Posts Tagged ‘deduction’

This week’s blogger is Raymond G. Russolillo, CPA, tax partner and leader of Withum’s Family Office service niche.

In an earlier post we described an interesting charitable technique known as thRaymond Russolilloe “conservation easement.”  In a nutshell, this technique allows you to swap some (permanent) flexibility with respect to your property for a healthy charitable deduction.  It is designed to encourage taxpayers to preserve open space for conservation or recreation purposes and to protect certain historic structures.   I encourage you to read the prior post for more details.  We think it is a great technique because, as we said then and still maintain now, it is the very essence of having your cake and eating it, too.

But, as in all things tax, you have to make sure you dot your I’s and cross your T’s.  A recently decided Tax Court case (David R. Gemplerle, et ux. v. Commissioner, TC Memo 2016-1) underscores the tax truism that form prevails over substance, especially in cases like this.

The Gemperle’s owned and lived in an historic home.  In 2007, they granted a facade easement on the property to the Landmarks Preservation Council of Illinois.  The Council guided them through the process, including the hiring of an appraiser who subsequently determined the value of the easement to be $108,000 which the taxpayers then claimed on their 2007 tax return.  On later examination, the IRS disallowed the deduction for the simple reason that the taxpayers did not attach a copy of the appraisal to the return as filed nor did they fully complete Form 8283, Noncash Charitable Contributions.  The Tax Court agreed with the IRS position, basically eliminating the deduction and, on top of it all, assessing  a 20% accuracy related penalty and a 40% valuation penalty.

In court, the IRS argued five points:  (1) the absence of a “qualified” appraisal; (2) the existence of some technical deficiencies with respect to the facade easement itself; (3) the failure of the taxpayers to include a copy of the appraisal with the return; (4) the failure of the taxpayers to attach an appraisal summary as required by regulations and; (5) the ultimate failure of the taxpayers to prove that the decrease in value was indeed $108,000.  The Tax Court stripped the issue down to its simplest and harshest essence – they threw out the taxpayer’s case because of the taxpayers’ failure to attach a copy of the appraisal to the tax return.  Because they were relying on this simple test of fact (was an appraisal attached? – No) they did not even need to consider any of the IRS’ other points.

We can argue this heavy handed decision on the part of the Court, but the moral of the story should be clear to taxpayers and practitioners alike – if the rules say to attach certain documentation to a return, do it!  Particularly in the area of valuation, form will often beat out substance.

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I’m on kind of a “Pease limitation” kick this week.  In my earlier blog post I railed about the limitation which basically scales back the itemized deductions of high income taxpayers by 3% of any excess adjusted gross income (AGI) over certain levels.  Essentially, once you reach the magic AGI number ($250,000 for singles, $300,000 for married filing jointly), your itemized deductions, including the deduction for charitable contributions, are dialed back by 3% of the excess income over that threshold amount.  (Example – a single individual with $375,000 of AGI would lose up to $3,750 of itemized deductions:  $375,000 – $250,000 = $125,000 x 3% = $3,750).  This limitation has an effective overall limitation to it – you cannot lose more than 80% of your total deductions.


I know what some of you are thinking – why should I feel sorry for the fat cats?  But I am not asking you to feel sorry for these folks – I am asking you to consider fairness and transparency in our tax system, both of which are in seriously short supply these days up and down the spectrum of the tax law.


The “Pease limitation” is a perfect example.  Through the careful use of smoke and mirrors, it can effectively add up to 1.2% to the ordinary tax rate.  Think of it this way – a top bracket taxpayer who is subject to the “Pease limitation” earns an additional $1,000.  His itemized deductions will be reduced by 3% of that $1,000, or $30.  This reduction in deductions is essentially an increase in income – his increase in overall taxable income will be $1,030.  Multiply that additional taxable income by 39.6% to get the additional tax of $408.  $408 divided by $1,000 is equal to 40.8%, which is 1.2% higher than the stated top rate of 39.6%.


But wait, there’s more!….

  • Combine this haircut along with the Obamacare tax on “excess” earnings of .9% and the top rate is further increased to 41.7% for earned income.  In our example, the marginal tax would be $417 instead of $408;
  • If the marginally generated income is actually net investment income rather than earnings, the situation is worse – the top tax rate on investment income rises to 44.6%, or $446 in our example;
  • And we haven’t even touched the phaseout of personal exemptions or the alternative minimum tax (AMT) yet!


So I guess that’s it – Phil Mickelson’s possible decision to stop making millions playing golf seems rational under these circumstances, correct?  If you’re gonna take what I earn, I may as well not earn it.  Well, I think that’s a bit extreme.  Let’s put it into some perspective.


The “Pease limitation” comes into play ONLY with INCREASES IN INCOME.  It has nothing to do with increases in deductions.  So the argument that charitable contributions will suffer because of the limitation itself is misguided.  Think of it this way – if income is held constant, each and every dollar of allowable charitable contribution will reduce taxable income by one dollar.  If my income is $X and I am in the 39.6% tax bracket and I decide to make a $10,000 to the Human Fund on December 31, 2013, I will save $3,960 in federal income tax.  Period.  Assuming that my charitable contributions are not constrained by the income limitation rules that have long existed for these deductions, I don’t lose ANY value of the additional deduction because of an increase in deductions.  However, if my income increases, I absolutely will lose the benefit of some of my deductions because of the “Pease limitation.”  The decision to increase or decrease charitable contributions or any other deductible expenses can and should be made independently of the decision to increase or decrease taxable income.


The bottom line is that additional deductions will always do you some good in saving taxes while additional income may end up being taxed at a rate higher than you would like.  Decisions about one versus the other should be made independently of one another.

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