Tax Law and Business Organization Strategy

Costs of Forming and Maintaining Entities

jack.howell@sprouselaw.com (Jack Howell) — Wed, 18 Nov 2009 15:25:54 -0600

I form and maintain many entities each year for my clients. Since I am located in Texas, I form mostly Texas entities. But I am frequently asked to form entities elsewhere -- mainly Nevada and Delaware. I always assumed that the filing fees and simlar charges made by Nevada and Delaware were less than those in Texas (not counting the cost of maintaining a registered office if you weren't actually located there). But the other day, I was informed that Nevada was going to start strictly enforcing its charges for a Business License. So, I asked one of my paralegals to investigate the various charges of each of these states. You may find the results as interesting as I did. Read on . . .

Texas

Texas only charges an initial filing fee for its entities. While that charge is high ($750 for limited partnerships and $300 for all other business entities), That is the only charge that it imposes.

Texas does have a franchise tax for all of its entities. But that tax is imposed based on Texas activitity. That is, you pay it if you have Texas activitity even if you are organized in Nevada or Delaware. And you don't pay it if you don't have Texas income or presence, even if you are organized in Texas.

Nevada

Nevada charges filing fees for the various types of entities. The basic filing fee charge is $75. However, you can add to that another fee of $125 for your list of officers, managers, members, or partners, depending on what type of entity you have.

Nevada also has a $200 charge for a Business License. Even if you don't do any business in Nevada, you have to obtain and pay for this license.

So, your real cost to organize a Nevada entity is at least $400. And this doesn't count the annual charges. the list of officers, etc., has to be filed annually. Similarly, the cost for the Business License is an annual cost. So, not only does it cost $400 to form a Nevada entity, it costs $325 per year to maintain the entity.

Delaware

Delaware is a little more complicated since the costs for corporations differs significantly from the cost of other entities. Like Nevada, their initial costs seem to be quite reasonable. The filing fees for a corporation are based on the amount of stock authorized, and begin at $89. Limited partnerships are $200; and limited liabitlity companies are $90.

But Delaware has annual costs that apply even if you don't do anything in Delaware. Corporations must file and annual report and pay $50. In addition, corporations must pay a franchise tax (even if the corporation has no Delaware activities) that ranges from $75 to $180,000. Limited partnerships and LLCs have to pay an annual tax of $250 per year to maintain their existence in Delaware.

Conclusion

Unless your entity is going to have a short life, the lack of annual expenses in Texas makes Texas entities more economical than Nevada or Delaware. This would be true even if your entity is not going to be doing business in Texas.

Joint Committee on Taxation Description of Business Tax Changes in President's 2010 Budget

jack.howell@sprouselaw.com (Jack Howell) — Thu, 10 Sep 2009 16:18:35 -0600

The staff of the Joint Committee on Taxation has released a comprehensive study on the business tax changes included in the President's FY 2010 budget proposal, as submitted to Congress on May 7, 2009. For a list of the proposed business tax changes, read on.

For tax years beginning after 2010, keeping the Code Sec. 179 expensing amount and investment-based phaseout at $125,000 and $500,000 respectively (under current law, after 2010, the amounts will fall to $25,000 and $200,000, respectively).

For qualified small business stock issued after Feb. 17, 2009, all gain from the sale or exchange of qualified small business stock would be excluded from gross income, and the alternative minimum tax (AMT) preference would be eliminated.

The research credit would be made permanent (under current law, the research credit, including the university basic research credit and the energy research credit, expires for amounts paid or incurred after Dec. 31, 2009).

The Administration proposes to work with Congress to make an extended NOL carryback period available to more taxpayers.

For transactions entered into after the date of enactment a transaction would satisfy the economic substance doctrine only if (i) it changes in a meaningful way (apart from federal tax effects) the taxpayer's economic position, and (ii) the taxpayer has a substantial purpose (other than a federal tax purpose) for entering into the transaction. A transaction would not be treated as having economic substance solely by reason of a profit potential unless the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the net federal tax benefits arising from the transaction.

For transactions entered into after the date of enactment, a 30% penalty would apply to an understatement of tax attributable to a transaction that lacks economic substance, reduced to 20% if there were adequate disclosure of the relevant facts in the taxpayer's return. The proposed penalty would be imposed with regard to an understatement due to a transaction's lack of economic substance in lieu of other accuracy-related penalties that might be levied with respect to the tax understatement. Also, there would be no deduction for interest attributable to an understatement of federal income tax arising from the application of the economic substance doctrine.

For tax years beginning after 2011, the LIFO inventory accounting method would be repealed. Taxpayers that currently use LIFO would be required to write up their beginning LIFO inventory to its FIFO value in the first tax year beginning after Dec. 31, 2011. The resulting increase in income would be taken into account ratably over eight tax years beginning with the first tax year the taxpayer is required to use FIFO.

For amounts paid or incurred after the date of enactment, the deduction for punitive damages paid or incurred as a judgment or in settlement of a claim would be repealed. If a liability for punitive damages is covered by insurance, any such damages paid by the insurer would be included in gross income of the insured person, and the insurer would be required to report such amounts to both the insured person and IRS.

For tax years beginning after 12 months from the date of enactment, the “lower of cost or market” (LCM) method and the write-down for subnormal goods would be repealed.

All of the following oil and gas tax breaks would be repealed:

the enhanced oil recovery credit
the marginal wells credit
the expensing of IDCs
the deduction for tertiary injectants
the exception for passive losses from working interests in oil and gas properties
percentage depletion for oil and gas
the domestic manufacturing deduction for income derived from the domestic production of oil, gas, or primary products thereof.

For forward contracts entered into on or after Dec. 31, 2010, a corporation that enters into a forward contract for the sale of its own stock would have to treat a portion of the payment received with respect to the forward contract as a payment of interest.

For tax years beginning after the date of enactment, commodities dealers, commodities derivatives dealers, dealers in securities, and options dealers would have to treat the income from their day-to-day dealer activities with respect to Code Sec. 1256 contracts as ordinary in character, not capital. This would not affect the application of the mark-to-market rules with respect to such gains and losses.

Other proposals would modify the rules that apply to sales of life insurance contracts, modify the dividends received deduction for life insurance company separate accounts, and expand the pro rata interest expense disallowance for company-owned life insurance (COLI).

Ninth Circuit rules that ESOP Trustees' Payment of Excessive Executive Compensation Could be Breach of Fiduciary Duty

jack.howell@sprouselaw.com (Jack Howell) — Thu, 27 Aug 2009 15:38:47 -0600

The Ninth Circuit has ruled that, where one of an ESOP's trustees was also the company's president, and on its board of directors, the trustees' “business decisions” leading to the payment of excessive executive compensation to the company president could constitute a breach of ERISA fiduciary responsibility to the ESOP. Johnson v. Couturier, (2009, CA9) 572 F.3d 1067. The court also ruled that ERISA preempted the indemnification agreements provided by the company to the president as a director and ESOP trustee.

In 2001, Noll, a closely held corporation, became fully owned by its ESOP. Clair R. Couturier, Jr., president of Noll, was designated as the sole trustee for the ESOP as of April 24, 2001. By the end of 2001, Noll's sole directors were Couturier and attorney David R. Johanson, who had previously represented the ESOP in connection with a leveraged purchase of all remaining Noll stock.

Before 2001, under a compensation continuation agreement (CCA), retired Noll executives were entitled to continue receiving 75% of their base salary, with an adjustment made every three years. In 2001, however, Johanson drafted three documents, which Noll, tying deferred executive compensation to company value:

an equity incentive plan establishing an incentive stock option plan for key management personnel;
an incentive stock option agreement granting Couturier 80,000 shares; and
a value enhancement incentive plan creating additional synthetic equity.

Sweetening the pot for Couturier, additional incentive agreements were enacted in February 2002, which included allowing for the issuance of up to 93,500 shares to Couturier, and an increase in Couturier's monthly CCA stipend by about 33%.

In 2003, Couturier's compensation expanded even further. That year, Couturier and Johanson approved a retroactive annual cash bonus to Couturier equal to 10% of the dollar amount of external debt repaid on certain loans. Noll then purchased a $5.5 million home (the Palm Desert home), and a $325,000 private golf club membership, for Couturier's personal use.

After unsuccessful negotiations for the acquisition of Noll, during which the value of Couturier's interest in the company became a point of contention, Couturier and Johanson appointed Couturier's financial advisor, Robert E. Eddy, as special trustee to the ESOP. Eddy's role was to evaluate proposed transactions involving Noll and the ESOP, including monetization of Couturier's financial interest in Noll. Couturier and Johanson ultimately opted to merge Noll into “The Employee Ownership Holding Company” (TEOHC), which Johanson had incorporated in Delaware on December 15, 2003. As the incorporator, Johanson appointed himself, Couturier, Eddy, and accountant James Roorda as directors. Under a new plan, the ESOP was now to be administered by trustees appointed by the TEOHC board. The board members appointed themselves as trustees.

On July 20, 2004, under the merger transaction, Couturier received over $26 million in cash, title to the Palm Desert home, a Bentley car valued at $200,000, and various other benefits in exchange for his deferred compensation interests. The parties valued this buy-out package at $34.8 million. Accordingly, Couturier's overall compensation package equaled about 65% of TEOHC's assets as of June 2004, and about 80% of Noll's assets as of each of the prior two years. The package was also more than two times Noll's 2002 stock market value.

On October 11, 2005, several former and current Noll employees, all ESOP participants, sued Couturier, Johanson, and Eddy (collectively, the defendants), seeking relief from the defendants' alleged breach of fiduciary duties under ERISA. In essence, the participants' claim was that Couturier was so overcompensated that it amounted to a breach of the defendants' fiduciary duty as trustees of the ESOP.

The defendants entered into indemnification agreements with Noll and TEOHC between 2001 and 2005. These agreements generally indemnified the defendants for any liabilities incurred as directors, and as ESOP trustees, as long as any such liability did not involve “deliberate wrongful acts” or “gross negligence.” At issue here were provisions within the indemnification agreements requiring TEOHC to advance defense costs. Seeking advancement as promised in the indemnification agreements, the defendants executed an undertaking to repay TEOHC for any expenses paid by it on their behalf in advance of the final disposition of the lawsuit, if it was ultimately determined that they were not entitled to be indemnified by TEOHC under Delaware law. Responding to this, the ESOP participants got the district court to issue a preliminary injunction prohibiting the advancement of defense costs. The defendants appealed this injunction.

The defendants made three separate arguments to avoid invalidation of the indemnification agreements under ERISA:

that they were not ERISA fiduciaries;
that the setting of executive compensation was a business decision not subject to ERISA; and
that whether TEOHC was obligated to advance their defense costs was purely a matter of state contract law.

The Ninth Circuit rejected each of these arguments.

Defendants were all ERISA fiduciaries. All of the Couturier defendants served as ESOP trustees, each was an ERISA fiduciary subject to the duties of loyalty and care, and to the prohibition against self-dealing, held the court. Couturier served as the sole trustee of the Noll ESOP beginning on April 24, 2001. Eddy was appointed special trustee to the ESOP in 2003. After Noll merged into TEOHC in 2004, all three defendants were appointed to the ESOP board of trustees. Further, all of the defendants were on the TEOHC board, which had the power to appoint the ESOP trustees.

ERISA applies to the executive compensation decisions here. ERISA confers upon federal district courts exclusive jurisdiction over any civil action brought by a plan participant or beneficiary for equitable relief from a trustee's breach of fiduciary duty. Johanson argued that the district court lacked subject matter jurisdiction over this case because the actions challenged by the participants, which resulted in Couturier's allegedly excessive compensation, were business decisions not subject to ERISA.

Decisions relating to corporate salaries generally do not fall within ERISA's purview, opined the Ninth Circuit. But, where plan assets include the employer's stock, the value of those assets depends on the employer's equity. Employee compensation levels are, of course, one of the many business expenditures reducing the value of the overall equity of any company. On the other hand, virtually all of an employer's significant business decisions affect the value of its stock, and thus the benefits that ESOP plan participants will ultimately receive. The court noted that taken to its logical conclusion, this line of thinking would, in the case of an ESOP, extend the application of ERISA to a corporation's annual expenditures on office supplies—clearly an absurd result.

On this basis, the Eighth Circuit has limited an ERISA fiduciary's duties to transactions that involve investing the ESOP's assets or administering the plan. (Martin v. Feilen, (1992, CA8) 965 F2d 660) Noting that setting executive compensation levels does not obviously fall into these categories, the Ninth Circuit, nonetheless, concluded that applying ERISA here did not risk encompassing within its confines any and all day-to-day corporate decisions shielded by the business judgment rule. Where, as here, an ESOP fiduciary also served as a corporate director or officer, imposing ERISA duties on business decisions from which that individual could directly profit did not seem to the court to be an unworkable rule. In fact, the court felt that to hold otherwise would protect the defendants here from ERISA liability for obvious self-dealing, which was detrimental to the plan beneficiaries.

ERISA preempts application of state law to the indemnification agreements. Defendants argued that whether TEOHC was obligated to advance their defense costs was purely a matter of state contract law, and that ERISA simply did not apply. However, the Ninth Circuit opined that ERISA contains a broad preemption clause, such that with only limited exceptions, ERISA supersedes any and all state laws that conflict with the provisions of ERISA or operate to frustrate its objects.

Here, the court found that the indemnification agreements provided complete indemnity as long as the challenged acts or omissions did not involve deliberate wrongful acts or gross negligence. ERISA § 404(a)(1)(B), by contrast, requires that a fiduciary act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. Since the defendants here would have been indemnified under the agreements even if they violated the ERISA prudent man standard of care, the court held that the application of state law here was preempted. Decision. Accordingly, the Ninth Circuit upheld the district court's preliminary injunction prohibiting TEOHC from advancing defense costs to the defendants, and remanded the case to the district court with instructions.

Source: Pension & Benefits Updates on Checkpoint Newsstand, 8/23/09

Latest IRS Pronouncements on Tax Avoidance Transactions and Transactions of Interest

jack.howell@sprouselaw.com (Jack Howell) — Fri, 17 Jul 2009 14:26:34 -0600

Notice 2009-59 updates the IRS' list of “listed transactions” published in Notice 2004-67, 2004-2 CB 600, by adding four transactions designated as listed transactions after the 2004 notice was issued. Notice 2009-55 carries a list of transactions designated as “transactions of interest” for various disclosure and penalty purposes.

Listed transactions update.

Promoting, advising taxpayers about, or participating in, a transaction that is the same as or substantially similar to a transactions determined by the IRS to be a tax avoidance transaction and a “listed transaction” triggers numerous disclosure and penalty rules. Taxpayers may need to disclose their participation in the listed transactions under Reg. § 1.6011-4, and material advisors may need to disclose these transactions under Reg. § 301.6111-3. Taxpayers who fail to disclose may be subject to penalties under Code Sec. 6662A and Code Sec. 6707A. Material advisors who fail to disclose may be subject to penalties under Code Sec. 6707. Material advisors also must maintain lists of advisees and other information with respect to these listed transactions under Reg. § 301.6112-1 or face penalties under Code Sec. 6708.

The last list of listed transactions issued in Notice 2004-67, 2004-2 CB 600, specified 30 transactions. Notice 2009-59, adds the following four transactions to the list of listed transactions:

Transactions in which a taxpayer enters into a purported sale-lease-back arrangement with a tax-indifferent person in which substantially all of the tax-indifferent person's payment obligations are economically defeased and the taxpayer's risk of loss from a decline, and opportunity for profit from an increase, in the value of the leased property are limited. These are often referred to as “sale-in/lease out” or “SILO” transactions.
Transactions in which a U.S. taxpayer uses offsetting positions with respect to foreign currency or other property for the purpose of importing a loss, but not the corresponding gain, in determining U.S. taxable income.
Certain arrangements involving a trust or other fund described in Code Sec. 419(e)(1), that is purportedly a welfare benefit fund and pays premiums on one or more life insurance policies with respect to which value is accumulated, where the employer has deducted contributions in excess of specified amounts.
Transactions in which a tax indifferent party contributes one or more distressed assets with a high basis and low fair market value to a trust or series of trusts and sub-trusts, and a U.S. taxpayer acquires an interest in the trust (and/or series of trusts and/or sub-trusts) in order to shift a built-in loss from the tax indifferent party to the U.S. taxpayer that has not incurred the economic loss.

New list of transactions of interest.

In 2007, the IRS added a new category of reportable transactions for purposes of Reg. § 1.6011-4(b)(6), Code Sec. 6111, Code Sec. 6112, Code Sec. 6662A, Code Sec. 6707, Code Sec. 6707A and Code Sec. 6708. The new category is called “transactions of interest,” which are so identified in published guidance. (Reg. § 1.6011-4(b)(6)) These are transactions that IRS believes have potential for tax avoidance or evasion, but for which it lacks enough information to determine whether they should be identified specifically as tax avoidance transactions. (Preamble to TD 9350) The change applies for transactions of interest entered into on or after Nov. 2, 2006.

Notice 2009-55 carries IRS's first list of identified transactions of interest, consisting of:

Transactions built on charitable contributions of successor member interests. In general, a taxpayer (1) directly or indirectly acquires certain rights in real property or in an entity that directly or indirectly holds real property, (2) transfers the rights more than one year after the acquisition to a charity described in Code Sec. 170(c), and (3) claims a charitable contribution deduction that is significantly higher than the amount that the taxpayer paid to acquire the rights.
Transactions that are “toggling” grantor trust transactions, in which grantors attempt to avoid recognizing gain or to claim a tax loss greater than any actual economic loss by purportedly terminating and then reestablishing the grantor status of trusts. These grantor trust transactions usually occur within a short period of time (typically within 30 days). One variation involves a trust funded with gain and loss options; another variation involves a trust funded with liquid assets such as cash or securities.
Transactions involving the sale or other disposition of all the interests in a charitable remainder trust (subsequent to the contribution of appreciated assets to and their reinvestment by the trust) resulting in the grantor or other noncharitable recipient receiving the value of that person's trust interest while claiming to recognize little or no taxable gain.
Transactions in which a U.S. taxpayer that owns controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership takes the position that subpart F income of the lower-tier CFC or an amount determined under Code Sec. 956(a) related to holdings of U.S. property by the lower-tier CFC does not result in income inclusions under Code Sec. 951(a) for the U.S. taxpayer.

Tax Court Clarifies Classification of LLP and LLC Interests Under PAL Rules

jack.howell@sprouselaw.com (Jack Howell) — Wed, 08 Jul 2009 12:33:02 -0600

The Tax Court held that the taxpayers' ownership interests in limited liability partnerships (LLPs) and limited liability companies (LLCs) are excepted from classification as “limited partnership interests” under the temporary regulations by operation of the general partner exception. Thus, they could use all seven tests for material participation in the temporary regulations, instead of only the three available for participation of individuals that are limited partners.

Under the Code Sec. 469 passive activity rules, passive activity losses cannot offset nonpassive activity income, such as wages, dividends, or profits from nonpassive activities. Passive activities include the conduct of trade or business activities in which the taxpayer doesn't materially participate and, generally, rental activities without regard to whether the taxpayer materially participates in them. (Code Sec. 469(c), Reg. § 1.469-1T(e)(1))

The regulations provide seven exclusive tests for material participation in an activity:

(1) The individual participates in the activity for more than 500 hours during such year;

(2) The individual's participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

(3) The individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

(4) The activity is a significant participation activity (within the meaning of paragraph (c) of this section) for the taxable year, and the individual's aggregate participation in all significant participation activities during such year exceeds 500 hours;

(5) The individual materially participated in the activity (determined without regard to this paragraph (a)(5)) for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;

(6) The activity is a personal service activity (within the meaning of paragraph (d) of this section), and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; or

(7) Based on all of the facts and circumstances (taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year. (Reg. § 1.469-5T(a))

Under Code Sec. 469(h)(2), a limited partner's interest in a limited partnership isn't treated as an interest in an activity in which the taxpayer materially participates, except to the extent provided in the regulations. The regulations permit a taxpayer to establish material participation in a limited partnership but constrain the taxpayer to only three of the seven regulatory tests that ordinarily are available. (Reg. § 1.469-5T(e)(1) and (2)). Reg. § 1.469-5T(e)(3)(i) provides that a partnership interest is treated as a limited partnership interest if:

A. the interest is designated a limited partnership interest in the limited partnership agreement or the certificate of limited partnership, without regard to whether the liability of the holder of the interest for obligations of the partnership is limited under the applicable state law; or

B. the liability of the holder of the interest for obligations of the partnership is limited under the law of the state where the partnership is organized to a fixed amount. For example, state law could limit the liability of the partner to the sum of the partner's capital contributions to the partnership and contractual obligations to make additional capital contributions to the partnership.

However, under Reg. § 1.469-5T(e)(3)(ii), a partnership interest isn't treated as a limited partnership interest for the individual's tax year if he is a general partner as well as a limited partner in a partnership during the partnership's tax year ending with or within the individual's tax year (the general partner exception).

Tax Court's decision. The Tax Court was faced with partial summary judgement motions on whether the "presumption" contained in Code Sec. 469(h)(2) applied to the LLP and LLC interests owned by the taxpayers. The Court ruled that the "presumption" did not apply by reason of the general partner exception. Since the Court did not overturn any portion of the temporary regulations, I conclude that the Court, in effect, held that LLP interests and LLC interests are both limited partner and general partner interests.

The Court stated that the IRS's view overlooked the fact that the operative condition for applying Code Sec. 469(h)(2) wasn't simply that there be an “interest in a limited partnership” but rather that there be an “interest in a limited partnership as a limited partner.” The Court rejected IRS's approach as narrow and literal.

The Court reasoned that if the general partner rule in Reg. § 1.469-5T(e)(3)(ii) applied, then an ownership interest can't be treated as a limited partnership interest subject to the "presumption" of Code Sec. 469(h)(2). Members of LLPs and LLCs, unlike limited partners in State law limited partnerships, aren't barred by State law from materially participating in the entities' business. Accordingly, it cannot be presumed that they do not materially participate. Rather, it is necessary to examine the facts and circumstances to ascertain the nature and extent of their participation. The Court concluded that this factual inquiry was appropriately made pursuant to the general Code Sec. 469 tests for material participation. The Court found that the Garnetts held their ownership interests in the LLPs and the LLCs as “general partners” within the meaning of the temporary regulations. While the taxpayers' status in these entities differed significantly from the status of general partners in State law limited partnerships, the Court recognized that their status also differed significantly from that of limited partners in State law limited partnerships.

Conclusion

While a taxpayer victory, taxpayers may not have actually gained as much from the decision as may appear at first blush. The Court did not rule that the taxpayers met any of the tests of material participation. It only expanded the number of tests the taxpayers could use to prove material participation. The temporary regulations already allow limited partners to attempt to prove material participation through tests (1), (5), and (6). The Court's decision now adds the significant participation tests (including the 100 hour tests) and the facts and circumstances test. These are significant additions; but they do not assure material participation for LLP and LLC owners.

It also remains to be seen whether the ruling in this case will have implications in the self employment tax area. Will LLP and LLC owners also be considered general partners (in addition to or in lieu of being limited partners) when applying the self employment rules? Presumably, such an argument will be among the IRS' next steps on this issue.

When is a Survival Statute Not a Survival Statute

jack.howell@sprouselaw.com (Jack Howell) — Mon, 29 Jun 2009 13:50:00 -0600

According to Gary Rosin, it is "when the legislature (bar committee?) forgets to check all the moving parts. See a discussion of the problem at his blog.

Texas Allows Series LLCs

jack.howell@sprouselaw.com (Jack Howell) — Mon, 22 Jun 2009 10:40:27 -0600

Texas recently amended its LLC law, effective Sept. 1, 2009, to provide for series LLCs. More information, including a link to the enrolled version of the bill signed by the Governor, is on
the Unincorporated Business Law Prof blog.

Discussion of Jorgensen, Another FLP Case

jack.howell@sprouselaw.com (Jack Howell) — Wed, 06 May 2009 12:50:56 -0600

Steve Akers of Bessemer Trust discusses the Jorgensen case here. Make particular note of the things you should avoid if you want to have your family limited partnership respected for estate tax purposes, including:

You need to have real and provable, non-tax reasons to form the FLP.
You need to respect the FLP as a separate entity.
- you must follow all the legal formalities.
- you should keep business books and records.
- you should make sure that partnership management has charge of the partnership's assets, including its checkbook
- don't make disproportionate distributions particularly to pay personal expenses.

Is There a Permanently Severable "Wind Estate" In Texas?

jack.howell@sprouselaw.com (Jack Howell) — Fri, 24 Apr 2009 02:00:00 -0600

Lisa Chavarria’s article on The Severance of Wind Rights in Texas was recently published on the Dallas Bar Association’s website. The article recognizes that there are questions about whether there is a severable real property estate consisting of wind rights. Legislative guidance may be necessary, particularly if the Texas courts don’t address this issue soon.

I’m going to play devil’s advocate to some of the article’s conclusions. As I’ve noted elsewhere in my blog (See, Thoughts and Questions on the Tax Aspects of Wind Energy and Wind Energy Part 2 -- Assignment of the "Tree" or the Income the "Tree" Produces), the analogy of a wind estate to a mineral estate should not be taken as a given. So, I question the article’s reliance on an analogy of wind rights to a mineral estate. The wind estate may be more analogous to riparian rights than the mineral estate. Or the court’s could simply “discover” a whole new set of common law rules to govern the property rights associated with wind energy. In Texas, riparian rights may be severable from the surface estate (See, Texas Co. v. Burkett, 117, Tex. 16, at 26.), but the Texas Supreme Court has ruled that a fairly specific description of the surface is necessary to permanently convey the rights to exploit surface water for energy production. See, Richter v. Granite Mfg. Co., 107 Tex. 58, at 63. If the riparian analogy is followed, there could be a wind estate, but failure to properly describe it’s attachment to the surface estate could defeat an attempted conveyance or retention of the estate. Reliance on the California decision of Contra Costa Water Dist. v. Vaquero Farms, Inc., (68 Cal. Rptr. 2d 272), which the article cites, regarding the existence of a wind estate is also risky, since that case interprets California law and not Texas law and involves a fact specific situation regarding eminent domain.

The article suggests that, under today’s uncertain state of law in Texas, severances should take the form of a conveyance of the right to receive a portion of the income stream from wind activities. This may be the prudent way to approach a severance from a state law standpoint, but is risky from a federal tax law standpoint. That is, if I make a gift of a portion of the income stream from wind leases, I may find myself being taxed on that income under assignment of income principles. Remember the fruit from the tree gets taxed to the owner of the tree and I can’t change this by giving ownership of the fruit without also giving ownership of the tree. Failure to shift the tax burden from the income attributable to rents and “royalties” usually constitutes the purpose of these types of gifts. So, it may come as a shock if the income tax burden stays with the surface owner. If the transfer is of a permanent right to income, then it may constitute property for federal tax law purposes. But whether a transfer of an income stream is permanent begs the question posed in the article: is there a severable real property estate in wind rights?

I happen to agree that the law will eventually sort itself out so that some sort of property right regarding wind energy can be permanently severed from the fee or surface estate. But anyone attempting to do so before the courts define the rights of the wind energy estate does so at their own risk.

Texas Schools Using Wind Tax Abatements to Avoid "Robin Hood" Tax

jack.howell@sprouselaw.com (Jack Howell) — Wed, 08 Apr 2009 09:00:00 -0600

Danny Robbins reports that many school districts have granted tax abatements for wind projects and the results are more income to the school districts. See, Texas Schools Get Millions from Wind Farm Deals. But those payments are in lieu of taxes instead of in the form of taxes. Therefore, the school districts do not include those receipts in the formula for determining the amount of tax revenues that they must return to the State of Texas to fund the statewide equalizing payments for education expenses. This has created a controversy explained in more detail in Robbins' article.

Gifts by Parents to Fund a Child's Roth IRA

jack.howell@sprouselaw.com (Jack Howell) — Wed, 08 Apr 2009 01:00:00 -0600

A recent article (Family tax savings compound when a parent funds a child's Roth IRA, R.E. Coppage and L.M. Blum, 82 Practical Tax Strategies 212 (April 2009).) presents an extremely interesting idea – gifting to provide a child funds to contribute to a Roth IRA. Article describes how, not only does the child reap the usual benefits from a Roth IRA and from early retirement savings, but there is also a net tax savings within the family as a whole when such a plan is implemented. Considering the magnitude of the accumulated tax savings, the authors believe a cash gift to fund a child's RIRA contribution is one of the most caring, thoughtful, and practical gifts a parent can make to a child, and I would agree with their conclusion.

Argument for Continued Expansion of Wind Power Projects

jack.howell@sprouselaw.com (Jack Howell) — Thu, 02 Apr 2009 16:10:34 -0600

Paul Sadler, Executive Director of the Wind Coalition, believes that effective power storage will someday be an economical reality. Therefore, we should continue developing wind energy capacity. See, The answer is in the wind.

Wind Credits Giving Way to Direct Financial Aid

jack.howell@sprouselaw.com (Jack Howell) — Wed, 01 Apr 2009 10:53:07 -0600

Wind developers have in the past relied on wind energy income tax credits to attract capital investment in their projects. But those credits require taxable income to remain usable. In the current economic times, investors with taxable income are harder to come by.

Some wind developers are now looking at whether the direct monetary aid contained in the American Reinvestment and Recovery Act might be accessible as reported in Wobbly wind sector sets sights on stimulus.

Using the Tax Code to Breach a Contract

jack.howell@sprouselaw.com (Jack Howell) — Fri, 20 Mar 2009 12:14:38 -0600

According to Charlie Rangel, the Chairman of the House Ways and Means Committee, The tax code is not “a political weapon.” That was just a few days ago. Now the House has passed a bill that would confiscate payments made under contracts between AIG and its employees. How quickly the worm turns.

I am not going to argue whether the amounts of the payments are justified. (Reasonable compensation is something that the tax courts struggle with on a daily basis. They realize that predicting the market for services is a subjective exercise and not a science.) But I am going to argue that what Congress now proposes in the form of a tax (and in this instance I use the term loosely), amounts to breach of contract and theft of services.

Not many details have been disclosed about the terms of the “bonus” program. However, it does appear that the formula for determining bonuses had a floor on it. That is, regardless of how well AIG did, no more than a certain amount of losses could be imposed against the bonus pool. Therefore, the recipients were guaranteed to receive a certain minimum amount.

This guarantee was then used as consideration to keep people from quitting until they had earned this additional compensation. That is the basis of the contract on which the employees continued to work for AIG. The AIG employees relied on the promise of this money in deciding whether to stay at AIG or quit.

Now that the employees have provided the contracted for services, Congress doesn’t want to pay them. Whether Congress entered into a good deal or a bad deal, they entered into a deal, and they should not be allowed to renege on it now that Congress and the US taxpayers have received the benefit of their bargain.

I believe that what is going on here is Congress trying to cover up the fact they they made a bad deal to begin with. The persons who should be paying for negotiating a bad deal are the people who negotiated the bad deal. If I had negotiated a deal like this, I’d probably be sued for malpractice. But Congress gets off scott-free, particularly if they are able to undo their bad deal after the fact.

If this scenario happens, who in their right mind would ever enter into a contract with the government to provide them services? If the government becomes disenchanted with the deal it cut, it can simply renegotiate the deal, after the fact. This is what third world, corrupt politicians do. It’s not what the United States of America is supposed to do.

What are your chances for being audited?

jack.howell@sprouselaw.com (Jack Howell) — Mon, 16 Mar 2009 14:05:19 -0600

The IRS has issued its annual data book, which provides statistical data on its 2008 fiscal year. The data book provides valuable information about how many tax returns IRS examines, and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections. A total of 1,391,581 individual income tax returns were audited during FY 2008 (Oct. 1, 2007 through Sept. 30, 2008) out of a total of 137.8 million individual returns that were filed in the previous year. This works out to 1.0% of all individual returns filed (about the same as the audit rate for the preceding year).

Of the total number of returns audited, 503,755 (36.2%) were selected on the basis of an earned income tax credit (EITC) claim (down slightly from the 36.5% rate for FY 2007).

Only 22.3% of the audits were conducted by revenue agents, tax compliance officers, and tax examiners. Most of the audits (about 77.7%) were correspondence audits. These percentages are about the same as they were in FY 2007.

About 1.36 million individual returns were farm returns that showed gross receipts from farming (Schedule F). Of this group, only 7,542 (0.5%) were audited in 2008.

The no-change rate (returns accepted as filed after examination) was 11% for individual returns examined by revenue agents, tax compliance officers, or tax examiners, and 15% for correspondence exams.

Here's a roundup of selected audit rates from IRS' latest databook.

Following are the audit rates for individual nonbusiness returns that didn't claim the earned income tax credit:
- For “selected nonbusiness returns” (includes returns without a Schedule C (nonfarm sole proprietorship), Schedule E (supplemental income and loss), Schedule F (profit or loss from farming), or Form 2106 (employee business expenses), 0.4% (same as for FY 2007).
- For returns with Schedule E or Form 2106 (excludes returns with a Schedule C, nonfarm sole proprietorship, or Schedule F, profit or loss from farming), 1.3% (up from 1.2% for FY 2007).
- For nonfarm business returns by size of total gross receipts: under $25,000, 1.2% (down from 1.3% for FY 2007); $25,000 under $100,000, 1.9% (down from 2% for FY 2007); $100,000 under $200,000, 3.8% (down from 6.2% for FY 2007); and $200,000 or more, 0.6% (down from 1.9% for FY 2007).
- For returns with total positive income (TPI) of at least $200,000 and under $1 million, the audit rate was 2.6% for nonbusiness returns (down from 2% for FY 2007) and 2.8% for business returns (down from 2.9% for FY 2007). For returns with TPI of $1 million or more, the audit rate was 5.6% (down from 9.3%).
The audit rates for entities were as follows:
- Fiduciary (estate and trust income tax returns), 0.1% (the same as for FY 2007);
- Corporations with less than $10 million of assets, 1.0% (up from 0.9% for FY 2007);
- Corporations with $10 million or more of assets, 15.3% (down from 16.8% for FY 2007);
- S corporations, 0.4% (down from 0.5% for FY 2007);
- Partnerships, 0.4% (same as FY 2007);
Estate tax returns, 8.1% (up from 7.7% for FY 2007); and
Gift tax returns, 0.4% (down from 0.6% for FY 2007).

Large Number of Significant Tax Provisions Expire in 2009

jack.howell@sprouselaw.com (Jack Howell) — Fri, 13 Mar 2009 10:52:39 -0600

A recent report by the Joint Committee on Taxation included a list of expired and expiring tax provisions from 2008 through 2020. The report serves as a reminder that numerous key provisions — many of them only recently extended by the Emergency Economic Stabilization Act and the American Recovery and Reinvestment Act of 2009 — are currently slated to be on the books only through 2009, while others last only through 2010. While these provisions may ultimately be extended (and some of them surely will be), one, where possible, should take action now to prevent losing out on tax breaks.

The EESA extended more than 30 tax breaks that either expired at the end of 2007 or had been scheduled to expire soon. The following individual tax breaks were retroactively revived to apply for the 2008 tax year and extended to apply to the 2009 tax year:

the election to deduct state and local general sales tax,

the above the line deduction for higher education expenses,

the above the line deduction for educator expenses, and

the ability of taxpayers age 70 1/2 or older to make nontaxable IRA transfers to eligible charities.

The extended business tax breaks include the research credit, the 15-year writeoff for qualified leasehold improvements and qualified restaurant property, and enhanced deductions for certain charitable contributions.

The EESA was shortly followed by the Recovery Act which extended boosted alternative minimum tax (AMT) exemption amounts for individuals for 2009 and allowed personal nonrefundable credits to offset AMT and regular tax. It also extended 50% bonus depreciation and increased expensing to 2009.

Some of the provisions expiring in 2009 (generally at the end of 2009, unless otherwise noted) include:

Increased AMT exemption amount under Code Sec. 55. The AMT exemption amounts for 2009 were increased to $46,700 for unmarrieds, to $70,950 for joint filers, and to $35,475 for marrieds filing separately. After 2009, the exemptions drop to $33,750 for unmarrieds, to $45,000 for joint filers, and to $22,500 for marrieds filing separately.
Personal tax credits allowed against regular tax and alternative minimum tax under Code Sec. 26(a)(2). After 2009, the nonrefundable personal credits — other than the adoption expense credit, the child tax credit, the saver's credit, the residential energy efficient property credit, and the nonbusiness portion of the qualified plug-in electric drive motor vehicle credit — will be subject to the limitation under Code Sec. 26(a)(1): the aggregate amount of those credits can't exceed the excess of:

(a) the individual's regular tax liability, over

(b) the individual's tentative minimum tax, determined without regard to the AMT foreign tax credit

Additional first-year 50% bonus depreciation for qualified property under Code Sec. 168(k)(2). Qualified property is allowed 50% depreciation (bonus depreciation) in the year that the property is placed in service (with corresponding reductions in basis and reductions of the regular depreciation deductions otherwise allowed in the placed-in-service year and in later years). In addition, an $8,000 increase in the first-year depreciation limit for passenger automobiles that are qualified property is also extended through 2009. (Certain aircraft and long-production-period property can continue to be placed in service through 2010.)
Increased expensing election to $250,000 (with a $800,000 investment ceiling limit) under Code Sec. 179. Taxpayers can elect to deduct the cost of any section 179 property placed in service during the tax year as an expense which is not chargeable to capital account. (For 2010, expensing is limited to $125,000 with a $500,000 investment ceiling limit (both figures indexed for inflation)).
Incremental research credit under Code Sec. 41. A taxpayer is generally allowed a research credit of 20% of the amount by which the taxpayer's qualified research expenses exceed a specific base amount (unless the taxpayer elects the alternative simplified credit computation).
Election to accelerate AMT and research credits in lieu of additional first-year depreciation under Code Sec. 168(k)(4).
Five-year depreciation for farming business machinery and equipment under Code Sec. 168(e)(3)(B)(vii).
Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements under Code Sec. 168(e)(3)(E)(iv), (v), and (ix).
Deduction allowable for income attributable to domestic production activities in Puerto Rico under Code Sec. 199.
New markets tax credit under Code Sec. 45D. A new markets tax credit is allowed for qualified equity investments in a qualified community development entity.
Expensing of “brownfields” environmental remediation costs under Code Sec. 198(h).
Additional standard deduction for state and local real property taxes under Code Sec. 63(c)(1)(C). The real property tax deduction — the lesser of: (a) the amount allowable as a deduction under the itemized deduction rules for state and local real property taxes; or (b) $500 ($1,000 for a joint return) — is included as a component of the standard deduction.
Deduction of State and local general sales taxes under Code Sec. 164(b)(5). At the taxpayer's election, state and local general sales taxes can be deducted in lieu of a state and local income tax deduction.
First time homebuyer credit under Code Sec. 36 (expiring in 11/30/09). A credit of $8,000 ($4,000 for marrieds filing separately) is allowed for first-time homebuyer (as specially defined). The credit isn't recaptured unless residence is sold or ceases to be a principal residence within 36 months of purchase.
Deduction for State sales tax and excise tax on the purchase of motor vehicles under Code Sec. 164(b)(6)(G). A new provision in the Recovery Act allows a standard or itemized deduction for sales and excise taxes imposed on most new vehicles purchased on or after Feb. 17, 2009 and before 2010.
Above-the-line deduction for qualified tuition and related expenses under Code Sec. 222.
Deduction for certain expenses of elementary and secondary school teachers under Code Sec. 62.
Credit for construction of new energy efficient homes under Code Sec. 45L. A contractor can claim a credit of $2,000 (for a 50% energy reduction in energy usage) or $1,000 (for a 30% energy reduction in energy usage) for each new energy efficient home he build.
Exclusion of unemployment compensation benefits from gross income under Code Sec. 85(c).
Encouragement of contributions of capital gain real property made for conservation purposes under Code Sec. 170(b)(1)(E) and Code Sec. 170(b)(2)(B). Special higher charitable deduction limitations on qualified conservation contributions by qualified farmers or ranchers expanded to apply to contributions of apparently wholesome food inventory.
Enhanced charitable deduction for contributions of food inventory under Code Sec. 170(e)(3)(C). A deduction is allowed for contributions by a noncorporate taxpayer from its trade or business of apparently wholesome food inventory for the care of the ill, needy, or infants.
Enhanced charitable deduction for contributions of book inventories to public schools under Code Sec. 170(e)(3)(D).
Enhanced deduction for corporate contributions of computer equipment for educational purposes under Code Sec. 170(e)(6)(G).
Waiver of the minimum required distribution (RMD) rules for IRAs and defined contribution plans under Code Sec. 401(a)(9)(H). Under the RMD rules, participants in qualified plans and individual retirement accounts and annuities (IRAs) are generally required to begin taking distributions no later than Apr. 1 of the year after they attain age 70-1/2. (For an employer-provided qualified retirement plan, the required beginning date for an individual who is not a 5% owner of the employer maintaining the plan is delayed to Apr. 1 of the year following the year in which the individual retires.)
Tax-free distributions from individual retirement plans for charitable purposes under Code Sec. 408(d)(8). An up-to-$100,000 annual exclusion from gross income is allowed for taxpayers age 70 1/2 who make otherwise taxable IRA distributions that are qualified charitable distributions. The distributions aren't subject to the charitable contribution percentage limits and are neither included in gross income nor claimed as a deduction on the taxpayer's return.

Seventh Circuit Allows Closely Held Corporation to Deduct $17 Million Bonus

jack.howell@sprouselaw.com (Jack Howell) — Thu, 12 Mar 2009 12:12:41 -0600

The Seventh Circuit reversed the Tax Court's holding that a closely held corporation could deduct only about $7 million of a $17 million CEO bonus based on a percentage of pretax net income. The appellate court's decision rejected the Tax Court's view that a repayment agreement in the event of IRS challenge was evidence that a dividend had been intended. It also rejected the Tax Court's methodology which concluded the CEO was overpaid relative to the compensation of CEOs of publicly held corporations in the same business. Menard, Inc. v Commissioner (CA 7 3/10/2009)

For an employer to deduct compensation paid, the amount must be reasonable. What's reasonable depends on the facts and circumstances of each case. The Tax Court generally applies a number of factors in determining the reasonableness of compensation, including the employer's qualifications and contribution to the company, and the employee's salary history with the company. But the Seventh Circuit in Exacto Spring rejected the Tax Court's multi-factor approach in favor a single “independent investor” test. Under the independent investor test, if a hypothetical independent investor would consider the rate of return on his investment to be far higher than he had any reason to expect, the compensation paid is presumptively reasonable. However, the presumption may be rebutted by evidence that the company's success was the result of extraneous factors, such as an unexpected discovery of oil under the company's land, or that the company intended to pay the owner/employee a disguised dividend rather than salary.

The taxpayer, Menard, Inc., is the country's third largest home improvement chain, trailing only Home Depot and Lowe's. In '98, the company operated about 160 stores in 9 Midwestern states, reporting revenue of $3.42 billion and taxable income of $315 million. John Menard is the controlling shareholder of the taxpayer (the remaining shares being held by family members and trusts). As CEO, Menard received a base salary of about $157,000. In addition, since '73 he has received an annual bonus equal to 5% of the corporation's net income before taxes. The bonus is subject to an agreement under which Menard must repay any portion of his compensation for which IRS disallowed a deduction to the corporation. The compensation of the other three corporate officers averaged about $115,000.

In '98, Menard's 5% bonus arrangement yielded him over $17 million which, when added to his salary and profit-sharing allotment, brought his total compensation for the year to over $20 million.

In 2004, the Tax Court concluded that only about $7 million of Menard's total compensation was reasonable compensation and treated the rest as a nondeductible dividend. In 2005, on reconsideration, the Tax Court upheld its determination of the approximately $7 million it found to be reasonable compensation. Now the Seventh Circuit has found that the Tax Court committed clear error in ruling that Menard's compensation was excessive in '98 and has reversed the Tax Court's ruling.

The Seventh Circuit's opinion focused on two aspects of the Tax Court's ruling: the bonus repayment agreement, and the Tax Court's settling on a $7 million reasonable compensation figure by looking at the compensation paid to similarly situated CEOs of publicly held corporations in the same field as Menard.

Bonus repayment agreement. The Tax Court said that the bonus was intended to be a dividend because Menard's entitlement to the bonus was conditioned on his agreeing to reimburse the corporation should its deduction of the bonus be disallowed by IRS or its state (Wisconsin) counterpart and because 5% of corporate earnings year in and year out “looked” more like a dividend than like salary.

The Seventh Circuit rejected these arguments as “flimsy grounds” because (a) it was prudent (and incidentally not in Menard's personal financial interest) for the company to require him to reimburse it should IRS successfully challenge the deduction; and (b) the 5% percent of net corporate income didn't look at all like a dividend. Dividends, said the Seventh Circuit, generally are specified dollar amounts—so many dollars per share—rather than a percentage of earnings. Paying a fixed (though occasionally altered) dividend gives shareholders a more predictable cash flow than if the dividend varied directly with fluctuating corporate earnings. It thus reduces the risk associated with ownership of common stock. Moreover, the reason for varying a manager's compensation with the company's profits is to increase his incentive to work intelligently and hard in order to increase those profits, and that reason has no application to a passive owner.

The Seventh Circuit also took a shot at IRS for questioning a compensation structure that had been in place for a quarter of a century and wondered whether it had just waited for Menard to “have such a great year that the IRS would have a great-looking case.”

Comparability of bonus. The main focus of the Tax Court's decision was on whether Menard's compensation exceeded that of comparable CEOs in '98 — that is, whether it was objectively excessive. In '98, the CEOs of Home Depot and Lowe's, both larger companies, were paid only $2.8 million and $6.1 million respectively. The Tax Court arrived at its reasonable compensation figure of about $7 million through the use of a formula that allowed Menard to treat as salary slightly more than twice the salary he supposedly would have earned had he been Home Depot's CEO and if Home Depot enjoyed as high a return on investment as Menard did. The Tax Court's assumption was that rate of return drives CEO compensation except for random factors assumed to have the same effect on Menard's compensation as it did on compensation paid to Lowe's' CEO (who got more than twice Lowe's CEO), even though Lowe's was a smaller company with a lower rate of return.

The Seventh Circuit termed the Tax Court's adjustment to be “arbitrary as well as dizzying” because it disregarded differences in the full compensation packages of the three executives being compared, differences in whatever challenges faced the companies in '98, and differences in the responsibilities and performance of the three CEOs. In arriving at its $7 million reasonable compensation figure, the Tax Court didn't compare the amount of work that the three CEOs did, or consider that Menard, a workaholic and head of his own company, performed tasks that would have consumed a team of people at a similarly situated company.

Treasury Official: No required minimum distribution relief for 2008

jack.howell@sprouselaw.com (Jack Howell) — Tue, 23 Dec 2008 16:10:23 -0600

In a Dec. 17 letter to Rep. George Miller (D-CA), Chairman of the House Committee on Education and Labor, a Treasury official has said that IRS will not relieve retirement plan account participants and IRA owners of the need to take required minimum distributions (RMDs) for 2008. The only relief these taxpayers can look forward to is the Pension Act's waiver of the requirement to take RMDs for 2009.

Tough year for retirement plan accounts. The stock market's decline has been especially painful this year for retirees whose retirement plan accounts and IRAs are invested in stocks or stock mutual funds. Because their retirement plan and IRA balances at the end of 2007 were much larger than their balances during 2008, they've been faced with the choice of not making the RMD for the year (and getting hit by a prohibitive penalty) or withdrawing a disproportionately large portion of their remaining account balances and being forced to sell stock or mutual fund shares when their value is exceptionally depressed.

New law relief, but only for 2009. The Pension Act (H.R. 7327, the “Worker, Retiree and Employer Recovery Act”) which awaits the President signature helps out, but for 2009 only. More specifically, for calendar year 2009 only, plan account participants and IRA owners don't have to make otherwise required lifetime RMDs, Likewise, their beneficiaries also don't have to take minimum distributions.

Dashed hopes for 2008. A number of Congressmen have written the Treasury Department asking for RMD relief for 2008. In the past, Treasury responded that Congress is considering temporary relief and that IRS is considering other ways that retirees' RMD problems could be “ameliorated administratively.” But on Dec. 17, Kevin I. Fromer, Assistant Secretary for Legislative Affairs, wrote Rep. George Miller and informed him that in light of passage of the Pension Act, Treasury and IRS “have determined that any further change to the required minimum distribution rules should not be undertaken. . . . Thus, all individuals who are subject to required minimum distributions for 2008 should take their distribution under the existing rules and, as a result of relief provided by Congress, they will be entitled to a complete waiver of the requirement to take any distributions for 2009.”

Worker, Retiree, and Employer Recovery Act of 2008

jack.howell@sprouselaw.com (Jack Howell) — Sun, 14 Dec 2008 14:42:48 -0600

The Congress passed this Act last Thursday, December 11, and the president is expected to sign it.

The Act should help give older Americans some much needed financial flexibility as they struggle to manage their finances during this difficult economic time. A key provision in the Act is designed to help alleviate the financial burden facing seniors who have seen their retirement savings shrink dramatically. The new provision provides relief to senior citizens by allowing them to continue to keep money in retirement accounts that they are typically required by law to withdraw once they reach age 70 1/2.

The Act also includes important provisions that ease funding requirements for employer-sponsored pension plans. Absent the new legislation, these plans would have been forced to make significantly increased contributions during the current financial crunch when they are very short on cash. The new law provides pension funding relief for both single-employer and multi-employer plans.

Here's a brief summary of the new provisions.

Generally, individuals with retirement accounts must make required withdrawals based on the size of their account and their age every year after age 70 1/2. This rule is intended to prevent wealthy individuals from using retirement accounts as a tax shelter. Any individual who fails to take a required minimum distribution (RMD) is heavily penalized with taxes equal to 50% of the amount not withdrawn. The Act suspends the required minimum distribution from retirement accounts in 2009. This waiver, which is available to everyone regardless of their total retirement account balances, applies to all defined-contribution plans, including 401(k), 403(b), 457(b), and IRA accounts. Suspending the mandatory withdrawal allows retirees to keep the money in their account if they choose, and possibly recover some of their losses.

The Act permits employers to “smooth” the value of pension plan assets over 24 months instead of having to apply the mathematical average that Treasury normally requires. This change will soften the accounting of 2008 plan losses.

Previous pension legislation phases in full pension funding targets from 90% to 100% over 5 years (2008 - 92%, 2009 - 94%, 2010 - 96%, 2011 - 98%, 2012 - 100%). If a plan misses its target in a phase-in year, then the target automatically increases to 100%. The new law adjusts the “phase-in” rule to allow plans which miss their phase-in funding target to retain the same target and not jump to the 100% target. For example, for plans that are less than 92% funded in 2008, their shortfall would be estimated relative to 92%, not 100%. With a sizable number of plans below 92% funded next year, the adjustment of this phase-in rule could provide significant relief.

Estate Tax Articles on ABA website

jack.howell@sprouselaw.com (Jack Howell) — Thu, 04 Dec 2008 10:43:50 -0600

Some recent articles of interest:

Stever Akers article on Bianca Gross v. Commissioner, which discusses the formation of a family entity, followed by a gift of interests in the entity.

Jim Roberts note on Simplicity in Valuation, which describes the Supreme Court's denial of certiorari in an 11th Circuit valuation case. This strenthens the argument that a valuation of a C corporation should reduce the value, dollar for dollar, by the amount of "built-in" taxes.