PRESIDENT BUSH SIGNS THE HOUSING AND ECONOMIC RECOVERY ACT OF 2008 WITH TAX BENEFITS AND TRAPS FOR THE UNWARY

Today President Bush signed the Housing and Economic Recovery Act of 2008. The eagerly anticipated housing-rescue law is intended to calm the mortgage market, the real estate market, homeowners on the verge of bankruptcy and foreclosure, victims of bank failures and others whose lives are topsy-turvy this year.



But from a tax perspective, the bill is likely to cause more upset than calm. Here is a look at four areas where tax law was changed along with housing law:



1. Tax credit for new homeowners

The housing act gives first-time homebuyers nationwide a temporary refundable tax credit equal to 10 percent of the purchase price of a home, up to $7,500 ($3,750 for married individuals filing separately) The credit begins to phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return).The credit is effective for homes purchased on or after April 9, 2008, and before July 1, 2009. If you buy the home in 2009, before July 1, 2009, you can make an election to report the purchase on your 2008 tax return and get the refund a year early.

Unlike other credits, however, the first-time homebuyer credit must be repaid in equal installments over 15 years, essentially making it an interest free loan from the government for most qualifying homeowners.

In other words, if you bought a home in August 2008, you start paying back 6.667% of the original credit on your 2010 tax return. This credit applies to purchases of new homes on or before April 9, 2008 and before July 1, 2009.

As a refundable credit, even if your total tax liability is zero, you can file to get a refund. Therefore, people who normally don't have to file tax returns will need to start filing tax returns just to pay the credit back. You can expect IRS computers to track this and to issue notices for unfiled returns. If you sell the house in less than 15 years, you will have to repay the rest of the credit immediately. Only people who have not owned a principal residence for three years before buying the new home qualify. If you've owned a vacation home or timeshare, you will still qualify.



2. New standard deduction rules

Currently, only individuals who itemize deductions may deduct real property taxes imposed by state and local governments. The new law gives non-itemizers a limited deduction for state and local real property taxes by increasing the amount of their standard deduction by the lesser of: (1) The amount of real property taxes paid during the year, or (2) $500 ($1,000 for a married couple filing jointly). This temporary deduction is available only for 2008. Taxpayers most likely to benefit from this deduction include homeowners who have paid off their mortgage (and, therefore, no longer itemize interest payments) and lower-income homeowners (whose overall itemized deductions generally do not exceed their standard deduction). There are no income limits to this benefit.



3. Vacation-home hit

Gain from the sale of a principal residence home will no longer be excluded from gross income under Code Sec. 121 (the $250,000 ($500,000 for couples filing jointly) personal residence capital-gains-tax exclusion) for periods that the home was not used as the principal residence.

In the past, savvy taxpayers have played hopscotch, moving from home to vacation home to the next home, etc. and avoiding income taxes on the sale of each one. That free ride is at an end.

The personal resident exclusion is still good on your personal home. However, you'll be paying taxes on the sale of your vacation home, or rental property converted to a home. The tax will be based on the amount of days the house was not a qualified personal residence divided by the total number of days you owned it. This ratio is multiplied by the amount of gain realized on the sale of the property. It's not clear if their temporary absences will be considered a period of nonqualified use.

This new income inclusion rule applies to home sales after December 31, 2008, and, under a generous transition rule, is based only on nonqualified use periods that begin on or after January 1, 2009. So, if you've got a second house you want to sell tax-free in the next year or two -- move into it before the end of this year.



4. Tighter tracking of credit card payments received by businesses

Under the new law, banks and other processors of merchant payment card transactions (credit and debit cards) will be required to report a merchant’s annual gross payment card receipts to the IRS (and to the merchant). The new law also requires reporting on third-party network transactions (such as ones used by many online retailers). In other words, IRS will get your business’ total merchant credit card gross revenue for the year. In the past, when the IRS wanted to get information from banks and merchant accounts, it was required going to a judge and getting a subpoena. With this new law in place, the IRS now has the information to step in and audit the business at any time.

Merchants and payment card processors have time to prepare. The new treatment is effective for sales made on or after January 1, 2011.

Family Limited Liability Companies (LLCs)

As a proponent of Family Limited Liability Companies (LLCs) for asset management, creditor protection, and ease of gifting, I was pleased to read about the U.S. Tax Court's decision in Mirowski v. Commissioner, T.C. Memo 2008-74. March 26, 2008.

Mrs. Mirowski, widow of the inventor of the heart defibrillator implant, created a trust for each of her three daughters in 1992, which were funded with portions of her interests in the patent licenses. Then, in 2001, she formed a single member LLC, transferring substantial assets to it. Shortly thereafter, Mrs. Mirowski gifted a 16% interest in the LLC to each of the trusts. A mere four days later, she died unexpectedly.

The IRS argued under Section 2036(a) of the Internal Revenue Code that Mrs. Mirowski retained the right to income or enjoyment of the gifted property, so that it was included in her taxable estate. The estate maintained that the Section 2038 "bona fide sale" exception applied, so that the transferred assets were not subject to estate tax.

The Tax Court agreed, holding that the LLC's activities do not have to be equivalent to those of a "business" for the bona fide sale exception to be applicable. The Court stated that Mrs. Mirowski had "legitimate and significant non-tax reasons" for establishing and funding the LLC, including 1) joint management of family assets, 2) combining family assets to maximize investment opportunities, and 3) enabling equal transfers to her daughters.

Some key points for Family LLCs to hold up for gift and estate tax purposes:

Strictly follow the terms of the Operating Agreement
State the reasons for the LLC in the Operating Agreement
Have the Agreement reviewed by separate counsel for all initial members
Leave enough assets outside the LLC to live on and pay taxes
Don't mingle LLC assets with personal assets
File the proper tax returns each year
File the necessary documents with the Secretary of State each year
Don't put your personal residence in a Family LLC
Make sure the senior generation does not have the power to allocate profits and losses
Require annual distributions
Have the junior family members (or their trusts) make initial contributions to the LLC to provide for the pooling of assets
Don't wait until the senior family member is near death

The bottom line is that Family LLCs remain a viable and attractive option for transfers of family wealth, while also providing asset protection and management advantages. Just make sure you use an attorney experienced in forming Family LLCs to assist you, and carefully follow all of his or her instructions.

The New Jersey Civil Union Act: Tax Benefits?

On February 19, 2007, following the New Jersey Supreme Court’s decision in Lewis v. Harris, New Jersey effectuated the Civil Union Act (hereinafter, “the Act”). The Act grants couples in same sex civil unions equal protection and equal rights to couples in heterosexual marriages. In Lewis, the court unanimously held that although same-sex marriage is not a fundamental right, “committed same-sex couples must be afforded on equal terms the same rights and benefits enjoyed by married couples” and that the legislature amend or implement laws accordingly. New Jersey has decided to create a parallel civil union system rather than attempt to incorporate same-sex marriages within the existing marriage law framework. The Act provides that the legal benefits, protections and responsibilities afforded spouses in heterosexual marriages be granted to spouses involved in civil unions with respect to “laws relating to taxes imposed by the State or a municipality including but not limited to homestead rebate tax allowances, tax deductions based on marital status or exemptions from realty transfer tax based on marital status”.

This Act has vast tax implications affecting same sex couples’ property rights, estate transfer taxes, and income taxes.

Tax Advantages Under the New Jersey Civil Union Act

A. Property Rights

In New Jersey, civil union members can now own residential real estate as tenants by the entirety thereby avoiding probate and transferring full title to the surviving spouse by operation of the law in the event of the death of one of its members. Further, a civil union member can enjoy the tax-free realty transfer benefit afforded to those in a marriage.
Senior citizens and disabled persons in a civil union can now qualify for the Property Tax Reimbursement Program designed to reimburse these persons of property tax increases. Also if a civil union member is 65 years or older or permanently and totally disabled, they become eligible for a $250 local property tax deduction provided that the couple’s combined income is less than or equal to $10,000.
Under New Jersey law, veterans enjoy specialized tax exemptions based on their status as US war veterans. These exemptions are now applicable to the members in a civil union as well under the Act. In other words, a disabled war veteran in a civil union is entitled to a 100% tax exemption of real property taxes, as is his or her survivor in the couple in the event of death. Further, the member who is the survivor to the union of one who died during active duty in a war is entitled to a $250 local property tax deduction.

B. Estate Transfer

In New Jersey, property passing from a decedent to a beneficiary valued at $500 or
more is subject to a Transfer Inheritance Tax. However property passing to the decedents' spouse and child (among others) is exempt from this tax due to their classification as Class A Beneficiaries. Under the Act, members in a civil union will be applicable for this exemption. Further, under state estate tax, the survivor in a civil union can now qualify for the exemption of death taxes incurred on property valued under $675,000. However they are still accountable, as are other married couples, of the federal estate tax on property transferred valued over $2 million.

C. Income Taxes

On a state level, members of the civil union will be able to file either civil
union joint or separate tax returns. Therefore they will qualify for any and all exemptions and deductions provided at the state income tax level. This means that even though members of the civil union do not have to file separately at the state level, they still must do so at the federal level. In general, federal income tax rates are higher than state taxes and filing jointly provides many exemptions for income tax purposes.


The Inequalities That Remain in Taxes between Civil Union Members and Married Individuals

It is important to note that although the Act constitutes a great leap forward for the homosexual community, the advancements marked by this Act come with a large disclaimer. Specifically, federal laws still do not recognize same-sex marriages. As a result, members of civil unions are not qualified as a couple under the federal rules of tax, immigration, social security, bankruptcy and others. For example, members of a civil union do not qualify for the unlimited marital deduction of federal gift taxes between spouses subjecting them to federal gift tax of all transfers over $12,000 within a year.
The addition of New Jersey as the third state recognizing civil unions is an achievement for the homosexual community because a vast number of family issues such as health care, child custody and employment benefits are handled at the state level. However, federal law still treats members of civil unions unequally.

Deferral is the Name of the Game: Funding a Trust With Retirement Assets

Many people today have a large concentration of their wealth in their IRA accounts and/or retirement plans, such as Pension, Profit Sharing and 401(K) plans. As a result, for married couples, it may be necessary to utilize these assets to fully fund the first spouse to die’s applicable exclusion amount. This article will highlight the income tax disadvantages associated with using such assets in this regard.

Under current law, the federal estate tax applicable exclusion permits taxpayers to transfer up to $2 million ($675K in NJ) at death to anyone other than a spouse without incurring a federal estate tax. The estate tax applicable exclusion is scheduled to increase to $3.5 million ($675K in NJ) in 2009. In 2010, the Federal estate tax is scheduled to be repealed, but only for one year. Starting in 2011, estates will once again be subject to estate tax at 2001 rates (top rate of 55%) with only a $1 million ($675K in NJ) exemption available.

Generally speaking, to maximize the applicable exclusion of the first spouse to die, Wills are drafted to provide that a trust is created automatically or via a disclaimer approach for the benefit of the surviving spouse and the decedent’s children and grandchildren and funded with the decedent’s then remaining applicable exclusion amount, taking into account any transfers the decedent may have made during his or her lifetime. These trusts are typically called bypass or disclaimer trusts. The balance of the decedent’s estate in most instances would pass to the surviving spouse.

If IRAs and/or retirement assets are used to fund the trusts as described above, there are significant income tax ramifications for the decedent and his or her family. If the surviving spouse is the beneficiary of the IRA and/or retirement assets, the surviving spouse has the ability to roll over these assets to his or her own IRA and treat it as a new IRA. Consequently, the surviving spouse is able to designate his or her own beneficiary. The new beneficiary designation means that at the surviving spouse’s death, the beneficiary can take required minimum distributions over that beneficiary’s life expectancy. In most circumstances, the beneficiaries of the surviving spouse’s IRA will be the next generation (i.e., children), so that the required pay out period will be based on the life expectancies of the children, which typically is a longer period of time.

While the surviving spouse is alive, required minimum distributions need to begin to be paid as of April 1 of the calendar year following the surviving spouse’s attainment of the age of 70 ½. After that date, in most cases, the required minimum distributions are based on IRS tables which factor in the life expectancy of the surviving spouse and a hypothetical beneficiary who is ten years younger than the surviving spouse.

The required minimum distributions are significantly accelerated if the beneficiary of the decedent’s IRA and/or retirement assets is the bypass or disclaimer trust under the decedent’s will, as opposed to the surviving spouse. First, during the surviving spouse’s life, assuming the surviving spouse is the oldest beneficiary of the trust, distributions during the spouse’s life must be taken over the spouse’s life expectancy, as opposed to the surviving spouse waiting until April 1 of the year following the attainment of age 70 1/2. In this event, the surviving spouse is not able to roll over the IRA and/or retirement assets and treat the IRA as his or her own IRA because he or she is not the beneficiary.

Second, at the surviving spouse’s death, while the beneficiaries are usually the younger generation, the required minimum distributions remain based on the surviving spouse’s life expectancy. The decedent’s family is not able to use the younger generation’s longer life expectancy to significantly delay distributions.

This is the major reason why IRAs and retirement assets should be the last resort to fund a bypass trust or a disclaimer trust to maximize the decedent’s applicable exclusion amount.

Generally speaking, the longer period of time a taxpayer can defer the payment of the income tax due from the IRA and retirement assets, the more the taxpayer will benefit. It is important to review your assets with your attorney to make sure your estate has the flexibility, to the greatest extent possible, to fund these trusts with non-retirement assets.

Summary of New Jersey Estate Taxes

New Jersey Estate Taxes
The New Jersey estate tax was revised on July 1, 2002, and made significant changes to the previous New Jersey estate tax scheme. The changes apply retroactively to decedents dying after December 31, 2001.

The New Jersey estate tax is imposed on resident decedents and is intended to absorb the maximum state death tax credit allowed under federal estate tax law. However, New Jersey has decoupled itself from current federal estate tax laws and no longer has a true "pickup" tax. Instead, the personal representative of the estate can elect to apply either the maximum state death tax credit in effect on December 31, 2001, or an amount determined by the Division of Taxation under the Simplified Tax System.

The New Jersey Domestic Partnership Act, which establishes domestic partnerships for same sex and opposite sex (age 62 and older) unrelated partners, made significant changes to the New Jersey transfer inheritance tax, applicable to decedents dying on or after July 10, 2004. Provided that a valid domestic partnership is established, the Act exempts all transfers made by will, survivorship, or contract to a surviving domestic partner.

However, the New Jersey estate tax is not affected by the Act. The estate tax is based upon the federal estate tax credit for state death taxes allowable under the provisions of the Internal Revenue Code, which does not provide an estate tax deduction for property passing to a domestic partner.

New Jersey also imposes a transfer inheritance tax, at graduated rates, on property having a total value of $500 or more which passes from a decedent to a beneficiary. Transfers of property to the surviving spouse of a decedent, and, applicable to estates of decedents dying on or after July 10, 2004, transfers of property to a decedent's domestic partner, are exempt from the New Jersey transfer inheritance tax. Also exempt from the tax are transfers of property to a father, mother, grandparent, child or children, adopted child or children, mutually acknowledged child, stepchild or issue of any child or adopted child of a decedent.

Deductions. The following items can be deducted from a decedent's estate when calculating New Jersey estate tax liability:
decedent's debts
funeral expenses (e.g., burial, funeral luncheon, minister/rabbi, monument, flowers)
ordinary administration expenses (including executors' and attorneys' fees)
state and local taxes up to the date of death
inheritance taxes paid to other states
mortgages (to show actual equity of mortgaged property)

Returns. A New Jersey transfer inheritance tax return (Form IT-R) is due within eight months after the decedent's death. Any taxes owed must be paid within the same eight-month period. A self-executing waiver (Form L-8) is available for surviving spouses and Class A beneficiaries exempt from the tax.

New Jersey estate taxes are due on the decedent's date of death and must be paid within nine months. There are two ways to file an estate tax return: the Form 706 method and the Simplified Tax System (Alternative) method.

The Form 706 method requires that a New Jersey Form IT-Estate is filed along with a 2001 federal Form 706 estate tax return completed according to the provisions of the Internal Revenue Code in effect on December 31, 2001. Using this method, the New Jersey return is due within nine months and 30 days of the decedent's date of death.

The Simplified Tax System method is not intended for use with all estates. It can only be used when federal income and estate tax returns need not be filed. Under this method, a New Jersey Form IT-Estate must be filed within nine months of the decedent's death.

Generation-skipping transfer tax. New Jersey does not impose this type of tax.

Knowing When an Estate is Required to File a Tax Return

In our previous issues, we have been following the Ashby family in order to address various issues that arise when a family member passes away.
When we last left Jillian Ashby, she was compiling a list of the estate’s assets (i.e. any assets that William owned individually, jointly, in trust, etc.), debts and expenses as of his date of death. This will determine if the estate is required to file any state or federal death tax returns.
A question that arises is, “How do I know if the estate is required to file a state or federal estate tax return?” For federal estate tax purposes, an estate is required to file an estate tax return if the decedent’s gross estate (plus adjusted taxable gifts) is worth $2,000,000 or more. In determining the value of the gross estate, Jillian should inventory every asset that William owned (either individually, jointly, in trust, etc.) as well as their values as of his date of death. This includes, but is not limited to, cash and securities, real estate, insurance, certain trust assets, annuities, retirement accounts, business interests, etc. An estate is required to file a New Jersey estate tax return, if the value of the decedent’s gross estate exceeds $675,000. In addition, New Jersey also imposes an inheritance tax on assets that pass to someone other than a spouse or a lineal ascendant or descendant. This will necessitate the filing of a New Jersey inheritance tax return.
When are these returns required to be filed and what happens if Jillian does not have all of the information ready by the due date? New Jersey and federal estate tax returns must be filed within nine months of William’s passing. If required, the New Jersey inheritance tax return is due eight months after the date of death. In addition, if William owned any real property in New York, a New York estate tax return must also be filed within nine months after the date of death. Extensions may be obtained for each of these returns; however, it should be noted that the extensions do not extend the time to pay any estate/inheritance tax due but only extends the time to file the returns.
Families always ask if there are any other tax filing requirements? William’s estate is now a separate income taxpaying entity and will be required to file annual federal fiduciary income tax returns, if income exceeding $600 each year is generated from estate assets. There may also be state fiduciary income tax return filing requirements depending upon the amount of estate income earned.
Once the death tax returns have been filed, how long can Jillian expect to wait before hearing from the Internal Revenue Service and the State of New Jersey? Generally, the taxing authorities have three years from the date the return is filed to examine it. Practically speaking, the taxing authorities will either accept the return as filed and issue a closing letter or select the estate for examination and this usually occurs approximately nine to twelve months after filing.
One predictable question asked is when can the estate assets be distributed? Generally, distributions should not be made until the estate has received clearance and tax waivers from all taxing authorities. In many circumstances; however, it may be appropriate for partial distributions to be made prior to receiving tax clearance. Special consideration must be given to the distribution of assets such as annuities, pension plans and other retirement assets as there may be adverse income tax consequences from delayed or premature distributions.
The administration of an estate raises many more issues than clients realize. There may be complex estate and income tax issues, distribution issues, valuation issues as well as complicated family dynamics that need to be addressed along with many other legal and non-legal issues that arise during estate administration. Jillian and those in her situation should enlist the aid of competent and experienced estate administration counsel in order to be guided through this process.

Businesses Owners Need To Plan for Their Exit: Companies should be prepared for the boss’s departure

By Scott Goldstein 6/2/2008 NJBIZ magazine

Owners of closely held companies—especially family businesses—have a lot on their minds, and it often doesn’t involve what happens if an owner or partner dies or leaves the company unexpectedly.
“To fail to plan is no plan. You are leaving things to chance,” says Parag P. Patel, a Woodbridge-based business and tax lawyer who helps companies create succession plans.
Experts say most small and mid-sized private companies don’t have succession plans—and that can lead to confusion and loss for the business.
The main questions for a succession plan are: Who will lead the company? Who will buy out the deceased partner? And in the case of a family business, will the successor come from within the company or from within the family?
“These are challenging questions. It’s better to have this conversation before a partner actually dies or pulls out, when the stakes and the emotions aren’t as high,” says Marguerite Mount, an accountant with The Mercadien Group in Princeton. “You can apply more intellect than emotion. That why it’s called succession planning.”
A succession plan addresses more than just death, she says. It can apply when a partner retires, gets divorced or becomes disabled.
“Do you have one partner sell to the others? Do you find another partner to sell to? Do you continue operating the business the same way? And who will take the leadership role?” Mount cites as questions that need to be explored.
And some of the answers help create a philosophy for the business as it currently exists, Mount says. Are you building the company to sell? To merge? Are you going to take the company public? Or will you let the company perpetuate in the same form?
When a partner is suddenly gone, the succession plan can designate whether the shares go to the departing shareholder’s estate or are sold to the surviving shareholders, says Patel.
“With a plan, you won’t have the remaining shareholders arguing and you won’t have an unexpected shareholder entering the business,” Patel says.
“Without a plan, you can have a bank become a shareholder in the case of a bankruptcy,” he adds. “And you can have a wife become a shareholder in the case of a divorce or death. There are many scenarios.”
Setting up a succession plan involves communication and time.
“First thing you need to do is set up a vision statement and if you can’t do that between yourselves, then you need to have that facilitated,” Mount says. “That can take the form of professional facilitators or you can use someone who has knowledge in your industry.”
When The Mercadien Group is hired as a facilitator, it sets up a meeting among company partners in a “retreat setting” for a day, Mount says. Then the firm follows up to implement the plan with a broker or an attorney if a legal document is created, says Mount.
“The idea is to have a game plan that covers the inevi-table but unexpected.”
A family business’ succession plan should include a “buy-sell agreement” that specifies terms of ownership am-ong partners and the value of their shar-es, Patel says. “Of course, the lower the specified sh-are price, the lower the estate- and gift-tax value of the shares,” Patel says. That “avoids valuation disputes with the IRS, which may otherwise value the business higher and seek more on taxes after it is sold.”
A way to reduce estate taxes is for a business owner to shift minority shares to family members before the owner retires, Patel says. The IRS taxes transfers of business shares among family at a lower rate than it does the inheritance of business shares, he notes.

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