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William Byrnes (Texas A&M) tax & compliance articles

TaxFacts Intelligence Weekly

Posted by William Byrnes on December 3, 2018


TAX DEVELOPMENTS

SEC Announces New Disclosure Requirements for Variable Annuities and Life Insurance 
The SEC recently proposed a rule change designed to improve disclosures with respect to variable annuities and variable life insurance contracts. The new disclosure obligations would help investors understand the features, fees and risks to these types of products in an effort to allow investors to make more informed investment decisions. Under the proposal, annuity and life insurance carriers would be entitled to provide information to investors in a summary prospectus form that would provide a more concise summary of the terms of the contract. For more information on variable annuities, visit Tax Facts Online and Read More.

Digging Into the Details of Hardship Distributions for Primary Residence Purchases
Qualified plans can to allow participants to take hardship distributions to help with the purchase of a primary residence. The distribution must be directly taken to purchase the residence–items such as renovations made prior to move-in do not qualify. Despite this, the distribution can cover more than just the purchase price of the residence itself. Closing costs would also qualify, as would the cost of a piece of land upon which the primary residence would be built. If a participant buys out a former spouse’s interest in a jointly-owned home pursuant to divorce, the distribution would also qualify. For more information on the hardship distribution rules, visit Tax Facts Online and Read More.
Avoiding Gift Tax Traps This Holiday Season
Most taxpayers believe that they are not required to file a gift tax tax return if they do not owe gift taxes–as many will not because of the current $11.18 million gift tax exemption will shield most donors from gift tax liability. Despite this, each gift made during a donor’s lifetime serves to reduce that $11.18 million amount, which applies both to lifetime gifts and transfers made at death. Taxpayers must file Form 709 to report taxable gifts in excess of the annual exclusion amount to avoid potential IRS penalties for failure to file a return. The form is required not because gift taxes are owed, but to provide the IRS with a mechanism for tracking any given taxpayer’s use of the exemption amount during life. For more information on the gift tax filing requirements, visit Tax Facts Online and Read More.

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IRS provides tax inflation adjustments for tax year 2019

Posted by William Byrnes on November 23, 2018


The Internal Revenue Service was very late (only on November 15) in announcing the tax year 2019 annual inflation adjustments for more than 60 tax provisions, including the tax rate schedules and other tax changes. Revenue Procedure 2018-57 provides details about these annual adjustments. The tax year 2019 adjustments generally are used on tax returns filed in 2020.

The tax items for tax year 2019 of greatest interest to most taxpayers include the following dollar amounts:

  • The standard deduction for married filing jointly rises to $24,400 for tax year 2019, up $400 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $12,200 for 2019, up $200, and for heads of households, the standard deduction will be $18,350 for tax year 2019, up $350.
  • The personal exemption for tax year 2019 remains at 0, as it was for 2018, this elimination of the personal exemption was a provision in the Tax Cuts and Jobs Act.
  • For tax year 2019, the top rate is 37 percent for individual single taxpayers with incomes greater than $510,300 ($612,350 for married couples filing jointly). The other rates are:

o 35 percent, for incomes over $204,100 ($408,200 for married couples filing jointly);

o 32 percent for incomes over $160,725 ($321,450 for married couples filing jointly);

o 24 percent for incomes over $84,200 ($168,400 for married couples filing jointly);

o 22 percent for incomes over $39,475 ($78,950 for married couples filing jointly);

o 12 percent for incomes over $9,700 ($19,400 for married couples filing jointly).

o The lowest rate is 10 percent for incomes of single individuals with incomes of $9,700 or less ($19,400 for married couples filing jointly).

  • For 2019, as in 2018, there is no limitation on itemized deductions, as that limitation was eliminated by the Tax Cuts and Jobs Act.
  • The Alternative Minimum Tax exemption amount for tax year 2019 is $71,700 and begins to phase out at $510,300 ($111,700, for married couples filing jointly for whom the exemption begins to phase out at $1,020,600). The 2018 exemption amount was $70,300 and began to phase out at $500,000 ($109,400 for married couples filing jointly and began to phase out at $1 million).
  • The tax year 2019 maximum Earned Income Credit amount is $6,557 for taxpayers filing jointly who have three or more qualifying children, up from a total of $6,431 for tax year 2018. The revenue procedure has a table providing maximum credit amounts for other categories, income thresholds and phase-outs.
  • For tax year 2019, the monthly limitation for the qualified transportation fringe benefit is $265, as is the monthly limitation for qualified parking, up from $260 for tax year 2018.
  • For calendar year 2019, the dollar amount used to determine the penalty for not maintaining minimum essential health coverage is 0, per the Tax Cuts and Jobs act; for 2018 the amount was $695.
  • For the taxable years beginning in 2019, the dollar limitation for employee salary reductions for contributions to health flexible spending arrangements is $2,700, up $50 from the limit for 2018.
  • For tax year 2019, participants who have self-only coverage in a Medical Savings Account, the plan must have an annual deductible that is not less than $2,350, an increase of $50 from tax year 2018; but not more than $3,500, an increase of $50 from tax year 2018. For self-only coverage, the maximum out-of-pocket expense amount is $4,650, up $100 from 2018. For tax year 2019, participants with family coverage, the floor for the annual deductible is $4,650, up from $4,550 in 2018; however, the deductible cannot be more than $7,000, up $150 from the limit for tax year 2018. For family coverage, the out-of-pocket expense limit is $8,550 for tax year 2019, an increase of $150 from tax year 2018.
  • For tax year 2019, the adjusted gross income amount used by joint filers to determine the reduction in the Lifetime Learning Credit is $116,000, up from $114,000 for tax year 2018.
  • For tax year 2019, the foreign earned income exclusion is $105,900 up from $103,900 for tax year 2018.
  • Estates of decedents who die during 2019 have a basic exclusion amount of $11,400,000, up from a total of $11,180,000 for estates of decedents who died in 2018.
  • The annual exclusion for gifts is $15,000 for calendar year 2019, as it was for calendar year 2018.
  • The maximum credit allowed for adoptions is the amount of qualified adoption expenses up to $14,080, up from $13,810 for 2018.

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Tax Facts was first published in 1951 in a slim, 137-page volume covering the income, estate and gift tax aspects of life insurance and annuity ownership, titled Tax Facts on Life Insurance. Since that first year, the breadth and depth of Tax Facts coverage has grown to include employee benefits, business continuation, individual and qualified retirement plans, as well as decades of hard-to-find rulings and clarifications of longstanding regulations.  In 1983, Tax Facts grew to two volumes, with the second covering investments of all types: stocks, bonds, mutual funds, real estate, and the tax requirements related to each. What began as a 234-page book grew rapidly as tax reform in the 1980s multiplied the rules covering the treatment of investments.

In 2010 Tax Facts expanded to its current 4 volume and online format.  In its 67-year history, Tax Facts has become the financial advisor industry’s standard for clear, up-to-date thorough tax information. Now in an all-inclusive online format, every answer, ruling and table is easier than ever to find.

Tax Facts is the place I go to find the answers to those tough life insurance questions that no one else has – and to check those they do. It’s THE SOURCE for authoritative income, estate, and gift tax information on life insurance and annuity contracts.”

Posted in Estate Tax, Retirement Planning, Taxation | Tagged: , , , | Leave a Comment »

TaxFacts Intelligence Weekly Nov 16th

Posted by William Byrnes on November 16, 2018


IRS Releases Guidance on Impact of Personal Exemption Suspension on Premium Tax Credit
The 2017 tax reform legislation suspended the personal exemption for tax years beginning after 2017 and before 2026. Relatedly, taxpayers are entitled to claim the Affordable Care Act premium tax credit with respect to an individual if the taxpayer has claimed an exemption with respect to that taxpayer (i.e., the personal or dependency exemption). A taxpayer is entitled to claim the premium tax credit with respect to another individual if the taxpayer would otherwise be entitled to claim a dependency exemption with respect to that individual, and includes the individual’s name and TIN on his or her Form 1040. For more information, visit Tax Facts Online and Read More.
OTHER IMPORTANT DEVELOPMENTS

Grandfathering Potential May Still Exist Under Section 162(m) Post-Regulations
The IRS regulations governing the new limitations on the Section 162(m) executive compensation deduction limits may have curtailed grandfathering opportunities that some had expected under the new tax law, but possibilities still remain. The test for determining whether grandfather treatment is permitted involves whether the company was legally obligated to pay the compensation under state law (meaning contract law) as of November 2, 2017. For more information on the new rules governing the deductibility of executive compensation, visit Tax Facts Online and Read More.

LITIGATION WATCH

Tax Court Rules Business-Provided Life Insurance Taxable to Insured Individual Under Split Dollar Rules
The Tax Court recently ruled that the “economic benefit” of business-sponsored life insurance provided to a key employee through a multiple-employer welfare benefit fund was taxable income to the employee. The Tax Court agreed with the IRS that this structure required current income inclusion under the split dollar life insurance principles, so that the economic benefit received by the employee was required to be included in his gross income for the year in question despite the fact that no actual cash benefits were received during that year. For more information on the rules governing split dollar life insurance, visit Tax Facts Online and Read More.

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TaxFacts Intelligence Weekly (Nov 2)

Posted by William Byrnes on November 2, 2018


TAX REFORM DEVELOPMENTS by William Byrnes & Robert Bloink

IRS Guidance Provides Market Discount Not Included Under Section 451
The IRS has released guidance on the treatment of market discount under the new accounting rules created by the 2017 tax reform legislation. For accrual basis taxpayers, income must be included in gross income when all events have occurred to fix the right to the income and the amount can be determined with reasonable accuracy. Post-reform, this “all events test” is satisfied when the taxpayer takes the item into account as revenue on an applicable financial statement. For more information on the rules governing accrual-based accounting post-reform, visit Tax Facts Online and Read More.

OTHER TAX REFORM DEVELOPMENTS

IRS Releases New Model Notice Implementing Tax Reform Rollover Changes for Safe Harbor Retirement Plans
The IRS has released a new safe harbor model tax notice under IRC Section 402(f), which is important for plans that use these notices for eligible rollover distributions (however, alternative notice formats should also be updated). The model notice incorporates the new rollover deadline for qualified plan loan offsets–the deadline has been extended from 60 days to the taxpayer’s tax filing deadline. The new self-certification procedures for waiver of the 60-day rollover deadline are also reflected in the notice (these were introduced in 2016) For more information on the rules governing qualified plan rollovers, including tax reform’s changes, visit Tax Facts Online and Read More.

Tax Court Finds Capital Gain Income Counted in Determining Premium Tax Credit Eligibility Although the Affordable Care Act (ACA) rules may seem to have taken a back burner following the repeal of the individual mandate, most ACA provisions remain in force and clients continue to claim the premium tax credit. A recent Tax Court summary opinion highlights the importance of continuing to understand the ACA rules. In the case, a taxpayer’s gross income from most sources was very low, allowing the taxpayer and her son to qualify for premium tax credit assistance. However, to make ends meet, they sold several of their personal belongings in the same year, generating capital gain income. Because the capital gain income exceeded 400% of the poverty line, they were required to repay all advance premium tax credit payments. For more information on the premium tax credit, visit Tax Facts on Individuals and Small Business Online and Read More.
LITIGATION WATCH

Court Rules Stock in Former Parent No Longer Qualified as “Employer Securities” for ERISA Purposes
A district court in Texas recently ruled that stock in a former parent ceased to qualify as an “employer security” following a spinoff, so that the ERISA exemption from the duty to diversify investments and the duty of prudence no longer applied. The plan at issue was a defined contribution plan that also contained an employee stock ownership plan (ESOP), which was formed after a spinoff. The plan held both newly issued employer stock, as well as stock in the former parent company that was transferred from an old plan. The court rejected the defendants’ argument that the ERISA exemption applied, finding that stock does not retain its character as employer securities indefinitely. For more information on the tax treatment of employer securities in retirement plans, visit Tax Facts Online and Read More.

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TaxFacts Intelligence Weekly (Oct 31)

Posted by William Byrnes on October 31, 2018


Tax Reform Developments by William Byrnes & Robert Bloink

IRS Official Explains Link Between Business Expense and Fringe Benefit Rules for Tax-Exempt Entities Post-Reform
The 2017 tax reform legislation disallowed deductions for certain transportation-related benefits, including parking expenses, transit passes, commuter vehicles, as well as other types of employee fringe benefits. The law also modified the rules governing unrelated business income, so that tax-exempt entities that provide these benefits may now be subject to the unrelated business income tax (UBIT) on the benefits’ value. An IRS official recently explained that because of the close ties between Section 512 (UBIT) and Section 274 (fringe benefit rules), tax-exempt entities that are considering o fringe benefits to employees should look to the Section 274 expensing rules. For more information on tax reform’s impact on tax-exempt entities, visit Tax Facts Online and Read More.

Section 199A QBI Deduction Introduces Potential Compensation Planning Issues
The Section 199A deduction for the qualified business income of certain pass-through entities presents potential compensation planning issues for both small and large businesses. For example, partnerships and S corporations may wish to reevaluate guaranteed payments to partners and wages to S corporation shareholders. Larger companies may benefit from converting subsidiaries to pass-through entities and using interests in these entities to compensate certain executives where the deductibility of compensation would otherwise be limited by the post-reform restrictions contained in IRC Section 162(m). For more information on the Section 199A QBI deduction, visit Tax Facts Online and Read More.
OTHER IMPORTANT TAX DEVELOPMENTS

IRS Extends Key Tax Filing Deadlines for Victims of Hurricane Michael in Florida and Georgia
The government has declared areas impacted by Hurricane Michael to be major disaster zones, and in recognizing this, the IRS has extended several key filing deadlines for individuals who reside or have businesses in the affected areas. The filing deadline has been extended for individuals who had extended their 2017 filing deadline to October 15, and the January 15, 2019 estimated tax filing deadline has been extended to February 28, 2019. Impacted entities required to file a Form 5500 also have until February 28, 2019 to file if the form was originally due on or after October 7, 2018 and before February 28. For more information on casualty loss deductions in major disaster zones, visit Tax Facts Online and Read More.

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TaxFacts Intelligence Weekly

Posted by William Byrnes on September 21, 2018


TAX REFORM DEVELOPMENTS

IRS Provides Guidance Updating Accounting Method Changes for Terminated S Corporations
The 2017 tax reform legislation added a new IRC section that now requires eligible terminated S corporations to take any Section 481(a) adjustment attributable to revocation of the S election into account ratably over a six-year period. Under newly released Revenue Procedure 2018-44, an eligible terminated S corporation is required to take a Section 481(a) adjustment ratably over six years beginning with the year of change if the corporation (1) is required to change from the cash method to accrual method and (2) makes the accounting method change for the C corporation’s first tax year. For more information on the rules governing S corporations that convert to C corporation status post-reform, visit Tax Facts Online and Read More.
OTHER IMPORTANT DEVELOPMENTS

IRS Guidance on Interaction between New Association Health Plan Rules and ACA Employer Mandate
The IRS recently released new guidance on the rules governing association health plans (AHPs), which permit expanded access to these types of plans, and the Affordable Care Act (ACA) employer mandate. The guidance provides that determination of whether an employer is an applicable large employer subject to the shared responsibility provisions is not impacted by whether the employer offers coverage through an AHP. Participation in an AHP does not turn an employer into an applicable large employer if the employer has less than 50 employees. For more information on the employer mandate, visit Tax Facts Online and Read More.

OCC Explains Employee Tax Consequences of Employer’s Belated Payment of FICA Tax on Fringe Benefits
The IRS Office of Chief Counsel (OCC) released a memo explaining the tax consequences of a situation where the employer failed to include $10,000 of fringe benefits. The employer paid the FICA taxes associated with the benefits in 2018, although the benefits were provided in 2016. The guidance provides that the payment in 2018 did not create additional compensation for the employee in 2016. If the employer collects the amount of the employee portion of the FICA tax from the employee in 2018, the employer’s payment is not additional compensation. However, if the employer does not seek repayment, the payment of the employee’s portion is additional compensation. For more information on FICA tax issues in the employment benefit context, visit Tax Facts Online and Read More.
LITIGATION WATCH

Employer Amendments to VEBA Did Not Result in Adverse Tax Consequences
The IRS recently ruled that an employer could amend its voluntary employees’ beneficiary association (VEBA) to provide health benefits for active employees in addition to retired employees without violating the tax benefit rule or incurring excise taxes. In this case, the VEBA provided health benefits for collectively bargained retired employees. When the VEBA became overfunded, the employer proposed transferring the excess assets into a subaccount for collectively bargained active employees. The IRS found that this proposed amendment would not violate the tax benefit rule because, the new purpose of providing health benefits to active employees under a collective bargaining agreement was not inconsistent with the employer’s earlier deduction. For more information on VEBAs, visit Tax Facts Online and Read More.
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Make Sure You’ve Made a Completed Gift

Posted by bonddad on August 28, 2018


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors and contributor to the Income Seeker section of Thestreet.com.

The determination of gift tax liability rests on whether the donor has “so parted with dominion and control of the property as to leave him, “no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete.” (Treas. Reg. §20.2511.2(b)).  The mosts obvious example occurs when the donor simply gives money to an individual or organization.  For example, the donor writes a check (or, as is more common now, makes a debit card transfer) to a charity.  Once the money leaves his account, the gift is complete.

Things can get a bit dicier when it comes to using trusts.  A revokable trust results in an incomplete gift because the trustor can simply terminate the trust, reverting the trust property back to his control.  But an irrevocable trust doesn’t necessarily result in a completed gift.  Consider the following facts:

  1. Can the trustor change the trustee?  If so, it’s possible the trustor could nominate a more aggreeable trustee that the trustor can bend to his will.  This could result in a determination that the donation to the trust was an incomplete gift.
  2. Does the trustor retain a power of appointment over the property?  If so, the gift is incomplete, at least to the degree of the power.

As with all things, the devil is in the details.

 

 

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Global Tax Guides

Posted by bonddad on August 13, 2018


Sorry for the lack of posting over the last few months.  William and I (along with several others) have been updating Matthew Bender’s Texas Estate Planning, which William has either uploaded or will upload soon.  

Here are a few key links to the global tax guides issued by some of the major accouting firms.  I’ve always found these guides to provide an excellent overview of various countries’ tax regimes.

E&Y Global Tax Guide

PWCs Global Tax Summaries

PKF Global Tax Guides

 

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TaxFacts Intelligence Weekly

Posted by William Byrnes on July 24, 2018


Tax Reform May Require Additional Disclosures for Withholding Purposes
The IRS released a draft Form W-4 designed to reflect the new changes to the tax code imposed by the 2017 tax reform legislation, including the elimination of the personal exemption. The new form is more complex and detailed than previously existing forms, because employers can no longer use the personal exemption to calculate withholding. The form itself is not yet finalized, and it is possible that changes following a very brief comment period. For more information on the suspended personal exemption, visit Tax Facts Online and Read More.
Small Business Valuation Discounts Less “Valuable” Post-Reform
With the enlargement of the estate tax exemption for 2018-2025, many planners are now seeking to reverse strategies that would have permitted clients to claim valuation discounts in their estate plans. Valuation discounts are primarily important in reducing the value of a client’s taxable estate–usually in the small business context. However, if the client is unlikely to be subject to the estate tax at all, use of a valuation discount can cause the client to forgo a portion of the basis adjustment to which his or her heirs would otherwise be entitled. Clients who do not expect to be subject to the estate tax may wish to revisit their estate planning. For more information on minority discounts in the small business context, visit Tax Facts Online and Read More.
OTHER TAX DEVELOPMENTS

Need to Know Information for Kids With Summer Jobs
Many teenagers and college students are likely to be working this summer, and it is important that both the parent and kids should know with respect to potential tax liabilities. First, kids should pay attention to their withholding to ensure that they aren’t under or over paying–any over-withholding will be returned in the form of a refund, and most minors should claim 0 or 1 allowances on their Form W-4. Kids also should be aware that some states will require even very low income workers to file state income tax returns, so even if the kid expects to be exempt at the federal level, a state filing may be required. Finally, if the kid has started his or her own summer business–such as a lawn mowing business–business-related expenses may be tax deductible, so should be carefully documented for tax time. For more information on the kiddie tax, visit Tax Facts Online and Read More.

Last Call for IRS Offshore Voluntary Disclosure Program is Looming
The September 28, 2018 closing date for the IRS’ offshore voluntary disclosure program (OVDP) is looming. Many advisors agree that the September 28 deadline is the last date for potential participants to submit an “initial submission” that requests admission, and note that a pre-clearance request is likely insufficient. The initial submission requires more detailed information, such as the history of any foreign accounts, assets and past reporting, as well as the source of any foreign funds and an estimate of foreign account value. For more information on foreign account reporting requirements, visit Tax Facts Online and Read More.
LITIGATION WATCH

Metlife Lawsuit Highlights Missing Plan Participant Issue
Metlife has recently been sued because of its failure to pay retirement benefits to pension plan participants that it claims it can no longer locate, highlighting the importance of the “missing participant” issue in the financial community. Metlife’s liability stems from a pension risk transfer transaction, where the pension plan itself purchased a group annuity contract from Metlife in order to reduce its pension liabilities. It then became Metlife’s responsibility to make payments to plan participants. For more information on pension plan rules, visit Tax Facts Online and Read More.

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5 Fundamentals Of LLCs (Guest Attorney Article by Haik Chilingaryan, Esq.)

Posted by William Byrnes on June 29, 2018


Haik Chilingaryan, Esq.

Please contact Mr. Chilingaryan to discuss the five fundamentals of an LLC at E-Mail: haik@chilingaryan.law or Tel: 818.442.7777

A Limited Liability Company (“LLC”) is a hybrid business entity which contains elements of a partnership and a corporation. LLCs consist of members and managers. An LLC may provide tremendous benefits for its members, which include asset protection, intergenerational transfers, tax saving strategies, wealth preservation, flexible management structures, and clarity on the roles of all essential parties involved in the company as set out in the Operating Agreement.

The following five concepts are fundamental for establishing an LLC: Asset Protection, Intergenerational Transfers, Tax Saving Strategies, Management, and Funding.

Asset Protection

Generally, the more assets a person owns in one’s name, the more likely it is that he or she will be a target mark for creditors. This is why it’s good practice to own as little as possible in your own name. In order to accomplish this goal, it’s important to evaluate the types of asset protections tools that are available to you. An LLC is one such tool that is effective for asset protection purposes.

For creditors of the LLC itself, a member’s personal liability will generally be limited to the amount of the member’s investment in the LLC unless the member personally guarantees the transaction in question.

For creditors of the member of the LLC, a creditor is generally precluded from acquiring an interest in the debtor-member’s interest in the LLC if the judgment was entered after the LLC was formed. However, most states allow for a judgment creditor to levy on assets after distributions have been made to the debtor-member by the LLC.

As a general rule, a creditor has no right to become a member, compel a distribution, or demand company assets. If such rights were given to a creditor, then the other members of the company would suffer from an action or inaction of a particular member. This would inevitably lead to an unjust result for the remainder of the group. Therefore, the creditor must wait until distributions are made to the member before any potential recovery can be pursued.

Another limitation on a creditor’s pursuit on a claim against the debtor-member is that an Operating Agreement has the power to prevent non-members from acquiring an interest in the company. This is especially important in the case of failed marriages and judgment creditors because courts may at times issue overreaching rulings in order to accomplish an equitable outcome in the event of divorces or other circumstances. An LLC can also provide the means for family members or ex-family members who are in dispute to not be compelled to communicate at the time their interest is being transferred from their donors to them.

There is another layer of asset protection that deals particularly with the recipients of the LLC interest. It’s standard practice for owner-members to make gifts to their heirs throughout their lives. Several problems are immediately surfaced when gifts of substantial value such as property or a significant amount of cash are transferred to their heirs. Without a proper plan in place, the recipients are likely to subject these assets to waste or relinquish them to creditors or former spouses. However, the transfer of an interest in the LLC can protect these assets from loss or waste by the recipient-members.

Keep in mind that the asset protection planning must be done well in advance of any anticipation to a claim. That’s because fraudulent transfers are broadly construed. Intent is generally presumed if a transfer is found to have been made before or after the claim arose with the intent to defraud, hinder, or delay a known creditor. If the transfer is deemed fraudulent by the court, the court may set aside the transfer, which may also lead to criminal consequences.

An LLC is the preferred homeplace for many types of properties, including real estate. Real estate held for the purpose of investment is a ubiquitous phenomenon. Yet in practice, it is widespread to see title to its ownership being held in an individual’s name. In fact, if an investor owns multiple income-producing properties, it’s recommended (subject to some exceptions) to form and operate a separate LLC for each piece of property. In the case of a primary residence, transferring title to a living trust is the preferred method primarily due to tax advantages and the homestead exemption.

One of the reasons for forming a separate LLC for an income-producing real estate is that an injury on its premises can be costly even if the insurance policy satisfies a portion of the claim. Thus, if an entity only owns one piece of real estate, the claims will only be limited to that piece of property. If, however, the entity owns other assets, all such assets are at the risk of being exposed to the creditor.

Let’s also not forget one crucial point in the context of asset protection. By merely establishing an LLC, it will not be enough to be sheltered from personal liability. Formalities must be followed to embolden the shield of limited liability (just like for corporations or other types of entities that are subject to limited liability). If formalities are not adequately followed or there is a personal guarantee against the particular risk in question, the member’s personal assets will likely be exposed to the creditor.

It’s also equally important to make sure that the business is never conducted in the individual member’s capacity, but only in business capacity. For example, as “Manager” or “Member.” In the context of distributions, the accounting must continuously be updated as the distributions are being made to the members. The lack of formalities will give more weight to the argument that the LLC had no business purpose and should be disregarded as a separate legal entity.

Despite all the asset protection tools, a creditor has a few recourses (some of which go beyond the scope of this article). The one recourse that is generally available to a creditor is commonly referred to as a “charging order.” A charging order permits a creditor to seize only those assets that have been actually distributed, but not the assets that the debtor-member may potentially be entitled to receive under his or her ownership interest in the LLC.

Charging orders are better known as “phantom income” for a reason. The IRS requires for the members of the LLC to pay income tax even if they do not receive any distributions. In the case of charging orders, the creditor would be required to pay income tax on the debtor-member’s interest in the LLC even if the creditor does not receive any actual distributions. This is perhaps the most deterring factor on a creditor’s pursuit in recovering from an LLC because a creditor generally ends up in a worse position than before his pursuit of the charging order. Additionally, a creditor’s tax bracket may also increase as a result of the charging order.

Intergenerational Transfers

An LLC can be structured in such a way to protect the assets of a family for generations. These are otherwise known as Family Limited Liability Companies (“FLLC”). Even though such entities are structured and operated just like typical LLCs, most, if not all of the assets, are owned by the family in FLLCs.

In general, LLCs have some of the same benefits as living trusts when it comes to intergenerational transfers. An LLC can provide for a smoother transfer of wealth upon the death of an owner by avoiding probate. It can further prevent assets from going through probate in the event of a member’s disability and even in guardianship or conservatorship proceedings.

Another similarity with a living trust is that the nature and character of the underlying assets of the company are private. In other words, details as to what assets the LLC owns will generally be outside the scope of the public domain. As opposed to probate, where the circumstances surrounding the transfers of the decedent’s assets are a matter of public record, transfers of LLC assets are generally accomplished under private circumstances.

The effective planning techniques involve not only how the assets will be transferred when the owner of those assets dies, but to also employ techniques that will allow the transfer of assets during the donor’s life. In the context of FLLCs, there is a planning method available through gifting which allows for senior family members to periodically gift a portion of their assets to their younger family members.

There are some assets, however, that by their nature make it difficult to gift in fractions. Transferring portions of real estate, farm, or other assets are difficult to calculate especially when their value can fluctuate on a daily basis. There are some factors that may make the particular asset periodically more or less valuable: external market conditions and the overall condition of the asset. However, the gifting of an interest in an LLC avoids the trouble of transferring a fraction of a particular asset.

Regardless of the type of asset being transferred, there are incentives in place for transferring wealth during a donor’s life. These incentives can range from reducing the donor’s taxable estate to providing for the living expenses of the donor’s children. As such, the implementation of an annual gifting method may play a significant role in the periodic transfer of wealth from the older family members to the younger ones.

In 2018, the annual exclusion amount is $15,000 for individual taxpayers. Under the taxation rule of gift-splitting, a married couple can transfer $30,000 to any individual without being required to pay a Gift Tax or having to file a Gift Tax Return. To illustrate the significance of annual gifting, suppose that a married couple has four children. The couple can potentially remove $120,000 per annum from their estate without the Gift Tax consequences.

An LLC can also provide an excellent tool for gifting an interest during the donor’s life without commingling the gifted portion of the assets with the recipient’s other assets that have been accumulated during his or her marriage. After the membership interest is directly transferred to the recipient or in a separate property trust that has been specifically established for the recipient, the “paper trail” can show that a particular asset (whether in the form of cash or other property interest) is in fact the separate property of the recipient-member.

In the context of LLC ownership transfers, it is the member’s interest – not the actual asset – being transferred. Thus, the interest is adjusted in value due to lack of marketability. That’s because the assets that are subject to the LLC generally have limitations. Such limitations may include the right of first refusal, the inability to demand a distribution, order a dissolution, or participate in the management of the LLC.

The fundamental reason for the lack of marketability is that the membership interest is not a liquid asset and generally cannot be freely assigned. In other words, if the buyer cannot indeed purchase the piece of a parcel, but instead he or she can only purchase a potential ownership interest in the parcel (e.g., by owning X% in the LLC) with some of the previously mentioned limitations, the value of the membership interest will be discounted in accordance with the limitations.

The discounting aspect for lack of marketability is especially useful in the context of gifting. For instance, if a member’s interest is discounted by 1/3 due to lack of marketability, a gift of $10,000 in the form of an LLC interest is equivalent to a gift of $15,000 in the underlying assets of the LLC ($15,000 x 2/3 =$10,000).

Upon the death of the owner-member, value adjustments may also apply to the remaining portion of the deceased member’s interest in the LLC based on lack of marketability. A general formula for calculating the taxable value of the estate of the deceased-member’s interest is the following:

% of ownership x FMV (1 – discount) = Estate Tax Value

Tax Saving Strategies

An LLC can be taxed as a disregarded entity, partnership, cooperative, or corporation. By default, a multi-member LLC is taxed as a partnership. By default, a single-member LLC is taxed as a sole proprietorship. Under such a classification, the member is considered self-employed and is consequently responsible for self-employment taxes (Social Security and Medicare).

For income tax purposes, sole proprietorships, partnerships, and S-corporations are classified as pass-through entities. This means that the income and expense will pass through to the owner’s personal tax returns. Under a pass-through scenario, the LLC itself will file a Form 1065 tax return, but it will not pay the income taxes on the LLC’s profits.

One strategy for lowering a member’s taxable income is to not have them actively participate in the management of the LLC. Members who do not participate in the management of the company will generally be exempt from paying the self-employment tax. Therefore, their overall income tax may be reduced since they will not pay the self-employment tax on the LLC portion of their income.

Another way to reduce the overall income taxes during the members’ life is by spreading them among members who happen to fall in lower tax brackets than the owners. This is especially useful in the context of FLLCs since younger family members may not necessarily earn as high of an income as their elder counterparts.

Another benefit of an LLC is that a transfer of an asset by an individual to the LLC is normally not a taxable event unless otherwise excepted. Similarly, transfers upon the dissolution of the LLC are also not taxable since they are deemed a return of capital. Of course, gain may be recognized if the asset is sold by the individual after the asset has been transferred from the LLC.

The general tax consequence on transfers (to and from) an LLC is especially significant when considering that virtually any transfer from one entity to another can either be accomplished by sale or gift. If it’s a sale, then the transferor must generally pay capital gain taxes if the asset has appreciated in value since its purchase. If it’s a gift, there may be gift tax consequences. In this case, we have the owner being a separate entity, transferring to the LLC (also a separate entity). Nonetheless, these transfers generally do not qualify as taxable events for IRS purposes.

In the context of FLLCs, calculating the basis of assets or membership interests can be problematic, especially if such assets are sold generations after their purchase. This will inevitably affect the basis adjustments of those assets. The basis of an asset is what the original owner paid for its purchase. Several factors may affect the adjustment of the basis by either increasing the original basis (e.g., capital improvements) or by decreasing the original basis (e.g., depreciation deductions).

The similar concepts on basis adjustments apply to a member’s interest in the LLC because these interests also have their own basis. If there are many assets with different basis inside the LLC, it can become a logistical nightmare for accountants and administrators to calculate each member’s separate basis in the LLC. Thus, mixing different assets in the same LLC can be problematic especially in the context of multi-generational entities (e.g., FLLCs). Instead of being limited to one LLC, it is recommended to consider additional or subordinate LLCs especially for preventing such problems down the road.

The last point with regard to tax consequences of LLCs pertains to state law. When forming an LLC, it’s essential to consider all of the laws that the state provides on the formation and governance of LLCs. Some states have favorable laws with regard to LLCs versus other business types of entities; other states tend to be less favorable.

Management of an LLC

LLCs consist of members and managers. If we can make an analogy with corporations, members would be equivalent to the shareholders of a corporation; whereas managers can be a hybrid between Board of Directors and senior officers of a corporation (depending on the scope of authority provided by the members and the Operating Agreement).

There are two types of structures in which LLCs operate. There are member-managed and manager-managed LLCs. In member-managed LLCs, the members of the company manage the company by voting in accordance with each member’s interest. In manager-managed LLCs, members appoint one or more managers to conduct business activities that fall within the scope authorized by the company’s members.

There is no requirement for a manager to be a member of the LLC. Even in a member-managed LLC, the members may appoint a manager to be responsible for the daily business operations, but nevertheless be prevented from exercising any decision-making management authority.

A managing entity is recommended for a variety of reasons. First, as opposed to an individual, a managing entity does not have the same limitations as a human being might have, including disability and death. Since managers generally answer to members, the level of control over investment decisions can be set by the members in accordance with the manager’s fiduciary duty to the LLC. The level of control may vary from how much income to distribute or reinvest to being limited to only managing simple day-to-day operations.

An LLC formed in California must have an Operating Agreement. The Operating Agreement sets forth the scope of authority of members and managers. It can also provide restrictions on the transferability of membership interests and determine the form of compensation of its managers. A membership interest can be in the form of percentage or membership units. Membership units are analogous to owning shares in a corporation.

There are generally four ways members can receive compensation from the LLC. First, the General Members can receive management fees for managing the company. Such compensation can even be in the form of “preferred equity interest,” whereby a certain percentage of income is paid to the individual or entity holding that interest.

The second way is for the LLC to make distributions to the members. In such a scenario, the limited members will generally be entitled to a pro rata share from the distributions. The third way is for the LLC to make loans to the members. This strategy should be implemented with extreme caution. The fourth way provides an option to the limited members to potentially purchase a more significant share in the LLC from the owners, thereby resulting in more direct income for the owners.

Funding the LLC

Funding is the process of transferring assets to the LLC. Funding is an essential step in order for the LLC to be legally enforceable. An LLC must have a business purpose. If the LLC does not have any assets or is not otherwise funded, it follows that it does not have a business purpose.

The similar concept of funding applies to revocable living trusts. If a revocable living trust does not have any assets, it can be the most potent trust instrument ever written, but it will generally have no legal effect. Therefore, an LLC must also be properly funded, for among other things, to potentially grant limited liability to its members.

The means for funding the LLC may vary from asset to asset. For example, different standards apply when real estate is transferred onto the LLC as opposed to a publicly traded security company. As a baseline rule, the transfer of an asset to the LLC must happen in the same manner in which title to the particular type of property is held. In case of real estate, such transfers may only be effectuated by deeds, regardless of whether the transfer is from person to person, or from (or to) an LLC.

Notwithstanding the type of asset being transferred, the value of the asset must be determined at the time of transfer. Determining the valuation of real estate and business interests in firmly held companies or LLCs is not an exact science. Consequently, such assets may be required to be appraised by a qualified appraiser (someone with an excellent reputation in the field of appraisals and a successful track record for audits). To justify any valuation discounts in the event of litigation or potential challenges by taxing authorities, qualified appraisals should also value the interest in the LLC at the time the member’s interest is either sold or gifted or when one of the members dies.

The transfer of stocks, bonds, and other securities to an LLC is accomplished by a stockbroker, the issuing company, or a third party agent. If a stockbroker is used to facilitate the transfer, it’s recommended for the stocks to be held in a “nominee securities” account. In other words, the brokerage account will be in the name of the LLC, however, the actual stocks will be held in the brokerage company’s name.

One final point concerning funding to keep in mind when it comes to stocks and investment assets are the “anti-diversification rules.” Generally, the transfer of an asset to the LLC is not a taxable event unless the transfer triggers an immediate tax consequence within the meaning of diversification of securities.

Several standards are used to determine issues related to diversification. First, “The 80% Rule” states that if 80% or more of the assets of the LLC are marketable securities, the LLC can be classified as an “investment company.” As a result, the anti-diversification rules may apply and tax may be due on the transfer. Therefore, if 20% or more of the assets are made up of real estate, the anti-diversification rules will not be triggered and no tax would be due on the transfer provided that real estate assets remain at 20% or more in the LLC after the transfer.

Second, “The Non-Identical Assets Rule” applies in a scenario where one person contributes one type of stock and another person contributes another type of stock, the anti-diversification rule may be triggered. However, if the same two people were to contribute two of the same stock or if one person contributes all of the assets (even if they are not identical), the anti-diversification rules will generally not be triggered.

Third, “The 25% Test and 50% Test” states that no diversification can occur when the transferor transfers a diversified portfolio of securities to the LLC which contains no more than 25% of the value of all securities from one issuer and no more than 50% of the value of all securities from five or fewer issuers. In this instance, the portfolio itself is considered diversified since it does not contain any one issuer which represents more than 25% of the value of the total securities nor five or fewer issuers which represent more than 50% of the securities in the same portfolio. Similar to mutual funds, diversification rules generally do not apply to a portfolio that is being contributed to the LLC that is already diversified.

The crux of the matter regarding the anti-diversification rules is that if an LLC owns securities and the LLC itself is in fact performing the functions of an investment company within the context of securities, then any asset being transferred (including cash) to the LLC may be subject to tax. The application of these rules can be pernicious and planning around them must be done with extreme caution to minimize the likelihood of a tax being due on a transfer.

Final Thoughts

The rigorous legal standards surrounding LLCs increase the likelihood for the LLC to lose its asset protection status against creditors or to be successfully challenged by taxing authorities. The LLC provides tremendous benefits to its members: asset protection, intergenerational transfers, tax saving strategies, flexible management structures, and wealth preservation. In order to enjoy all the benefits that an LLC has to offer, it’s important to be in constant contact with qualified advisors, including attorneys, CPAs, tax specialists, and financial advisors to make sure that all applicable legal matters are properly addressed in advance.

Remember that an LLC is a business, it must have a business purpose, and it must be operated as a business. Problems are bound to occur when the owners of LLCs deviate from these standards and become overconfident in the notion that their LLC is an enforceable legal entity that is unequivocally protected against creditors and taxing authorities by virtue of its existence.

Important Note: Chilingaryan Law or its affiliates are not rendering legal, financial, or tax advice by providing the content above. No attorney-client relationship is formed based on the information provided above. The above content is designated only for educational use. Accordingly, Chilingaryan Law assumes no liability whatsoever in reliance on its use. Additionally, certain changes in law may affect on the legality of the information provided above and certain circumstances of the reader may vary the applicability of the above content to his or her situation.

About Chilingaryan Law

Our law firm focuses its practice on serving professionals and business owners who, among other things, seek counsel on matters relating to Estate Planning and Business Planning with an emphasis on tax efficiency.  We work with of counsel attorneys, financial advisors, tax specialists, and accountants to provide the most optimal services for our clients. We recognize that some clients wish to minimize their tax consequences, others are more concerned about posterity, yet many others are concerned about their financial security and lifestyle needs once they retire.

Our main office is in Glendale, California. We also have offices in Downtown Los Angeles, West Los Angeles, and Sherman Oaks. Tel: 818.442.7777

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New SEC Rules on Fiduciary Standard

Posted by fhalestewart on April 19, 2018


From the SEC:

SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals

FOR IMMEDIATE RELEASE
2018-68

Washington D.C., April 18, 2018 —

The Securities and Exchange Commission today voted to propose a package of rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.

Under proposed Regulation Best Interest, a broker-dealer would be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.  Regulation Best Interest is designed to make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.

In addition to the proposed enhancements to the standard of conduct for broker-dealers in Regulation Best Interest, the Commission proposed an interpretation to reaffirm and, in some cases, clarify the Commission’s views of the fiduciary duty that investment advisers owe to their clients.  By highlighting principles relevant to the fiduciary duty, investment advisers and their clients would have greater clarity about advisers’ legal obligations.

Next, the Commission proposed to help address investor confusion about the nature of their relationships with investment professionals through a new short-form disclosure document — a customer or client relationship summary.  Form CRS would provide retail investors with simple, easy-to-understand information about the nature of their relationship with their investment professional, and would supplement other more detailed disclosures.  For advisers, additional information can be found in Form ADV.  For broker-dealers, disclosures of the material facts relating to the scope and terms of the relationship would be required under Regulation Best Interest.

Finally, the Commission proposed to restrict certain broker-dealers and their financial professionals from using the terms “adviser” or “advisor” as part of their name or title with retail investors.  Investment advisers and broker-dealers would also need to disclose their registration status with the Commission in certain retail investor communications.

Taken as a whole, the proposed rules and interpretations would enhance investor protection by applying consistent principles to investment advisers and broker-dealers: provide clear disclosures, exercise due care, and address conflicts of interest.  The specific obligations of investment advisers and broker-dealers would be, however, tailored to the differences in the types of advice relationships that they offer.

SEC Chairman Jay Clayton stated, “The tireless work of the SEC staff has proven to me that we can increase investor protection and the quality of investment services by enhancing investor understanding and strengthening required standards of conduct.  Importantly, I believe we can achieve these objectives while simultaneously preserving investors’ access to a range of products and services at a reasonable cost.  The package of rules and guidance that the Commission proposed today is a significant step to achieving these objectives on behalf of our Main Street investors.”

The public comment period will remain open for 90 days following publication of the documents in the Federal Register.

*   *   *

FACT SHEET

SEC Open Meeting
Apr. 18, 2018

The Commission proposed two rules and an interpretation to address retail investor confusion about the relationships that they have with investment professionals and the harm that may result from that confusion.  Evidence indicates that retail investors do not fully understand the differences between investment advisers and broker-dealers, which could lead them to choose the wrong kind of investment professional for their particular needs, or to receive advice that is not in their best interest.  The Commission will therefore consider strengthening the standard of conduct that broker-dealers owe to their customers, reaffirming and, in some cases, clarifying the standard of conduct that investment advisers owe to their clients, and providing additional transparency and clarity for investors through enhanced disclosure designed to help them understand who they are dealing with, and why that matters.  The rulemaking package seeks to enhance investor protections while preserving retail customer access to transaction-based brokerage accounts and a broad range of investment products.
Proposal’s Highlights
Regulation Best Interest 

A broker-dealer making a recommendation to a retail customer would have a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.

A broker-dealer would discharge this duty by complying with each of three specific obligations:

  • Disclosure obligation: disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
  • Care obligation: exercise reasonable diligence, care, skill, and prudence, to (i) understand the product; (ii) have a reasonable basis to believe that the product is in the retail customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest.
  • Conflict of interest obligation: establish, maintain and enforce policies and procedures reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives; other material conflicts of interest must be at least disclosed.

Investment Adviser Interpretation

An investment adviser owes a fiduciary duty to its clients — a duty that the Supreme Court found exists within the Advisers Act.  The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty that an investment adviser owes to its clients.

Form CRS – Relationship Summary

Investment advisers and broker-dealers, and their respective associated persons, would be required to provide retail investors a relationship summary.  This standardized, short-form (4 page maximum) disclosure would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist.

Investment advisers and broker-dealers, and the financial professionals who work for them, would be required to be direct and clear about their registration status in communications with investors and prospective investors.  Certain broker-dealers, and their associated persons, would be restricted from using, as part of their name or title, the terms “adviser” and “advisor” — which are so similar to “investment adviser” that their use may mislead retail customers into believing their firm or professional is a registered investment adviser.

Background

The Commission has been considering issues relating to changes in the market for investment advice, retail investor understanding of their advice relationships, and broker-dealer conflicts of interest, since the mid-1990s.  The staff studied these matters further pursuant to the Dodd-Frank Act’s mandate in Section 913.  Most recently, in June 2017, Chairman Jay Clayton sought public input on a variety of issues associated with standards of conduct for investment professionals.  Today’s proposed rules and interpretations are the outcome of the Commission and the staff’s extensive experience in and consideration of these issues

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What Exactly Is A Fiduciary Standard?

Posted by fhalestewart on March 27, 2018


Last week, I noted that a court overturned the DOL’s new “fiduciary” rule.  Since its enactment, the new rule has been a point of contoversy within the investment community.

However, what exactly is a fiduciary standard?  Let’s begin by looking at the definition of fiduciary, which, according to the Merriam-Webster online legal dictionary, is

“one often in a position of authority who obligates himself or herself to act on behalf of another (as in managing money or property) and assumes a duty to act in good faith and with care, candor, and loyalty in fulfilling the obligation : one (as an agent) having a fiduciary duty to another.”

The definition contains a number of key concepts:

  1. “one … in a position of authority.”   The person on whom the law places the duty is “superior” to the other person, usually because the fidicuary has a specific skill-set that the other does not.  The fiduciary is an expert.
  2. The fiduciary “act[s] on behalf of another.”  The fiducairy must not consider himself ot his personal situation when making decisions, but instead the situation of the person for whom he is exercising his skills.
  3. The fiduciary “assumes a duty” or a “moral obligation.”  There’s an ethical component to the duty; it’s almost like a higher calling.
  4. The fiduciary must act
    1. In good faith: The Restatement of Contracts defines good faith as, “honesty in the fact of the conduct.”  Most other areas of law use similar terminology and concepts.
    2. “and with care, candor, and loyalty.”  To a certain extent, these restate the need to act for another instead of oneself irrespective of the fiduciary’s situation.
  5. The definition for obligation contains a number of phrases that imply a moral component …
    1. “binding oneself … by a moral tie.”
    2. “A duty … to follow a code.”
    3. “A course of action … imposed by conscience.”
      1. (The American Heritage Dictionary, (c) 1985).

Because the fiduciary has more knowledge or skill in a particular area, he can also take advantage of his client.  The law therefore casts the relationship between the fiduciary and his client in moral terms.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

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IRS Releases 2018 “Dirty Dozen” Tax Scam List

Posted by fhalestewart on March 22, 2018


This link will take you to a page that has a link to each of the IRS’ targeted transactions for 2018.

Here is a screen grab of the main IRS page:

IRS

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Court Overturns DOL Fiduciary Rule

Posted by fhalestewart on March 20, 2018


From the NY Times:

FR1

FR2

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The Arguments Against Asset Protection Trusts

Posted by fhalestewart on March 11, 2018


My colleague Jay Adkisson has written a summation of a new domestic asset protection trust case at Forbes.  Another colleague, Steve Oshins, has weighed in as well.   Mr. Adkisson argues this case is the final nail in the asset protection trust industry; Mr. Oshins argues for a less sweeping interpretation.

I counsel against these structures for a number of reasons, which are listed below in no order of importance.

1.) We have yet to see a grantor of a foreign or domestic asset protection trust (APT) win a case.  Planners who still like APTs correctly argue that these cases have a potent negative combination: blatant fraudulent transfers and unsavory characters — an admittedly very bad combination of facts.  Regardless, there are now a number of decisions where the APT failed when challenged.  Why?  That leads to point number two:

2.) APTs are bad public policy.  At the heart of any case involving an APT is a creditor enforcing a judgment.  A court upholding an APT will be opening the door to the idea that a debtor can “have his cake and eat it too;” he can be adjudicated to owe somebody money, have the financial capability to satisfy the debt, yet not do so — and, in fact, have a court say they don’t have to.  That’s a detrimental holding in a capitalist economy that depends on credit financing to fuel economic growth.  So far, courts don’t want to play.

3.) Point number 2 is derived from the Uniform Trust Code’s commentary to §505 which “… follows sound doctrine in providing that a settlor who is also a beneficiary may not use the trust as a shield against the settlor’s creditors.  The drafters of the UTC concluded that traditional doctrine reflects sound public policy.”  Several courts that have ruled against APTs have referenced this section ot the UTC.

4.) Are courts turning against asset protection planning?  It depends on where you do it, but in California they are:

As indicated by Defendant’s testimony that prior to filing his bankruptcy petition, he met with an asset protection firm, and one of his goals in doing so, was to potentially protect his assets from potential creditors . . . and while he changed his mind about using the asset protection firm, the evidence of his consideration, meeting and paying the asset protection firm supports a finding that Defendant intended to hinder or delay his nonpreferred creditors. 

One could argue that this decision should be taken with a  grain of salt because it’s from California — a valid point.  But, you can see the argument being effective regardless of the jurisdiction.  Imagine this line of questioning in a deposition or at trial:

Lawyer: And on this date, you saw John Smith, correct?

Defendant: Yes.

Lawyer: Doesn’t Mr. Smith hold himself out as an “asset protection lawyer?”

Defendant: Yes

Lawyer: why did you feel the need to consult with him?

There’s no answer to this question that can’t be spun in a negative light.

5.) Creditors have a number of well-defined and clearly articulated methods of obtaining a judgment.  Even Texas — my home and debtor’s haven — has a statutory path for creditors to obtain a judgment and satisfy it.  What usually keeps creditors from pursuing a claim is time (litigation is an inherently long and drawn-out process), money (they will probably have to pay at least a portion of their ongoing legal bills), and effort (litigation takes an inordinate amount of time away from running a business).  If a debt is small, it’s far easier to write it off as a business loss (see §165) and be done with it.  But an aggressive creditor will eventually get his money.

6.) Every time I hear someone extol the virtues of a spendthrift trust, I’m reminded of the following line from the movie, A Princess Bride: “That word doesn’t mean what you think it means.”  A spendthrift provision prevents the voluntary or involuntary alienation of the beneficiary’s interest (§502 of the Uniform Trust Code).  So, let’s assume that beneficiary John Smith owes $10,000 to Mr. X.  Mr. Smith cannot transfer his interest to Mr. X to satisfy the debt (For more, please see Nichols, Assignee v. Eaton Et Al, 91 U.S. 716, 23 L.Ed. 254 (1875) ).

But a spendthrift provision only applies to the trust; once the money is distributed, it can be attached any number of ways.  If it’s transferred to a pass-through entity such as a family limited partnership, a creditor can use a charging order to obtain his funds.  If the money is transferred to a bank account, the creditor can simply levy the bank account.  For a discussion of the procedures in my home state of Texas, please read “Post-Judgment Remedies: Garnishment, Execution, Turnover Proceedings, Receiverships Under the DTPA, and “Other Stuff” by Donna Brown.  Ultimately, this gets back to point number 5: an aggressive creditor is going to get his money eventually.

7.) Why would you choose to be shielded behind an APT’s spendthrift provision — which is a new legal concept (in legal years) — when you can use a pass-through entity like an LLC whose liability shield is very well-developed?  Brief history: the corporate limited liability shield came about sometime in the mid-1800s.  I believe New York was the first state to adopt the concept.  It caught on like wildfire and has now been praised as a key concept of a capitalist society (For an in-depth discussion, please see Stephen Presser’s book, Piercing the Corporate Veil).

Corporate limited liability is now a very well-developed legal concept developed over hundreds of cases.  This is great news for planners because we have exacting detail about what works and what doesn’t.  Why not use this area of law — that also has a number of favorable decisions — instead of APT law which so far has issued a large number of anti-APT decisions?

Again, these are presented in no order of importance.  But with yet another asset protection trust failing when challenged, I believe these points have a great deal of merit.

 

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

 

 

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Foreign Asset Protection Trusts; Let the Buyer Beware

Posted by fhalestewart on March 6, 2018


This is an article that I wrote for the TaxAnalysts Service a few months ago.157tn1817-Stewart

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Deferred Compensation, Part VII: Taxation of Benefits

Posted by fhalestewart on February 26, 2018


I often refer to reading the tax code as “hop, skip and jump” reading because one paragraph or section of the code will require the reader to reference several other sections in order to comprehend the meaning behind the first code section.    §402, which explains the taxability of deferred compensation, is a prime example of this approach.   Section (a) states:

Except as otherwise provided in this section, any amount actually distributed to any distributee by any employees’ trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee, in the taxable year of the distributee in which distributed, under section 72 (relating to annuities)

Section 401(a) provides the relevant rules for a trust to obtain tax-exempt status.  By way of quick review, these include certain vesting timelines, minimum participation standards, and non-alienability requirements.  Section 501(a) is the tax code section that grants tax-exempt status to certain organizations as well as trusts specifically mentioned in §401(a).  And §72 contains the rules for annuities, which provides rules allowing the recipient to not be taxed on his return of principal.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

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Deferred Compensation, Pt. VII: Vesting

Posted by fhalestewart on February 19, 2018


The online Merriam-Webster dictionary defines “vesting” as “the conveying to an employee of inalienable rights to money contributed by an employer to a pension fund or retirement plan especially in the event of termination of employment prior to the normal retirement age”

The purpose of the vesting rules is to make sure that the money the employee contributes to the plan is his, and can never be taken away.  Here, there are actually two rules — one for contributions made by the employee.  These rights are “non-forfeitable” — they cannot be taken away.

The second rules apply to the employer’s contributions.  The statute contains two approved vesting schedules.  The first is the “3-year rule.”  If an employee has at least three years of service, he has a non-forfeitable right to 100% of the employer’s contributions.   The second is a schedule based on the years of service:

Untitled

Due to its somewhat stricter nature, most this schedule is more attractive from the employer’s perspective.

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Deferred Compensation, Part VII: Profit-Sharing

Posted by fhalestewart on February 13, 2018


Adding a profit-sharing component to your 401(k) plan can increase your contributions while also motivating employees.  All of the previously-discussed rules apply: you can’t have a top-heavy plan, you can’t discriminate in favor of certain employees, etc…

Here’s a general description of what’s involved from the code:

A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. A formula for allocating the contributions among the participants is definite if, for example, it provides for an allocation in proportion to the basic compensation of each participant.

The best part is the company is not required to make contributions every year; they can also determine the total amount of their contribution in the first quarter of the year, after sitting down with their accountant and getting a good idea for the previous year’s performance.

The total contribution is limited to the lesser of 25% of compensation or $55,000 (for 2018; $54,000 for 2017, subject to cost-of-living adjustments for later years).

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

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Deferred Compensation, Part VI: Minimum Participation Standards

Posted by fhalestewart on February 6, 2018


In general, a plan cannot specifically require that employees work for the company at least 1 year or attain the minimum age of 21.  For large employers with several divisions, this can happen accidentally.  Here are two examples from the accompanying Treasury Regulations:

Example 1. Corporation A is divided into two divisions. In order to work in division 2 an employee must first have been employed in division 1 for 5 years. A plan provision which required division 2 employment for participation will be treated as a service requirement because such a provision has the effect of requiring 5 years of service.

Example 2. Plan B requires as a condition of participation that each employee have had a driver’s license for 15 years or more. This provision will be treated as an age requirement because such a provision has the effect of requiring an employee to attain a specified age.

Second, the plan cannot exclude an employee who attains a specific age.

Finally, there are minimum participation standards, which must comply with one of the following three rules.

1.) The plan must benefit at least 70% of the “non-highly compensated” employees

2.) The plan benefits—

(i) a percentage of employees who are not highly compensated employees which is at        least 70 percent of

(ii) the percentage of highly compensated employees benefiting under the plan.

3.) The company sets up its own classification system approved by the Secretary that benefits at least 70% of the non-highly compensated individuals.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

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Deferred Compensation, Part V: Exemption Planning

Posted by fhalestewart on January 30, 2018


When a person declares bankruptcy, all of their property becomes part of the estate — the total assets that are used to pay existing creditors.  Here is the exact definition contained in the bankruptcy code:

(a) The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:

      (1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.
     (2) All interests of the debtor and the debtor’s spouse in community property as of the commencement of the case that is—

        (A) under the sole, equal, or joint management and control of the debtor; or
        (B) liable for an allowable claim against the debtor, or for both an allowable claim against the debtor and an allowable claim against the debtor’s spouse, to the extent that such interest is so liable.

This is very similar to the definition the gross estate in the estate tax code or gross income in §61 — it’s an exceedingly broad definition, designed to include every piece of property owned by the debtor.

The code, however, does allow several specific exemptions.  Under the federal statute, the debtor may choose federal or state law exemptions.  Under federal statute, retirement plans are excluded

§522(b)(1) Notwithstanding section 541 of this title, an individual debtor may exempt from property of the estate the property listed in either paragraph (2) or, in the alternative, paragraph (3) of this subsection.

…..

     (C) retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.

 Most states allow this exemption as well.

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Deferred Compensation, Part IV: Non-Discrimination

Posted by fhalestewart on January 24, 2018


According to §401(a)(4), a deferred compensation plan cannot discriminate in favor of highly compensated employees (HCEs), which is a person who either owned 5% of the business at any time during the year or made more than $80,000 (inflation-adjusted) during the preceding year.

The regulations provide two safe-harbor tests for defined contribution plans (which comprise the vast bulk of 401ks).  The first is a “unified allocation formula,” which requires all plan contributions to be allocated in one of three ways:

  • the same percentage of plan year compensation,
  • the same dollar amount, or
  • the same dollar amount for each uniform unit of service (not to exceed one week) performed by the employee during the plan year.

While the rules do allow a C-Suite executive to benefit from the plan based on their status within the company, it doesn’t allow them to benefit more than their status would allow.

The second method uses a “uniform points method” which are determined by summing “the employee’s points for age, service, and units of plan year compensation for the plan year.”

The main point that advisers should take from these rules is that the regulations contain very rigid, mechanical rules that prevent the top of the employee ranks from rigging the retirement plan to their benefit at the expense of the rank-and-file.

 

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

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Understanding the New Tax Law

Posted by fhalestewart on January 22, 2018


For those of you who are interested in the new tax law, please see this paper from Sam Donaldson, titled, Understanding the New Tax Law.

 

SSRN-id3096078

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Deferred Compensation, Pt. III: Non-Diversion of Trust Assets

Posted by fhalestewart on January 15, 2018


In order for a deferred compensation trust to the “qualified,” it must comply with all of §401s specific requirements.  Complete compliance creates tax-deferred status.  §501 states (emphasis mine), “An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.”

One of 401’s most important requirements is that funds can only be used for the benefit of the employees.  §401(a)(2) states in relevant part,

“(2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees or their beneficiaries…”

To borrow language from contract law, this section contains a condition precedent, which is, “…  an event which must take place before a party to a contract must perform or do their part.”  The following hypothetical illustrates: Company A owes a significant amount of money and also has a large, well-funded retirement plan.  401(a)(2) prevents the company from raiding the retirement fund until every possible obligation of the trust is paid.

The Treasury Regulations add additional color:

(2) As used in section 401(a)(2), the phrase “if under the trust instrument it is impossible” means that the trust instrument must definitely and affirmatively make it impossible for the nonexempt diversion or use to occur, whether by operation or natural termination of the trust, by power of revocation or amendment, by the happening of a contingency, by collateral arrangement, or by any other means. Although it is not essential that the employer relinquish all power to modify or terminate the rights of certain employees covered by the trust, it must be impossible for the trust funds to be used or diverted for purposes other than for the exclusive benefit of his employees or their beneficiaries.

The phrasing is unambiguous, providing no legal “wiggle-room.”

In my introductory post on the topic, I specifically noted this code section uses trust language, placing a fiduciary duty and obligation on the sponsoring company.  This section furthers that observation.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

 

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Deferred Compensation, Pt. 2: ERISA

Posted by fhalestewart on January 10, 2018


29 U.S.C. Chapter 18 contains ERISA — the Employee Retirement Income Security Act, which was passed in 1974.  Its purpose is to protect employee benefit plans from employer malfeasance, such as using employee plans to fund corporate operations or pay corporate debts.

Like the deferred compensation section of the tax code, ERISA itself its own legal specialty.   A complete discussion would be the subject of an entire course in law school.  For our purposes, the following points are salient:

1.) The statute gives federal courts jurisdiction over a large number of causes of action related to ERISA: (“Except for actions under subsection (a)(1)(B) of this section, the district courts of the United States shall have exclusive jurisdiction of civil actions under this subchapter brought by the Secretary or by a participant, beneficiary, fiduciary, or any person referred to in section 1021(f)(1) of this title. State courts of competent jurisdiction and district courts of the United States shall have concurrent jurisdiction of actions under paragraphs (1)(B) and (7) of subsection (a) of this section.).  This greatly increases the weight of potential litigation.

2.) The statute creates a complex compliance burden.  Here is a list of the sections contained in 29 U.S.C. Part I: Reporting and Disclosure:

ERISA Reporting

This is yet another reason why an entire industry exists to service deferred compensation plans.

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The First Revenue Bulletin of the Year Covers Several Important Issues

Posted by fhalestewart on January 7, 2018


IRB1

 

You can download it at this link:

irb18-02

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Deferred Compensation, Part 1: Introductory Concepts

Posted by fhalestewart on January 2, 2018


Certain sections of the tax code (such as §1031 like-kind exchanges and §482 transfer pricing) have become their own mini-specialty.  §401-§420 (deferred compensation) is another such area of the code.  In the following posts, I’ll go over the “high points” of these code provisions, starting with today’s general introduction to the topic.

The opening sentence of §401 contains a large amount of important information:

A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section— 

Here are that sentence’s key provisions:

  • “A trust:” trust law has over 500 years of common law history, dating back to Britain. There is an entire restatement on trusts which has been adopted by all U.S. states.  The legal tome Scott on Trusts is the leading academic treatise on the topic.  For an attorney, the word trust immediately leads to the phrase “fiduciary obligation,” which is best explained by these two phrases: “Alleged good faith on the part of the fiduciary forgetful of his duty is not enough…he must not have “honesty alone, but the punctilio of an honor the most sensitive.”[1] This is a very long and well-developed common law doctrine that has no wiggle room for legal shenanigans.  This is the duty placed on the company forming the plan regarding plan assets.  It’s also a primary reason why most companies outsource this task to third parties.
  • “organized in the United States – self-explanatory, but it should be noted
  • “forming part of a stock bonus, pension or profit-sharing plan:” Like “trust,” these words are also terms of legal art, each connoting specific concepts under the law.
  • “for the exclusive benefit of his employees:” “exclusive” is the key word, which, according to the online Merriam-Webster dictionary, means, “excluding other from participation.” Management can only use trust assets for employees.  Put another way, management can’t use the funds for company purposes like funding ongoing operations or acquisitions.
  • “qualified trust” is a trust that complies with section 401(a) (Treas. Reg. 1-401(0)) which has 33 different sub-sections. Some are very broad while others are very situation specific.  Regardless, it’s a very technical section of the code, which further explains why compliance is usually outsourced to third parties.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

 

 

 

[1] In Re Rothko, 43 N.Y. 2d 305 (I have reversed the order of the quotes for the sake of clarity).

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(Delayed) Merry Christmas and Happy New Year

Posted by fhalestewart on December 29, 2017


On behalf of Professor Byrnes and myself, we’d like to wish you a Merry Christmas and Happy New Year.  We’ll return next week.

 

 

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Deferred Compensation and Rabbi Trusts

Posted by fhalestewart on December 18, 2017


This will be the last post in our NQDC series.

Revenue Procedure 92-64 contains model language for a “Rabbit Trust,” which is a trust a company can establish to set-aside funds for a NQDC plan.  Companies routinely use these structures to allay employee concerns about actually receiving NQDC payments.

You can read the entire Procedure at this link on the Legal Bit Stream website.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

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Exempt Organization Oversight On the Decline

Posted by fhalestewart on December 18, 2017


From the Washington Post:

Years of conservative attacks on the Internal Revenue Service have greatly diminished the ability of agency regulators to oversee political activity by charities and other nonprofits, documents and interviews show.

The fall in oversight, a byproduct of repeated cuts to the IRS budget, comes at a time when the number of charities is reaching a historic high and they are becoming more partisan and financially complex.

…..

The main part of government tasked with policing those lines, the IRS’s Exempt Organizations division, has seen its budget decline from a peak of $102 million in 2011 to $82 million last year. At the same time, division employees have fallen from 889 to 642.

The division now lacks expertise, resources and the will needed to effectively oversee more than 1.2 million charities and tens of thousands of social welfare groups, according to interviews with two dozen nonprofit specialists and current and former IRS officials.

“This completely neutered them,” said Philip Hackney, a tax law professor at Louisiana State University and former Exempt Organizations lawyer at the IRS. “The will is totally gone.”

 

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New Paper: “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation”

Posted by fhalestewart on December 11, 2017


With new tax legislation comes new tax games, which is the topic the new paper, “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation,” available from SSRN.  I haven’t reviewed it, but it has received a large amount of publicity in the press.  It’s written by a group of tax professors.  Here is the abstract:

This report describes various tax games, roadblocks, and glitches in the tax legislation currently before Congress. The complex rules proposed in the House and Senate bills will allow new tax games and planning opportunities for well-advised taxpayers, which will result in unanticipated consequences and costs. These costs may not currently be fully reflected in official estimates already showing the bills adding over $1 trillion to the deficit in the coming decade. Other proposed changes will encounter legal roadblocks that will jeopardize critical elements of the legislation. Finally, in other cases, technical glitches in the legislation may improperly and haphazardly penalize or benefit individual and corporate taxpayers. This report highlights particular areas of concern that have been identified by a number of leading tax academics, practitioners, and analysts.

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Recent PLRs Highlight How Not to Run a Charitable Organization

Posted by fhalestewart on December 10, 2017


Every week, the IRS releases PLRs covering the gamut of tax issues.  Several released this week drive home the point that running a 501(c)(3) organization is a complex process.

From PLR 2017-49015

PLR1

From PLR 2017-49014PLR2

Neither of these releases involves complex issues.  Instead, we see organizations that are not operating charitably,  not maintaining adequate books and records or allowing the IRS to examine records as requestions.  Anyone of these problems will provide the IRS adequate reason to revoke a tax-exempt status.

As a final point, charitable giving typically ramps up at year-end.  This is a good time to contact organizations to see if they are still tax-exempt.

 

 

 

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EU Finance Minister Blacklists 17 Jurisdictions

Posted by fhalestewart on December 7, 2017


From the Financial Times

European finance ministers have blacklisted 17 countries in a key part of the bloc’s crackdown on aggressive tax avoidance, while 47 other nations promised reforms to avoid being labelled tax havens.

American Samoa, Bahrain, Barbados, Grenada, Guam, South Korea, Macau, Marshall Islands, Mongolia, Namibia, Palau, Panama, St Lucia, Samoa, Trinidad & Tobago, Tunisia and United Arab Emirates were all listed as so-called non-compliant jurisdictions.

The grey-list of countries promising to reform to meet the European Union’s criteria has grown by nine countries since Friday. Cape Verde and Morocco were the last two countries to agree commitments; Tunisia’s reform proposal arrived too late for it to be moved off the blacklist.

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Non-Qualified Deferred Compensation: When Can You Make Distributions (pt. 2)?

Posted by fhalestewart on December 5, 2017


As I noted in my previous post, the NQDC statute specifically states there are six events when a NQDC plan can make a distribution, one of which is when the service provider “separates from service,” which is defined in the Treasury Regulations as:

An employee separates from service with the employer if the employee dies, retires, or otherwise has a termination of employment with the employer.

As with other aspects of this statute, there is little room for a liberal legal interpretation of the definition.

The statute further defines “termination of employment” as,

Whether a termination of employment has occurred is determined based on whether the facts and circumstances indicate that the employer and employee reasonably anticipated that no further services would be performed after a certain date or that the level of bona fide services the employee would perform after such date (whether as an employee or as an independent contractor) would permanently decrease to no more than 20 percent of the average level of bona fide services performed (whether as an employee or an independent contractor) over the immediately preceding 36-month period (or the full period of services to the employer if the employee has been providing services to the employer less than 36 months).

The statute provides 2 tests.  Either there is a complete termination of employment or an 80% reduction in the amount of work performed (as compared to the preceding three years) by the service provider.  This is one of the few areas where a bit of definitional “play” exists in the statute.

Finally, the statute provides the following, non-exclusive set of factors to use in a “facts and circumstances” determination as to whether termination has in fact occurred:

1.) Whether the employee continues to be treated as an employee for other purposes (such as continuation of salary and participation in employee benefit programs),

2.) Whether similarly situated service providers have been treated consistently, and

3.) Whether the employee is permitted, and realistically available, to perform services for other service recipients in the same line of business.

 

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

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Recent IRS Releases of Interest to Wealth Professionals

Posted by fhalestewart on December 4, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

Announcement 2017–15, page 534.

Announcement 2017–15 provides relief to victims of Hurricane Maria and the recent California wildfires. It permits easier access to funds held in workplace retirement plans and in IRAs, for periods beginning in September and October 2017 and ending March 15, 2018. The relief provided in the announcement is in addition to the relief already provided by the IRS pursuant to several recent news releases.

Notice 2017–67, page 517.

This notice provides guidance on the requirements for providing a qualified small employer health reimbursement arrangement (QSEHRA) under section 9831(d) of the Internal Revenue Code, the tax consequences of the arrangement, and the requirements for providing written notice of the arrangement to eligible employees.

 

https://www.irs.gov/pub/irs-irbs/irb17-47.pdf

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Non-Qualified Deferred Compensation: When Can You Make Distributions (pt. 1)?

Posted by fhalestewart on November 29, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

Section 409A contains a very strict set of times when a NQDC plan can make distributions.  They are:

(i) separation from service as determined by the Secretary (except as provided in subparagraph (B)(i)),
(ii) the date the participant becomes disabled (within the meaning of subparagraph (C)),
(iii) death,
(iv) a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral of such compensation,
(v) to the extent provided by the Secretary, a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation, or
(vi) the occurrence of an unforeseeable emergency.

Death (iii) and a specified time (iv) are not legally debatable; they simply are.

Like other key provisions of 409(A), disabled is specifically defining in the statute:

(C) Disabled: For purposes of subparagraph (A)(ii), a participant shall be considered disabled if the participant—
(i) is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or

(ii) is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under an accident and health plan covering employees of the participant’s employer.

This term is tightly written, offering lawyers little interpretational wiggle room.  It’s obvious that a formal medical opinion (and probably a second) is required for the client file.

Finally, there is the unforeseen emergency:

The term “unforeseeable emergency” means a severe financial hardship to the participant resulting from an illness or accident of the participant, the participant’s spouse, or a dependent (as defined in section 152(a)) of the participant, loss of the participant’s property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant.

The terminology strongly implies the “fortuity” element in an insurance contract, strongly hinting that the insured does not have the ability to take preventative measures to avoid the event.  It’s also highly likely that a medical opinion will also be required.

Next, we’ll discuss the “separation from service” requirement.

 

 

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Today’s Tax Legislation Headlines

Posted by fhalestewart on November 27, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

Republicans look at making changes (WaPo)

CBO says Senate hurts poor more than originally thought (WaPo)

New tax bill will lift the prohibition on churches engaging in political activity (NYT)

Do or die time for tax legislation (Politico)

Thune predicts that changes will occur but that the tax bill will pass (Politico)

 

 

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Happy Thanksgiving From the Wealth and Risk Management Blog

Posted by fhalestewart on November 22, 2017


On behalf of Prof. Byrnes and myself, we’d like to wish you and your family a happy Thanksgiving.

We’ll return next week.

 

 

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Today’s Tax Policy Headlines

Posted by fhalestewart on November 20, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

The plan is unpopular (WaPo)

Will the tax plan help the middle class?  The answer is complicated (NYT)

The Joint Committee on Taxation’s publication website has numerous studies on the tax plan (JCT)

Tax bill reflects the growing division between Republicans and higher education (WaPo)

 

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Will Trump Keep His Promise that No One’s Retirement Will Be Taken Away?

Posted by William Byrnes on November 16, 2017


The 2017 Tax Reform discussion originally was, like the 1986 discussion, about whether the Internal Revenue Code should be used for incentives and subsidy in favor of a particular activity or particular group of taxpayers. Broaden the base, lower the rates, simplify the variations, exceptions, and exemptions. But the dueling Chamber proposals are now out and tax reform based on equity and on eliminating tax-incentives was dead on arrival. It the same old ‘every interest’ vying for a portion of the pie. That’s the democratic, political “Gulchi Gulch” process. What is my interest then? I work for a public research university. I have ‘a dog in this fight’ described below. Hope that the government relations staff of NTEU, of state universities, and of other government employee stakeholder groups raise their voices like the Seraphim to the Republican members of the Finance Committee that are willing to listen.

So what’s so alarmed me to divert my attention to the retirement provisions of the Senate Chair’s mark? Did not the President state that retirement would be left alone (see his tweet here)?  Appears the Senate ignored him as usual.

The Senate Finance Committee Chair slipped in (at page 178) an explosive measure for government employees that also impacts public academic institutions. The Senate Finance Committee Tax Reform Chair’s Mark under the current status (November 9, 2017) will limit public employees to one aggregate amount of $18,500 for retirement plans 403(B) and 457 as of January 1, 2018.

Finance Committee Chair Proposal: The proposal applies a single aggregate limit to contributions for an employee in a governmental section 457(b) plan and elective deferrals for the same employee under a section 401(k) plan or a 403(b) plan of the same employer. Thus, the limit for governmental section 457(b) plans is coordinated with the limit for section 401(k) and 403(b) plans in the same manner as the limits are coordinated under present law for elective deferrals to section 401(k) and section 403(b) plans.

Government, including public educational institution, employees needs to become immediately aware that this provision will critically reduce their ability to contribute to their employer retirement plan(s) by $18,500 (or $24,500 for employees 50 years and older) as of January 1, 2018.  Thus, while there is still time to make December 1st contribution changes to preserve the last year of the additional $18,000 (or $24,000 if at least 50 years of age), these employees need to arrange with their payroll officers to contribute before December 31st any difference between what is allowed in 2017 and what has actually been contributed. As of January 1, 2018, the ability to contribute is gone forever.

Hatch Amendment #2 An amendment to the catch up contribution rules for section 401(k), 403(b) and 457)(b) retirement savings plans. Description of Amendment: This amendment would require all catch up contributions to section 401(k), 403(b) and 457(b) retirement savings plans to be Roth only, and increase the $6,000 catch up contribution annual limit applicable to such plans to $9,000.

See what he’s done here to Americans trying to save for retirement? At age 50 plus, we will pay on average – say 30 percent – for each catchup retirement dollar. How many years does it take to catchup with this 30 percent loss out the door? Based on historical annual average market returns, it will require four years to break even on the 30 percent loss. Only in year five will the 50-year-old, based on historical returns, start to earn towards retirement relative to her situation today in 2017. Where does our 30 percent loss out the door go? To pay for …. an energy credit? I don’t know. The revenue raised is relatively minuscule. The damage to retirement savings – tremendous.

Lack of Impact Analysis on Retirement and Public Employees

Curiously, I have not found many informative articles about the impact to retirement from these above-mentioned changes. Why is it silence from the public university crowd that is usually quite loud although this provision will damage their ability to attract researchers, faculty, and staff from the higher compensation opportunities of private educational institutions and for-profit industry?  Are we embarrassed to appear to be lobbying to keep a tax break? Just caught by surprise?  At least the NAGDCA has sent out an alert (Government Defined Contribution Administrators) to its members.

Instead of the beneficial retirement system, government agencies and public institutions need to find more revenue to pay competitive salaries and employee benefits to replace the loss of the retirement benefits (doubtful) Senate Finance will take away. Lacking better salaries, government agencies and public institutions will experience disproportionate employee turnover of the best performing management coupled with a declining ability to attract highly accomplished professionals and researchers to replace the pool.

Is this Payback Against the IRS?

Perhaps this provision is a Republican payback to government agencies like the IRS because Republicans think that the current government management pool is biased against Republican groups or lacks service for taxpayers? But taking out the best performing managers from government service will exasperate the challenges, not remediate them. If this is a ‘payback’, then it is “cutting off one’s nose”.  Perhaps the provision is but a Machiavellian move in a contest for talent between a state university and its private counterpart (Utah v BYU comes to mind)?

Maybe the silence from the government and public institutions employees is ‘heads in the sand’, and perhaps ‘those in the know’ think this provision will not survive because JCT scored it as only worth $100 million a year at least until 2021 (so why waste the political capital). Apportioned amongst all government employees in the US (being federal and state), state public academic institutions I suspect are less than 10 percent of this score, thus about $10 million a year for offset (inconsequential basically).

Can Public Institutions Be Saved?

A carve-out from this provision for public educational institutions would address the harmful issue and can be negotiated in response to the also proposed loss of the current carve-out for deferrals allowed for section 403(b) plan for at least 15 years of service to an educational organization, hospital, home health service agency, health and welfare service agency, and church. Seems to me that Republicans would prefer to incentivize via retirement doctors, nurses, social workers, and clergy to stay long-term in their public positions instead of paying higher government salaries.

Interested to learn the impact on your clients of the 2018 tax changes, and what to do about it?  Read the online version of Tax Facts.

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Why Do Republicans Want to Impose an Inflation Tax? Thought They Were for Lowering Taxes?

Posted by William Byrnes on November 15, 2017


 

Raising our Taxes and Killing Social Security via the Republican’s Proposal for an Inflation Tax in Tax Reform

This so-called “Tax Reform” is going to raise our tax burdens while killing social security.  The Republicans have proposed, and Democrats have agreed, that actual inflation should not be recognized in future years, limiting inflation adjustments of tax brackets to increase tax on persons who earn more because of inflation, and decreasing social security benefits by half over 20 years.  This Tax Reform, besides reducing retirement opportunities for public employees, imposes “Chained CPI” (also known as the inflation tax) upon social security benefits to keep them from increasing and upon tax brackets to keep them from increasing as well. But tax brackets not increasing is bad for taxpayers. Tax brackets that do not move up to account for actual inflation require a higher tax rate be paid on future income as actual inflation pushes it into the next bracket.

I thought Republicans wanted lower taxes imposed on people who sweat and toil? Or do Republicans actually want lower taxes only on idle passive investors?

What if I like organic apples?

How’s that again? “Chained CPI” is sold as the savior of Social Security (see Heritage Foundation explanation). The example employed by Heritage in favor of Chained CPI: if apples go up in price, then consumers stop eating apples and eat cheaper oranges instead. What if I prefer apples? What if I am allergic to oranges? To my actual point: it is not a ‘choice of apples versus oranges world. It’s a choice between quality and cheaper (generally imported) goods. Chained CPI over time eliminates the local farmer’s organic apples in favor of the imported, genetically modified, pesticide grown cheap apples. Chained CPI requires that we reduce lean meat (sorry vegans) in favor of affordable fast food.

Chained CPI is a system built on forcing a degrading quality of life onto retirees. 

Compounded over time, it’s a choice between affording medication and going without medication, giving up restaurant dates with my spouse in favor of TV dinners. The monthly annuity from social security, as little as it is relative to a 15.4% pay-in of salary (albeit capped, but so are benefits) over 40 years, could be cut significantly over 20 years (see New Republic explanation) in respect to what it can actually buy in today’s terms. In 20 years when my generations retirees wake up to this death by a thousand substitutions, the monthly social security annuity is so relatively inconsequential, it won’t be worth discussing any longer. Worse, over these 20 years, our tax bills will increase annually via the Chained CPI bracket creep that keeps brackets from adjusting upward as our wages hopefully increase. So inflationary tax takes away our ability to try to mitigate the loss of our catchup retirement and social security. We MUST work, if able, until we drop dead, assuming that we are not substituted for a cheaper wage worker.

Retired, Older Experience Hirer Inflation Than Younger Population  

The Congressional Research Service has published a study that finds that elderly persons actually experience higher inflation than younger ones (see CRS Research Report A Separate Consumer Price Index for the Elderly?).  Instead of going the wrong direction to a Chained CPI, the CRS suggests a CPI for the elderly spending patterns to be called CPI-E.

Follow the impact analysis of the 2018 tax updates after these pass by a team of experts who will map out how these affect your clients and what planning you need to do – TaxFacts Online.

 

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Non-Qualified Deferred Compensation: The “Substantial Risk of Forfeiture” Requirement

Posted by fhalestewart on November 14, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

Income for tax purposes is defined in the broadest possible terms.  §61 states it as “income from whatever source derived.”[1]  The case law adds further clarification and detail.  Glenshaw Glass defined income as “undeniable accessions to wealth, clearly defined, and over which the taxpayers have complete dominion.”[2]  The latter term is central to a properly structured non-qualified deferred compensation (NQDC) plan.  If the taxpayer has any control over the plan’s income, he will have to include the total income in his annual income.

Therefore, all money in a NDQC plan must be subject to a substantial risk of forfeiture.[3]  “[E]ntitlement to the amount [must be] conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial.”  The future services must be performance based, and they cannot include “any amount or portion of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria is established.”[4]  These two conditions further support the requirement that the NQDC contract must be in writing.[5]  They also strongly allude to an employment law component in which the service recipient and provider agree on a basic compensation level and an additional layer, which will be paid for through the NQDC plan.

Finally, the “substantial risk of forfeiture” element can’t be met if the service provider is the sole owner of the company.  The underlying rationale is simple: he or she will not use their management position to not pay themselves – it’s simply not going to happen.  The examples in the Treasury Regulations imply that a 20% ownership stake is the maximum amount the service provider can own of the company and still benefit from the NQDC plan.  But this same section also says the ultimate determination is based on the “facts and circumstances.”[6]

[1] 26 U.S.C. §61

[2] Comm’r v. Glenshaw Glass, 348 U.S. 426 (1955)

[3] Treas. Reg. 1.409-1(a)(d)(1)

[4] Treas. Reg. 1.409A-1(e)(1)

[5] See also Treas. Reg. 1.409(A)-1(e)(“The term performance-based compensation means compensation that amount of which, or the entitlement to which, is contingent on the satisfaction of pre-established organizational or individual performance criteria relating to a performance period of at least 12 consecutive months.”)

[6] Treas. Reg. 1.409(A)-1(d)(3)

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New Limits For Qualified Plans

Posted by fhalestewart on November 12, 2017


Code section 415 specifically defines the total benefits and contributions allowed for a “qualified” plan.    Exceeding these limits will strip a plan of its tax-deferred status.  Code section 401(b) requires the Secretary to annually adjust various amounts.  A few weeks ago, the IRS released Notice 2017-64 which contains various adjustments.  You can read the entire release at this link.

 

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

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Today’s Tax Policy Headlines

Posted by fhalestewart on November 9, 2017


Senate bill differs from House’s (NYT)

Tax bill math is getting complicated (WaPo)

House leaders rounding up votes (Politico)

Support for tax plan still positive (Politico)

Election results potentially change the tax plan (Politico)

Multinational companies lobby against 20% excise tax (BB)

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

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Non-Qualified Deferred Compensation: Some Additional Definitions

Posted by fhalestewart on November 6, 2017


In this post, I’ll take a look at several more definitions related to non-qualified deferred compensation (NQDC) plans, beginning with the definition of “plan:”

“The term plan includes any agreement, method, program or other arrangement, including an agreement, method, program or other arrangement that applies to one person or individual.”[1]

Here, we see the Treasury using the standard definitional tactic of using several words that, while moderately different, convey the same idea.  However, the commonplace definition of the word “plan” (“a method for achieving an end.”)[2] along with its synonyms[3] would have sufficed.

The plan must be in writing.  While not explicitly stated, it is strongly implied in the regulations.

“…a plan is established on the latest of the date on which it is adopted, the date on which it is effective, and the date on which the material terms of the plan are set forth in writing.  The material terms of the plan may be set forth in writing in one or more documents.”[4]

In addition, because of the sheer complexity of NQDC, it’s best to have a governing document.  (I googled the search term “NQDC sample plan and found several online examples, here, here and here).

There are only six events that allow the plan to distribute assets:

  • separation from service as determined by the Secretary (except as provided in subparagraph (B)(i)),
  • the date the participant becomes disabled (within the meaning of subparagraph (C)),
  • death,
  • a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral of such compensation,
  • to the extent provided by the Secretary, a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation, or
  • the occurrence of an unforeseeable emergency.[5]

These terms are not subject to over-lawyering.  Potentially malleable terms (e.g. “disabled” or “separation from service”) are further defined in the statute or require the Secretary’s approval.  The underlying message is clear: don’t get cute.

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

[1] Treas. Ref. 1.409(A)(c)(1)

[2] https://www.merriam-webster.com/dictionary/plan

[3] Id (“arrangement, blueprint, design, game, game plan, ground plan, master plan, program, project, roadmap, scheme, strategy, system”)

[4] Treas. Reg. §1.409(A)(3)(i):

[5] 26 U.S.C. 409(A)(2)(i)-(vi)

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ICIJ Begins to Release the “Paradise Papers”

Posted by fhalestewart on November 5, 2017


As you may know, the International Consortium of Investigative Journalists released the Luxembourg Leaks database in 2014 (which you can view here).  This showed a number of EU based tax structures based in Luxembourg.  “Luxembourg Leaks” helped to jump-start the OECD’s base erosion and profit shifting initiative.

From today’s release:

The Paradise Papers is a global investigation into the offshore activities of some of the world’s most powerful people and companies.

The International Consortium of Investigative Journalists and 95 media partners explored 13.4 million leaked files from a combination of offshore service providers and the company registries of some of the world’s most secretive countries.

The files were obtained by the German newspaper Süddeutsche Zeitung.

The Paradise Papers documents include nearly 7 million loan agreements, financial statements, emails, trust deeds and other paperwork from nearly 50 years at Appleby, a leading offshore law firm with offices in Bermuda and beyond.

 

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

 

 

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Today’s Tax Policy Headlines

Posted by fhalestewart on November 3, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

 

Potential impact of the proposed changes (NYT)

Mortgage deduction change could hurt the housing industry (NYT)

Plan delivers a permanent corporate tax cut (NYT)

GOP plan is a “sensible framework,” but it still explodes the deficit (WaPo)

The hidden 465 tax bracket (Politico)

Who pays more under the GOP plan? (Politico)

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The Lastest Tax Policy News Headlines

Posted by fhalestewart on November 2, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors.   

Republican tax plan to lower cap on mortgage interest deduction to $500,000 loans (WaPo)

Red State Dems are willing to work with Republicans on taxes (WaPo)

8 Charts of the US tax system from Wonkblog (WaPo)

Republicans release tax plan (NYTimes)

A list of the plans major changes (BB)

 

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Non-Qualified Deferred Compensation: Timing and Constructive Receipt Issues

Posted by fhalestewart on October 30, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors.    

 

It’s doubtful that anybody in the Financial Services industry is unaware of qualified retirement plans such as 401(k)s and IRAs.  Knowledge of them is required to pass licensing exams and every firm includes them in sales literature.  Non-qualified plans (NQDC), however, are less well-known, largely because they are more complex and appeal to a far smaller group of potential buyers.  Although their application is narrower, in the right circumstances they can provide clients with tremendous advantages.

This post begins a series on NQDC.  We will be spending a large amount of time with the tax code and accompanying treasury regulations; this is necessary due to NQDC’s complexity and numerous regulations.  But before delving into the code, let’s use basic statutory analysis and analyze the “plain meaning” of the words, beginning with “non-qualified.”  The primary difference between NQDC and qualified plans is that the former don’t comply with §401’s safe harbors – especially the rules relating to “highly compensated individuals”[1] and the plan funds not being subject to the plan sponsor’s general creditors.[2]  In fact, the treasury regulations define NQDC as much by what it isn’t[3] as what it is.  Moving onto the other words, the Merriam Webster online dictionary defines the word “deferred” as “withheld for or until a stated time”[4] and “compensation” as “payment.”[5]  Combining these two definitions, we get: payment for services that is withheld until specifically enumerated events.

A properly implemented NQDC plan requires that the client does not formally receive income before certain events[6] or else he will become liable for the accompanying taxes at inopportune times (along with penalties).  Therefore, we need to know when a taxpayer recognizes income to avoid attribution from these events.  This naturally leads to a discussion of the two accounting methods.  The cash method stipulates that “all items which constitute gross income … are to be included for the taxable year in which actually or constructively received.”[7]  The most obvious example occurs when the taxpayer’s account increases by a specific amount of money.  The accrual method is the second system.  It has two factors: all events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy.[8]  For example, once the taxpayer has done the agreed upon work and sent an invoice, he can book the income under the accrual method.

The client must also avoid constructively receiving income, which is defined in §1.451-2(a):

Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

The service provider cannot reach, attach, pledge, or be credited with all or any portion of the money set aside under the plan.  This requires that all funds in the NQDC plan be subject to a substantial risk of forfeiture, which is discussed in treasury regulation §1.83-3(a).

a substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person, or upon the occurrence of a condition related to a purpose of the transfer if the possibility of forfeiture is substantial.

The most commonly used situations in NQDC contracts are continued performance by the service provider or the occurrence of a major corporate event such as a merger or acquisition, specific sales goals, going public, and the like.    

            This post only covers the surface of several key NDQC components.  However, it should provide the reader with a basic overview of these key elements.

Next, we’ll dig deeper into the definition of an NQDC plan.

 

[1] 26 U.S.C. 401(a)(4)

[2] See 26 U.S.S. 401(a)(2)

[3] The Treasury regulations define NQDC by what it isn’t.  See generally Treas. Reg. §1.409A-1(a)(2)(i) through Treas. Reg. §1-409A-1(2)(ix)

[4] https://www.merriam-webster.com/dictionary/deferred

[5] https://www.merriam-webster.com/dictionary/compensation

[6] 26 U.S.C. 409(A)(2)(A)(i)-(vi)

[7] Treas. Reg. §1.446-1(c)(i)

[8] Treas. Reg. §1.446-1(c)(ii)

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The Destination-based Approach to Business Taxation, Explained

Posted by fhalestewart on October 30, 2017


In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors.    

 

From the article:

An alternative approach has been to identify fundamental tax reforms that can deal more adequately with the new economic realities. One such approach builds on the concept of business cash-flow taxation, first proposed in the late 1970s by the Meade Committee (Institute for Fiscal Studies 1978). Originally conceived as a tax on the cash flows of domestic producers (an ‘origin-based’ tax), the cash-flow tax had many potential benefits, including eliminating the tax on normal returns to new investment, removing tax-based incentives for corporate borrowing, and eliminating the need to measure income of companies with complex business arrangements. But this standard cash-flow tax leaves in place the pressure for international tax competition via incentives for companies to shift the location of profitable activities and reported profits to low-tax countries. This shortcoming led to consideration of a destination-based cash-flow tax (DBCFT), which adds ‘border adjustment’ to cash-flow taxation and has the effect of basing the tax on the location of consumers rather than on the location of profits, production, or corporate residence.

As described in a series of papers, including Auerbach (2017), converting an origin-based cash-flow tax into a destination-based cash-flow involves relieving tax on export revenues and imposing tax on imports, in precisely the same manner as is done under existing value-added taxes (VATs). The key difference from a VAT is that the DBCFT maintains the income tax deduction for wages and salaries, and thus amounts to a tax on domestic consumption not financed by labour income, in principal a much more progressive tax than the VAT.

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