Source: http://slideplayer.com/slide/3529081/
Timestamp: 2017-06-28 09:08:47
Document Index: 724097492

Matched Legal Cases: ['§1', '§2010', '§164', '§ 1', '§469', '§311']

Providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments. - ppt download
Providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments.
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Presentation on theme: "Providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments."— Presentation transcript:
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Business Succession/Estate Planning – Tax, Non-Tax and Entity Considerations* Roger A. McEowen** _______________ *Presented at the 2013 National Farm Business Management Conference, Overland Park, Kansas, June 10, 2013. **Director of the ISU Center for Agricultural Law and Taxation. Member of the Iowa and Kansas Bar Associations and licensed to practice in Nebraska.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 H.R. 8 - The Fiscal Cliff Bill What the Bill does not do: –No extension of the payroll tax cut 6.2% rather than 4.2% ($113,700 wage base) Applies to wages paid and self-employment income paid with return Note: –Don’t forget.9% Medicare surtax on earned income exceeding $250,000 (MFJ); ($200,000 single) –Does not address carried interest
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Ordinary Income Rates Old Law: Top rate of 35%, starting at taxable income MFJ, $388,350 New Law: Top rate of 39.6%, starting at $450,000 MFJ taxable income, $400,000 single.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill New Brackets Single To $8925 10% -to $36,25015% -to $87,85025% -to $183,25028% -to $398,35033% -to $400,00035% >$400,000 39.6% MFJ To $17,85010% -to $72,50015% -to $146,40025% -to $223,05028% -to $398,35033% -to $450,00035% >$450,000 39.6%
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Marriage Penalty Returns (and is worse than before) Example –Married couple with each earning wages of $400,000 Income tax owed - $260,000 Medicare surtax - $4,950 –Two single persons living together each earning wages of $400,000 Income tax owed - $228,000 (total) Medicare surtax - $3,600 (total)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill New Brackets 39.6% bracket for trusts begins at $11,950 for 2013(replaces old 35% bracket) Note: This is the IRS position, but it may not be correct – rate may only be 35%
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Trust Tax Rates Sec. 101(b)(1)(B) of ATRA adds I.R.C. Sec. 1(i)(3), which says that rate of tax under subsections (a),(b), (c) and (d) rises from 35% to 39.6% for income above the “applicable threshold” –Trusts and estates are not taxed under any of these subsections –ATRA provides no threshold amounts at which the 39.6% bracket would start –Thus, 39.6% bracket should not apply to trusts and estates
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Phase-out of itemized deductions (The “Stealth Tax”) Itemized deductions phase out for each dollar of AGI over: $300,000 (MFJ) $275,000 (HOH) $250,000 (Single filers) $150,000 (MFS) So, what’s the impact of reinstating PEP and PEASE? PEP reduces personal exemption by 2% for every $2,500 of income above the threshold amount for single taxpayers and every $1,250 of income above threshold amount for MFJ Personal exemption is $3,800/person, so a married couple with 2 kids with incomes above $300,000 (up to about $425,000) will have about a 4% increase in marginal tax rate
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Pease Limitation Pease cuts itemized deductions by 3% of AGI above the threshold amounts up to maximum of 80% Deductions not included: –Investment interest –Medical expenses –Casualty, theft and wagering losses
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Phase-out of itemized deductions (The “Stealth Tax”) The phase-outs cause tax increases to kick in at much lower levels. -Families in 33% bracket could have an effective marginal rate exceeding 38% -Families in 39.6% bracket would have an effective rate over 46% (after adding in Medicare surtax of 3.8%)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill New Brackets, adjusted for phase outs Single $183,250-$398,350 (33.99%) $398,350-$400,000 (36.05%) $400,000 and up (40.788%) MFJ $223,050-$398,350 (33.99%) $398,350-$450,000 (36.05%) $450,000 and up (40.788%)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill New Capital Gain Brackets (as applied to taxable income) Single To $8925 0% -to $36,250 0% -to $400,00015% >$400,000 20% MFJ To $17,850 0% -to $72,500 0% -to $223,05015% -to $398,35015% -to $450,00015% >$450,000 20% Adjust for the phase-outs as needed.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 How Do The Higher Rates Apply To Clients With Both Ordinary Income and LTCGs? Example: –Bob and Mary file as MFJ and have ordinary income of $300,000 and LTCG of $200,000. Thus, taxable income after deductions is $500,000 Threshold for 39.6% rate is $450,000, so at what rate is the capital gain taxed? In other words, what is the ordering rule? –Does the capital gain get applied to the threshold first, so that it’s taxed at 15%? –Does the ordinary income get applied to the threshold first, so that none of the ordinary income is subject to the 39.6% rate, and a portion of the capital gain is taxed at 15% and the balance at 20%?
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Capital Gain/Ordinary Income Ordering Rule Of course, the Congress didn’t answer the question in H.R. 8 Look to I.R.C. §1(h) –Determine portion of taxable income that will be subject to ordinary rates using graduated rate tables Greater of taxable income reduced by capital gain ($300,000), or Lesser of –Amount of income taxed at rates below 25% ($72,500 for MFJ in 2013), or –Taxable income less adjusted capital gain ($300,000)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Continuing the Example The $300,000 of the $500,000 of taxable income is taxed at ordinary income rates, subject to the graduated rate tables –None taxed at 39.6% (even though taxpayer has taxable income over $450,000) because their ordinary income does not exceed $450,000
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Continuing the Example How much of the LTCG is subject to the 0% rate? –H.R. 8 extends the 0% rate for taxpayers otherwise in the 10% or 15% bracket. –The amount of the 0% rate is the lesser of: Net capital gain ($200,000), and The top of the 15% bracket ($72,500) reduced by taxable income less adjusted taxable gain ($500,000 - $200,000) [$72,500 - $300,000 = 0] –Thus, none of the capital gain is taxed at the 0% rate.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Capital Gain Example Clay Tile –$600,000 of Schedule F net income for 2013. –Sale of farmland in 2013 that had unharvested crop LTCG of $800,000 –$60,000 of itemized deductions
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Capital Gain Example Tax issues associated with unharvested crop –No deductions for expenses (add to basis) –Gain is LTCG if land held for more than a year –Allocate portion of selling price to unharvested crop –Result changes if retained right to reacquire land –What about pre-paid expenses? Amended return –Potential application of 3.8 Medicare surtax
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Return to Clinton Era Tax Rates? The Administration touts the deal as a “return to Clinton-era tax rates” –Not a chance: Capital gain rates about 3-5% points higher Medicare tax is higher Stealth tax makes individual rates higher than advertised –Economic growth slowed down (as did revenues) after the Clinton tax hike Real wages declined
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill At least we have an AMT fix -Single AMT exemption for 2012: $50,600 -MFJ AMT exemption for 2012:$78,750 -Adjusted henceforth for inflation -Retroactive for tax years beginning after 2011, an individual can offset their entire regular tax liability and AMT liability by the nonrefundable personal credits -Adjust for the phaseouts as needed
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill AMT Capital gain rates They are same as regular tax capital gain rates, but using AMT taxable income.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Permanency of Transfer Tax Provisions Rate raised to 40% (from 35%) Lifetime exemption remains at $5 million, with inflation indexing ($5,250,000 for 2013 deaths) The exclusion remains coupled Matching Gifting and GST exemption “Portability” retained (surviving spouse can inherit decedent’s unused exemption) 2
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Transfer Tax Changes The rate change is easy to deal with –No carryover effect from year-to-year or from gifts to estates –No need to revise familiar estate planning techniques –New law doesn’t give any reason to alter existing plans But revisit plans where there have been changes in finances or personal life
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Transfer Tax Changes How the new rate structure works: –40% rate reached at a taxable estate or cumulative gifts of $1 million The “run up the brackets” for the first $1 million is $54,200 (i.e., any tax payable would be $54,200 less than if the tax were a flat 40% from the first dollar) –Unified credit is $2,045,800 and offsets a taxable estate (or taxable gift) of $5.25 million
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 State Estate Taxes State estate taxes remain deductible in calculating the federal taxable estate In those states (most of them) that don’t have an estate tax, or have a state estate tax that is coupled to the (now extinct) state death tax credit, 40% will be the only estate tax rate above the exemption
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 State Estate Taxes Most states that have an estate tax tie it to the pre-2002 federal credit for state death taxes –Top rate of 16% for taxable estates over $10.1 million In states that follow the federal law and allow a deduction for the state tax, the total federal and state top marginal rates will be 48.3%
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Portability Made permanent Technical correction made –“Basic exclusion amount” changed to “applicable exclusion amount” in I.R.C. §2010(c)(4)(B)(i) June 15, 2012 portability regulations remain applicable Still have to file Form 706 in first spouse’s estate to make election –9 months after death with 6 month extension possible
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Impact of Portability Since it is now “permanent,” the use of bypass trusts for all but the wealthiest of families might be reduced But, there are still reasons to use bypass trusts: –Protect assets from creditors –Surviving spouse might remarry –Assets might go down in value –Plan might already use a bypass trust –Bypass trusts avoid administrative pitfalls
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate Planners Not Irrelevant Many non-tax reasons to see an estate planner: –Asset protection through entities, trusts, pre-nups and post-nups –Planning for long-term health care –Powers of attorney –Reviewing beneficiary designations and coordinating them with estate plan –Business succession
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 GSTT Made permanent is the allocation of the GSTT exemption and the GSTT inclusion ratio Exemption same as that for estates and gifts ($5.25 million for 2013)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Transfer Tax Issues What was not included in the bill: –No attack on valuation discounts –No 10-year term limit on GRATs –No limit on the duration of the allocation of the GSTT exemption
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Retroactive business extenders 5-year S corporation built-in gain recognition period For 2012 and 2013 (10 year rule in 2014) Thus, S corporations with BIG that have been an S for at least 5 years as of the beginning of 2012 or 2013 will not owe BIG tax on sale of appreciated assets If installment sale made after recognition period (e.g. 5 years) and recognition period reverts to 10 years, gain on installment sale is protected from BIG tax If BIG income is carried forward to future years due to taxable income limitations and BIG period has expired, no BIG tax on expired amount 3
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Energy-Related Provisions “Renewable” Energy PTC Extended for one year Taxpayer can make irrevocable election to take a 30% energy credit instead of the PTC Qualified property defined as being constructed, reconstructed, erected or acquired by the taxpayer and the original use of which commences with the taxpayer
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Section 179 limit raised for 2013 – and 2012 Limit for 2012 had been $139,000, with deduction starting to phase out at $560,000. 2013 limit had been $25,000, with phase- out starting at $200,000 2
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Section 179 limit raised for 2013 – and 2012 New law boosts limit for both 2012 and 2013 to $500,000, with phaseout starting at $2 million. Windfall for clients that purchased expensive assets in 2012 and thought they would be limited to $139,000 Limit to return to $25,000 in 2014. The $139,000 amount for 2012 is gone 2
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HR 8: the Fiscal Cliff Bill Section 179 provisions from 2011 extended Includes treatment of up to $250,000 in “qualified real property” expenses and qualification of computer software for Section 179 treatment. You can still make or revoke a Section 179 election on an amended return for open tax year Good through tax years beginning before 2014 Huge planning opportunity
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Bonus Depreciation 50% first-year bonus depreciation extended for 2013 3
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Expense Method and Bonus Depreciation Sec. 179 –New or used equipment –No farm buildings, unless they are single- purpose agricultural/horticultural structures –Use in trade or business –Must have income from trade or business
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Expense Method and Bonus Depreciation Bonus Depreciation –20-year MACRS property or less –Must be new –Farm buildings Ordering rule –Sec. 179 first, then bonus, then regular MACRS
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Charitable Donation To Charity From IRA Reinstated for 2012 and extended through 2013 Must be over age 70.5 Limit is $100,000 annually Donation must be to qualified charity directly (trustee of IRA must draft check in charity’s name) Any distribution received during 12/12 not included in income if donated during 1/13 Distribution cannot be taken into account for determining the “other” charitable contributions to be allowed as a deduction under I.R.C. Sec. 170 –In other words, the distribution cannot be added to AGI for purposes of the AGI limitation Can help avoid 3.8% Medicare surtax (if desire is to benefit charity) –Required distribution is passive and counts toward threshold, but not if donated directly to charity
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 ACA (Obamacare) Provisions Starting in 2013 Medical expenses (Schedule A) –Reduced by 10% of AGI for those under age 65 Applicable if either spouse under age 65 –If 65 or older, reduced by 7.5% Applicable if either spouse 65 or older 7
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 New Excise Tax on Medical Reimbursement Plans I.R.C. Sec. 4376. –An amendment to ERISA added by ACA. –Imposes a "fee" on any applicable self-insured health plan for each plan year ending after 9/30/2012. Fee is $1 per average number of lives covered under the plan for plans that end during fiscal year 2013, $2 thereafter. The fee is to be paid by the "plan sponsor" defined as the employer for plans established or maintained by a single employer. An "applicable self-insured plan" is any plan for providing accident or health coverage if any portion of the coverage is provided other than through an insurance policy and is established or maintained by 1 or more employers for the benefit of their employees. An excise tax remitted via Form 720. First payment is due Jul. 31 for the calendar year 2012. Basically, it's due seven months after the plan year end. It doesn't apply to plan years ending after 9/30/2019.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Proposed regulations on 3.8% tax on “Net Investment Income”
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 The ACA imposes two related taxes: A 0.9% wage tax high-income individuals, paired with a 0.9% self-employment tax at the same income levels. (Sec. 3101(b)(2)) –No employer match on the 0.9% tax A 3.8% tax on "investment income" at higher AGI levels. (Sec. 1411) 6-7
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Wage/SE tax applies to: Wage/SE income over $200,000 for single filers Joint wage/SE income over $250,000 for joint filers, or Wage/SE income over $125,000 for married taxpayers filing separately.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Wage/SE tax Employers will have to withhold when wages for an individual exceed $200,000. Any shortfall or overpayment has to be dealt with on the employee 1040. –Example: Jack and Jill each earn $150,000 in 2013 wage income. Because both are below $200,000, no 0.9% tax will be withheld on their wages. When they file their 2013 return, they will owe $450 (($300,000-250,000) x.9%) as additional tax on their 1040.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Implications for partners? Choose your poison! If you materially participate in a partnership with trade or business income, you will have self-employment income, potentially subject to the.9% tax – and the old 2.9% Medicare tax. If not, you will have passive income subject to the 3.8% tax.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Implication for S corporations: more reason to keep a lid on "compensation." S corporation K-1 income is not subject to FICA or SE tax. Reasonable compensation required.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Implication for Entity Planning S corporation is favored over partnerships because of better ability to avoid both employment tax and investment income tax of active owners.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Investment income (Sec. 1411) 3.8% tax applies to lesser of “net investment income" or the excess (if any) of the taxpayer’s "modified AGI" over: –$200,000 for single filers –$250,000 for joint filers, and –$125,000 for married taxpayers filing separately. –Top bracket cutoff for trusts ($11,950 in 2013)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 NII The 3.8% surtax is not deductible Self-employed persons can’t claim the surtax as part of the 50% deductible portion of S.E. taxes under I.R.C. §164(f).
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Investment income includes: Interest not derived in the ordinary course of a trade or business. (Preamble Sec. 5.A) –This excludes interest earned in a banking business. See Preamble Sec. 5.A.vi. Dividends Rents Non-qualified annuities to extent taxable and required minimum distributions Royalties Capital gains, except from sales of active businesses But, include capital gain from sale or liquidation of closely-held C corporation, even though taxpayer materially participated Passive trade or business income
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 “Net Investment Income” Does Not Include Salary, wages or bonuses Distributions from IRAs or qualified plans Pension income Any income taken into account for self- employment tax purposes Gain on the sale of an active interest in a partnership or S corporation Items which are otherwise excluded or exempt from income under the income tax law
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Capital gain from the sale of interests in partnerships and S corporations (1.1411-7) 1.The partnership or S corporation is deemed to dispose of all of the entity's properties in a fully taxable transaction for cash equal to the fair market value of the entity's properties immediately before the disposition of the partnership or S corporation interest. 2.Determine the amount of gain or loss for each property.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Capital gain from the sale of interests in partnerships and S corporations (1.1411-7) 3. “Applying the rules of chapter 1, the partnership or S corporation determines the amount of gain or loss for each property that is allocable to the interest disposed of by the transferor.” 4. Adjust out the gain attributable to non- passive property items from the total gain.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Sec. 1411 tax Running investment income through a pass-through that otherwise has trade or business income does not avoid the tax.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Net Investment Income: Itemized Deductions Taken into account to extent allowed as a deduction. Examples include: –Investment interest –Investment expenses (e.g., >2% AGI) –Income taxes “properly allocable” to gross income. Allocation based on gross income is proper (1.1411- 4(f)(3)(C) Pass-through entity disclosure isn’t addressed. Query state taxes on pass-through income (e.g. Illinois, California, Kentucky) and composite state taxes.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 3.8% Surtax – Application to Trusts and Estates 3.8% of lesser of undistributed NII for the tax year, or the excess (if any) of AGI for tax year, over the dollar amount at which highest tax bracket begins ($11,950 for 2013). –Note: If beneficiaries do not have sufficiently high MAGI and passive income such that they would not be subject to the 3.8% surtax, and are not otherwise in the highest marginal tax bracket, fiduciary should distribute the amount of AGI for trust or estate that exceeds the threshold for the top rate
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Trusts and Passive Income The IRS view is that only the trustee, acting in its capacity as trustee, can satisfy the material participation test for a trust –No regulations –The one court that has decided the issue said the IRS position is “arbitrary, subverts common sense, and attempts to create ambiguity where there is none” –Tax Court case pending.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 3.8% Surtax Critical terms: –Net investment income –Threshold amount $200,000 (single) $250,000 (MFJ) $11,950 (trusts and estates) –Modified adjusted gross income AGI (line 37 of 1040) plus net foreign earned income exclusion
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Illustration of investment income: MAGIInvestment Income Wages300,000 Interest10,000 Non-qualified Annuity20,000 403(b) annuity30,000 Gain on stock sale40,000 Gain on principal residence 800,000 Residence gain exclusion(500,000) Total700,000370,000
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Illustration of function of income threshold: MAGIInvestment Income Wages150,000 Dividends5,000 Interest15,000 403(b) annuity30,000 Gain on stock sale40,000 Passive Income15,000 Non-passive income5,000 Total260,00075,000 Tax Base10,00075,000 Tax380
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example Single taxpayer –$100,000 of salary –$50,000 of net investment income –MAGI is $150,000 –MAGI is less than threshold – no 3.8% tax
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example Single taxpayer –$0 employment income –$225,000 net investment income –MAGI is $225,000 –MAGI exceeds threshold by $25,000 –Surtax is.038 x $25,000 = $950
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example Married filing jointly –$300,000 combined salary –$0 net investment income –No surtax (wages exempt)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example MFJ –$400,000 salary income –$50,000 net investment income –Surtax applicable to $50,000 of net investment income.038 x $50,000 = $1,900
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example MFJ –$200,000 salary income –$150,000 net investment income –Excess of MAGI over threshold is $100,000 –Surtax is.038 x $100,000 = $3,800
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example Single –$200,000 investment income –$125,000 RMD from IRA –MAGI is $325,000 –Excess of MAGI over threshold is $125,000 –Surtax is.038 x. $125,000 = $4,750
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Another Example MFJ –$100,000 pension income –$150,000 IRA income –$25,000 tax-exempt interest –There is no net investment income, so no surtax
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Passive income tests 500 hours in an activity Significant participation - 100-to-500 hour activities that add to 500 hours in a year Substantially-all participation in the activity 100 hours, and as much as anyone else Materially-participated in 5 of last 10 years (or any three years for personal service businesses)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Special Rule For “Retired" Farmers Material participation in 5 years in the eight year period before you start drawing social security is evergreen.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Special rule for real estate professionals to avoid "per-se passive" treatment: threshold test 750 hours of participation in real estate trades or businesses owned, and More real estate hours than anything else.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Recharacterization Tax rules treat some otherwise passive income as non-passive, including –Land rent (under 30% of unadjusted basis depreciable) –“Self-rental” to a material participation activity
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Grouping: real estate and other items. What is an "activity?" Sec. 469(c)(7) grouping election for real estate pros Other taxpayers can group appropriate units, but must disclose groupings and cannot change absent material change in circumstances.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Grouping basics (1.469-4(d)) Rental and trade or business activities may not be grouped unless one is “insubstantial” with respect to the other. Real property rental activity cannot normally be grouped with personal property rental. You can group activities of renting from one activity to another if both activities have identical ownership.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Disclosure of groupings (Rev. Proc. 2010-13) Grouping changes must be disclosed on returns. Once made, groupings can’t be changed by taxpayer unless initial grouping was “clearly inappropriate” or there was a “material change in circumstances”. New activity groupings must be disclosed.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Special grouping election in proposed regulations (Proposed Reg. Sec. 1.469- 11(b)(3)(iv)). May regroup activities in first taxable year beginning after December 31, 2013 that they are over the income threshold and have net investment income. Taxpayers over the threshold may regroup for 2013. Taxpayers may only regroup once under this provision. Regrouping must be disclosed pursuant to 1.469- 4(e) and other regrouping rules.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Required disclosure (1.1411-7(d)) 1.A description of the disposed-of interest; 2.The name and taxpayer identification number of the entity disposed of; 3.The fair market value of each property of the entity; 4.The entity's adjusted basis in each property;
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Required disclosure (1.1411-7(d)) 5.The transferor's allocable share of gain or loss with respect to each property of the entity 6.Information on whether property was subject to the tax 7.The net amount of gain, and 8.The computation of the gain subject to the Sec. 1411 tax.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Self-rental Are "self-rentals" that are non-passive subject to the 3.8% tax as rentals? –“Self-rental” income that is not passive under the passive loss “recharacterization” rules will still be subject to the Sec. 1411 tax. Preamble Sec. 6.B(i)(b)(3)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Real estate professionals Real estate professionals get lame guidance: –If a taxpayer meets the requirements to be a real estate professional in section 469(c)(7)(B), the taxpayer's interests in rental real estate are no longer subject to section 469(c)(2), and the rental real estate activities of the taxpayer will not be passive activities if the taxpayer materially participates in each of those activities. However, a taxpayer who qualifies as a real estate professional is not necessarily engaged in a trade or business (within the meaning of section 162) with respect to the rental real estate activities.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Planning issues Affects gifting, grouping decisions. Compensation issues. If you are going to claim material participation in an S corporation or LLC, you should expect to pay wages or SE tax. Monitoring participation: if participation is even potentially iffy, the taxpayer should keep a current time diary.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Implications for Trusts Trusts threshold is the top tax rate bracket under the proposed regulations (1411(a)(2)). –Surtax applies to lesser of undistributed NII or the excess of an estate/trust’s AGI over $11,650 Regulations allocate investment income between distributed and undistributed income under usual trust allocation rules. Electing small business trusts will have to combine their S corporation and non-S corporation portions for computing the tax (Proposed § 1.1411-3(c)(1)(ii)).
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 3.8% Surtax – Planning Strategies Anything that reduces NII or MAGI will reduce or eliminate the 3.8% surtax Increase municipal bond investments Maximize qualified plan contributions Avoid spikes in income Structure farm business as a member- managed LLC –While non-manager’s interest is passive, spouse can take into account m.p. of manager-spouse
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 SUCCESSION PLANNING Volume B, Chapter 5
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Reasons Why Businesses Don’t Have Succession Plans Successor doesn’t believe that the predecessor will ever retire –Arthur Andersen survey Between 25% and 33% of leaders of family businesses don’t intend to retire or plan to remain involved throughout their lives 30-40% of family businesses have no plan in place Taboo subject –Relationships and emotions involved –Business may be founder’s self-identification –Animosity toward younger generation Primogeniture
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 OBJECTIVES OF SUCCESSION PLANNING Objectives must drive the process and must be clearly articulated
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Objectives of Succession Planning Successfully bringing the next generation into the business Providing vocation for next generation Establishing a base for a financially successful business into future Providing a plan for the older generation Providing an estate plan that is fair to business and non-business heirs Tax minimization B197
Thread Through Other Efforts Estate Planning Business Planning Succession Planning
Steps to Successful Succession Planning Determine business owner’s long-term goals and objectives Determine financial needs of business owner and spouse and develop plan assuring financial security Determine who will manage the business and develop the management plan Determine who will own the business and how to transfer owner’s interest Minimize transfer taxes and establish estate plan
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 BUSINESS ORGANIZATION STRATEGIES B198
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Single Entity Most U.S. Businesses 70 to 75% of farms and 50-60 percent of non- farm businesses
Multiple Entities OPERATIONAL ENTITY OPERATIONAL ENTITY REAL ESTATE ENTITIES REAL ESTATE ENTITIES Sole Proprietorship Partnership LLC C Corporation S Corporation __lease____ Parents’ capital Child’s capital Equipment LLC B198
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Operational Entity Typical choices include: –Sole proprietorship –General partnership –LLC –C Corp –S Corp
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Operational Entity Assets Possible to Be Placed into Business –Checkbook –Inventory –Equipment –Very Limited Real Estate
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Landholding Entities Selected entity is usually sole proprietorship or LLC Typically not wise to put real estate in corporation
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Basic Entity Choices (See Pages B199-200 for Summary Table) Sole Proprietorship General Partnership Limited Partnership Limited Liability Company Limited Liability Partnership S Corporation C Corporation Cooperatives
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Primary Considerations in Choosing Entity Form Continuity –Corporation –Sole proprietorship –General partnership Giles v. Giles Land Co. (Kan. Ct. App. 2012)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Removing a Partner Without Terminating the Partnership Giles v. Giles Land Co. (Kan. Ct. App. Jun. 15, 2012) –State partnership dissociation statute invoked to remove the “magnanimous savior of the family” Must value and buy-out his interest Note: In a limited partnership, a limited partner can assign their interest without impacting dissolution B201
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Transferability of Entity Interests Transferring entity interests rather than individual assets –Partnership interests –LLC interests Is transferred property subject to debt? What about bankruptcy exemptions? B201-202
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Flexibility Corporation – perhaps greatest in terms of management structure Partnership – look to the agreement LLC – the agreement controls –Based on state law, chance for greater creditor protection –Passive loss issue
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 LLCs and the Passive Loss Rules How is a loss characterized? –Depends on whether the taxpayer is materially participating Seven tests for material participation Per-se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in Regulations –Statute pre-dates states LLC statutes and advent of LLPs Three tests for limited partners in a limited partnership
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 LLCs and the Passive Loss Rules I.R.C. §469(h)(2) –Per-se rule of non-material participation for limited partner interests in a limited partnership, unless regulations specify differently “Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates.”
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Garnett v. Comr., 132 T.C. No. 19 (2009) Taxpayer incurred losses in LLCs and IRS characterized them as passive under the “per-se” rule Tax Court rejected IRS position –LLC is materially different than a partnership –Oregon Federal District Court had already ruled similarly based on Oregon law
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Thompson v. Comr., 87 Fed. Cl. 728 (2009) IRS position again rejected –IRS position given no deference
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Hegarty v. Comr., T.C. Sum. Op. No. 2009-153 Follows Thompson and Garnett
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Newell v. Comr., T.C. Memo. 2010- 23 Is the managing member’s interest in a California LLC that was classified as a partnership for income tax purposes a limited partnership interest for purposes of Sec. 469? –IRS said it was –Court (again) said it was not –No unforeseeable circumstance present
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Rental Activities and the Passive Loss Rules Remember, Sec. 469 disallows passive activity losses for any taxable year except to the extent they offset passive income –Rental activities are per se passive (with two exceptions) Real estate professionals (Sec. 469(c)(7)) $25,000 annual deduction if AGI $150,000 or less (Sec. 469(i))
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Rental Pros Losses fully deductible if material participation present But, what is a real estate pro? –More than 50% of personal services performed in trades or businesses by taxpayer during year must be performed in real property trades or businesses in which taxpayer materially participates –750-hours in real property trades or businesses in which taxpayer materially participates
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Chambers v. Comr., T.C. Sum. Op. 2012-91 Real estate professional test invoked –750 hours –More than 50% test IRS said petitioner’s hours spent in LLC management activities didn’t count –Court disagreed based on Garnett
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Limited and General Partnerships Prop. Treas. Reg. (Nov. 25, 2011) –For purposes of passive loss rules, focus is on whether taxpayer has right to participate in management at any time during tax year
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Organizational Options Self-Employment Tax –If an LLC is not conducting a business, there is no self-employment income. –If an LLC is conducting a trade or business, then self-employment income results, unless the limited partnership exception exists (Sec. 1402(a)(13)).
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Liability Sole proprietorships and general partnerships –Unlimited liability LLCs and corporations –Limited liability –Tax issues typically drive the decision –Charging orders (B203) Example 2 B202
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Liquidation Costs C Corp –Highest liquidation cost –Distributions in excess of stock basis result in capital gain S Corp –Others LLC –Distribution of assets on tax-free basis Discounting of Business Interests B204
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Organizational Considerations Income tax considerations –Double level tax for corporations other than S corporations –Recognition of gain on liquidation for S corporation liquidating distributions §311(b) –Flow-through tax considerations with no or limited gain recognition on liquidation for partnership- type entities LLCs LPs GPs, etc. B206
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 What To Consider Before Making S Election Unused NOLs of C corporation cannot be used by S corporation to offset future S corporation income S corporation compensation issues –Payment of “reasonable” wages Payroll tax issue –Watson case –No cases involving issue of reasonable compensation where salary at least at FICA wage base
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Using an S Corp. To Minimize FICA & Medicare Tax Watson, 668 F.3d 1008 (8th Cir. 2012) –Taxpayer earned 200,000 in 2002 and 2003 from CPA business but paid himself annual salary of 24,000 (firm established as a partnership of S corporations) Court reclassified about $67,000 of S corp. dividends as salary for each year resulting in about $91,000 of FICA/Medicare wages B206
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 S Corporation Tax Fails (Again) S. 2343 –Would have applied payroll tax to taxpayers with income over $250,000 by requiring them to include for payroll tax purposes income received from an S corporation or L.P. interest in professional services business where 75 % or more of gross revenue derived from services of three or fewer shareholders
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 S Corporation Disproportionate Distributions Can make disproportionate distributions to correct disproportionate distributions –PLR 201236003 (Apr. 11, 2012) B207
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 S Corp. Debt Basis Regs. How to increase basis: –Bona fide debt –Circular loans can work –Guarantees don’t work unless shareholder actually makes payment –Unsecured promissory note doesn’t work
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Fringe Benefits Health Insurance and retirement plans –Tax distinctions between various entities Qualified retirement plan options B207
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Valuation Discounting FLPs –No recognition of gain or loss for FIT purposes to either the party making the transfer or to the entity. Sec. 721(a) –Change in theoretical basis for fractional interest. Interests in farmland if held by more than one person may qualify for fractional interest discounts. –Take the FMV of the land as a whole and subtract the estimated costs of a partition action divided by the percentage of land held –Once land is held by an entity, the valuation of units will be subject to normal lack of marketability, minority interest discounts and (perhaps) a control premium B210
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Valuation Discounting FLPs –Change in status of property for state law purposes Real estate of real property is normally sitused for purposes of state death tax statutes to the place where the land is located –Result not normally changed even if the land is held by a revocable trust –NOTE: LLC interests are generally personal property and personal property is generally sitused to the decedent’s state of residence
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Family Limited Partnerships Keller, et al. v. United States, No. 10-41311, 2012 U.S. App. LEXIS 20119 (5th Cir. Sept. 25, 2012) –In 1998, $300 million transferred into revocable trust. FLP later created but not community property bonds that were to fund it not transferred before wife died on 5/15/00. Estate paid over $147 million in estate tax in 2/01 FLP funded post-death FLP funding meant that estate didn’t have funds to pay estate tax; transaction restructured as $114 million loan and estate issued promissory note at Feb. ‘01 AFR Estate filed claim for refund in 11/01
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Keller v. United States (5th Cir. Sept. 25, 2012) Grounds for refund claim: –Failed to claim discount –Failed to claim deduction for interest paid on loan Estate wins –Under TX law, the intent to transfer the bonds to the FLP was sufficient – refund of $115 million
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Current Developments in Estate and Business Planning Family limited partnerships (FLPs) –Estate of Wimmer Making sure gifts of FLP interests qualify as present interests even where restrictions present –Right to income from the interests –FLP generated income from its investments –Some portion of the income would flow to donees on consistent basis –Amount flowing to donees could be ascertained
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 You Can’t Take a 40% Discount on a 100% Interest Estate of Lockett –Mrs. Lockett moved into an assisted living facility when her health began to decline and formed an FLP and funded it two years later with cash and marketable securities from her trust and her personal assets. Trust later dissolved, and Mrs. Lockett became sole owner of the partnership. Two sons listed as general partners in the agreement, but the sons never contributed any assets, and their interests were listed as 0 in the agreement.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate of Lockett After the funding of the partnership, the partnership made loans to some of the children – many of which were documented in loan agreements with no terms on the principal payment, but with interest payments set up. The partnership also purchased some rental property and Mrs. Lockett kept some assets out of the partnership to care for herself.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate of Lockett Estate filed a tax return and claimed 40% discount on the partnership assets Two issues at trial, –Whether Mrs. Lockett held the assets individually or in the partnership; and –Whether the loans were gifts or loans.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate of Lockett Court found no evidence of property contributed by the two sons or gifts of partnership interest to the two sons. After the dissolution of the trust, Mrs. Lockett directly owned 100% of the partnership –FLP agreement supplemented that observation because it provided that if a partner acquired all the interests of the other partners, the partnership would dissolve. –Court ultimately found that the assets belonged to the estate, so no discounts were justified.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate of Turner Transferred FLP assets were included in the decedent’s gross estate. Court also addressed the issue of whether the decedent’s payment of life insurance policy premiums were subject to the annual exclusion under Section 2503(b).
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Estate of Turner Sloppy Crummey gifting –Decedent was grantor of irrevocable life insurance trust that had purchased three separate life insurance policies. –In 2000-2003, the decedent paid the insurance premiums directly from a joint checking account instead of transferring money to the trustees to pay the premiums. IRS included the premiums paid on the life insurance policies in the estate’s total adjusted taxable gifts. Tax Court held that the premium payments were a gift of a present interest and were subject to the annual exclusion under Section 2503(b) – beneficiaries had “right to demand withdrawals from the trust”
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Other FLP Issues Estate of Stone and Estate of Kelly –Survive attack –Bona fides Creation of family asset to be managed by family Transferors not dependent on distributions from FLP No commingling of personal and partnership funds No discounting of interests claimed Transferors in good health at time of transfer No evidence of implied agreement
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 HEIRS NOT IN THE BUSINESS How to achieve equitable treatment B213
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Heirs not in the Business Usually not wise to involve non-business heirs in day-to-day operations –Often do not distribute any income –Operational business may have day to day decisions that do not match objectives of business heirs –Ownership usually small compared to on business heirs –Little incentive for business heirs to buy out interest of non-business heir Value of non-business heir’s minority interest has severe value discount
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 How to Treat Non-Business Heirs Inheritance or gift Beneficiaries or life insurance Beneficiaries of retirement plans Acquire interest in business real estate –Possibly in conjunction with gifting
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 How to Treat Non-Business Heirs The non-business heir may not be distributed an equal share in the value of assets If non-business heir were to receive real estate –Subject to long term rental contract in favor of business heir’s business –Subject to purchase options favoring business heir –Placed into an entity in which either all heirs are co-owners
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 How to Treat Non-Business Heirs Seldom is it recommended that real estate be inherited by children as tenants in common –Joint decision making difficult –Each co-owner has power of partition –Usually no structured buy-out provision –Often questions of rights of possession
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Other Ways to Minimize Estate Tax? “Charitable Lid” Planning –An estate plan is created where the testator leaves a set dollar amount of the estate to the children with the residuary estate passing to a charitable organization. The portion passing to the charity qualifies for the estate tax charitable deduction and, thus, puts a lid on the amount of estate tax owed B214
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 “Charitable Lid” Planning Attractive technique when combined with hard to value assets such as business interests or family partnership interests Good way to defeat an IRS audit –If IRS challenges the valuation of assets on audit, any increase in value on audit does not increase the estate tax due – it simply passes to the charity B214
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 “Charitable Lid” Planning Key case – Christiansen v. Comr., 130 T.C. No. 1 (2008) –Decedent owned cattle ranches in South Dakota with her husband. He died in 1986 and she continued to operate the ranches until her death in 2001. Her entire estate passed to her daughter, but the will said she could disclaim all or any portion of her inheritance, with the disclaimed property passing 75 percent to a CLAT and 25 percent to a private foundation
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Christiansen Case Daughter filed a disclaimer. Largest asset in estate were FLP interests that carried out valuation discounts. –With discounts, decedent’s estate was just over $6.5 million –Daughter’s disclaimer resulted in the foundation and the CLAT receiving about $140,000 –IRS audited and increased FLP interests by about 35% - but that resulted in more property passing to charity and no increase in estate tax Daughter did not retain a continuing interest in the CLAT after the disclaimer, so no charitable deduction
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Christiansen Case IRS appealed the portion of the decision allowing the enhanced deduction for the amount passing to the foundation –Attacks the disclaimer: Any amount passing to the charity was contingent on a condition subsequent (i.e., the Service’s ultimate determination of value of the decedent’s estate) Adjustment clause in disclaimer should be declared void on public policy grounds – discourage them from examining estate tax returns –Court disagreed with IRS (586 F.3d 1061)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Petter v. Comr., T.C. Memo. 2009-290 Court upheld a defined-value gift tax clause and rejected IRS’ policy-based argument –UPS stock in LLC transferred to IDGTs and charities, with split determined by formula –IRS tried to negate defined-value clause based on policy reasons, but court determined that gift was of ascertainable value of stock rather than a specific number of shares or percentage interests in LLC 9th Circuit affirmed on appeal (Aug. 4, 2011)
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Hendrix v. Comr., T.C. Memo. 2011-133 Court approved transfers with “defined value” formula provisions to limit gift tax exposure from the transfers –Transfer of closely held stock in a gift/sale transaction to family trusts and gift to Foundation under coordinated formula provisions was at arm’s length and not contrary to public policy –Clause at issue allocated stock between family trusts and Foundation based on values as determined by IRS willing buyer/willing seller test
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Wandry v. Comr., T.C. Memo. 2012-88 Facts: –Married couple gifted membership units in LLC to children and grandchildren; transfers made in accordance with dollar value of gifts and were determined by a fraction (numerator was state dollar amount and denominator was value of entire company as determined by IRS or court) –IRS claimed gifts were of fixed fractional interests in LLC and, as a result, LLC unit value understated; court determined that defined value clause reallocated LLC membership units among parties in conformance with formula in which unit value as of transfer date was "unknown constant“ –IRS lost –Appealable to 10 th Cir. [Appeal docketed on Aug. 28] –Case settled in late October –IRS issued non-acquiescence on Nov. 9, 2012
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Estate/Remainder Arrangements Handling Allocated Basis –Example: At death, Sam leaves $500,000 of securities to his wife, Sara for life, with the remainder passing to his son, Sid. Sara is 48 at the time Sam dies. Under 20.2031-7A(c), the life estate factor for a female age 48 is.77488 and the remainder is.22512. Thus, the present value of the portion of the uniform basis assigned to Sara’s life interest is $387,440, with $112,560 assigned to Sid. Sara sells her life interest to her nephew, Seth, for $370,000 while she is still 48. Sara does not realize a loss (Sec. 1001(e)) and her gain is $370,000. Seth’s basis is $370,000 which is recoverable by amortization over Sara’s life expectancy B225
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Estate/Remainder Arrangements Handling allocated basis –Example: Same facts, except that Sara retains the life interest until age 60 and then sells it to Seth when the securities are worth $650,000. The life estate factor for Sara is.63226 and the remainder factor is.36774. So, the present value at the time of the sale assigned to Sara’s interest is $316,130 and the present value assigned to Sid’s interest is $183,870. Sara sells her interest for $410,969 ($650,000 x.63226). Her gain is the amount realized, and Seth’s basis is $410,969.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Estate/Remainder Arrangements Handling allocated basis –Example: Larry died at age 39 owning a pasture worth $18,800 at the time of death. The land is devised to Lance for life, remainder to Lisa (unrelated). Shortly after Larry’s death, Lance sells his life estate, Lance and Lisa jointly sell the entire property to Loraine for $25,000 and divide the proceeds equally. The remainder factor for a 39 year old male is.20146, thus the present value of the uniform basis assigned to Lisa’s remainder interest is $3,787.45. On sale, Lance realizes a loss of $2,512.55 ($15,212.55 - $12,500) [this is the portion of uniform basis not disregarded] and Lisa’s gain is $8,712.55 ($12,500 - $3,787.45). Loraine’s basis in the entire property is $25,000 (none recoverable by amortization deductions over Lance’s lifetime.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts The GSTT –Tremendous planning opportunity through balance of 2012 to fund GSTT trusts –Watch for Administration’s continued attempts to limit planning opportunities Limitation on GRATs Elimination of valuation discounts via FLPs B226
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 The GSTT Clearly of interest to wealthy clients Don’t overlook GSTT trusts for clients with more modest wealth May not be of interest for small estates
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Avoidance of transfer taxes for multiple generations Lasts as long as allowed by maximum term allowed by local law
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Mechanics –Irrevocable trust –Spendthrift provision –Initial funding tied to grantor’s transfer tax exemption Take note of the net investment return possible with enhanced exemption through 2012
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Tax aspects –Not subject to GSTT if grantor allocates sufficient GSTT exemption to make inclusion ratio zero Must elect to allocate exemption to transfers Need to preserve GSTT inclusion ratio for any additional property transferred to the trust B227
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Tax aspects –Treated as an irrevocable trust Initial funding subject to gift tax and will use up grantor’s unified credit to extent of excess over present interest annual exclusion
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Can be structured as grantor trust –Income accumulated tax-free –During settlor’s lifetime, settlor taxed on trust income and gains –How to achieve grantor trust status: Trust terms give discretion over distributions of income and principal that can be exercised by majority of trustees that are related or subordinate to settlor B229
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Trust Term Tied to state’s rule against perpetuities –Establish situs in state with relaxed or no rule Trust term should so state Appoint trustee located in jurisdiction with favorable rule –Works for personal property –Real property governed by law of state where located
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Trustee considerations –Important to select carefully Consider limitations on trustee’s exercise of power What is the process for replacing a trustee B230-231
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Dynasty Trusts Trustee as a fiduciary? –Most courts require that trustee must commit serious breach before removal will be allowed –Statutory procedures may apply –UTC provision does not focus on trustee conduct –Trustee retained powers and tax issues
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Structure of the Trust Commonly drafted as spendthrift trust so as to provide asset protection –Beneficiary cannot assign or transfer or encumber an interest in net income or principal of trust No creditor attachment until distribution –Trustee has absolute discretion over distributions B230
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 The Use of Life Insurance as a Succession Planning Tool General Comments –Tax favored status –What if estate tax (and stepped-up basis) is repealed –If in ILIT, death benefits not subject to FET or GSTT B232
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Insurance Benefits of life insurance in business succession process –Estate liquidity and asset preservation Ownership in ILIT Proceeds payable to business owner’s estate via loans or buying assets from estate at FMV ILIT could buy decedent’ s business interest at discount –Freeze accomplished –Cash received by surviving spouse could be gifted to non-business heirs and/or fund ILIT for benefit of non- business heirs
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Benefits of Life Insurance Wealth replacement Estate equalization Fund a buy-sell Tax hedge Retirement income Fund stock redemption Liquidity NQDC
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Benefits of Life Insurance Key-person insurance GRATs Asset protection planning Private annuities and SCINS Family bank
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 GRATs and GRUTs Types of irrevocable trusts Established for a fixed term of years and the donor/grantor retains an income right –Stated amount paid to donor/grantor annually during term of trust Upon termination, the trust fund is paid to the holders of the remainder –GRAT: income interest is a fixed sum of dollars determined at the outset of the trust, payable annually –GRUT: Grantor/holder receives amount equal to fixed percentage of FMV of trust. Percentage is fixed at time GRUT created. FMV of GRUT is determined annually
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Charitable Lead Annuity Trusts Similar to a GRAT, but charity receives the annuity during the CLAT’s term of years –Remainder passes to donor’s family at a reduced gift tax value determined at outset of the trust –Donor receives charitable income tax and gift tax deduction for the annuity
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Qualified Personal Residence Trusts Gifting technique that can be utilized to transfer house (usually a vacation home – but can be primary residence) to donor’s children at a discounted value –It’s an irrevocable trust to which the house is transferred and donor reserves right to live in the house for a term of years, with either the children owning the house outright at donor’s death or in trust –Grantor trust –If house sold, QPRT can be converted to GRAT
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 ILITS Basic planning points –Death benefits held at death Allows use of grantor’s gift tax exemption and GSTT exemption amount Multiple beneficiaries can have interest in death benefits Draft with flexibility in mind B233
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 ILITS – Accomplishing Flexibility Donor powers –Change beneficiaries that will receive Crummey powers –Use tiered Crummey powers –Beneficiaries holding contingent remainders can have a vested interest in ILIT
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 ILIT Drafting Provisions 5 and 5 power applied to entire ILIT Ordering rule for donee holding mutiple withdrawal rights Special powerholder with limited power to appoint trust property during grantor’s lifetime
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Beneficiary Powers Testamentary limited powers of appointment in beneficiaries Power of grantor, grantor’s spouse and beneficiaries to change trustee
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Trustee Powers Discretion to satisfy Crummey notice requirements Crummey powers satisfied against all trust property Allow trustee to appoint guardian for minors likely to receive Crummey withdrawal right
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Corporate Buy-Sell Agreements Entity purchase agreement –Contract between stockholders and corporation Cross purchase agreement –Contract between stockholders Hybrid agreements –Contract between corporation and stockholders whereby stockholders agree to offer their shares first to the corporation and then to other stockholders B234
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Advantages of Buy-Sell Agreements Prevention of the sale of stock outside the family unit Relatively simple Creates a ready market for the stock –Remedies a liquidity problem –Can help set a value for stock
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Disadvantages of Buy-Sell Agreements Hybrid type agreement may pose difficult tax issue –Must meet technical requirements of Sec. 302(b) or Sec. 303 Less tax problems with cross-purchase agreements B236
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Buy-Sell Agreement and Life Insurance Provides funds to cover purchase price or down payment –Premiums not deductible and can cause ongoing expense
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Other Post-Mortem Issues Buy-out of deceased shareholder’s stock could jeopardize estate’s making Sec. 6166 election –Watch acceleration of deferred taxes Planning around this? Buy-sell could trigger gift of stock to trust for surviving spouse not to qualify for marital deduction –Rinaldi case
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Funding a Buy-Sell Life insurance often funds if death is triggering event –Proceeds received by beneficiary without income tax liability
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Funding a Buy-Sell Problems with life insurance –If proceeds received by C corporation can increase C corporation’s AMT liability by increasing C corporation’s current earnings –May not be sufficient to fund lifetime redemption caused by stockholder’s disability or retirement B237
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Funding a Buy-Sell Accumulated earnings –May not be a “reasonable need of the business” and, thus, could subject corporation to accumulated earnings tax
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Funding a Buy-Sell Buy enough permanent life insurance to fund post-mortem buyouts, obtain debt financing to pay for stock bought other than at death, with use of excess of postmortem purchase price over insurance death benefit to pay off loan
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Income Tax Treatment Cross-purchase agreement –Gain is capital gain regardless of character of corporation’s underlying assets (unless shareholder is dealer in stock) –If estate sells stock shortly after shareholder’s death, no gain recognized if agreement sets sales price at date of death value –Purchasing shareholders increase basis in total holdings of corporate stock by price paid for shares purchased via agreement B236
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Income Tax Treatment Redemption agreement –Must satisfy Secs. 302 or 303 to avoid dividend treatment Big potential problem for post-mortem redemptions
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Income Tax Treatment Hybrid agreement –Corporation must redeem only as much stock as qualifies for sale or exchange treatment under Sec. 303, and other shareholders must buy balance of available stock.
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Income Tax Treatment “Wait and See” agreement –Definition –Alternative approach –Combination for funding
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Top Ten Developments in Agricultural Law* Roger A. McEowen** ________ *Presented at the National Farm Business Management Conference, Overland Park, Kansas, June 10, 2013. **Director, Center for Agricultural Law and Taxation, Ames, Iowa
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Contact Information mceowen@iastate.edu (515) 294-5217 www.calt.iastate.edu
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 10 Court tosses out EPA’s pollution rule –EME Homer City Generation, L.P. v. Environmental Protection Agency, et al. (D.C. Cir. Aug. 21, 2012) EPA was in the process of promulgating four new pollution rules to diminish the coal industry Court struck down the Cross-state air pollution rule – a cap and trade styled program to expand existing limitations on sulfur dioxide and nitrogen dioxide emissions from coal-fired power plants in 28 “upwind” states. –EPA claimed it had authority to cap emissions that supposedly travel across state lines –EPA admitted that rule would cost $2.7 billion and force many coal-fired power plants to close. Seven states sued and court ruled that EPA exceeded its authority under CAA –Upwind states can only be required to reduce their own significant contributions to downwind state’s non-attainment, not any more –EPA departed from its own past approach to implementing good neighbor provision –The litigation could have been avoided, but the U.S. Senate, in 2011 defeated a resolution to nullify the rule –On Jan. 24, the court denied the Administration’s request for a full court review of the ruling
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 9 Defined value clause upheld where no charitable beneficiary involved –Wandry v. Comr., T.C. Memo. 2012-88 IRS revaluation served to reallocate interests in excess of the defined value to the original donor Tax Court provided roadmap of points to follow when implementing a defined value clause Donors made fixed dollar gifts of family LLC units –Good approach for gifting business interests of large value and those that are difficult to value
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 8 Reasonable compensation in the S corporation context –David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012) Income can be extracted from S corporation in form of wages and in distributions (dividends) –Wages are subject to self employment tax –Dividends are not subject to self employment or payroll tax Case instructive on what is a reasonable compensation
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 7 Special use valuation regulation invalidated (again) –Finfrock v. United States, 860 F. Supp. 2d 651 (C.D. Ill. 2012) 25% test IRS regulation created requirement not contained in statute IRS regulation invalid even under greater deferential standard Important planning implications
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 6 Pesticide drift not a trespass –Johnson, et al. v. Paynesville Farmers Union Cooperative Oil Co., 817 N.W.2d 693 (Minn. 2012) A trespass requires a physical invasion Can pesticide drift constitute a physical invasion? –MN Court of Appeals said “yes” –MN Supreme Court reversed »No evidence presented of whether drift reached EPA threshold of 5 percent »Must have an intentional and direct physical and tangible entry – spray drift doesn’t count »Nuisance and negligence appropriate remedies »Plaintiffs caused their own damages
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 5 Wetlands and Swampbuster –Sackett v. Environmental Protection Agency, 132 S. Ct. 1367 (2012) Sec. 404 of Clean Water Act EPA “compliance order” technique freezes landowner in place until permit obtained –No right to hearing or ability to get judicial review because compliance order not “final agency action” – so no appeal rights –Landowner had no way to force EPA to take action Supreme Court unanimously rejected EPA’s argument
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 5 Swampbuster –Maple Drive Farms Family Limited Partnership v. Vilsack (W.D. Mich. Dec. 13, 2012) 2.24 acre tract drained in 1964 and crops grown through 1982 Drainage deteriorated Plaintiff later wants to again grow crops Status of land as of December 23, 1985 controls
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 4 Chapter 12 Bankruptcy Taxation –Hall v. United States, 132 S. Ct. 1882 (U.S. 2012) 2005 BAPCPA provision –Not applicable to post-petition taxes because no separate bankruptcy estate from the debtor –Pre-petition taxes covered by the new rule
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 3 Constitutional Takings Developments –The Edwards Aquifer Authority v. Day, 369 S.W.3d 814 (Tex. 2012) Groundwater and oil and gas deposits are subject to the rule of capture Historic use – what if groundwater hasn’t been used in the past? Land ownership includes “in-place” groundwater
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 3 Arkansas Game & Fish Commission v. United States, (U.S. Sup. Ct. Dec. 4, 2012). –Recurrent flooding, even of finite duration, are not categorically exempt from Takings Clause liability
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 2 Individual mandate provision of health care law upheld as “tax” –National Federation of Independent Business v. Sebelius, 132 S. Ct. 2566 (2012) Individual mandate unconstitutional under the Commerce Clause It is constitutional as a tax
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Development No. 1 Uncertainty caused by expiring tax legislation –House passed H.R. 8 during summer 2012, but Senate refused to take it up until later December 2012 –Delay created major uncertainty in tax, estate and business planning –New law makes “permanent” many provisions of the 2001 law –Tax increase for all wage earners and other “high” income taxpayers
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 The article detailing all of these developments from 2012 can be found on the CALT Website homepage –www.calt.iastate.edu
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Insurance Demutualization Dorrance (D. Ariz. Mar. 19, 2013) –Plaintiff’s basis in stock comprised of fixed component for giving up voting rights and 60 percent of variable component representing past contributions to surplus Basis was slightly over 60 percent of stock value 9-10
2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Life Insurance Demutualization Reuben v. United States, No. CV 11-09448 SJO (PJWx) (C.D. Cal. Jan. 15, 2013) –Plaintiff failed to establish that any of the premiums paid were for membership rights in insurance company Consequently, plaintiff did not have an income tax cost basis in share of stock issued on demutualization when shares eventually sold in 2005 Plaintiff failed to offer evidence of purchase price paid for membership rights in particular as opposed to policy as a whole; thus, plaintiff failed to satisfy proof burden that income tax basis other than zero. Facts of case distinguishable from those in Fisher, et al. v. United States, 82 Fed. Cl. 780 (2008)).
providing timely, critically objective information to producers, professionals and agribusinesses concerning the application of important developments in agricultural law and taxation 2321 N. Loop Drive, Suite 200  Ames, IA 50010 (515) 294-5217 Thank You! mceowen@iastate.edu (515) 294-5217 www.calt.iastate.edu
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American Taxpayer Relief Act of 2012 John Kilroy, CPA, CFP ® January 23, 2013. About project