Taxing Issues

District Court Invalidates Special Use Valuation Regulation

Admin — Mon, 16 Apr 2012 03:16:00 GMT

D. Finfrock-Ware Est., 2012-1 USTC ¶60,641; 109 AFTR 2d 2012-1439 (Dist. Court, IL, 3/20/2012); Internal Revenue Code Sec. 2032A

Executors of estates with real property whose highest and best use is development may qualify to elect to have such property valued at its current use. The election applies primarily to farmland and small businesses. It also applies to timberland and to a lesser extent timber. The decedent in this case owned four parcels of farmland under her 61-percent interest in a closely held corporation. She did not farm the land herself; however, her son had farmed it for the corporation for the entire eight years prior to her death. All four parcels constituted “qualified real property” under Code Sec. 2032A and in total comprised 68 percent of the adjusted value of the gross estate. The special use valuation election was made only for one of the parcels, accounting for 15 percent of the adjusted value of the gross estate. Reg. §20.2032A-8(a)(2) requires that the qualified real estate constitute 25 percent of the adjusted value of the gross estate. The beneficiaries intended to sell the other three parcels.

The court ruled as invalid the regulation requiring that the 25 percent rule applies to both all the qualified property and the property for which the election is made. The court found this requirement to be inconsistent with the clear language of Code Sec. 2032A, i.e. the rule applies to the property for which the election is made.

Several other issues have not yet been considered by the court, including indirectly owned property and material participation. A pretrial conference on a summary judgment is scheduled for April 30 and the bench trial for May 1, 2012.

It’s likely that the IRS will appeal the ruling invalidating the regulation to the 7^th Circuit Court of Appeals.

Family Limited Partnership for Timberland Tested in Tax Court

Admin — Thu, 05 Apr 2012 04:24:00 GMT

Estate of Joanne Harrison Stone, et al., TCM 45,585(M), TC Memo 2012-48, 2/22/2012

Family limited partnerships are commonly used to transfer ownership interests to succeeding generations. In addition to providing children with a reason to become interested in the management of the woodland and reduce the potential for partition of the land, they are used to reduce the taxable estate of the current generation. Mr. and Mrs. Stone owned 740 acres of timberland when a family limited partnership (FLP) was formed in 1997. They immediately began gifting interests in the FPL to 21 different family members. They did not apply any partial interest discounts to the value of these gifts.

When she died in 2005 Mrs. Stone held only a one-percent general partnership interest in the FLP. The IRS claimed that the entire interest in the FLP was includible in her estate. The Tax Court ruled that the transfer of the property to the FLP was a bona fide sale because creating a family asset and protecting the woodland from partition were valid and significant nontax reasons. The factors listed by the court included the fact that title to the property was actually transferred to the FLP, the value used for gifted interests were not discounted, the FLP didn’t make distributions, FLP and personal funds were kept separate, and the couple was in good health when the transfer was made.

Critically, the court held that the adequate and full consideration requirement for transfers was met. The basis for this determination was that the transfer had legitimate nontax purposes, not simply an attempt to change the form in which the decedent held the property. Only the fair market value of the Mrs. Smith’s interest in the FLP was includable in her estate under Code Sec. 2036(a).

Overview of 2009 Estate Tax Statistics

Admin — Tue, 08 Nov 2011 05:18:00 GMT

The federal estate tax is of great concern to many family forest owners. This concern is valid if your estate will be subject to the tax, but most estates are not. An estate tax return must be filed if the gross estate exceeds the excludable amount, but this doesn’t mean any tax is due. The excludable amount gradually increased from $675,000 in 2001 to $3.5 million in 2009. It was repealed for deaths in 2010, but later reinstated for 2010 estates of $5.0 million or more electing to not be subject to a limited step-up in basis for assets in the hands of heirs. The excludable amount stays at $5.0 million for 2011 decedents.

The number of estate tax returns filed decreased from 108,000 in 2001 to fewer than 34,000 in 2009. The total number of deaths in the US in 2007 was a little over 2.4 million. The decline in returns filed resulted mostly from the increase in the excludable amounts. Estates filing in 2009 reported over $194,000 billion in assets. It’s not possible to breakout how much of this was due to timberland. It is included in “other real estate” category.

Overall less than one-half of estates had to pay any tax. The marital bequest played large in reducing the estate tax. Such bequests totaled $62 billion. Only 10 percent of estates with this reduction owed any estate tax. The tax paid totaled $21 billion. Charitable bequest deductions totaled $16 billion. Returns with gross estates of $20 million or more accounted for 58 percent of the tax paid, but only 3 percent of filers.

Source: IRS Statistics of Income, http://www.irs.gov/pub/irs-soi/10esesttaxsnap.pdf

Estate Planning about much more than the estate tax. Your estate plan is about much more than minimizing the estate tax due. It’s mostly about achieving your post-death goals for the assets included in your estate.

Profit Motive Constrains Provision of Environmental Services

Admin — Thu, 08 Sep 2011 03:53:00 GMT

With the exception of property taxes, non-capital expenses for the management of forest land are deductible only if the taxpayer has a profit motive. Profit is broadly defined to include appreciation in the value of assets, including timber and land. Increases in these values is how many forest landowners show their intention to make a profit.

Forest landowners are frequently required or requested to incur costs primarily to improve the environment, not their profit. Many make improvements because they believe that it’s the right thing to do. These activities frequently reduce income potential, rather than increase it, as well as requiring cash expenditures. Examples are restoration of natural ecosystems, such as wetlands, and improving habitat for non-game wildlife. Activities that improve habitat for game species, for which hunting fees are charged, are treated like any other for-profit enterprise.

Operating expenses are deductible when the activity paid for is “ordinary,” “necessary,” “reasonable in amount,” and “directly related to the production of income.” Ordinary means broadly accepted by the industry, a standard practice within the industry. Necessary means that the enterprise would not be as successful without the action. Reasonable in amount means that the operator made an effort to carry out the activity with as little cost as possible. Directly related to the production of income means that the activity increases the quality and/or quantity of the product produced. Pre-commercial thinning of pine stands, maintenance of firebreaks, protection of young hardwood stands from deer browsing, and other protection measures meet these four criteria.

But, what about activities with direct costs or reduced income potential. Leaving stands to mature for Red Cockaded woodpecker habitat, bald eagle nesting trees and buffer, and riparian buffers are examples. Is the lost production simply the cost of doing business? Or, is a public benefit provided for which some form of compensation should be available?

In an earlier editorial we took a position in favor of tax simplification. But, if the Internal Revenue Code (Code) continues to be used to provide incentives for various industries to make environmental improvements, forest landowners should have a stake. Incentives for most industries are in the form of tax credits or accelerated depreciation. The Code has not been used to offset the direct and indirect costs for forest landowners to make required or voluntary environmental improvements. The Federal focus has been cost-share programs, primarily through the Natural Resources Conservation Service -- Farm Services Agency, US Forest Service and some states. These are good programs when administered efficiently and equitably, but restricted by annual budget allocations.

Mark Koontz, a Purdue graduate student at the time, looked at ways to modify the Code to provide environmental incentives to complement cost share programs. (See Financial Incentives to Promote Environmental Management by Nonindustrial Private Forestland Owners.” MS Thesis, Purdue University, May 1999, 102 p.) The possibilities include expanding the reforestation tax credit and adjusting amortization to include environmental expenditures whether or not planting is for commercial timber production, create an entirely new authority for a conservation credit and amortization, authorize outright deductions (even if the activity won’t make a profit), provide timberland owners with a choice between a cost share payment or tax deduction for qualified expenditures, or treat qualified expenditures as a charitable contribution through a well established conservation organization. You of course noticed our frequent use of the word “qualified.”

Federal income tax system is self-assessed, subject to audit. For practices that are universally accepted as beneficial, there is no reason that Congress couldn’t specify these and use the IRS audit process to verify compliance. Other possibilities include allowing federal and state agencies to authorize what qualifies in a given state. This is how cost-share programs are handled. Koontz also suggests considering the use of private conservation organizations such as The Nature Conservancy or local land trusts that employ natural resource professionals and are knowledgeable about environmental needs in their operating areas.

The dramatic changes we’ve seen in the demands placed on private lands call for creative thinking to inspire institutional adjustments. Our market economy, based on private property rights, has served us well. Forest landowners will continue to do what’s right with the proper incentives. But, asking them to bear an increasing portion of the cost of environmental services without reasonable compensation is inconsistent with the historical basis of the American economy. Let’s work with the environmental community to get the incentives needed to provide both timber resources and environmental services through incentives, not regulatory disincentives.

Tax Simplification - Time to Prepare Our Case

Admin — Thu, 08 Sep 2011 03:45:00 GMT

It’s hard to imagine any circumstances under which our U. S. Senators and Representatives would have sufficient support from constituents to engage in a process leading to simplification. The sectors of our economy tied to specific tax provisions are endless. These provisions can all be justified individually. Usually it’s the critical nature of a sector to the viability of our economy and way of life. Others are based on attempts to strive for economic and social justice. The analogy of a blind person identifying an elephant by touch applies. The totality of our Federal tax system is the elephant in the room. The authors of Tax Foundation Special Report No. 138 estimate a Federal Income Tax compliance cost of a quarter-trillion dollars in 2004, increasing to almost half a trillion in 2015.

Reversing the process that created the elephant, i.e. “unjustifying” each provision one-at-a time won’t work. No sector would give-up first, anticipating that others wouldn’t follow. Success would require a fresh start.

Discussions of flat tax proposals generally focus on the taxation of returns to labor. Objections to a single tax rate deal with equity and ability to pay. An indexed tax rate would be needed, unless an excludable amount could be agreed on. It’s doubtful that a tax system and federal budget not supporting some level of transfer of wealth would win Congressional support.

Less discussed is the taxation of land and capital, the other major components of an economy. Most economists and tax systems in other countries distinguish between returns to capital, and returns to labor. Forest landowners by-in-large believe that gains that take decades to realize are fundamentally different than returns to labor -- earned income. Annual returns to land from crops or rent generating activities are currently ordinary income. We see no reason to change this.

The dual nature of timber as a crop and as capital in the form of growing stock has been debated at least since 1944 when capital gains treatment was first provided for timber held for use in a trade or business, or held primarily for sale to customers in the ordinary course of a trade or business. The only condition under which gains from timber could reasonably be considered ordinary income is from ownerships large enough to have a regulated forest, i.e. annual harvests that approximately equal annual growth. Even then the large amount of capital tied-up in growing stock argues for treatment as capital gains. The case is much clearer for family forest ownerships providing sporadic timber gains. Returns from processing timber are now and should remain ordinary income.

We believe that it would be necessary to negotiate timber owners’ position on tax simplification in good faith, but that we should take a strong position in support of a lower tax rate for gains from timber disposals.