Wednesday December 6, 2023
Prepare For Hurricane Season
On August 4, the NOAA published guidance on the 2022 outlook. It estimates there will be 14 to 20 tropical storms with wind speeds of 39 mph or greater, 6 to 10 hurricanes with winds reaching 74 mph or greater and 3 to 5 major hurricanes with wind speeds of 111 miles per hour or more.
With the substantial risk of hurricanes in the southeastern region and the possibility of tornadoes, fires, earthquakes and other natural disasters throughout the nation, it is important for all Americans to take reasonable steps to be prepared. These steps could include securing and duplicating essential documents, creating lists of collections and other valuable property and understanding how to find assistance. By planning ahead, taxpayers will be better able to recover financially from a natural disaster.
1. Secure Documents – Taxpayers should keep important documents in waterproof containers and in a secure location. The important items include tax returns, birth certificates, deeds to homes and other property, insurance policies and similar documents. Some individuals choose to have a copy of these documents held by a relative or friend in a different state.
2. Copies of Documents – Some documents are available only on paper but should be converted to a digital file format. Once items are digitized, using commercial cloud–based storage systems can be helpful and will provide additional security.
3. Inventory of Valuables – Taxpayers should have a detailed inventory of valuable property. Take photos or videos of collections, art, jewelry or other valuable items. It is also helpful to have a general description of property, which may include the make and model numbers of some items. Keeping detailed documentation of possessions may be helpful when filing claims for insurance purposes or tax benefits.
4. How to Get Help – If a natural disaster strikes, it is important to understand how to obtain assistance. Contact insurance agents to report any losses. Some financial institutions are able to provide statements and electronic documents that may assist in rebuilding financial affairs. The IRS.gov site has a helpful page with the title "Reconstructing Records."
5. IRS Assistance – After every federal disaster declaration, the IRS provides assistance. The IRS Tax Relief in Disaster Situations webpage on IRS.gov may be helpful. In many cases, the IRS allows a delayed filing or tax payment date. The date will be specific by geographic area, which can be found on IRS.gov. There also is an IRS disaster hotline at (866) 562-5227.
6. Disaster Loss Deduction – If a substantial loss occurs, taxpayers may qualify for a disaster loss deduction. The uninsured or unreimbursed disaster loss may be deductible under the rules set forth in IRS Publication 547, Casualties, Disasters and Thefts.
Ken Graham, Director of the National Weather Service, urged everyone to be ready for the fall hurricane season. He stated, "Communities and families should prepare now for the remainder of what is still expected to be an active hurricane season. Ensure that you are ready to take action if a hurricane threatens your area by developing an evacuation plan and gathering hurricane supplies now, before a storm is bearing down on your community."
Easement Deduction Valuation Contest
In Glade Creek Partners LLC et al. v. Commissioner; No. 21-11251 (11th Cir. 2022), the Eleventh Circuit vacated a Tax Court decision that disallowed a partnership deduction. The extinguishment provision in the deed was disregarded, but the Eleventh Circuit determined that the Tax Court valuation was proper and applied a substantial valuation misstatement penalty.
International Land Co. purchased approximately 2000 acres of land in Tennessee for more than $9 million in 2006. They sold a portion of the property to Hawks Bluff Investment Group, Inc. The property was then sold to Glade Creek Partners, LLC. After the syndication, the plan was to sell a parcel to Sequatchie Holdings, LLC and grant a conservation easement.
The syndication was designed to raise $17.7 million to offset the Hawks Bluff debt. Following the syndication, Glade Creek donated a conservation easement to Atlantic Coast Conservancy, Inc.
The deed to the Conservancy stated that the extinguishment proceeds would be calculated using the easement's fair market value at time of sale "minus any increase in value" that was "attributable to improvements" made after the date of the easement deed. Glade Creek reported a $17,504,000 charitable deduction. The IRS denied that deduction and assessed a penalty for misstating the value of the easement. The Tax Court determined that the Glade Creek evaluation substantially overstated the "before" value and a penalty applied.
Glade Creek challenged both the claim that the deed was improper and the substantial overvaluation penalty. In Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), the Eleventh Circuit determined that Reg. 1.1740A-14(g)(6)(ii) violated the Administrative Procedure Act (APA) procedural requirements and was invalid. Therefore, the defect in the deed was not determinative.
However, the Tax Court reviewed the valuation by appraiser Claud Clark III. Clark estimated the highest and best use value as $17,314,049. The Clark appraisal "deviated from industry practice by including profit as a line-item and expense" rather than using a discount rate. Clark valued the theoretical developer's profit as a separate 15% expense and then applied an 11.25% discount rate, rather than using an overall 26.25% discount rate.
Because the Clark appraisal did not follow industry practice, the Tax Court calculated the before value using the 26.25% discount rate and determined that the easement value was $8,876,771 and not the reported $17,504,000. Therefore, the easement had been overvalued by more than 150%, and the substantial valuation misstatement penalty applied. The Tax Court also determined that Glade Creek did not qualify for the "reasonable cause" exception because they had not made a good faith investigation of the property value. See Section 6664(b)(3).
Glade Creek argued the Tax Court created a new appraisal method and the Tax Court also did not rely on the IRS appraiser. However, the Eleventh Circuit noted the Tax Court had the right to determine the valuation according to appropriate appraisal standards and principles.
In addition, because the valuation was not based on a market analysis but was designed to raise the required amount of money to pay the existing debt, Glade Creek did not show that it had made a good faith investigation into the property's value. Therefore, the reasonable cause exception failed and the penalty was affirmed.
Editor's Note: The IRS has previously been successful asserting the defect in the deed extinguishment provision, leading to a denial of the charitable easement deduction. After Hewitt in the Eleventh Circuit, the IRS now must proceed to determine the actual value under appropriate appraisal standards.
Early Distribution a Tax, Not a Penalty
In Kirgizia I. Grajales v. Commissioner; No. 21-1420 (2nd Cir. 2022), the taxpayer had taken an early distribution from a retirement plan and was assessed a 10% tax under Section 72(t). The taxpayer claimed that this was an addition to tax under Section 6751(c) and required written IRS supervisory approval. The Second Circuit sustained the Tax Court decision that the 10% payment was an additional tax rather than a penalty that required supervisory approval.
The taxpayer was an employee of the State of New York and borrowed from her pension account at age 42. She received IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The distribution was reported as $9,026, and the IRS assessed a deficiency of $3,030 and an additional tax of $902. At Tax Court, the parties stipulated that the taxable portion of the distribution was $908.62, and the additional liability was $90.86.
The Tax Court considered the taxpayer's argument that a 10% added Section 72(t) payment should be considered an "additional amount" under Section 6751(c). If this were the case, then the additional payment would require supervisory approval.
The Second Circuit noted that Section 72(t) and Section 6751(b) are listed as "Additions to the Tax." The plain language of Section 72(t) is that the income tax shall be "increased by an amount equal to 10% of the portion of such amount which is includable in gross income." This is express language that the tax is merely increased by the 10%, and is not a penalty.
A tax is an exaction to support the government. Therefore, the Section 72(t) exaction is a tax and not a penalty. It does not require IRS supervisory approval.
Applicable Federal Rate of 3.6% for September -- Rev. Rul. 2022-17; 2022-36 IRB 1 (15 August 2022)
The IRS has announced the Applicable Federal Rate (AFR) for September of 2022. The AFR under Section 7520 for the month of September is 3.6%. The rates for August of 3.8% or July of 3.6% 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 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.