Washington News

On December 23, President Obama signed the Temporary Payroll Tax Cut Continuation Act of 2011 (H.R. 3765). This two-month payroll tax cut bill will reduce Social Security contributions by employees from 6.2% to 4.2% during January and February of 2012. The employer contribution amount remains 6.2%.

President Obama was pleased with the bill and noted, "Anyone who knows what it's like to stretch a budget knows that at the end of the week or the end of the month, $40 can make all the difference in the world." He was referring to the estimate that the average worker will receive an increase in his or her paycheck of $40 with the reduced payroll tax.

Majority Leader Harry Reid (D-NV) also supported the bill. He stated, "I would hope the new members of the House understand legislation is the art of compromise, consensus building." Reid and Speaker of the House John Boehner (R-OH) had engaged in a fairly contentious contest prior to passage of the two-month extension.

Both leaders have appointed a committee to negotiate a potential full year payroll tax cut. Sen. Reid has named Senate Finance Committee Chair Max Baucus (D-MT), Sen. Benjamin Cardin (D-MD), Sen. Jack Reed (D-RI) and Sen. Robert Casey Jr. (D-PA) to the committee. The House Democrats include Ways and Means Committee Ranking Minority Member Sander Levin (D-MI), Rep. Xavier Becerra (D-CA), Rep. Chris Van Hollen (D-MD), Rep. Allyson Schwartz (D-PA) and Rep. Henry Waxman (D-CA).

Speaker Boehner named Ways and Means Chair Dave Camp (R-MI), Rep. Kevin Brady (R-TX), Rep. Tom Price (R-GA), Rep. Tom Reed (R-NY), Rep. Renee Ellmers (R-NC), Rep. Nan Hayworth (R-NY), Rep. Fred Upton (R-MI) and Rep. Greg Waldon (R-OR).

The Democratic members of the committee continue to believe that a surtax on incomes in excess of $1 million is the proper method to pay for the payroll tax cut. Reid stated that he thinks the surtax is appropriate because he has, "talked to Senate Republicans who think there should be a fair tax on rich people."

The Republican members have proposed reforms in the administration of the unemployment benefits and a one year pay freeze for federal employees. Meetings of the joint committee will start in early January.

Payroll Tax Cut "Recapture" Plan

The Temporary Payroll Tax Cut Continuation Act of 2011 will reduce the contributions of all employees to Social Security by 2%. However, part of the bill creates a new "recapture" tax for upper-income taxpayers.

Taxpayers pay the 4.2% (January and February) or 6.2% (balance of 2012) employee contribution on income up to $110,100 for 2012. The Social Security contributions are not levied on incomes above that level.

Under the payroll tax bill, a taxpayer with income over $18,350 for the two months will pay a 2% additional income tax on his or her excess earnings.

If this provision is extended for the full year, the upper-income person will pay 4.2% payroll tax on income up to $110,100. However, on the income from $110,100 to $220,200, the person would pay an added 2% income tax.

The 2% savings could amount to $2,202 on the first $110,100 of income. Assuming that the "recapture" provision is applicable for the full year, the added tax of 2% on the amount in excess of $110,100 will eventually amount to $2,202. In effect, individuals with incomes over $220,200 will pay the full 6.2% of employee contribution for Social Security. There will be no deductions or credits against the additional 2% income tax.

Recreation Nonprofit is Tax Exempt

In TAM 201151028 landowners on an island that is partially public and partly private created a private foundation to build a recreation path on the island. The nonprofit applied for exempt status and the IRS granted a favorable determination with its initial application.

There is one principal road on the island that is used by automobiles, pedestrians, joggers and bicyclists. Because of the narrowness of the road, the automobiles present a hazard to the other users. The island residents created a foundation for the purpose of building and maintaining a recreation path that would be available to walkers, joggers and bicyclists.

All island residents and guests are permitted to use the path. Part of the island is public and it includes a grocery store, restaurant and deli. Much of the land is private and owned by individuals who maintain summer homes on their property.

The path extends from the entry point of the public road to the golf course. It enters the gated private section of the island. Users of the path must stop at a guard house to show that they are residents or guests of residents.

After review of the circumstances, an IRS examiner determined that the foundation did not qualify for exempt status and requested a technical advisory memorandum from Treasury.

A recreation service may be exempt if it operates "exclusively for one or more exempt purposes" and serves primarily the public rather than a private interest. Reg. 1.501 (c)(3)-1(d)(1)(ii).

The ruling lists several potential examples of recreation facilities that met that standard and some that did not. For example, a public swimming facility maintained for 1,000 residents of Cold Spring Harbor School District #8 was deemed acceptable. However, a foundation formed to dredge a waterway that benefited 14 of the 22 owners of the property bordering the waterway was held not qualified. The benefit accrued primarily to the adjacent land holders rather than to the general public.

In Rev. Rul. 70-186, 1970-1 C.B. 129, an organization created by the landowners surrounding a lake was deemed exempt. Its primary purpose was to preserve the lake as a public recreational facility. The public benefit was deemed to be the primary purpose and there was incidental benefit to adjacent landholders.

Similarly, where recreation facilities have a primary benefit of assisting the general public and the group enjoying the facilities is sufficiently large, exemption is permitted.

In the case of the recreation foundation building a path on the island, both the residents of the private area of the island and members from the adjacent village are permitted use of the path. There is no clear economic benefit to residence of the private area of the island. At a public hearing, some of the residents expressed strong concerns that the path might actually lead to a reduction in property value.

Because the number of residents in the private section and in the adjacent community is a sufficiently large group and there is access for all members of that group and their guests, there is a benefit to the entire community. With this benefit to a sufficiently large community and no evidence of specific enhancement of property values for the residents, the private foundation qualifies for exemption.

Editor's Note: This TAM is a good analysis of public versus private benefit. While the phrase "exclusively public" requires a reasonably large class, there may be some incidental private benefits. The 1,000 members of the class that was acceptable is a quite useful planning guide for counsel. If the class that is benefited can be this great or larger and there is no measurable or substantial private benefit to adjacent landowners, a nonprofit should qualify for exemption.

Applicable Federal Rate of 1.4% for January – Rev. Rul. 2012-2; 2012-3 IRB 1 (19 Dec. 2011)

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