Washington Hotline – August 14 2012

Should Olympic Medal Winners Pay Tax?

At press time, the United States was embarked on a successful 2012 Olympics.  The U.S. had received 90 medals — 39 gold, 25 silver and 26 bronze.  Our Olympic team was on a path to receive well over 100 medals.
While each medal has very high personal value, there also is value to the tangible materials.  The gold medals contain approximately $675 in materials, the silver $385 and the bronze medal value is $5.
However, the U.S. Olympic Committee (USOC) also provides a cash gift for medal winners.  The gift values are $25,000 for a gold medal, $15,000 for a silver medal and $10,000 for a bronze medal.
Should the Olympic winners pay tax?  The general income tax rule is that all prizes are taxable unless specifically excluded.  Several Senators and Representatives have proposed that the value of the medal and USOC cash award should be excluded from taxable income.
Senator Marco Rubio (R-FL) introduced the Olympic Tax Elimination Act.  It would exempt medal winners from paying tax.  Rubio stated, “Athletes representing our nation overseas in the Olympics shouldn’t have to worry about an extra tax bill waiting for them back home.”
Similar bills were introduced in the House by Rep. Blake Farenthold (R-TX), Rep. Mary Bono Mack (R-CA) and Rep. Aaron Schock (R-IL).
All of the bills would exempt the medal and cash award from taxation.  CPAs who have commented on the proposal note that the athletes would need to report the cash awards as income, but also could offset this income with “ordinary and necessary” expenses related to the awards.  For example, the five women gymnasts who won the gold medal could take deductions for their classes, costs of coaches and their travel expenses.
House Ways and Means Committee Chairman Dave Camp (R-MI) joined the group that favors excluding the Olympic medals from taxation.  He stated, “These athletes deserve every bit of our support and appreciation for representing the United States on the world stage.  Allowing our Olympians to receive and enjoy their medals and awards without having to worry about whether they can pay the taxes on their accomplishment is just one small way we can show that support.”

House Attacks Identity Theft Tax Fraud

On August 1 the House passed the Stopping Tax Offenders and Prosecuting (STOP) Identity Theft Act of 2012 (H.R. 4362).  This act was introduced by Rep. Debbie Wasserman Schultz (D-FL) and increases tax fraud penalties in an effort to attack the tax-related identity theft problem.  The bill also encourages the Attorney General to devote greater resources to the problem of identity theft-related tax fraud.
A report by the Treasury Inspector General for Tax Administration (TIGTA) published on July 16 indicated that tax identify fraud is still a major problem.  The IRS noted that in 2011 it had detected one million potential tax I.D. fraud cases and withheld $6.5 billion in refunds.
However, the TIGTA report suggested that there were another 1.5 million potential tax I.D. fraud cases and that $5.2 billion in fraudulent refunds had been distributed.  The TIGTA report suggests that “substantial changes are needed to the individual taxpayer identification number program to detect fraudulent applications.”
House Judiciary Committee Lamar Smith (R-TX) urged Congress to act.  He stated, “Tax identity theft costs American families and taxpayers millions of dollars each year.  It also results in confusion and needless worry as taxpayers must work to correct the I.D. problem created by the false filers.”
Senator Bill Nelson (D-FL) has introduced the Identity Theft Tax Fraud Prevention Act (S. 1534).  He noted that Florida is a “particular hotspot for identity theft tax fraud.”  The cities of Tampa and Miami are especially serious problem areas with 16,000 returns filed and $749 million in potentially fraudulent refunds.
House Ways and Means Committee Member Sam Johnson (R-TX) expressed great concern about tax fraud after the publication of the TIGTA report.  He stated, “I am deeply outraged by this report.  American taxpayers deserve better protection of their hard-earned money.”

Insurance Retirement and Inheritance Plan Not Deductible

In Mark Curcio et ux. et al. v. Commissioner; Nos. 10-3578, 10-3585, 10-5004, 10-5072-ag (2nd Cir. 2012), the Second Circuit determined that contributions to a welfare benefit plan with the title “The Benistar 419 Plan” did not qualify for deductions.
The court consolidated four cases.  Mark Curcio and Ronald D. Jelling were business partners in three car dealerships.  Each funded a Benistar 419 Plan that purchased a $9 million insurance policy.  Their businesses made and deducted $200,000 in annual policy premiums.  Their accountant Stuart Raskin was not an expert on welfare benefit plans and relied on an opinion letter by the Edwards & Angell, LLP law firm to support the deduction.
Samuel H. Smith also participated in the plan.  His contributions of $54,000 annually to the plan were used to purchase a $5 million insurance policy.  His CPA deducted his contributions.
Steven Mogelefsky used the Benistar 419 Plan to acquire a policy for $350,000 and one for $1,020,000.  His company made and deducted approximately $750,000 in premium contributions.
The IRS audited the four taxpayers and denied the deductions because the contributions were not qualified under Sec. 162(a) as “ordinary and necessary expenses.”  The taxpayers claimed that the welfare benefit plan contributions under Sec. 419 were deductible.
The Second Circuit noted that expenses are deductible if they are “helpful for the development of the business” of the taxpayers.  The Benistar 419 Plan was advertised as a way for “Key Executives” to transfer funds into an account, deduct the funds, and acquire insurance that would be payable eventually to their families.  The insurance held by the welfare benefit plans could subsequently be transferred to the insured for a fraction of the policy value.  The Second Circuit determined that the plan did not meet the business development standard of Sec. 162 and was instead a “significant personal monetary benefit.”
While insurance for key employees can be deductible under Sec. 162, these payments failed that test.  In addition, Sec. 419A(f)(6) plans are explicitly not deductible unless they qualify under Sec. 162(a) or another section.  Therefore, the plan contributions used to pay the insurance premiums are not deductible.
The IRS also assessed penalties under Sec. 6662(a).  Sec. 6662(c) notes that the penalty is applicable if there is “any failure to make a reasonable attempt to comply with the provisions” of the Internal Revenue Code.  There also is a “reasonable clause” exception.
The four taxpayers all relied in good faith on the advice of their accountants.  However, they did not make a sufficient investigation and the accountants were not authorities on welfare benefit plans.  Because the taxpayers did not investigate the opinion letters by Edwards & Angell, they failed the “significant investigation” standard and the penalties are applicable.
Editor’s Note:  There is a parallel between this case on use of a welfare benefit plan as a retirement strategy and some types of charitable planning strategies.  Qualified retirement plans permit tax-free contributions and tax-free growth of assets.  There are both contribution limits and strict nondiscrimination standards.  For contributions to be deductible, a qualified plan must meet these standards.  The Benistar 419 Plan quite clearly failed to meet the nondiscrimination standard.  Plans that fail to meet the basic intent of Congress fare poorly in the courts.
Similarly, there are charitable plans that are designed to provide a charitable deduction and comparable value to the nonprofit that is used for the exempt purpose or the public good.  When a plan fails to meet those standards, even if there are technical arguments in favor of the plan, the courts are likely to deny deductions.  For retirement plans and charitable plans, taxpayers and their advisors should consider both the technical rules and the fundamental underlying purposes.  Just as there are many qualified retirement plans, there are many excellent charitable planned gifts.  Good planning involves compliance with both the technical rules and the underlying intent and charitable purpose of the plan.

Applicable Federal Rate of 1.0% for August — Rev. Rul. 2012-21; 2012-32 IRB 1 (18 July 2012)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2012.  The AFR under Section 7520 for the month of August will be 1.0%.  The rates for July of 1.2% or June of 1.2% 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 2012, pooled income funds in existence less than three tax years must use a 1.8% deemed rate of return. Federal rates are available by clicking here.