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Thursday July 9, 2020

Washington News

Washington Hotline

Taxpayer Advocate Nina Olson Seeks Prompt IRS Guidance

National Taxpayer Advocate Nina Olson will be retiring on July 31. Olson has been praised by members of both parties for her consistent efforts to assist taxpayers and urge the IRS to improve its services.

In a speech to the New York University Tax Controversy Forum, Olson criticized the IRS for producing guidance just before the April 15 filing deadline.

When new tax laws are passed by Congress, the IRS must publish explanations for taxpayers, CPAs and other tax preparers. Because many tax provisions are complicated, it is difficult for tax preparers to correctly calculate the tax due and file the required tax forms without IRS guidance. This is especially a problem if the IRS guidance or explanations are published just before the April 15 filing deadline.

Olson noted, "When you get guidance related to the filing season that comes on April 11 or April 13, like we've seen with 199A, or we have seen with 965 last year, that is really a violation of the taxpayer trust. I see FAQs as an important tool, but they are vastly overused by the IRS."

The IRS publishes Frequently Asked Questions (FAQs) in many areas. The FAQs often include specific examples showing how to calculate and determine the correct tax. They are an excellent guide if taxpayers have questions regarding how to apply the tax law to their specific situation.

Editor's Note: Olson continues to seek to advocate for taxpayers. She has created a nonprofit, the Center for Taxpayer Rights, and will continue to attempt to assist taxpayers.

"Clean Up" of Old Masters Supports Valuation

In Estate of Eva Franzen Kollsman et. al. v. Commissioner; No. 18-70565 (9th Cir. 2019), the Ninth Circuit upheld a Tax Court decision to value two Old Masters paintings based upon their "cleaned up" value.

The estate of Eva Franzen Kollsman included two Old Master paintings, Village Kermesse with Dance Around the Maypole (Maypole) and Orpheus Charming the Animals (Orpheus). The Tax Court recognized the estate's argument that both Old Masters needed to be cleaned in order to have full value.

IRS expert Dr. Peter Cardile opined that the paintings could be cleaned with minor risk to the artwork. The IRS claimed "a prospective buyer could have ascertained that a skillful cleaning effort probably would have been successful."

The estate's expert appraiser, George Wachter, noted, "Under all the dirt the pictures seem to be in reasonably good condition." However, he claimed that the dirt on the paintings dramatically reduced their value. The Tax Court determined that Wachter overstated the amount of dirt and the cleaning risk.

The Maypole painting was subsequently sold in 2009 at five times Wachter's appraised value. While Wachter claimed that the value of the Old Masters dramatically increased in 2009, the estate failed to substantiate the fivefold increase. Wachter was also unwilling to use comparable sales to support his valuation.

Therefore, the Court "largely accepted" the valuations of IRS expert Cardile. He researched the paintings and provided several comparables. The Tax Court applied a discount to the Cardile valuations. The final Tax Court value and deficiency of $585,836 was within "the range supported by the evidence."

Editor's Note: When an asset sells for five times the appraised value within a short time and there are no comparables listed in the initial appraisal, the estate is likely to have a major valuation problem.

Higher Ed Desires Lower Kiddie Tax

In a letter to Senate Majority Leader Mitch McConnell (R-KY) and Minority Leader Chuck Schumer (D-NY), Ted Mitchell, President of the American Council on Education, asked Congress to repeal the changes in the Kiddie Tax enacted by the Tax Cuts and Jobs Act.

The Kiddie Tax applies to passive income of students up to age 24. Prior to passage of the TCJA, the Kiddie Tax (beyond a basic exclusion amount) was set at the rate of the student's parents. The intent of the Kiddie Tax was prevent affluent parents from lowering tax rates by creating trusts to split income between themselves and their children.

The drafters of the Tax Cuts and Jobs Act changed the Kidde Tax rate from the parents' rate to the income tax rate for trusts and estates.

Because trusts and estates do not vote, those entities have a highly compressed tax bracket. The top income tax rate of 37% is applicable for a trust or estate with income over $12,750 in 2019. This is dramatically different from the 37% top tax rate for single filers with 2019 income over $510,300 or married couples with income over $612,350.

Mitchell explains that the TCJA Kiddie Tax rates are especially oppressive for students from low-income families. While most of their scholarships are not taxable, the portion allocated to room and board is passive income subject to the Kiddie Tax.

For many students whose parents are in the 12% income tax bracket, the TCJA Kiddie Tax may greatly increase the amount of tax payable. Mitchell offers the example of a talented student on full scholarship whose parents have joint income of $50,000. Because $11,500 of the student scholarship is allocated to room and board, it is taxable.

Under the pre-TCJA rules, the student paid $1,400 in tax. However, with the high trust income tax rates under the TCJA applicable to the Kiddie Tax, the student must pay $2,600 in 2019.

Editor's Note: Mitchell is correct that subjecting students from disadvantaged backgrounds to high income tax rates makes no sense. The TCJA Kiddie Tax provisions are an obvious example of tax drafters who had good intentions and yet created a provision with unfortunate and unintended effects. The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) would repeal the TCJA Kiddie Tax provisions. It is quite likely to pass by the end of this year.

Applicable Federal Rate of 2.6% for July -- Rev. Rul. 2019-16; 2019-28 IRB 1 (18 June 2018)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2019. The AFR under Section 7520 for the month of July is 2.6%. The rates for June of 2.8% or May of 2.8% 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 2019, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.

Published June 28, 2019
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