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Friday August 28, 2015

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Back to School Tax Benefits

As students return to colleges and universities this month, the IRS summarized the tax benefits available to students in IR-2015-102. Two of the primary credits are the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC).

A taxpayer may claim one or the other credit for a particular student. You must file IRS Form 140 or 140A and also Form 8863, Education Credits. The student must attend an eligible college, university or vocational school.

A college or university must give each student IRS Form 1098-T by January 31 each year (however, in 2016 the due date is February 1 because the previous day is a Sunday). A taxpayer will use Form 1098-T and refer to the instructions for Form 8863 to calculate the credit amount. Upper-income taxpayers may have limited benefits from these education credits.

The American Opportunity Tax Credit is a maximum of $2,500 per student and there are several requirements.

1. Maximum Duration – The credit may be claimed for up to four tax years per student.

2. Student – A student may not have completed four years of post-secondary education prior to 2015.

3. Qualified – The credit is available for payments of tuition and fees. Room and board amounts are not covered.

4. Amount – The credit is 100% of the first $2,000 in qualified expenditures and 25% of the next $2,000. An expenditure of $4,000 may produce qualification for the full $2,500 credit.

5. Refundable – Up to 40% of the credit is refundable. If a person pays no federal income tax, it is still possible to receive a $1,000 refund.

6. Limits for Upper-income Taxpayers – The AOTC is phased out for single persons with modified adjusted gross income (MAGI) over $80,000 and couples with MAGI over $160,000.

The Lifetime Learning Credit is $2,000 per tax return (not per student). It applies to both graduate and undergraduate education. None of the LLC is refundable.

1. Qualified – The LLC is available for payment of tuition and fees.

2. Amount – The LLC equals 20% of qualified expenditures. A tuition payment of $10,000 times 20% produces the maximum $2,000 credit.

3. Phaseout – Individuals with modified adjusted gross income (MAGI) over $55,000 for single persons or $110,000 for married couples will be subjected to the phaseout rule.

There also are other helpful educational benefit options. Scholarships and grants are generally tax-free to the extent that they cover tuition and books. Scholarships for room and board are taxable.

If a student has loans, there is an interest deduction of up to $2,500 per year. Finally, parents may choose to fund a Sec. 529 plan. A parent may give up to five annual gift exclusion amounts in one year. With the current $14,000 annual gift exclusion, each donor may transfer up to $70,000 to a Sec. 529 plan. The plan permits tax-free growth and tax-free distribution to a student for qualified education expenses.

Busy September for Congress

The Committee for a Responsible Federal Budget (CRFB) is a bipartisan organization that seeks to encourage Congress to enact appropriate financial and tax bills. Many of the CRFB Directors previously were Members of Congress.

On August 20, CRFB published “The Gathering Storm: Fiscal Clouds Amass This Fall.” The article explains that there are four major challenges that will lead to a very crowded Congressional docket for September and October.

1. Sequester on October 1 – The House has passed six of the twelve budget bills for the fiscal year that starts on October 1. The Senate has not passed any budget bills. It will be necessary to pass a continuing resolution or the budget bill by that time. Under the “Bipartisan Budget Act,” spending levels were set for 2014 and 2015. In 2016, the sequester limits on discretionary spending only allow an additional $3 billion in the budget. This would be a reduction of $90 billion over a previous plan. There will be major reductions, particularly in defense spending, if Congress does not take action.

2. Highway Bill – The temporary Highway Bill has an October 30 deadline. The current gas tax leads to a shortfall of approximately $13 billion for this year. CRFB suggests that unless other options are available, there should be a nine cents per gallon increase in federal gas tax.

3. Federal Debt Ceiling – The current $18.15 trillion debt ceiling was reached in March of this year. Currently, the Department of Treasury is using “extraordinary measures” to borrow from various retirement and other funds to keep the government functioning. These extraordinary measures will run out at the end of October. By that time, Congress must address the debt ceiling.

4. Tax Extenders – Members of both parties would prefer to pass the 54 tax extender provisions in permanent form. However, this would involve a ten year cost of $940 billion. The two parties cannot agree on offsets that come close to this amount. The House has passed some business and charitable permanent extenders, while the Senate Finance Committee has proposed a two-year extension of 50 items for 2015 and 2016. CRFB proposes a one or two-year tax extender plan with a fast-track strategy for comprehensive reform.

Editor’s Note: In September, there will be a full schedule of business for both the House and the Senate. The Senate is expected to vote in late September on a tax extenders bill for 2015-16. If that passes the Senate, it is quite probable that the House will accept the two-year plan. However, it is uncertain how long it will take the House and Senate to take action. All nonprofits and professional advisors hope that a bill with the IRA Charitable Rollover and other tax extenders will be passed by early October.

Gift Tax Interest Limited to Gift Value

In United States v. Elaine T. Marshall et. al.; No. 12-20804 (5th Cir. 2015), the Court held that the total payment for gift tax and interest was limited to the gift's fair market value.

In 1995, J. Howard Marshall sold a large block of Marshall Petroleum, Inc. stock to his company. Because the stock was sold at a bargain price, there was an increase in the value of the remaining shares and thus an indirect gift to the other shareholders. These shareholders included former wife Eleanor Stevens, son E. Pierce Marshall, daughter-in-law Elaine T. Marshall and trusts for other heirs.

J. Howard did not pay gift tax prior to passing away. Following extensive negotiations between the estate and the IRS, in 2012 the District Court published several orders. First, the shareholders were liable for gift tax under Sec. 6324(b). Second, former wife Eleanor Stevens was recipient of an indirect gift. Third, estate representatives E. Pierce Marshall and Finley Hilliard were personally liable due to distributions that they had made from the estate.

The court noted that the stipulated value for the gifts was $84,191,754. This amount of indirect gift created a potential tax of $47,509,047. Because the estate failed to pay the IRS deficiency, the Service pursued an action against the beneficiaries under Sec. 6324(b).

First, the court held that former wife Eleanor was a beneficiary of a grantor retained income trust (GRIT) and therefore there was an indirect gift to her. Because executors Finley Hilliard and E. Pierce Marshall knew she had a gift tax obligation, they were both liable.

The estate claimed that the specific language of Sec. 6324(b) limited the payment to “the extent of the value of such gift.” Because the gift was approximately $84 million, the tax plus interest should be limited to that total amount.

The IRS observed that 20 years had passed between the date of the gift and the current proceeding. With two decades for accrual, there was approximately $75 million of interest. If Sec. 6324(b) is combined with Sec. 6901, then under the IRS position the tax and full amount of the interest should be paid.

Judge Priscilla Owen noted that the statute text was clear. Therefore, the Court held that the total for tax and interest would be limited to the fair market value of the gift.

Dissenting Judge Prado would read Sec. 6324(b) and Sec. 6901 together and require payment of the full amount of the interest. Prado observed that if this were not the case, then once the tax plus interest reach the gift fair market value there is an incentive to defer payment as long as possible because no further interest will accrue.

The court held that the tax plus interest was limited to $84,191,754, the fair market value of the gift.

Applicable Federal Rate of 2.2% for September -- Rev. Rul. 2015-19; 2015-36 IRB 1 (18 August 2015)

The IRS has announced the Applicable Federal Rate (AFR) for September of 2015. The AFR under Section 7520 for the month of September will be 2.2%. The rates for August of 2.2% or July of 2.2% 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.

Published August 21, 2015

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