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Monday September 1, 2014

Washington News

Washington Hotline

Whopper of an Inversion

Burger King, Inc. announced this week that it would acquire the Canadian restaurant chain Tim Hortons, Inc. Following the acquisition, Burger King will move its corporate headquarters to Ontario. The “inversion” will save an estimated $8 million per year in U.S. corporate taxes.

Burger King’s lead product is the Whopper. This oversized hamburger with a quarter pound patty has been very popular. Burger King now has more than 11 million customers per day and over 13,000 restaurants in 95 countries.

Burger King shareholders will receive 0.99 share of the new company and 0.01 share of a Canadian partnership for each share of common stock. Generally, shareholders may choose to receive partnership units rather than stock shares in the new company.

Alex Behring is Executive Chair of Burger King. He commented on the inversion, "While I know there has been a great deal of discussion in the media about the motivations for the transaction, I want to point out that it is a strategic transaction that is creating a new global leader in the sector and is not being driven by tax rates. We will continue to pay federal, state, and local taxes in the United States."

Congress is considering two bills to limit inversions. The Stop Corporate Inversions Act of 2014 (H.R. 4679) and No Federal Contracts for Corporate Deserters Act of 2014 (H.R. 5278) include a 50% limit for U.S. ownership after an inversion. However, both bills permit an exception for "substantial business activity" in a foreign country. Under that standard, the Burger King inversion might still qualify.

Sen. Dick Durbin (D-IL) opposed the inversion. He noted, “With every new corporate inversion, the tax burden increases on the rest of us to pay what these corporations don’t. That burden is made worse when these corporations profit off of all the public benefits that help American companies succeed and then run from their U.S. tax responsibility. I'm disappointed in Burger King's decision to renounce their American citizenship. I call on companies currently mulling this tax dodge to reconsider, and on Congress to protect U.S. taxpayers from more of these schemes.”

Congressional Budget Office Director Douglas Elmendorf also expressed concern. He stated, “Our projections of corporate tax receipts over the coming decade do incorporate some erosion of the corporate tax base through a variety of tax reduction strategies. One factor there would be corporate inversions."

Remainder Gift Valuation Contest


In RERI Holdings I LLC et al. v. Commissioner; 143 T.C. No. 3; No. 9324-08 (11 Aug 2014), the Tax Court denied partial summary judgment to the IRS. The Service claimed that a charitable remainder interest did not include a qualified appraisal, there was substantial overvaluation, the interest was owned by an LLC that may not be disregarded and the wrong property was appraised.

This was the second action with respect to a gift by RERI of a successor member interest (SMI) in a property held by an LLC. RERI had created an 18 year term lease with AT&T on property in Hawthorne, California. The remainder interest in the property, described as a successor member interest, was transferred to a second LLC. That LLC transferred the SMI to a university.

Appraiser Howard C. Gelbtuch determined that the value of the property was $55 million and, under the Sec. 7520 tables, the remainder interest had a value of $32,935,000. The claimed total charitable deduction by the partnership was $33,019,000. The IRS determined that the charitable deduction was overvalued by approximately $29 million and issued a final partnership administrative adjustment (FPAA).

The Tax Court noted that the transfer was completed on August 27, 2003. On December 23, 2005, in accordance with its agreement to hold the property for two years, the charitable organization sold the SMI to an affiliate of the donor for $1,940,000. The SMI was immediately transferred by the affiliate to a third party for $3 million. On December 26, 2005, the SMI was gifted to another charitable organization and a deduction was determined by appraiser Gelbtuch on the second gift to be $29,930,000.

The court noted that Reg 1.7520-3(b)(2)(iii) permitted deductions for a remainder interest provided that there was “an undiminished interest in the property transferred at the time of the termination of the prior interest.”

The IRS noted that Gelbtuch had appraised the Hawthorne property, but had disregarded the ownership of the property by an LLC. The IRS claimed that the transfer was of the LLC and the valuation should be for that interest, not for the underlying property.

The court noted that the two subsequent sales of the LLC interest were at 5% to 9% of the claimed values. In addition, the use of the Section 7520 tables is contingent upon there being appropriate property interests and the Gelbtuch appraisal did not determine whether or not the existence of the LLC or the two year no-sale agreement were valuation factors. The court noted that use of the Sec. 7520 tables is not permitted if there is “an unrealistic and unreasonable fair market value standard.”

Because there was a genuine issue as to the applicability of the Section 7520 tables, the IRS motion for partial summary judgment was denied.

Façade Easement Effective When Recorded


In Marco Zarlengo et al. v. Commissioner; T.C. Memo. 2014-161; Nos. 3701-10, 26747-10 (11 Aug 2014), the Tax Court held that a New York City façade easement gift was not effective until recorded.

In 1975, Dr. Marco Zarlengo and Merilyn Sandin-Zarlengo purchased a four story townhouse on the upper west side of Manhattan for $150,000. They completed a substantial renovation of the property, but retained its existing character because it was designated in a historic district by the New York City Landmarks Preservation Commission (LPC).

Dr. and Mrs. Zarlengo divorced in 1999, but both held interest in the townhome. It was listed for sale in 2003 but did not actually sell until 2007.

In 2004, the Zarlengos entered into discussions with the National Architectural Trust (NAT). They determined that it would be appropriate to transfer a façade conservation easement to NAT. Appraiser Jerome Haims valued the property. He completed an appraisal effective as of July 26, 2004 and valued the property at $6 million. He opined that a conservation easement would reduce the value by 11%, and therefore had a value of $660,000.

On September 10, 2004 the Zarlengos signed a conservation deed and transferred it to NAT. On September 22, 2004, the deed was signed on behalf of NAT. However, it was not recorded until January 26, 2005. The Zarlengos both reported charitable gift contributions of $330,000 on their respective 2004 tax returns. The home was sold in 2007 for $4,650,500. When the purchasers discovered that there was a conservation easement, they continued to complete the acquisition of the home at the specified price.

The IRS audited the respective returns of the Zarlengos and issued a deficiency with interest in penalties for Dr. Zarlengo for 2004. They issued deficiencies for Ms. Sandin-Zarlengo for years 2005 through 2007.

The Tax Court noted that under Sec. 170(h)(2), a conservation easement qualifies for a charitable deduction if it is granted in perpetuity. However, under New York law, there is no enforceable conservation easement until the deed is recorded. The taxpayer noted that delivery had occurred in September and that for federal law purposes delivery was sufficient. However, because the federal law required the easement to be granted in perpetuity and that was not effective under New York law until the deed was recorded, the deduction was not permitted for 2004 and instead qualified for 2005.

The IRS noted that the effective date of the July 26, 2004 appraisal was more than 60 days prior to the January 26, 2005 recordation of the deed. However, the court determined that because the nonprofit had been in control of that process, there was substantial compliance with the appraisal requirements.

Finally, the court reviewed the “before and after” valuation. The taxpayer’s appraiser Haims inflated the before value and used a simplistic 11% reduction formula to value the conservation easement. IRS Appraiser Timothy Barnes produced an unrealistically low value and claimed that the conservation easement produced zero reduction in actual fair market value. Based on the data from both appraisers, the court determined a 3.5% reduction in value, producing a qualified deduction in 2005 of $157,500. Both Zarlengos were qualified to deduct one-half of this amount.

Ms. Sandin-Zarlengo was permitted a good faith defense to penalties for the 2005 gift. However, following passage of the Pension Protection Act of 1996, the claimed deduction by Ms. Sandin-Zarlengo was a gross valuation misstatement and the good faith defense was not applicable. Therefore, she was subject to the Sec. 6664(c) penalty for 2006 and 2007.

Applicable Federal Rate of 2.2% for September -- Rev. Rul. 2014-22: 2014-36 IRB 1 (19 Aug 2014)


The IRS has announced the Applicable Federal Rate (AFR) for September of 2014. The AFR under Section 7520 for the month of September will be 2.2%. The rates for August of 2.2% or July of 2.2% 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 2014, pooled income funds in existence less than three tax years must use a 1.4% deemed rate of return. Federal rates are available by clicking here.

Published August 29, 2014

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