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Sunday April 26, 2015

Washington News

Washington Hotline

IRS 'Courtesy Disconnect' Hearing

During the recent filing season for 2014 tax returns, IRS Commissioner John Koskinen reported a substantial reduction in IRS phone support.

Because of IRS staff reductions, many taxpayers were not able to have questions answered. If the anticipated waiting time was deemed too long by the IRS, there would be an automatic decision by the IRS phone system to terminate the call. The IRS term for hanging up on taxpayers is “courtesy disconnect.”

In comments about the IRS service for taxpayers, Commissioner Koskinen acknowledged that the taxpayer support level this year was “abysmal.”

At a hearing of the House Ways and Means Oversight Committee on April 22nd, Chairman Peter Roskam (R-IL) stated, “For filing season 2015, the IRS reported that only 54% of taxpayers who called the agency were able to talk to a live assister. By April, the IRS estimated that the telephone level of service was less than 40%. Keep in mind that the IRS goal for customer service is 80%.”

Roskam continued to outline some of the specifics of the taxpayer problems with the IRS. He commented, “Those who could get through at all had to wait an average of 34 minutes, over 15 minutes longer than last year. The number of abandoned calls increased by 1.3 million. The IRS also reported that as of April 8, the number of 'courtesy disconnects' – a nicer way to say the system automatically hangs up on you because the wait time would be too long – had reached 5 million.”

Chairman Roskam suggested that a main cause of the reduced service was a decision by the IRS to divert user fees away from phone support for taxpayers to other purposes. During the prior year, $183 million of user fees had been allocated to phone support. Chairman Koskinen reduced this number by 73% to $49 million of user fees allocated to taxpayer support this year.

Ranking Member John Lewis (D-GA) responded and defended the IRS performance. He attributed the failure to provide taxpayer service to the reduced budget for the IRS.

Lewis acknowledged, “Taxpayer service this filing season was terrible. This was not the fault of hardworking IRS employees. National Public Radio (NPR) recently ran a story called, 'IRS Budget Cuts Make for a Nightmarish Filing Season.' Taxpayers seeking assistance from the IRS waited in lines for hours. Only 4 in 10 taxpayers who called the agency were able to talk to a customer service representative.”

Chairman Koskinen noted that the filing season did go “relatively smoothly” with respect to the filing of returns and distribution of taxpayer refunds. However, he explained the failures by noting “Because of cuts to our budget, the agency was unable to provide adequate levels of taxpayer service, as I will explain in detail below. Thus, while I am pleased with the performance of IRS staff in very difficult circumstances, I am disappointed that because of budget cuts, taxpayers did not get the customer service experience they deserved.”

IRS Approving “Too Many” Nonprofits?

At a Washington Tax Conference on April 23, National Taxpayer Advocate Nina Olson accused the IRS of inadequate oversight of nonprofit organization applications. Under the new Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” the IRS has approved approximately 93% of the applications during the past year. IRS Commissioner of the Tax Exempt and Government Entities Division Sunita Lough reported to conferees of a Baltimore meeting that this method is working well and has reduced the average waiting time for tax exempt status.

Olson expressed concern that the blanket granting of exempt status is allowing unqualified organizations to become exempt. She describes the problems that a joint test by the IRS and her office revealed. They selected a random group of 13 organizations that had been approved under the accelerated Form 1023-EZ process. These 13 organizations were asked four additional questions and required to submit their Articles of Incorporation.

When the Taxpayer Advocate office reviewed the 13 organizations, it determined that only three of the 13 met the required organizational test for nonprofit status.

Olson stated, “Basically what they have done, in my opinion, with the 1023-EZ as it is designed today, is they solved an inventory problem, because they have gotten through their backlog and they are passing these things through really quickly. But they are creating a compliance problem down the line.”

IRS Form 1023-EZ was introduced in July of 2014. The two and one-half page form does not require a specific statement of activities. It is much less comprehensive than the 26 page standard Form 1023.

Chairman Koskinen noted that the Form 1023-EZ permits nonprofit organizations to obtain exempt status in a shortened and convenient process. He expects to use “IRS compliance resources” to catch offending entities at a later time.

Taxpayer Advocate Olson suggested that this plan is an abdication by the IRS “of its responsibility to determine whether an organization is organized and operated for an exempt purpose.”

Annual Exclusions Survive “In Terrorem” Clause

In Israel Mikel et ux. v. Commissioner; T.C. Memo 2015-64; Nos. 16538-13, 16563-13, (6 Apr 2015), the Tax Court determined that gifts from a couple to 60 beneficiaries were qualified for the present interest annual exclusion, even though there was an “in terrorem” provision within the trust document.

In 2007, Israel and Erna Mikel transferred $3,262,000 in value of real property to a trust with 60 beneficiaries. The IEM irrevocable trust included a 30 day withdrawal right for each beneficiary. Trustee Salomon Mikel also held a completely discretionary right to make distributions to any of the 60 beneficiaries for health, education, maintenance or support.

If there were a dispute with respect to any distribution, the beneficiaries were permitted to appeal to a panel “consisting of three persons of the Orthodox Jewish faith.” This panel is referred to as a “beth din” entity. The document also included an in terrorem clause that is intended to reduce potential conflict.

The clause stated, “In the event a beneficiary of the trust shall directly or indirectly institute, conduct or in any manner whatever take part in or aid in any proceeding to oppose the distribution of the trust estate, or files any action in a court of law, or challenges any distribution set forth in this trust in any court, arbitration panel or in any other manner, then in such event the provision herein made for such beneficiary shall thereupon be revoked and such beneficiary shall be excluded from any participation in the Trust Estate.”

The donors did not file IRS Form 709. Following a request from the IRS, the donors filed IRS Form 709 and each spouse claimed gifts with value of $1,631,000 and annual exclusions under Sec. 2503(b) of $720,000. The annual exclusion total of $1,440,000 equaled 120 times the $12,000 amount.

The IRS determined that the gift exclusion was not qualified, assessed a deficiency of $268,950 and also a late-filing fee of $67,238.

The court noted that Sec. 2503(b)(1) permitted a potential $12,000 annual exclusion for both grantors and the 60 beneficiaries. Each of the beneficiaries received a withdrawal right to $24,000 for the period of 30 days. The Mikels claimed that this enabled them to qualify for the present interest annual exclusion under Reg. 25.2503-3(b).

However, the IRS noted that each heir did not have an unconditional right of withdrawal because the in terrorem clause made it very difficult for the beneficiary to go before a state court and risk the loss of all benefits.

All 60 beneficiaries did receive appropriate notice of their 30 day withdrawal right. There was no claim by the IRS that the trustee had a legal basis for rejecting an exercise of that withdrawal power.

The Tax Court determined that there were two errors in the IRS argument. First, a withdrawal right must be enforceable, but enforcement in a state court is not an exclusive requirement. The beneficiaries could obtain a “beth din” enforcement right.

Second, the purpose of the in terrorem clause was to restrict a challenge to a distribution to any of the other beneficiaries. It did not restrict the ability of each beneficiary to enforce his or her 30-day withdrawal right. Therefore, the transfers qualified as present interest gifts.

Applicable Federal Rate of 1.8% for May -- Rev. Rul. 2015-8; 2015-17 IRB 1 (17 Apr 2015)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2015. The AFR under Section 7520 for the month of May will be 1.8%. The rates for April of 2.0% or March of 1.8% 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 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 April 24, 2015

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