Wills, Trusts & Estates Prof Blog

Avoiding the Kiddie Tax

The “kiddie tax” prevents high-net-worth individuals from avoiding taxes by shifting investment assets into their children’s names.  In 2013, “children under age 20 and full time students living with the parents will pay income taxes at the parents highest marginal tax rate on all unearned income above $2,000.”  But there are methods of avoiding the kiddie tax or at least minimizing it.

The easiest way to avoid the kiddie tax is to ensure that the unearned income the child receives does not exceed $2,000.  This can be accomplished by limiting gifts to those assets that are non-interest bearing or that pay no dividends, such as raw land.

Another way to avoid the kiddie tax is to create a 529 savings account.  If the assets are going to be used for qualified educational expenses, all gains and income in a 529 savings account are tax-deferred and then tax-free.

Other options include U.S. savings bonds and tax-deferred annuities.  No matter what method is used to avoid the kiddie tax, high-net-worth individuals should always be aware of the risk of transferring assets to children and strongly consider the use of a trust to control the flow of money.

See John Napolitano, Wealth Planning Across the Ages, WealthManagement.com, May 3, 2013.

IRS Warns Tax-Exempt Groups To File by May 15th

The IRS warned all tax-exempt organizations that under the law they are required to file a Form 990-series report by May 15 of every year. Under the Pension Protect Act of 2006, non-profit organizations and charities must file an annual Form 990. If the organization fails to file the form for three consecutive years, then the organization will automatically lose their federal tax-exempt status. The new filing requirements also apply to small organizations, although it does not place that requirement on church and church-related organizations. If an organization will likely not make the deadline, it might be in its best interest to file a Form 8868 to receive a filing extension. 

See Michael Cohn, IRS Warns Tax-Exempt Groups to File by May 15 or Lose Status, Accounting Today, May 10, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Tips To Help Achieve A Negative Tax Result

As the tax rules change financial, advisors are responsible for weighing the different tax implications of their advice. Recently, there has been a change of conventional thinking regarding trust strategy. It was believed that assets should be held in a bypass trust. The rational behind the bypass trust was to have the assets grow out of the estate. However, with higher capital gains taxes the opposite might be more accurate. Many people say that equities should be held in the spouse's name and bonds should be put in a bypass trust. However, the yield for bonds is flat and interest rates are rising. As a result, the increase in rates would have a negative impact on bonds.

In the current economy, many wealthy people have turned to fixed-income substitutes such as master limited partnerships in oil, or sovereign debt funds. A person with these substitutes might want to consider holding them in a bypass trust. Nonetheless, the trustee making this decision would still face challenges. Trustees owe a duty to all beneficiaries not just the spouse. Additionally, provisions in the will are not enough to offer a fiduciary only investing in these asset types.It will be up to the financial advisor to alleviate the negative income tax result. According to financial advisor Martin Shenkmen, any combination of the following might help with that goal:

1. Modify asset location decisions to favor investments generating cash flow in an individual client's name to cover income tax costs, or non-income-producing assets (such as growth stocks) in the trust, to lessen the income tax burdens added by the trust.
2. Favor tax-advantaged investments, such as tax-exempt bonds and insurance products inside the trust. If life insurance is to be used, be certain that the trust is suitable for holding the insurance since it may not have been designed with that purpose in mind.
3. Harvest gains and losses more aggressively and coordinate planning to reduce the income tax burden.

See Martin Shenkman, New Take on Trust Strategy, financialplanning.com, May 1, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

Indiana Legislature Passes Its Budget And Will Eliminate Its Inheritance Tax

As I have previously discussed, the State of Indiana was in the process of passing a budget for this fiscal year. Within its budget, the Indiana legislature sought to move the date the inheritance tax would expire to later this year. Recently, the State of Indiana passed its $30 billion budget; therefore, a plan in place to eliminate the inheritance tax. Other than eliminate the inheritance tax, the two-year budget will increase school funding and provide more than $300 million in tax cuts.

See Associated Press, Indiana Legislature Passes $30 Billion Budget, Indianapolis Business Journal, Apr. 27, 2013.

Special thanks to Sean J. Fahey (Hall Render Killian Heath & Lyman, P.C.) for bringing this article to my attention.

Article on Formula Clauses in Valuation

Patrick J. Duffey (Attorney, Florida), Brian K. Duffey (Attorney, Florida), & Lee-ford Tritt (Professor of Law, Florida Levin College of Law) recently published an article entitled, A Question of Value: The Evolution of Formula Clauses Through The Decades,  47 Real Prop. Tr.& Est. 467 L.J. (Winter 2013). Provided below is the editor's synopsis from the Real Property, Trust and Estate Law Journal:

Wealthy families often use closely-held businesses to manage, preserve, and transfer wealth. These entities are difficult to value and, therefore, present estate planning and transfer challenges when owners attempt to give or sell portions of the business. Attorneys often use formula clauses to ensure predictability in the parties' expected tax liabilty. Recently, the Tax Court decided Wandry v. Commissioner in favor of the taxpayer, where the taxable transfer employed a defined value clause with a non-charitable value. Until this decision, courts have endorsed only the use of charitable values in conjunction with defined value clauses. This Article analyzes the Tax Court's decision in Wandry and attempts to fit it within well-established case law decided in the last century. Although Wandry was decided in favor of the taxpayer, this Article suggests that attorneys who step outside the boundaries of court-blessed formula clauses do so at their own risk.

Judge Revokes Widow's Sentence for Tax Evasion

79-year-old millionaire, Mary Curran pleaded guilty for tax evasion and was sentenced to one year of probation in federal court. However, the judge immediately revoked the sentence. Reports allege that the judge suggested that the prosecution was unnecessary. Originally, Curran faced up to six years in prison plus one year of probation and a fine. Curran had not paid income tax on her $43 million dollars in an offshore account. As a result, she faced prosecution for tax evasion. Nonetheless, Curran did file a voluntary disclosure with the IRS. In spite of this, the disclosure came too late. The Department of Justice had started an investigation, which precluded her from the voluntary disclosure program. Curran has agreed to pay roughly 21.7 million dollars as a penalty. 

See Alistar M. Nevius, Widow Avoids Jail Time and Probation in Sentencing for Offshore Account Tax Evasion, American Institute of CPAs, Apr. 26, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Obama’s Budget Proposal Likely to Have Negative Effect on Charities

As I have previously discussed, President Obama’s budget proposal could have a huge impact on charitable donations.

For every donation to a nonprofit organization, taxpayers in the highest tax bracket currently receive a 39.6 percent tax deduction.  Obama proposes to cap the tax deduction for donations at 28 percent for all tax brackets.  Along with increased income taxes, capital gains taxes, and Medicare surcharges, this cap on tax deductions could provide an additional disincentive to donate.  Charities also worry about another budget proposal known as the Buffett Rule that would require those with an annual income over $1 million to pay a minimum tax of 30 percent.

This proposal comes during a period of stagnant revenue for the charitable sector.  One study shows “that the top 2.2 percent of taxpayers were responsible for 27 percent of all charitable giving.”  Providing disincentives for the top tax brackets to donate may have a devastating effect on the charitable sector and the needy who benefit from it. 

See Colleen O’Dea, Charities Fear Obama Budget Will Hurt Donations, Private Wealth, Apr. 19, 2013

Why It Might Be Good Practice To Keep Your Tax Returns

Many people ask how long they should keep their tax returns. Some believe keeping your returns for 3-6 years is enough time. However, there are many reasons why you should at least keep an electronic copy of all of your tax returns. Below are some reasons why keeping your tax returns is a good idea. 

1. Your tax returns can be used as proof and protect your Retirement and Social Security benefits.
2. Protect yourself from audits.
3. Keeping better records will prevent any surprises regarding taxes owed or refunds due.
4. Sometimes insurance policies switch companies and the payout of a policy can be an issue. If you need to prove the payout amount, you can do that with a tax return.
5. Keeping your tax returns can greatly benefit your IRA and retirement plan contributions. Your state deduction may mean part of your contribution will not be taxable. Additionally, if you made non-deductible contributions for federal purposes it might mean the IRS may not tax part of your contribution.

See Eva Rosenberg, Never Throw Away Your Tax Returns Why You May Need Those Old 1040's Someday, MarketWatch.com, Apr. 22, 2013. 

Special thanks to David S. Luber (Attorney at law, Florida Probate Attorney Wills and Estates Law Firm) 
for bringing this article to my attention.

Sheep Ranching Property Considered Charitable Use Assets

A private foundation owned sheep ranching property that was used for two purposes. First, the foundation used the property has a place where it held retreats for clergy members. Second, the foundation used the property for "a research program 'to enhance the quality, and the increase the production, of range sheep' in western states."

In PLR 201315031, the IRS held that the assets that were owned by the foundation should be treated as charitable use assets. The foundation was originally a Type III supporting organization before the enactment of the Pension Protection Act of 2006. Under the law, the foundation, which was organized as a trust, was integrated to a private foundation. The ranch was originally owned by a subsidiary that transferred those assets to a LLC that it formed. The foundation was assigned an interest in the LLC. The ranch itself operated at "loss" because of its purpose. It's goal was introduce better breeding sheep to farmers. In carrying out its purpose, it would not sell the culled sheep for breeding, which were used for slaughter. The foundation argued that if it sold those sheep in would undermine their purpose. Here, the IRS accepted the proposed explanation from the farmers, and held that the foundation would not have to include "the value of the ranch...in calculating the foundation's minimum investment return for purposes of the excise tax on undistributed income."

See PLR 201315031 - Sheep Ranching As An Exempt Activity, Charitable Planning, Apr. 15, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Obama's Charitable Tax Deduction Change

As I have previously discussed, Obama's budget proposal was released. One of the changes includes a limit on the value of the charitable tax deduction. For the past several years, a version of the change in the charitable tax deduction has been proposed. The current budget proposal alters the existing 35% charitable tax deduction to 28%.

Critics remark that the proposal raises the cost of donating to charity. The proposed change is effectively a 20% increase on the charity tax. As a result, it is likely that charitable donations will decline. The Chronicle of Philanthropy estimates that the reduction in the charitable tax deduction could cost 9 billion yearly in potential donations. The new charity tax deduction decreases the tax liability of the wealthy. Stanford University's Rob Reich advocates that the tax be limited only to donations with a "redistributional effect." The administration states the tax is fair and the purpose is to cap the deductibility of major tax expenditures.

See Howard Husock, The Obama Budget Proposal: Tax Increase on Charity, Forbes, Apr. 10, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Article on Reforming the Taxation of Retirement Income

Richard L. Kaplan (Peer and Sarah Pedersen Professor of Law, University of Illinois College of Law) recently published an article entitled, Reforming the Taxation of Retirement Income, Virginia Tax Review, Vol. 32, No. 2, pp. 327-366 (2012); Illinois Program in Law, Behavior and Social Science Paper No. LBSS13-23. Provided below is the abstract from SSRN:

Legal and financial analyses abound about various means of saving for retirement and the tax advantages that they present, but very little attention has been paid to how retirement income is generated and the tax consequences that pertain to its generation. This article fills that void by examining the three major sources of retirement income: Social Security, employment-based retirement plans, and personal savings. For each of these sources, this article considers how retirement income is generated, sets forth the applicable federal income tax treatment, and proposes reforms to make the pertinent tax rules more sensible. Among its recommendations are simplifying how Social Security retirement benefits are taxed, bifurcating defined contribution plan withdrawals into capital gains and ordinary income components, repealing certain exceptions to the early distribution penalty, reducing the delayed distribution penalty and adjusting the age at which it is triggered, and changing the residential gain exclusion to avoid unanticipated problems with reverse mortgages.

Taxes Take A Large Portion of Koch's Estate

As I have previously discussed, Ed Koch, the former mayor of New York, left portions of his estate to several different people and entities including the LaGuardia and Wagner Education Fund at CUNY. Unfortunately, they will only receive three-fourths of his $10 million estate. The other one-fourth will go to the federal government and the State of New York. This will likely be the case even after we take into consideration the unified credit and the New York estate tax exemption. Currently, under federal law, $5.25 million is exempted from the estate tax. There is a 40% tax on income that exceeds the amount. The New York estate tax exemption is $1 million, and there is a tax of 16% on income that exceeds the amount. Based upon these rates, it is likely that from Koch's $10 to 11 million estate the federal government will take about $1.45 million in taxes, and the State of New York will likely take about $1.1 million in taxes. He gave the remainder to his three nephews instead of his sister.

Some experts argue that this move is actually quite clever. They argue that had he given the remainder to his sister, the money might have incurred the New York estate tax again when she died. However, those same experts argue that it might have been better if Koch decided to leave the residue in a trust. This move would have protected the residue of the estate from his nephews' creditors. Some experts also argue that it might have been better for Koch to make a few deathbed gifts. This could have been helpful to reduce both his state and federal tax liability. It is important to remember if a person is going to make deathbed gifts, the gift must be complete before the donor dies. In other words, the donee must usually cash their check before the death of the donor.

See Deborah L. Jacobs, Ed Koch's Will: Taxes Take Big Bite Out of Hizzoner's Nest Egg, Forbes, Mar. 15, 2013.

The Intra-Family Loan, A Tax & Estate Planning Tool Many Don't Know About

The Intra-Family Loan is a tax and estate-planning tool that many estate planners do not know about. As a result, it is not used often. The idea of an Intra - Family Loan is an older generation serving as a lender of cash or other assets to a younger generation serving as the borrower. Typically, the loan is cash and the understanding is summarized in a promissory note. The Intra - Family Loan is less complicated than many other advanced estate planning tools. This type of loan could allow a borrower to pay the interest and principal after death by using life insurance as payment.

The interest rate for the loan should be equal to or greater than the minimum Applicable Federal Rates (AFR) to avoid tax regulations. According to JDSupra.com, a long-term loan, classified as a nine year period or more, cannot have an interest rate lower than 2.63%. JDSupra.com continues to explain the advantage of an Intra- Family Loan "the idea that if you can borrow money at the long-term AFR and earn an investment rate of return on a tax-advantaged bas in excess of the long-term AFR, outside of the taxpayer's estate, the taxpayer wins by a landslide." Currently, interest rates are low which makes the Intra-Family Loan a tool that can come in handy for tax and estate planners. Additionally, the Intra-family loan may be a more manageable tool than other related options because of its simplicity.

See Gerald Nowotny, The Family Loan Shark-Leveraging The AFR In The Taxpayer's Favor Intra-Family Loans And Private Placement Insurance Products- Part 1, JDSupra.com, Mar. 13, 2013.

Effects of Supreme Court's Decision in Windsor

As I have previously discussed, the Supreme Court is set to hear arguments in Windsor v. United States. The case involved Edith Windsor and her wife Thea Spyer. When Thea passed away, Edith inherited her entire estate. The problem here was that Edith and Thea was a same-sex couple; therefore, their marriage was not recognized by the federal government and Edith was not able to take advantage of marital deduction. Without the marital deduction, Edith incurred a large estate tax. Now that the case is before the United States Supreme Court, what would happen if the justices concluded that DOMA does violate the 14th Amendment Equal Protection Clause?

Some experts believe, from the estate tax perspective, the change would not be that large. According to Reuters, “[t]he Williams Institute, a University of California-Los Angeles think tank that studies sexual orientation, estimates that if DOMA is overturned, only about 50 same-sex couples would qualify for the spousal exemption each year.” The much larger change would come in the rules that govern income tax filing. With invalidation of DOMA, same-sex couples would likely face many of same problems that heterosexual couples now experience when filing their taxes. This means that some same-sex couples (likely the working poor or the wealthy) could face the “marriage penalty,” while middle class couples could get the tax break. The point to take away here is that fiscal equality does not always equal a fiscal positive.

See Kim Dixon, Analysis: Death, Taxes and Supreme Court’s Gay Marriage Case, Reuters, Mar. 7, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention. 

Can The Rich Fix The Social Security Program?

Recently, senators proposed new legislation that imposes a 6.2% Social Security tax on wages and self-employment income exceeding $250,000. This tax is in addition to the already existing 6.2% Social Security tax on wages or self-employment income up to the Social Security wage base. Senators, Bernie Sanders from Vermont, Harry Reid from Nevada, and Pete Defazio from Oregon proposed the legislation. If passed, the legislation would become effective in 2014. The additional Social Security tax on income exceeding $250,000 will not be capped. As a result, the tax obligation of people with high income would increase dramatically. According to Forbes, if the legislation passes, a taxpayer earning $400,000 dollars a year would end up paying out $9,300 more per year in employment taxes. Many believe the legislation, is forcing affluent taxpayers to mend the broken Social Security program.

See Tony Nitti, Congress Looks To The Wealthy To Bail Out Social Security, Forbes, Mar. 7, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this to my attention.

Article on Tax Advice For the Second Obama Administration

Paul L. Caron (Charles Hartsock Professor of Law, University of Cincinnati College of Law) recently published an article entitled, Tax Advice for the Second Obama Adminstration, 40 Pepperdine L. Rev. 5 (2013). Provided below is the abstract from SSRN:

Twenty-five of the nation’s leading tax academics, practitioners, journalists, and public intellectuals gathered in Malibu, California on the Friday before President Obama’s second inauguration to plead for tax reform. The papers published in this issue of the Pepperdine Law Review provide very different prescriptions for America’s tax ills. But there is a unanimous diagnosis that the country’s tax system is sick indeed. A re-elected president’s inauguration offers a particularly propitious moment to put politics aside and embark on a treatment plan. If our lawmakers are interested in healing our tax wounds, the ideas presented in these pages offer a good place to begin. They run the gamut from relatively minor procedures to total transplantation. But all would improve the health of our current tax system.

Article on Future Wealth Transfers

John A. Miller (Weldon Schimke Distinguished Professor of Law, University of Idaho College of Law) & Jeffrey A. Maine (Maine Law Foundation Professor of Law, University of Maine School of Law) recently published an article entitled, Wealth Transfer Tax Planning for 2013 and Beyond, (Feb. 9, 2013). Provided below is the abstract from SSRN:

On January 1, 2013 Congress avoided the tax part of the so called “fiscal cliff” when it passed the American Taxpayer Relief Act of 2012 (ATRA). Among its many impacts this law prevented the application of a number of sunset provisions that would have dramatically altered the operation of the federal wealth transfer taxes. Instead Congress made permanent two significant transfer tax provisions introduced as temporary measures in 2010: the indexed basic exclusion amount and the deceased spousal unused exclusion amount. The latter provisions are sometimes referred to as the portability rules. ATRA also introduced a new maximum transfer tax rate of 40%. In addition ATRA made permanent a deduction for state death taxes and prevented the return of the state death tax credit. Thus, the main transfer tax emphasis of the actions taken by Congress in ATRA was to stabilize the wealth transfer tax system in a fashion that eliminates or reduces its planning impact on most taxpayers while also permanently establishing a significant new planning tool for the wealthy, the deceased spousal unused exclusion (DSUE) amount.

In this article we summarize the operation of the federal wealth transfer taxes in the wake of ATRA and describe the basic tax planning techniques for wealth transmission. In doing so, we offer a thorough analysis of the operation of the portability rules and discuss their planning virtues and drawbacks. The overall design of this article is to bring the general practitioner into the current wealth transfer tax planning picture while providing references to more detailed treatments of particular topics within this broad field. 

Estate of Nancy P. Young

The decedent, Nancy Young, died in 2008 and the executor of estate requested an extension of time to file the necessary estate tax return. The extensions the estate requested were granted and the estate paid their taxes within a timely manner. Because of the recession, the estate sought to have some of the estate's real estate assets to be re-appraised. The estate had two options at this point because the deadline to file the estate tax return was upon them. According to Proskauer Rose LLP, they could have "(1) file the estate tax return with the appraised values, and then file a supplemental return later when the real estate holdings were sold; or (2) wait until the real estate holdings were sold, and then file one estate tax return after the filing deadline." They chose the second option, to file the estate tax return after the deadline had passed. They believed that this would simplify the process and the estate would not be adversely affected. The IRS felt differently and accessed a penalty against the estate. 

In Nancy P. Young v. United States, the estate argued that it should not be penalized because it relied on expert advice. The district court disagreed with the estate and claimed that there was not reasonable cause here because the estate was well aware that it was legally required to file an estate tax return. The only advice that the estate relied on was that it would not be assessed a penalty. The court cited precedent that has already held that in this particular instances like this one, the reliance is not a reasonable cause.

See Proskauer Rose LLP, Estate of Nancy P. Young v. United States, Associate of Corporate Counsel - Lexology, Feb. 12, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.

Tax Bills For The Rich At A 30-Year High

Washington is again gridlocked over whether to increase taxes for the wealthy. As the politicians debate, it is important to note that at this moment the wealthiest taxpayers in this country still pay more taxes than they have in past years while most of the population pays at historically low rates. The sobering truth of the matter is that lower income taxpayers are no longer paying the same amounts that they used to pay.

In 2013, the highest earning taxpayers will likely pay up to 35% of their income in taxes. The poorest taxpayers will likely have a negative income tax. In other words, they will file for more credits than they will owe in taxes. Some at the Tax Policy Center believe that this situation is why many high income taxpayers feel abused by the system. The issue, unfortunately for them, shows no sign of going away as President Obama and Democrats in Congress insist that any tax reform should include more taxes in addition to spending cuts.  

See Stephen Ohlemacher, Tax Bills For Rich Families Approach 30-year High, Northwest Herald, Mar. 4, 2013.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Tax Panel On Conservation Easements

Strafford Webinars & Teleconferences will host a live 110-minute CLE/CPE teleconference with interactive Q&A entitled, Tax Planning With Conservation Easements on March 7, 2013 from 1:00-2:50 EST. If a person registers by tomorrow, there is $50 discount on the registration fee. Provided below is a description of the event.

This teleconference will explain the tax advantages and potential tax treatment of conservation easements. The panel will discuss recent case law developments, how to structure easements to avoid IRS challenges, and how to pair conservation easements with the historic tax credit.

Description

Conservation easements granted in perpetuity as a charitable donation can provide donors with significant income, estate and property tax planning opportunities if structured properly.

The charitable contribution deduction for conservation easements has been under heightened IRS scrutiny in recent years. The IRS has frequently challenged the valuation of the easement, and also attacked other deficiencies in structuring transactions. Several critical tax court cases were decided in 2012.

Moreover, the 3rd Circuit’s Historic Boardwalk Hall ruling regarding a historic tax credit transaction could also have a significant impact on existing and planned tax credit structures for conservation easement transactions.

Listen as our authoritative panel of practitioners reviews tax planning opportunities with conservation easements and recent IRS scrutiny of the charitable donation. The panel will explain how to structure easements to avoid IRS challenges and pair conservation easements with the historic tax credit.

Outline

1. Tax planning opportunities with conservation easements
2. Potential IRS challenges to the charitable donation of conservation easements
3. Recent case law developments
4. Structuring easements to avoid IRS challenges
5. Pairing conservation easements with the historic tax credit

Benefits

The panel will review these and other key questions:

• What are common IRS challenges to conservation easement donations?
• What lessons does recent case law provide on elements practitioners should consider when structuring conservation easements to minimize challenges by the IRS?
• What is the potential impact of the Historic Boardwalk Hall ruling on existing and planned tax credit structures for conservation easement transactions?
• How can conservation easements be paired or combined with the historic tax credit?

Following the speaker presentations, you'll have an opportunity to get answers to your specific questions during the interactive Q&A.

Upon completing this seminar, you will understand the tax advantages and potential tax treatment of conservation easements, how to structure easements to avoid IRS challenges, and how to pair conservation easements with the historic tax credit.

Special Thanks to Alice McCarthy for bringing this article to my attention.