Entries tagged with “Tax”.


Well it finally happend — something that I never thought I would see.  No, my kids didn’t clean up their rooms without being asked – something even more remarkable. Congress has allowed our federal estate tax to expire. There have been an abundance of articles written on this issue in the last few weeks and I have been delaying this newsletter in hopes that I would be able to bring you some “hot off the press” discussion of new tax legislation. Congress is simply not cooperating with me.

So what is all the big talk on this estate tax repeal? Under the current law, anyone dying in 2010 is not subject to estate tax, no matter how large their estate. However, it is widely believed that Congress will enact legislation which will reintroduce the tax retroactive to January 1 of this year with an exemption yet to be determined but likely equal to the amount which was available in 2009 ($3,500,000). If Congress doesn’t act, then in 2011 the estate tax will return with a vengeance; the law will revert to what existed in 2001 with top rate of 55% and, more importantly, a reduction in the exemption to $1,000,000.What does this mean for you or your friends or clients? Today is a good day to die. However, I am not suggesting that as a prudent estate plan. My advice is that you all continue to pay attention to the headlines to see what action Congress may take. For most of you there should be no immediate need to modify your estate planning documents, but it is important to understand how the ground rules may change in this area of tax law. When we have some definitive action from Congress, I am sure I will have something more to say.

Any of you paying attention to this estate tax repeal saga will note that I haven’t mentioned “carryover basis” rules. When Congress gave us this 2010 estate tax repeal, it included a little surprise income tax increase by changing the way capital gains taxes are determined for heirs of a decedent’s estate. Imagine that. I will spare you all of the ugly details, but if you want to know more, a quick internet search will give you plenty of bedtime reading.

While I am on the subject of taxes, I do want to mention one other income tax change that might be of interest. As of January 1 all of you can convert your traditional IRA’s into a Roth IRA. Previously this conversion option was subject to annual income limitations, but those limitations have been eliminated. With a Roth IRA your assets grow tax-free and your distributions during retirement will be tax-free. A traditional IRA gets you the same tax-free growth but distributions are subject to tax. The trade off here is that the conversion to the Roth will generate an immediate income tax liability based on the value of the assets converted. So the choice is to pay tax now or pay later. If you believe that your tax rates will be higher in retirement then that weighs in favor of converting now. However there are many variables that impact this decision, including future changes in tax laws and whether you have other sources of liquidity to pay the current tax liability, so I encourage you to talk to your tax advisors about this planning option. Also keep in mind that Congress really wants you to convert in 2010 and the law includes special rules that will allow you to defer payment of your income tax over two years. This makes the conversion option a lot more attractive. Remember the show Let’s Make a Deal…I hope we all pick the correct door!

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Do you have real estate owned in your corporation?  Watch out for a tax surprise!

Many of you have heard from your advisors (including yours truly) that if you own real estate either for your business or for investment then you need to protect yourself from liability by having the property titled in some form of corporate entity; see my June newsletter.  However, it is very important that you choose the right type of entity to own your real estate.  As a general rule, you should not use a corporation.  Why?  Corporate tax law is not friendly to the real estate owner.

I will spare you a lengthy discourse on the ins and outs of corporate tax laws, although I assure you that it’s fascinating!  The short answer is that real estate owned inside of a corporation generates an unexpected tax liability if you ever wish to move that property out of the corporation.  Let’s say that you acquire a couple of rental properties with a friend and you set up a corporation as the owner, but some years later you and your friend decide to part ways and split up the properties.  This would typically involve dissolving the corporation and transferring property out to each owner.  The problem is that the tax law treats that transfer of property as a “deemed sale.”  If the property has appreciated then that deemed sale triggers a capital gains tax for the corporation.  It is irrelevant that you haven’t actually sold the property or that no cash has changed hands.

For this reason, you should avoid using a corporation to own real estate in most cases.  Keep in mind that I am talking about real estate that you buy and hold (e.g. a location for your operating business, rental or investment property).  If, on the other hand, you are in the business of buying and selling real estate on a short term basis, then a corporation may work perfectly well for your needs, since you will recognize a tax liability anyway when you sell property; there is not the same potential for a deemed sale surprise.

Enter stage left….the limited liability company (LLC).  An LLC is typically taxed as a partnership, which operates under entirely different tax rules.  In particular, real estate can almost always be moved in and out of the name of an LLC without generating a tax liability.  Since the LLC still provides the same basic limited liability protection available in a corporation, the LLC has become the entity of choice for owning real estate.

What about an “S” corporation?  An “S” corporation is, in many ways, taxed like a partnership, however one important difference is that the deemed sale rule described above will still apply for an S corporation.  Although there may be special circumstances that help decrease this tax liability with an S corporation, the better option is to stay away from a corporation altogether.

If you are unfortunate enough to have a corporation that owns real estate already, then you may be stuck with this potential tax issue until you are ready to sell the property.  But please talk to your tax advisors before you take any action; you may have planning options to help minimize the tax liability.

Remember, tax time is no time for surprises.

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How to carry out the decedent’s wish — 101.   I bet many of you have heard some variation of the following .

Aunt Lucy had no kids of her own but she had a bunch of nieces and nephews – seven of them in fact.  She loved them all but she was particularly close to her niece Mary who  helped out quite a bit during Aunt Lucy’s final years.  Aunt Lucy regularly talked about how she wanted Mary to inherit the old family farm.  When the time came, the family discovered that Aunt Lucy’s Will left all of her property and assets equally to her nieces and nephews and didn’t make any special provisions for Mary alone. Unfortunately Aunt Lucy’s statements didn’t change the Will.  This meant that after Aunt Lucy’s death the family farm was owned by all the nieces and nephews together.

So is there any way to fix this?  How can you carry out Aunt Lucy’s wishes when she failed to make the necessary provisions in her Will?  Some of you may wonder if a court proceeding would do the trick, but our courts are not in the business of changing provisions in a Will.  A court proceeding is appropriate if there is some ambiguity or conflict in the terms of the Will itself or if there is a question of the Will’s validity.  None of these applies for Aunt Lucy’s Will.

However there is a solution which is pretty simple, provided we have the agreement and cooperation of all the nieces and nephews.  As legal owners of the property, the nieces and nephews can execute a quitclaim deed in favor of Mary to transfer title to the property entirely to her.  This transaction does not require any court approval or any court procedure, other than recording the deed.   This is simply an independent action of the beneficiaries to fulfill the wishes of the Aunt Lucy notwithstanding the terms of the Will.

One caveat in this solution is that the valuation of the property is very important.  The transfer in this case is a gift from all the other nieces and nephews to Mary.  Under the tax law, each niece and each nephew can give Mary up to $13,000 worth of property in any given year; this is known as the annual gift tax exclusion.  As long as the value of the property divided among all of the nieces and nephews is below the $13,000 annual exclusion, there is no gift tax concern.  However, if the gift for each donor will exceed the annual exclusion, then you can always spread the gift out over several years with multiple deeds or you may also determine that a larger gift will not create tax issues for the donors.

OK that all works fine if everyone agrees, but what if you have that one nephew who doesn’t get along with Mary and won’t cooperate in the deed.  In this case you may be out of luck unless Mary and/or the other beneficiaries are willing to work out some type of “settlement” with the nephew.   Again the key is reaching some agreement between the beneficiaries.  As long as the beneficiaries can all agree and as long as the gift tax consequences can be addressed, then we really can fulfill Aunt Lucy’s wishes.  Of course all of this trouble can be avoided if we can just get people to update their Wills to reflect their wishes – get off the sofa Aunt Lucy!

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Why am I still talking about lawsuits? Last month we reviewed the benefits of limited liability protection available in the form of a corporation or LLC.  But there is a little more to the story…..

Remember, business liability arises out of the operation of your business or ownership of property.  An LLC or corporation (a “business entity”) can help shield your personal assets from business liability.  But what if you have signed a personal guarantee?  If you need a business bank loan, you can count on the bank asking you (and maybe your spouse or business partners) to sign a personal guarantee in most cases.  The personal guarantee ensures that if the business is unable to repay the loan, then the bank can recover from your other financial  assets; this is basically an end run around the limited liability protection of the business entity.  Personal guarantees are also common in commercial office leases, equipment purchases or other commercial contract relationships with suppliers.  It is crucial for you to understand what you are signing and what exposure you have in these various business relationships.  You may have signed personal guarantees and not even realized it.  Be very careful when you sign any documents related to these types of transactions and make sure you are aware if you are undertaking personal liability.  Also be very careful how you sign on behalf of your business entity — you should always indicate your title (e.g., President, Manager, etc); that way it is clear you are signing only in your capacity as an officer for the company and not as an individual.

I also mentioned last time the importance of following corporate formalities in the operation of your business entity.  What I mean is that you can’t simply create an entity in name only.  You have to actually operate your business through the entity.  Again, use your entity name in all of your contract relationships.  Maintain bank accounts for the entity and handle all inflows and outflows of revenue through these accounts.  File your business annual reports with the Secretary of State each year.  Be consistent in your tax reporting; usually you need to prepare a separate tax return for your business entity.  Why are corporate formalities important?  You are trying to avoid an argument by a creditor that your business entity is simply a sham, and that the creditor should be allowed to collect against you individually.  This is known as “piercing the corporate veil.”  That’s all of the legal jargon I want to include on this, I think you get the point…pun intended.

Finally, consider options to protect against liability with insurance.  Professionals such as lawyers, CPAs, and doctors, carry professional liability insurance largely because they have personal liability exposure  for mistakes they make regardless of whether they operate through a business entity.  For other businesses which don’t involve typical professional liability, there is Errors and Omissions (“E & O”) insurance.  Most E & O policies are designed to cover liability arising out of your or your employees’ negligence — somebody made a big mistake and now the client is mad and has lost money.  If you are sued in this case, your insurance company helps defend you and ultimately pays for any claims that are successfully made against you (as long as they are covered by the policy).  The terms of the policy are very important so read it carefully.  In my experience,  many, if not most, businesses don’t carry E & O insurance, so don’t assume that is an absolutely necessity, but it may help you sleep better at night if you are worried about your exposure to this type of liability.

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