deemed to not require Sec. 2036 or Sec. 2038 inclusion because of the fiduciary obligation.

Grassley Targets Donor Advised Funds

Sen. Charles Grassley (R-IA) was the principal author of significant reforms for donor advised funds and supporting organizations in the Philanthropy Protection Act of 2006. As part of that act, Treasury was required to complete a study on supporting organizations and donor advised funds. The Treasury study was recently released.

After viewing this Treasury study, Grassley stated, "The study is disappointing and unresponsive. It doesn't advance the ball in closing abusive loopholes. If anything, it gives abusive organizations cause for celebration. The Treasury Department seems to be forgetting that for years, supporting organizations and donor advised funds were on the IRS annual 'Dirty Dozen' list of tax scams."

Grassley was concerned that some donor advised funds were accumulating assets and not benefiting charities directly. He included the Treasury study requirement in PPA 2006 in order to examine the question of mandatory payout rates for donor advised funds.

Grassley expressed concern that the study failed to "describe average payout rates" and didn't state how many donor advised funds and supporting organizations are not making payouts. In his view, Treasury should be encouraging donor advised funds and supporting organizations to make grants for charitable work. Grassley comments that the current grants are "especially critical in these tough economic times."

Editor's Note: There is no specific action pending in Congress that is likely to produce a reform of donor advised funds and supporting organizations in 2012. However, community foundations are concerned that a mandatory 5% payout rate for donor advised funds could result in increased costs of administration. Some donors prefer to create a donor advised fund and build it up to a particular level to accomplish a specific grant objective. Most donor advised funds are distributing substantially over 5% each year. With 7,000 Baby Boomers turning age 65 every day, the class of individuals who have a high propensity for creating donor advised funds is growing rapidly. As the number of DAFs increase, it is probable that the questions on ensuring effective philanthropy by DAFs will continue.

Applicable Federal Rate of 1.6% for December – Rev. Rul. 2011-31; 2011-49 IRB 1 (17 Nov. 2011)

The IRS has announced the Applicable Federal Rate (AFR) for December of 2011. The AFR under Sec. 7520 for the month of December will be 1.6%. The rates for November of 1.4% or October 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 2011, pooled income funds in existence less than three tax years must use a 2.8% deemed rate of return. Federal rates are available by clicking here.