News Notes

Rolling Average Cost Inventory Method • Disregarded Entities • New Energy Incentives for Individuals • Revised K-1 for Trusts and Estates (Box) • Stock Transfers to FLPs and FLP Transfers to Donor’s Children Are Indirect Gifts (Box)

Lesli S. Laffie, J.D., LL.M.

AICPA Activities

Rolling Average Cost Inventory Method

In Jan. 19, 2006 comments, the AICPA proposed that the IRS and Treasury should allow the use of the rolling average cost method in valuing inventories when this method approximates actual cost. Revenue rulings issued in 1971 and 1977 held that average cost determinations could not consider costs incurred before the beginning of the year (i.e., rolling average costs). Because inventory costing systems at that time were less sophisticated, the averaging process took place infrequently; in periods of rapidly increasing prices, an averaged cost for ending inventory items could be lower than any cost incurred during the current year. It was for this reason that the IRS rejected the rolling average cost method.

Because today’s accounting systems are much more sophisticated, “the weight accorded to the costs incurred in prior years is so slight that the ending inventory cost more nearly approximates first in, first out (FIFO).” In addition, because there is an increasing number of inventory costing systems that use a rolling average cost, a continuation of the ban puts taxpayers at risk. Noting two recent revenue procedures that allowed a replacement cost method that approximated actual cost, the AICPA urged the IRS and Treasury to “allow the use of rolling average cost whenever it approximates actual cost consistent” with these rulings.

Disregarded Entities

On Jan. 30, 2006, the AICPA asked the IRS to withdraw proposed regulations on the treatment of disregarded entities in allocating partnership liabilities under Sec. 752.

Under the proposed regulations (issued in August 2004), when determining economic risk of loss for Sec. 752 purposes, a disregarded entity’s payment obligation should be taken into account only to the extent of the entity’s net value. According to the AICPA, however, the proposal, in application, will “create significant compliance burdens for taxpayers” and will “result in inconsistent treatment” for different entities.

There may be situations in which partnership interests are held through disregarded entities for nontax considerations. Under the current regulations, it is assumed that all partners with obligations to make payments intend to actually perform those obligations (regardless of their actual net worth); if the facts and circumstances indicate a plan to circumvent or avoid the obligation, a partner’s obligation may be disregarded. Under the proposed regulations, however, this “intent element” is removed, leaving a regime that applies a net value standard when a disregarded entity holds a partnership interest while an intent standard is used in all other situations.

Rather than this proposal, the AICPA believes that the existing ant-abuse rule should be expanded, to make clear that the rule addresses the concerns at which the proposed regulations are aimed.

From The IRS

Energy Tax Benefits for Individuals

The Service has issued a fact sheet (FS-2006-14) highlighting the changes for individuals in the Energy Policy Tax Act of 2005 (P.L. 109-58) that are available for property placed in service after 2005 and before 2008. New Sec. 25C provides personal tax credits for making a principal residence (which must be in the U.S.) more energy efficient, and for buying certain energy efficient items. At the same time, the new law provides credits for various types of alternative motor vehicles (including hybrids).

Nonbusiness energy property: The new law provides a 10% credit for buying qualified energy efficient improvements. To qualify, a component must meet or exceed the criteria established by the 2000 International Energy Conservation Code (including supplements) and must be installed in the taxpayer’s main home in the U.S. The following items are eligible:

Insulation systems that reduce heat loss or gain;
Exterior windows (including skylights);
Exterior doors; and
Metal roofs (meeting applicable Energy Star requirements).

Residential energy property expenses: In addition, there is a credit for costs relating to residential energy property expenses. To qualify as residential energy property, the property must meet certain requirements prescribed by the Secretary of the Treasury and must be installed in the taxpayer’s main home in the U.S. Eligible items include:

$50 for each advanced main air-circulating fan;
$150 for each qualified natural gas, propane or oil furnace or hot water heater; and
$300 for each new item of qualified energy efficient property.

The maximum credit for all tax years is $500; no more than $200 of the credit can be attributable to expenses for windows.

Solar equipment: The new law creates a credit available to those who add qualified solar panels, solar water heating equipment or a fuel cell power plant to their homes in the U.S. In general, a qualified fuel cell power plant converts a fuel into electricity using electrochemical means, has an electricity-only generation efficiency of more than 30% and generates at least 0.5 kilowatts of electricity. Taxpayers are allowed one credit equal to 30% of the qualified investment in a solar panel up to a maximum credit of $2,000, and another equivalent credit for investing in a solar water heating system. (No part of either system can be used to heat a pool or hot tub.) Taxpayers are allowed a 30% tax credit for the purchase of qualified fuel cell power plants; the credit may not exceed $500 for each 0.5 kilowatt of capacity.

Alternative motor vehicles: The new law includes a tax credit for hybrid vehicles, which can be as much as $3,400 for those who purchase the most fuel-efficient vehicles.

Hybrid vehicles have drive trains powered by both an internal-combustion engine and a rechargeable battery. (Many currently available hybrid vehicles may qualify for this credit.) Because taxpayers may claim the full amount of the allowable credit up to the end of only the first calendar quarter that is after the quarter in which the manufacturer records its sale of 60,000 hybrid and /or advanced lean burn technology motor vehicles, taxpayers seeking the credit may want to buy early in the year.

In addition, credits are available for purchasing certain other vehicles, including fuel cell vehicles, alternative fuel vehicles and hybrid heavy trucks. The maximum allowable credit depends on the specific vehicle.

Revised Schedule K-1 for Form 1041 for Trusts and Estates

by Eileen Sherr, CPA, MT, AICPA Technical Manager—Taxation, Washington, DC

In IR-2006-11, the IRS announced the availability of a revised Form 1041 Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc., for trusts and estates, for this year’s filing season.

Income, deductions and credits from trusts and estates are reported to beneficiaries on Schedule K-1. The redesigned schedule is similar to partnership and S corporation Schedules K-1, which were changed last year. The new format features an improved layout similar to that of Form W-2, as well as streamlined instructions. It is also scannable, reducing the risk of transcription errors.

The IRS says that approximately 26 million Schedules K-1 are filed each year, with 3.5 million being filed by estates and trusts. The new Schedule K-1 has been simplified to reduce common errors and the burden associated with preparation and filing requirements. The schedule is available at www.irs.gov/pub/irs-pdf/f1041sk1.pdf. Printed copies are also available by calling the IRS at 1-800-829-3676.

Stock Transfers to FLP and FLP Interest Transfers to Donor’s Children Are Indirect Gifts

by Eileen Sherr, CPA, MT, AICPA Technical Manager—Taxation, Washington, DC, and Vinu Satchit, CPA, BDO Seidman LLP, High Point, NC

In Mark W. Senda, 8th Cir., 1/06/06, aff’g TC Memo 2004-160, the Eighth Circuit held transfers of stock to two family limited partnerships (FLPs)—coupled with the transfers of FLP interests to the donor’s children on the same day—to result in indirect gifts of stock to the children, because the donors did not present reliable evidence that they contributed the stock to the FLPs before transferring the FLP interests to their children. According to the court, the sequence of the transfers is critical; a contribution of stock after the transfer of partnership interests is an indirect gift of the stock to the partners (to the extent of their proportionate interest in the partnership) as opposed to a gift of the partnership interest. The finding of an indirect gift of stock severely restricts (or eliminates) the availability of valuation discounts. In Senda, the gifts were valued at the full undiscounted value of the stock transferred. If the gift had been determined to be of FLP interests, the taxpayer and the IRS had agreed to allow combined discounts of between 39% and 45% in valuing the FLP interests.

This case is a reminder to practitioners of the dangers of sloppy FLP implementation. The Eighth Circuit noted (among other matters) that the general partner did not maintain any records, the certificates of transfer were not recorded in a timely manner, the donor’s testimony was evasive as to the timing of the transfers and there was a failure of after-the-fact paperwork (i.e., gift tax returns) to provide reliable evidence on the timing of the transfers. Further, to properly document the establishment of a FLP and the transfers of interests, some time should elapse between the contribution to the partnership and the gift of the limited interests—at least until the contribution is recorded on the partnership’s books and the contributing partner’s capital account has been properly credited. An AICPA FLP administration checklist that highlights these and other concerns and which may be helpful can be found at http://tax.aicpa.org/
Resources/Trust+Estate+and+Gift/Family+Limited+Partnerships/ AICPA+Checklist+on+Family+Limited+Partnerships.htm.