Washington News

Members of both parties have introduced bills in the House and Senate that would avoid a scheduled increase in the interest rate on student loans. If there is no action by Congress, the interest on Stafford student loans is scheduled to increase from 3.4% to 6.8% on July 1, 2012.

Leaders of both parties and President Obama have indicated a willingness to pass legislation to avoid that dramatic increase in interest rates. While there is bipartisan support for maintaining the reduced 3.4% rate for one year, there are different opinions on the best methods to pay for the cost. A one year extension of the lower rate is estimated to cost $5.9 billion.

Senate Majority Leader Harry Reid (D-NV) introduced the Stop the Student Interest Rate Hike Act of 2012 (S. 2343). This bill extends the 3.4% rate for one year. It pays for the $5.9 billion cost through a change in the law on Subchapter S corporations.

For Subchapter S corporations with one to three employees who have incomes over $250,000 per year ($200,000 for single persons), they would no longer be able to pass through income directly from the Subchapter S corporation. Rather, the income would be reported personally and owners would pay Social Security and Medicare taxes on that income.

Rep. Judy Biggert (R-IL) introduced in the House the Interest Rate Reduction Act (H.R. 4628). It also extends the 3.4% interest rate for one year, but reduces funds in the Prevention and Public Health Fund to pay the $5.9 billion cost.

It is anticipated both the Senate and the House will vote on bills to extend the 3.4% interest rate within the next few weeks.

Editor's Note: Your editor and this organization do not take a position on the best method for payment for the bill. The good news for individuals with student loans is that both parties now support the lower interest rate extension. In the negotiation over offsets, the parties are far apart. Given the political differences and the fact that this is an election year, the bill may be passed without any offsets.

Federal Taxes and the State Budget Crunch

On April 25, 2012, the Senate Finance Committee held a hearing to discuss tax reforms at the federal level that impact state governments.

Chair Max Baucus (D-MT) opened the hearing by acknowledging that the state governments were facing budget problems and seeking federal assistance. He stated, "Most state governments are in tough financial shape. In 2010, 48 states had budget shortfalls. All states except one are required by state law to balance their budgets. That has forced states to make tough decisions, such as raising taxes or cutting spending. Since the financial crisis, 46 states have cut services and 30 states have raised taxes."

Sen. Baucus notes that the federal government provides substantial assistance to the states from stimulus funds. In addition, he indicated that 36% of total state revenue is transferred through various grants from the federal government.

Baucus also observed that the states benefit through the federal tax exemption on state and local bonds. In addition, many state and local taxes are deductible on IRS Form 1040. The total benefit to states from these tax savings is $105 billion per year.

Ranking Member of the Senate Finance Committee, Sen. Orrin Hatch (R-UT), stated, "Federal discussions about state finances frequently highlight budgetary pressures that have required cuts in spending. These are no doubt difficult issues for states, but it simply is not the responsibility of the federal government to address state budget shortfalls."

In the view of Sen. Hatch, state governments are collecting more taxes. He noted that the 2011 state tax revenues were 8% higher than those in 2010. With the tax savings granted to the states through income tax deductions and the federal grants to states, Hatch suggests that "state officials need to take responsibility for their own spending decisions."

FLP Assets Included in Estate

In Estate of Lois L. Lockett et al. v. Commissioner; T.C. Memo. 2012-123; Nos. 8922-09, 8940-09 (24 Apr 2012), the Tax Court held that assets in a family limited partnership were included at fair market value in the taxable estate.

The decedent Lois Lockett was born May 2, 1912 to a pioneer family from Arizona. Her parents had transferred business interests to her. From 1976 to 2000, she made gifts of her interests in Lakin Cattle Co. and Lakin Milling Co. to her children and their spouses.

The decedent had married Robert W. Lockett, Sr. and he predeceased her. Their heirs included sons Robert and Joseph and five grandchildren.

On February 2, 2000, the decedent created a revocable living trust with herself and ex-daughter-in-law Mary Lockett as co-trustees. On March 13, 2000, her attorney filed Articles of Organization with the state of Arizona for Mariposa Monarch, LLLP (MMLLLP).

However, due to family discord and discussions, MMLLLP was not funded until 2002. On March 26, 2002, the MMLLLP was formally organized with Joseph and Robert each holding a 1% general partnership interest. Between May 6 and May 10 of that year, the decedent transferred $1,044,189 in cash and other assets to the MMLLLP.

After further family discussions, the decedent signed an amended certificate that effectively terminated MMLLLP on December 31, 2002. The amended certificate was filed with the state of Arizona on January 27, 2004. The decedent passed away on October 14, 2004.

There were several transfers to family members that were either loans or gifts. Son Joseph received a loan of $200,000 on May 21, 2004 and an additional $100,000 on August 16, 2004. The transfers were recorded with 10 year promissory notes bearing an interest rate of 5.85%. MMLLLP filed a claim July 28, 2008 against the estate of Joseph for $315,000 based upon the note. In addition, Joseph also received an added check for $20,000 on August 31, 2004.

Robert received a loan on a 10 year promissory note on May 2, 2002 for $200,000. He repaid $150,000 later that year. Robert subsequently borrowed an additional $80,000 on a similar note dated August 16, 2004.

Granddaughter Meredith received a check for $5,000 in 2004.

At her death, the decedent owned $1,109,102 in personal assets. MMLLLP held assets valued at $1,106,841. The estate claimed discounts for marketability and reported the value of MMLLLP as $667,000.

The IRS took two alternative and inconsistent positions. It claimed that there either were taxable gifts in the amount of the notes and a gift tax deficiency was applicable. Alternatively, the notes were valid and includible in the estate at full fair market value and there was a $706,110 estate deficiency.

The court noted that the first issue is the existence of gifts or loans. The transfers to Joseph of $315,000 were measured against the facts and circumstances test for a loan. If there is a note, interest is charged, there is security, there is a fixed maturity, the lender makes demands for payment, there is actual repayment, the borrower has ability to repay and there are appropriate records, then a loan exists. In this case, the $315,000 amount was documented with a promissory note and the MMLLLP accountant recorded it as a loan. There was a demand by Mariposa against the estate of Joseph for the $315,000. Therefore, this was a valid loan. However, the $20,000 transfer was not similarly documented and therefore deemed a gift.

Similarly, the $135,000 amount transferred to Robert and Karen was documented with a promissory note. It was reported on IRS Form 706 as an asset of the estate and therefore also a loan.

Finally, the $5,000 payment granddaughter Meredith received was not documented in any manner. It therefore constitutes a gift.

The final issue was the claimed discount for MMLLLP. While Robert and Joseph each received a 1% general partnership interest, they performed minimal services for the partnership and there was no other evidence of ownership. All of the income was reported by the decedent prior to her demise. There is no demonstrated evidence of intent on the part of the decedent to make gifts to her two sons of partnership interest.

Finally, the document filed with Arizona indicated that as of December 31, 2002, the partnership had been dissolved and that all of the assets were the individual property of decedent. Therefore, the estate must pay the deficiency based on the fair market values of the assets.

Applicable Federal Rate of 1.6% for May -- Rev. Rul. 2012-13; 2012-19 IRB 1 (16 Apr. 2012)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2012. The AFR under Sec. 7520 for the month of May will be 1.6%. The rates for April of 1.4% or March of 1.4% 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.