The Treasury Inspector General for Tax Administration (TIGTA) reported recently that there has been an increase in the growth of fake IRS websites. Criminals who are attempting to acquire taxpayer information are creating these sites. The rapidly growing number of fake IRS sites are frequently based overseas.

In 2006, the IRS identified 245 fake sites. This number grew to 14,000 sites in 2011. For 2012, the IRS expects to find over 20,000 sites.

TIGTA official Russell George stated to Congress on April 19, "While the amount of fraudulent tax refunds the IRS detects and prevents is substantial, the IRS does not know how many identity thieves are filing fictitious tax returns and how much revenue is being lost resulting from the issuance of fraudulent tax refunds."

The fake IRS sites are commonly used to contact U.S. taxpayers. If the operators of these sites can obtain your confidential information, they frequently will apply for tax refunds.

The principal strategy for identity thieves is to send out a false email or social media appeal. The "phishing" email includes links to the fake IRS site. It also may install "malware" or code on the identity theft victim's computer that will aid the thief in the future.

On www.irs.gov, there are specific guidelines for protecting yourself from these fake IRS sites.

1. IRS Contacts – Any official contact from the IRS will use a regular letter or phone call. The IRS does not contact taxpayers through email or social media. Any contacts you receive through email or social media should not be trusted.

2. Suspicious emails – If you receive an email claiming it is from the IRS, do not respond. Do not open any attachments. Do not click on any links to websites. Without opening the email, forward it to phishing@irs.gov. Then delete the suspicious email.

3. Suspicious Websites – If you are contacted and given a link to a suspicious website, do not click on the link or any attachments. Send the web address of that site to phishing@irs.gov.

4. Suspicious Phone Calls – If you receive a phone call from a person claiming to be from the IRS and you are concerned, ask that person for a callback number and his or her IRS employee badge number. Then call the IRS to confirm the identity of your caller.

If you would like further information, go to www.irs.gov. On the IRS website, use the search box at the upper right and type in "phishing." Click on the search button to view IRS web pages that provide further information.

HSA Limits Increase for 2013

In Rev. Proc. 2012-26; 2012-20 IRB 1 (27 Apr 2012), the IRS announced increased limits for health savings accounts for 2013.

Each year, a participant in HSA may make contributions from earned income. These contributions will reduce taxable income. The limit for 2013 for a self-only coverage policy is $3,250. For a family policy, the contribution may be up to $6,450.

An HSA must use a "high deductible health plan" to qualify. This plan must have a minimum deductible each year of $1,250 for self-only coverage or $2,500 for family coverage. The maximum out-of-pocket payment for self-only coverage is $6,250. For family coverage, the out-of-pocket limit is $12,500.

Estate Tax Paid on QTIP Remainder Gift Tax

In Estate of Anne W. Morgens et al. v. Commissioner; No. 10-73698 (3 May 2012), the 9th Circuit affirmed a Tax Court decision. The Tax Court ruled that a transfer of a QTIP trust remainder using a net gift method to heirs created a taxable gift. Because the transferor passed away within three years, the gift tax was includable in her estate and substantially increased the amount of estate tax.

Decedent Anne Morgens survived Howard Morgens who passed away in January of 2000. In October of 2000, his one-half of their community property was divided between a survivor's trust and a residual trust. The estate elected to qualify the residual trust under the qualified terminable interest property (QTIP) provisions. That trust was subsequently divided into QTIP Trust A with a value of $8.3 million and QTIP Trust B with a value of $28 million.

On December 8, 2000, the decedent relinquished her lifetime interest in QTIP Trust A. The gift tax of $2,287,309 was paid from the trust, leaving a net gift of $4,111,592 for the heirs.

On January 10, 2001, decedent Morgens relinquished her income interest in QTIP Trust B. The gift tax was $7,692,502, leaving a transfer to heirs on the net gift of $13,983,787.

Decedent Morgens passed away within three years of both transfers on August 25, 2002.

The estate did not include the approximately $10 million in gift tax under the Sec. 2035(b) "gross-up rule." The estate claimed that the tax had not been paid by the decedent under the net gift tax theory. The IRS disagreed and issued a deficiency.

The Court noted that Sec. 2035(b) requires gift tax payments within three years of death to be added back to the estate if they are "paid by the decedent." Even with a net gift transaction, the liability for the tax still remains with the decedent or his or her estate.

The estate claimed that Sec. 2207A mandates an obligation for the estate of surviving spouse to pay transfer taxes on the QTIP trust. In the view of the estate, this provision demonstrates congressional intent to shift the financial responsibility for QTIP trust gift taxes to the heirs and away from the income recipient.

However, the Court determined that "the trustees acted as a conduit of funds for Mrs. Morgens, who actually paid the gift tax for the purposes of Sec. 2035(b)." Therefore, the Sec. 2519 deemed transfers of the residual trusts created a gift tax that is included in her estate.

Editor's Note: With an increase in the estate of approximately $10 million for the payment of gift tax, the estate will be required to pay $3.5 million in additional estate tax. The gross-up rule creates an estate tax on the previously-paid gift tax amounts.

Façade Easement Charitable Deduction Denied

In Loren Dunlap et al. v. Commissioner; T.C. Memo. 2012-126; Nos. 28849-08 10393-09, 12168-09, 14860-09, 14865-09, 14866-09, 20138-09, (1 May 2012), the Tax Court determined that seven taxpayers did not qualify for charitable contribution deductions for gifts of conservation easements.

The seven taxpayers were all owners of units in the Cobblestone Loft Condominium (Cobblestone). It is a loft building in the Tribeca North Historic District of New York. There are 31 units and 14 parking spaces in the building. Andrews Building Corp. (ABC) is the building manager and a board of five owners manage the property.

ABC introduced a Sec. 501(c)(3) organization with the title NAT to the board in 2003. NAT has received over 500 conservation easements on buildings in New York City and expressed an interest in receiving and holding façade easements on Cobblestone. NAT suggested that an opinion letter be obtained from the law firm Herrick, Feinstein, LLP. Attorney Dennis Russo of that firm prepared an opinion letter dated December 31, 2003. However, a footnote in the letter referenced a document released in July of 2004.

On September 29, 2003, Cobblestone asked the National Park Service to certify the condominium as an historic structure. It was certified in December of 2003. On December 16, 2003, the Cobblestone board voted to execute a façade easement deed. The deed was accepted by NAT and delivered to the New York City Department of Finance Office of the City Register on December 29, 2003.

The Cobblestone board obtained an appraisal from Mr. Jonathan Miller, who is a licensed real estate appraiser in New York. The Miller appraisal included a comprehensive description of the property, discussed façade easements and stated that the fair market value of the easement granted was $8,171,000, or 12% of the appraised value of $68,095,000.

The appraisal allocated the total charitable deduction to the various individual units. The appraisal determined the value based on the status as a certified historic structure, the fact that ads would no longer be permitted on the east façade and the existence of three street-level façades.

NAT was founded by Springfield Management Services (SMS). During 2003, NAT received cash gifts together with conservation easements and paid the for-profit SMS $5.5 million for services. The cash gifts were to pay for "monitoring fees." SMS was responsible for visiting each site and photographing it once per year. It also would respond to requests for alterations or discuss sales of units with prospective new owners.

Cobblestone was located in an area subject to the New York City Landmarks Preservation Commission (LPC). LPC designated Cobblestone as a "sound, first-class condition" property. This applied to only 150 out of 26,000 properties in New York and required a higher standard of preservation.

Seven taxpayers were owners of Cobblestone units and reported charitable deductions ranging from $174,000 to $282,000. The IRS denied all deductions and assessed interest and penalties. The IRS claimed that the Cobblestone board did not have powers to grant the façade easement, the easement was not recorded until 2004, the substantiation was inadequate, the façade easement was not valid under Sec. 170 and the façade easement had no value.

The Court reviewed appraisals by Marilyn Weitzman and Michael Ehrmann. The Weitzman appraisal valued Cobblestone at $65,109,788 based on comparable sales. However, she determined the income approach valuation to be $34,138,106. By reducing the value for the easement, she determined that the final value was $28,760,817. Using a 15.5% discount on the $65 million amount, she claimed the charitable deduction was $10,118,000. IRS expert witness Timothy Barnes noted that Ms. Weitzman's appraisal failed to use the required "highest and best use" standard.

Mr. Ehrmann used a comparable sales approach. Based on his selected discount rate of 10% and multiple comparables, he determined a reduction in a value of 16.45%. He then reduced that to 14.40% and finally to 12%, leading to an easement value of $6,795,000. IRS expert witness Barnes criticized Ehrmann's report and noted that the selected discount rate created a "huge distortion" in valuation.

The Tax Court analyzed both of the taxpayer appraisers' methodology. It determined that the Weitzman appraisal report did not base the value on Cobblestone's "highest and best use." Therefore it was not valid. In addition, the Weitzman report did not recognize the fact that the LPC regulations enforcement was more stringent than NAT enforcement. NAT paid SMS approximately $5.8 million in 2004 and $13,345 was expended on monitoring expenses.

The Court also noted that the Ehrmann report involved discounting that distorted the appropriate level of reduced price for the conservation easement. Based on the Court's calculation, the final spread was closer to 3% than the claimed 12%. The Court determined that the 3% reduction in value was not deemed significant.

Therefore, because the appraisers for the taxpayers failed to meet the burden of proving the Cobblestone façade easement value was greater than zero, there was no charitable deduction.

The donors also had been required to make a cash gift of 7% of the value of the façade deduction to NAT as part of the transaction. The purpose of the cash gift was to cover the monitoring expenses. The IRS denied deductions for the cash gifts as a fee for services or a contingent gift.

The Court noted that the services provided were fairly minor. Generally, it is permissible to pair a conservation gift with a cash gift. So long as the donor does not receive substantial direct benefits from the cash gift, it is deductible.

The IRS also assessed an accuracy related penalty under Sec. 6662(a).

In this case, the seven owners acted with good faith. They discussed the gift with an attorney prior to making the transfer. It was disclosed on their tax returns. They obtained an appraisal by a licensed New York real estate appraiser. The appraisal did substantially comply with all requirements. Therefore, there were no Sec. 6662(a) penalties.

The final issue was a claim by the IRS that appraiser Jonathan Miller was not qualified because he had not done other façade appraisals. The Court noted that he was licensed in New York and had founded a major appraisal firm. In addition, he was managing principal of another firm that completed appraisals on commercial real estate. Therefore, the court deemed these acceptable qualifications to perform the façade conservation easement appraisal.

Editor's Note: The IRS has objected strenuously to the use of percentage discounts to value façade easements. To qualify for an easement, it is necessary to show that there is an actual reduction in the value under a "before and after" standard. In addition, the reduced value must exist as a result of the easement deed and not because of other regulatory actions such as the requirements of the New York Landmark Commission.

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.