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WASHINGTON TAX UPDATEJUNE 13, 2012

Look Inside

What’s New from the IRS

Tax Planning Tip of the Week

What’s New from the Courts

It Bears Repeating

Tax Laughs

Welcome to Washington Tax Update, where you will find useful information about taxes, including current events in our nation’s capital, as well as informed opinions and predictions about what is expected to happen.

what’s newfrom the IRS

Annual limit comes to flexible spending arrangementsFor plan years beginning after Dec. 31, 2012, salary reduction contributions to health

flexible spending arrangements will have a statutory annual limit of $2,500.

Prior to the Pension Protection Act of 2006, no statutory limit existed for the amount of

salary reduction contributions that employees could elect to contribute to their health

FSAs, other than the limit imposed by the plan sponsor.

The IRS has issued guidance in Notice 2012-40 with the following provisions:

➤ The $2,500 limit does not apply for plan years that begin before 2013.

➤ The term “taxable year” refers to the plan year of the cafeteria plan – the period for

which salary-reduction elections are made.

➤ Plans may adopt the required amendments to reflect the $2,500 limit at any time

through the end of calendar year 2014.

➤ In the case of a plan

providing a grace period

(which may be up to two

months and 15 days),

unused salary-reduction

contributions to the health

FSA for plan years

beginning in 2012 or later

that are carried over into

the grace period for that

plan year will not count

against the $2,500 limit for

the subsequent plan year.

The new guidance also

provides relief for certain

contributions that mistakenly

exceed the $2,500 limit but

are corrected in a timely manner. Relief is available if the excess is due to a reasonable

mistake, not willful neglect, and the employer corrects the mistake.

what’s newfrom the IRS

tax planning tip of the week

The Roth option: Pay now, save laterYou may be familiar with Roth IRAs, but do you know that some employer-sponsored

retirement savings accounts, like 401(k) plans, also offer a Roth alternative?

Few people choose that option because they have to pay tax currently on the amount that

goes into the Roth account. Paying more taxes now doesn’t sound like a good idea.

But Roth accounts offer longer-term tax advantages:

➤ Traditional retirement accounts present you with taxable income when you receive

retirement distributions. Of course, many people expect to be in a lower tax bracket

when they retire. Distributions from Roth accounts are entirely tax-free once you have

established a five-year history of using a Roth account.

➤ A traditional retirement account requires you to begin taking distributions when you

reach age 70½. Roth accounts have no required minimum distribution.

➤ Taxable retirement distributions can have other adverse income tax consequences:

◆ The higher your income, the greater the portion of your Social Security benefits

subject to income tax.

◆ Beginning in 2013, a 3.8 percent tax on investment income will apply to married

couples with income above $250,000 and singles with income over $200,000.

Taxable retirement distributions may push you over these thresholds.

➤ For those on Medicare, the monthly premiums for some benefits are higher, depending

on the person’s income. Roth distributions are not counted as income for purposes of the

taxation of Social Security benefits, the 3.8 percent tax on investment income or

Medicare premium determinations.

You can transfer funds from your traditional retirement account to a Roth account, but you

must pay tax on the rollover amount. However, you cannot go the other way: Funds in a

Roth account may not be transferred to a traditional account.

tax planning tip of the week

what’s new from the courts

Nice gift if you can get itIn a recent case, the Tax Court allowed a gift tax annual exclusion for gifts of

interests in a family limited partnership.

The gift tax annual exclusion is available only for gifts of present interest, not for

gifts of future interest. A present interest is an unrestricted right to immediate use,

possession or enjoyment of property or the income from property.

With many family limited partnerships (FLPs), including the FLP in this case,

restrictions are imposed on the ability of a partner to transfer an interest in the

partnership (Estate of George Wimmer et al. v. Commissioner, TC Memo

2012-157, June 4, 2012). In the Wimmer case, partners could transfer

partnership interests to existing partners or their relatives.

However, before an interest could be transferred to an outsider, the other

partners had to approve the transfer. Since the donees did not have an

unrestricted right to transfer their partnership interest to others, the court

determined that the gifts of partnership interests were not gifts of a present

interest in the equity of the FLP.

The court then went on to determine whether partners who received the gifts

had a present interest in the income from the partnership. The court determined

that a present right to income exists if:

1. The FLP will generate income;

2. Some portion of that income would flow steadily to the recipients of the gifts;

and

3. That portion of the income could be readily ascertained.

Since the FLP assets consisted of publicly traded, dividend-paying stocks, the

court determined that the first test was met. With respect to the second test, the

court concluded that the general partner had a fiduciary responsibility to

distribute income to the limited partners and, in fact, made such distributions.

Finally, the third test was met because the partners could estimate their share of

the income by looking at the dividend history of the securities held

by the FLP.

Not all gifts of interest in FLPs will qualify for the gift tax annual

exclusion, which is currently $13,000 per year per donee, or

recipient. But this case demonstrates one set of circumstances in

which the gift tax annual exclusion was available.

it bears repeating

The Tax Court sympathizes – but rules are rulesIn a case that trounces any semblance of fairness, the Tax Court has

denied more than $4 million in charitable contribution deductions

claimed by a couple who had

undervalued the contribution.

Joseph Mohamed is a real estate broker,

a certified real estate appraiser and a

successful entrepreneur. In 1998, he and

his wife Shirley formed a charitable

remainder unitrust, or CRUT.

A CRUT is a special kind of trust that

allows someone to claim an immediate

deduction for a portion of the value of

property transferred to the trust. The

income from the trust goes to the donor for

life or for a term not to exceed 20 years,

with the remainder going to charity.

The Mohameds contributed a number of

real estate properties to the trust. Joseph

prepared his own tax returns and listed

the gross value of the properties at about $18.5 million and the

charities’ share at more than $4 million.

After their returns were examined by the IRS, the Mohameds hired

appraisers, who valued the properties at more than $20 million.

The problem was that no appraisal was attached to the original

returns filed by the Mohameds.

Although Joseph was a certified real estate appraiser, he was not a

“qualified appraiser” as defined by the IRS. A qualified appraiser

cannot be the donor or the donee. As a result, the court somewhat

reluctantly concluded that the Mohameds did not comply with the

Treasury Regulations governing charitable contribution deductions.

The court stated:

We recognize that this result is harsh – a complete denial of

charitable deductions to a couple that did not overvalue, and

may well have undervalued, their contributions – all reported

on forms that even to the Court’s eyes seemed likely to mislead

someone who didn’t read the instructions. But the problems of

misvalued property are so great that Congress was quite

specific about what the charitably inclined have to do to

defend their deductions, and we cannot in a single

sympathetic case undermine those rules.

The moral of this story: Joseph should not have tried to prepare his

own return (Joseph Mohamed, Sr., et ux. v. Commissioner, TC Memo

2012-152, May 29, 2012).

it bears repeating

tax laughs

What’s next? Gargle, spit and pay the rinse tax?Your parents always told you there is no such thing as a free lunch. In Vermont,

the tax collectors apparently decided there was no such thing as a free

toothbrush either.

As reported by WPTZ News in Burlington, Vt., the state legislature had to rein

in aggressive tax collectors who decided that dentists should be charging

Vermont sales tax on the toothbrushes they gave to their patients at the end of

an office visit.

Undoubtedly, the tax collectors reasoned that the toothbrushes were not “free.”

Rather the cost of the brush was built into the dentist’s pricing arrangement.

And if people had to pay sales tax on toothbrushes they bought at a store,

they should also pay tax on similar items “bought” from their dentist.

Apparently, the Vermont legislators thought this tactic was

going a bit too far. So they reacted by placing a moratorium

on this practice – as well as the tax collectors’ efforts to

collect sales tax on meals served at senior citizen homes.

“Treat your password like your toothbrush. Don’t let anybody else use it,

and get a new one every six months.”

– Clifford Stoll, Ph.D., U.S. astronomer and author

Courts

Tax

IRS

Congress

The technical information in this newsletter is necessarily brief. No

final conclusion on these topics should be drawn without further

review and consultation. Please be advised that, based on current

IRS rules and standards, the information contained herein is not

intended to be used, nor can it be used, for the avoidance of any

tax penalty assessed by the IRS.

© 2012 CPAmerica International