Washington Hotline – July 26, 2016


Washington Hotline

Natural Gas Disaster Tax Relief

In Announcement 2016-25; 2016-31 IRB 1, the IRS announced that it will exclude most payments to residents affected by the Aliso Canyon natural gas leak.

Aliso Canyon was originally an oilfield developed by J. Paul Getty. After the oilfield was depleted, it was sold and is currently used by Southern California Gas Company (SoCal Gas) for underground storage of 86 billion cubic feet of natural gas. The area now is a northern Los Angeles suburb with thousands of residents.

On October 23, 2015, SoCal Gas discovered a natural gas leak on well SS25, which was initially drilled in 1953. The well casing and wellhead failed to contain the pressurized natural gas.

Area residents reported headaches, nausea and nosebleeds. About 2,500 households were temporarily relocated until Feb. 18, 2016, when California state officials stated that the leak was plugged.

Because many residents received compensatory payments from SoCal Gas for their relocation costs, the IRS excluded from taxable income most SoCal payments during the period from November 19, 2015 to May 31, 2016. The excluded amounts include the following:

  1. Hotel expenses, including meal allowances.
  2. Payments to family or friends for room and board at $150 per day.
  3. Home rental costs for alternative housing until May 31.
  4. Mileage for transporting children to schools from the temporary location.
  5. Home and vehicle cleaning expenses related to the natural gas leak.

Residents who were relocated are permitted to exclude all of these payments from taxable income. However, family and friends who received any SoCal Gas payments will be required to report them as taxable income to the extent they exceed the 14 day exclusion under Sec. 280(A).

Executrix Personally Liable for Taxes

In United States v. Marci McNicol: No. 15-2214 (1st Cir., 17 Jul 2016), the court held Executrix Marci McNicol personally liable for an outstanding tax bill.

Decedent Robert Reitano and wife Marci McNicol operated two fishing vessels. The craft were owned by corporations Sophia Gale, Inc. and RR Fishing Corp. Robert owned 100% of Sophia Gale and the couple jointly owned the stock of RR Fishing Corp.

Robert Reitano died in July 2002 with a pending IRS tax claim for $342,538.93. His estate value was less than this amount and therefore it was insolvent.

Executrix Marci transferred the stock in both companies to herself. The IRS initiated an action to require payment of the tax. The U.S. District Court in Massachusetts held that the estate was insolvent and Executrix Marci was personally liable for tax of $125,938. The valuation of the liability was reduced from the initial amount to the $125,938 figure based upon the actual sale of the two fishing vessels.

The First Circuit noted that Sec. 3713(a)(1)(B) requires personal liability. The statute states that the “claim of the United States Government shall be paid first when the estate of a deceased debtor in the custody of the executor or the administrator is not enough to pay off all debts of the debtor.”

This statute creates personal liability if three requirements are fulfilled. First, the executor must transfer assets prior to making payment of the U.S. tax bill. Second, the estate must be insolvent. Third, there must be a notice of the tax bill that “would lead a reasonably prudent person to inquire as to its existence.”

The District Court determined that all three requirements were fulfilled and personal liability existed. Executrix Marci claimed that the assets were used to pay estate expenses and the valuation of the stock was not correct.

The court noted that there was no proof of expenses offered except “unsupported hearsay” and the estate admitted the value during the discovery process. Therefore, the Executrix is liable for the tax.

Substantial Charitable Deductions Denied

In Embroidery Express LLC et al. v. Commissioner; T.C. Memo. 2016-136; Nos. 7784-11, 6748-11 (20 Jul 2016), the Tax Court denied substantial business and charitable tax deductions.

Brent and Lynette McMinn operated a resort, a farm, a construction business and an embroidery business. The IRS audited both the embroidery business and their personal returns for 2004-2007 and issued deficiencies in excess of $400,000.

First, the Tax Court reviewed the business deductions. Based upon the Reg. 1.183-2(b) eight factor test, because the McMinns spent little time, had little expertise and made small profits, the resort and farm did not constitute profit-making entities. Business expense deductions for three cars and a motorhome were also denied. Taxpayers failed to fulfill the Sec. 274(d) requirements to record the date, expenditure, mileage and business purpose for each trip.

There were five charitable deductions reviewed, with several limitations to the permitted amounts.

1. Kayit’s Children’s Home – A gift of $2,600 to the home in Mexico was denied because the nonprofit was not an exempt U.S. charity.

2. Children’s Research Foundation – Gifts of $381 in 2004 and $1,356 in 2005 were denied due to no Sec. 170(f)(8)(B) contemporaneous written acknowledgment. Gifts of $112, $129 and $168 were approved.

3. R.L. Montgomery Ministries – Gifts of $3,000, $6,300 and $2,135 were denied. Montgomery claimed to be an agent of nonprofit Ranch House Ministries, but there was no evidence that the funds were transferred to the exempt organization.

4. Faith Family Worship Center – Taxpayers gave office furniture valued at $4,050 and $2,900. They received a contemporaneous written acknowledgment, but the generic description was not “in detail reasonably sufficient” and the deduction was denied. Taxpayers also transferred a 2002 Chevy Suburban in a bargain sale. The cash amount of $11,000 reduced the charitable gift to $15,245. The Tax Court refused to accept a Kelly Blue Book valuation and permitted only a $5,000 deduction because there was no qualified appraisal.

5. Jamaica Mission Trip – The $3,013 deduction for this missions trip was denied because there was no contemporaneous written acknowledgment.

Editor’s Note: This is a good summary of charitable deduction substantiation requirements. When the taxpayer failed to substantiate some gifts, the Tax Court was quite rigorous in application of all rules.

Applicable Federal Rate of 1.4% for August — Rev. Rul. 2016-18; 2016-31 IRB 1 (17 July 2016)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2016. The AFR under Section 7520 for the month of August will be 1.4%. The rates for July of 1.8% or June 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 2016, 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.