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Joint vs. Separate Trusts for Married Couples

Deciding between joint and separate trusts for married couples has been a conundrum within the estate planning community for a long time. While many attorneys swear by one trust over the other, there are many factors—such as, the state in which the couple resides, the total of their marital estate, and the couple’s relationship itself—that contribute to the decision of which trust is more suitable. Historically, joint trusts have been popular among married couples due to their cheaper start-up costs, ease of management, and the fact that a joint trust reflects the traditional view of a marital estate as a singular unit. However, separate trusts, have some great (and often superior) benefits for a married couple in regards to asset protection, management flexibility, and cost savings after the death of the first spouse.

To aid in this decision process, I’ve compared the strength and weaknesses of each trust type for various situations. The check mark signifies which trust is the better option for that category.

Asset Protection

Separate Trusts – Depending on state law, separating the marital estate into two separate trusts may insulate the assets of one spouse from any financial risks brought on by, or actions taken against the other spouse. Since the innocent spouse’s assets are in a separate trust, they may be out of reach from his or her spouse’s creditors.

Joint Trusts – Since all marital assets are located in one trust, all assets would be at risk if a creditor obtains judgment over either spouse.

Note, however, that some states have extended tenancy by the entirety (T/E) protection to T/E property contributed to a joint trust. See e.g. MO Rev Stat § 456.950 and 765 ILCS 1005/1c. (If your client is domiciled in a T/E state, check your state law for possible statutory protection.) If so, the joint trust will provide superior protection from judgments against one spouse.

Planning Tip: Separate trusts may be a better option to protect assets from creditors.

Administration during the couple’s lifetime

Separate Trusts – Separate trusts require a bit more work, as each spouse is required to manage their own trust. If a couple wishes to keep their martial estate as a singular unit, separate trusts can still accommodate this by naming each spouse as the other’s co-trustee. This allows both spouses to maintain control of all assets, despite being located in separate trusts.

Joint Trusts – Joint trusts are easier to manage during a couple’s lifetime. Since all assets are rolled into one trust, trust management would be very similar to pre-trust ownership, in that both spouses control their separate assets in the trust and have equal say in the management of the joint assets held by the trust. Since each spouse, however, has the right to revoke the trust as to his or her separate property or trust share, this may not be a safe solution if there exists any volatility between spouses.

Planning Tip: Joint trusts may be easier to manage during a couple’s lifetime.

Administration after the first spouse’s death

Separate Trusts – Separate trusts provide more flexibility in the event of the first spouse’s death because the trust property is already divided when the trust is funded. Separate trusts preserve the surviving spouse’s ability to amend or revoke the assets held in the surviving spouse’s trust. Separate trusts also allow each spouse to designate exactly what they would like done with their assets—who inherits what, if they would like to provide for their surviving spouse—all while protecting their assets from being inherited by new children from another marriage (should their spouse ever remarry).

Joint Trusts – Spouses can fund their joint trust with their joint or community property and with any property interests that the spouses own individually. An improperly drafted joint trust may result in the surviving grantor’s making a completed gift of his or her separate trust property and share of community property to the remainder beneficiaries of the trust when the joint trust becomes irrevocable upon a grantor’s death. See Commissioner v. The Chase Manhattan Bank, 2 AFTR 2d 6363, 259 F.2d 231 (5th Cir 1958). To avoid this gift tax issue, each spouse should be given the power to withdraw his or her separate trust property at any time without the consent of the other spouse. Retaining the unrestricted right to withdraw the grantor’s separate property makes any potential gift incomplete and thus creates no gift tax liability. In a properly drafted joint trust, the surviving spouse retains significant rights in his or her separate trust property and his or her share of any community property or tenancy in common property. The retained rights prevent the occurrence of an immediate gift to the remainder beneficiaries of the joint trust.

This division, however, must be recognized after the death of the first spouse, which may create additional complications both in the initial drafting of the trust and the subsequent administration. It is also especially difficult to draft a joint trust in which the beneficiaries receive different distributions upon the death of each spouse. This makes drafting problematic especially in second marriage situations where the spouses each have different distributions schemes for their beneficiaries. Joint trusts, however, are superior from an income tax perspective if funded with community property. Community property in a properly drafted joint trust receives a 100% step up in basis upon the death of the first spouse to die!

Planning Tip: Separate trusts may be easier to manage after one spouse has died.

Estate tax benefits

Separate Trusts – With property marital trust planning, separate trusts provide estate tax relief for affluent couples who’s estate totals higher than the federal estate tax exemption, (a combined $22,400,000 for 2018).

Joint Trusts – A property drafted and funded joint trust will consist of community property—property treated by law as ½ the separate property of each spouse. It may also be funded with joint property under common law and should be converted specifically to tenancy in common property (either by separate property agreement or by the trust language) so that ½ can be treated as each spouse’s separate property. By converting the property to separate property of each spouse for gift tax purposes, the separation allows a property drafted joint trust to achieve the same estate tax marital deduction planning benefits as separate trusts.

This one’s a tie, since, if properly drafted, both separate trusts for each spouse, and joint trusts can provide the same estate tax benefits.

Circumstances where one trust may be more advantageous than the other

Separate Trusts – Separate trusts are a good option for remarriages (who may differ in their beneficiary designations) or couples own individual property prior to the marriage; couples who expect to receive an individual inheritance that they would like to keep separate; and is a better option for common law marriages and couples who have already signed a prenup agreement.

Joint Trusts – Joint trusts are a good option for first marriages that have the same beneficiaries, the same distribution patterns, and the same trustee; and for couples who wish to keep their marital estate as a singular unit.

***Please note: in a community property law state, property that is acquired during marriage is considered to be jointly owned by both spouses. In these states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), an estate planner may want to only offer joint trusts.

May 2018 Market Commentary: “Back to Normalcy?”

Markets were again plagued by volatility in May, largely due to heightened political risk. The US administration’s approach to global trade, North Korea and Iran remain uncertain, while Italy’s new populist government added to market concerns. Risk-off sentiment contributed to a significant rise in the value of the US dollar, which strengthened 2% vs. a basket of major currencies.

Despite the noise, the macro backdrop is still relatively supportive. The ongoing strength of global growth was evident in corporate earnings reports. Moreover, inflation remains benign, and so any interest rate normalisation looks set to be gradual. Therefore, despite significant intra-month swings, developed world equity markets rose over the month by more than 1% and broad fixed income markets were down around 1%.

US data was strong across the board. April consumer confidence is still close to the 17-year high reached in February, and the flash manufacturing purchasing managers’ index (PMI)—the key business survey—increased in May, indicating an acceleration in the pace of activity into the second quarter. The tailwind to growth from tax reform and the energy sector should more than offset any drag to consumption caused by higher gasoline prices.

What has been unusual about recent events is not the volatility of the S&P 500, the unusual part is that the bond market has performed poorly at the same time. In fact, over the last 20 years there have only been four instances where the S&P 500 and the bond market both fell by more than 1% over a 3 month period….we just experienced one of those periods (February through April, the S&P 500 was down 5.8% and the bond market was down 1.1%). The only other times this occurred over the last 20 years was once in 2004 and twice in 2008.

Overall, the calm markets of 2017, which saw both bond and stock prices drifting gently upwards on a monthly basis, seem firmly behind us. Geopolitical risk is likely to continue to be felt most keenly in currency markets. We continue to believe that over the long term a combination of a large trade deficit and rising government debt should weigh on the value of the dollar. But in the near term, geopolitical risk is likely to coincide with dollar strength. Looking through the noise, we still expect a benign growth environment—characterised by above-trend growth, relatively low inflation and accommodative global monetary policy—to be supportive for earnings growth and equity markets. But a more unpredictable US administration and the re-emergence of political risk in Europe serve for caution in the degree of risk taken at this stage in the cycle.

We encourage you to tune out the markets (whatever they decide to do) and enjoy your summer. Rest assured, we will be here listening nonetheless…noise and all…focused on keeping your plans on track.

Tax Reform Increases the Tax Benefits of Employing Your Child

The recent tax reform eliminated personal exemptions for taxable years after December 31, 2017, and before January 1, 2026. This makes your child worthless to you on your Form 1040. But there is a way to get even or, perhaps, much more than even.

Let’s set the stage first. For taxable years after December 31, 2017, and before January 1, 2026, the standard deduction for a single taxpayer begins at $12,000 in 2018 and increases every year for inflation. The 2017 standard deduction for a single taxpayer was only $6,350.

The new standard deduction means that a single taxpayer such as your child can earn up to $12,000 in W-2 wages and pay not a penny in federal taxes. As the owner of a business, you have the advantage of being able to hire your child to work in your business, and that creates tax-saving opportunities for both you and your child.

Self-Employed Businesses

The big dollar benefits of hiring your child go to the Form 1040, Schedule C taxpayer and the husband-and-wife partnership because such businesses are exempt from FICA when they employ their children who are under age 18. The parental proprietorship and partnership hiring rules also exempt wages paid to a child under the age of 21 from unemployment taxes. Keep in mind that the single-member LLC that did not elect corporate tax treatment is taxed as a sole proprietorship for federal tax purposes.

Example. You employ your 9-, 11-, and 13-year-old children to work in your proprietorship. You pay them a fair market wage for the work they perform, and that just happens to equal $12,000 per child and total $36,000 for the year.

Children’s federal taxes. Zero! The $12,000 standard deduction zeroed each of the children out of federal income taxes for the year.

Your federal taxes. You claim the $36,000 W-2 wages deduction on your Schedule C, where it reduces both your income taxes and your self-employment taxes. If you are single with Schedule C income and taxable income of $120,000, you save at the 38.13 percent rate, for a total of $13,127. Of course, your tax rate is likely higher or lower than the example above, but you get the idea of how this works to your benefit. No taxes to the child and tax savings to you. Yes, you are having your cake and eating it, too.

 

S and C Corporations, Non-Spouse Partnerships, and Self-Employed Taxpayers with Children Age 18 and Over

When you hire the child under age 18, the Form 1040, Schedule C business and the partnership with only the child’s parents are exempt from Social Security, Medicare, and federal unemployment taxes. The S and C corporations and the non-spouse partnerships do not qualify for this benefit. They have to pay the payroll taxes on all employees—period. There is no parental benefit. (Similarly, the self-employed individual or the spouse-only partnership with a child age 21 or over does not qualify for any employment tax breaks.) This obviously changes the game. Let’s look at the three children above and apply the payroll taxes. Here’s how:

• $2,754 employer FICA taxes on the $36,000 in wages paid to the three children
• $2,754 employee FICA taxes extracted from the three children’s $36,000 in wages
• $1,200 in state and federal unemployment (this could be a little higher or lower depending on the employer’s experience with unemployment and the unemployment condition of the state where the business resides)

The payroll taxes above have left the pockets of either the children or the business entity. But the bottom line is that the money is now with the governments. All is not lost, and in most cases, this actually works out pretty well.

The business does get a tax deduction for its FICA and unemployment taxes. Let’s say this is your business and you operate it as an S corporation, so the net income passes to you. The tax deduction for hiring your three children is the $36,000 of wages paid, plus the $2,754 in FICA and the $1,200 in unemployment taxes, for a total of $39,954.

If you are in the 35 percent tax bracket, you save $13,984 on your $39,954 deduction. Remember, the children pay no income taxes, although they did suffer the $2,754 in FICA taxes.

Here’s the tally for the family:

Cash received from the government $13,984
Corporate cash paid out for FICA -$2,754
Corporate cash paid out for unemployment taxes -$1,200
Children’s cash paid out for FICA -$2,754
Net cash benefit to the family $7,276

You can see that payroll taxes take a toll, but they by no means kill the strategy. You, as the owner of this S corporation that hired the children, just put $7,276 in the pockets of the family. And you are going to do this for a number of years, so this one corporate strategy could be worth a lot of money to you. Of course, it’s unlikely that your savings will equal the calculation above. You might save more or less. Use the example above with your tax rates to calculate your exact savings.

Takeaways

If you can hire your children, the recent tax reform did you a big favor with the new $12,000 standard deduction.

The biggest benefits accrue to the Form 1040, Schedule C business or the spouse-only partnership when such a business can hire the under-age-18 child of the parent (or parents, in the case of the partnership). Why? Because with such a business, both the business and the parents are exempt from FICA taxes.

But every business where the owner can employ his or her children likely produces a nice financial benefit for the family. Make sure to review the tax savings in this article to see how you can come out ahead.

Maximize Your Travel Deduction

As you likely know by now (I love assuming everyone has read the new tax bill), your travel meals continue under tax reform as tax-deductible meals subject to the 50 percent cut. And tax reform did not change the rules that apply to your other travel expense deductions.

One beauty of being in business for yourself is the ability to pick your travel destinations and also deduct your travel expenses. For example, you can travel to exotic locations using the seven-day travel rule and/or attend conventions and seminars in boondoggle areas. From these examples, you can understand why the IRS might want to see proof of your business purpose for any trips, should it examine them.

With deductions for lodging, a meal, or other travel expenses, the rules governing receipts, business reasons, and canceled checks are the same for corporations, proprietorships, individuals, and employees. The entity claiming the tax deduction must keep timely records that prove the four elements listed below:

1. Amount. The amount of each expenditure for traveling away from home, such as the costs of transportation, lodging, and meals.
2. Time. Your dates of departure and return, and the number of days on business.
3. Place. Your travel destination described by city or town.
4. Business purpose. Your business reason for the travel, or the nature of the business benefit derived or expected to be derived.

When in tax-deductible travel status, you need a receipt, a paid bill, or similar documentary evidence to prove

• every expenditure for lodging, and
• every other travel expenditure of $75 or more, except transportation, for which no receipt is required if one is not readily available.

The receipt you need is a document that establishes the amount, date, place, and essential character of the expenditure.

Hotel example. A hotel receipt is sufficient to support expenditures for business travel if the receipt contains

• the name of the hotel,
• the location of the hotel,
• the date, and
• separate amounts for charges such as lodging, meals, and telephone.

Restaurant example. A restaurant receipt is sufficient to support an expenditure for a business meal if it contains the

• name and location of the restaurant,
• date and amount of the expenditure, and
• number of people served, plus an indication of any charges for an item other than meals and beverages, if such charges were made.

You can’t simply use your credit card statement as a receipt. Like a canceled check, it proves only that you paid the money, not what you purchased. To prove the travel expenditure, you need both the receipt (proof of purchase) and the canceled check or credit card statement (proof of payment).

In a nutshell, a travel expense is an expense of getting to and from the business destination and an expense of sustaining life while at the business destination. Here are some examples from the IRS:

• Costs of traveling by airplane, train, bus, or car between your home and your overnight business destination
• Costs of traveling by ship (subject to the luxury water travel rules and cruise ship rules)
• Costs of renting a car or taking a taxi, commuter bus, or airport limo from the airport to the hotel and to work destinations, including restaurants for meals
• Costs for baggage and shipping of business items needed at your travel destination
• Costs for lodging and meals (meal costs include tips to waiters and waitresses)
• Costs for dry cleaning and laundry
• Costs for telephone, computer, Internet, fax, and other communication devices needed for business
• Tips to bellmen, maids, skycaps, and others

The travel deduction rules are the same whether you operate your business as a corporation or a proprietorship, with one important exception. When you operate as a corporation during the tax years 2018 through 2025, you must either

• have the corporation reimburse you for the expenses, or
• have the corporation pay the expenses.

If You’re a S Corp, Review your Fringe Benefits

Fringe benefits are usually a good thing—but there’s a catch when you own more than 2 percent of an S corporation. The good news? Federal tax law allows the cost of these fringes as deductible expenses for your S corporation. The bad news? You, the shareholder-employee who owns more than 2 percent, may suffer additional taxes on some of the benefits because the tax code requires your corporation to put selected benefits on your W-2 (sometimes favorable, sometimes not).

Here’s the ugly rule that causes this problem. Under the federal income and employment tax rules for the most popular fringe benefits, tax law treats the more than 2 percent shareholder-employee of an S corporation as a partner. And—we know you are just waiting for this—more bad news: related-party stock attribution rules apply to the S corporation. Under these rules, tax law says that your spouse, parents, children, and grandchildren own the same stock you own—and if you employ them in your S corporation, their fringe benefits suffer the same ugly fate as your fringe benefits.

In this article, we are going to explain the following:

1. Four fringe benefits that are (a) deductible by your S corporation, (b) taxable to you as a shareholder who owns more than 2 percent, and then (c) deductible by you on your personal tax return. You can see that navigating this maze is a little crazy, and you have to do it right to make it work—which, of course, we explain how to do.
2. Six stinky fringe benefits. These benefits are stinky because, first, you get nothing from them because you are a shareholder-employee who owns more than 2 percent and, worse, you pay extra taxes because the “non-benefit to you” goes on your W-2 subject to FICA.
3. Three maybe (but maybe not) fringe benefits. This group of S corporation fringe benefits comes with special rules that can disqualify your eligibility for the benefits.
4. Four no-problem fringe benefits.

Four Beneficial but Somewhat Crazy Fringe Benefits

The following four fringe benefits work their way through a tax code maze to eventually produce a personal benefit to the shareholder-employee who owns more than 2 percent. For example, for the more than 2 percent shareholder-employee to get any tax benefit whatsoever from health insurance, he or she needs to follow the exact road map you see in No. 1 below.

1. Health Insurance

If you are a shareholder-employee who owns more than 2 percent of an S corporation and you want a tax benefit from your health insurance, you need to follow the three-step path that we lay out in Update: 2018 Health Insurance for S Corporation Owners. The three steps are described below:

1. Make the S corporation pay for your insurance premiums, either directly or through reimbursement to you.
2. Have the S corporation include the health insurance as wages not subject to FICA on your W-2.
3. Deduct (as an individual taxpayer) the cost of the premiums, using the self-employed health insurance deduction on page 1 of your Form 1040.

Warning No. 1—No Section 125 plan. You, as a more than 2 percent S corporation shareholder-employee, can destroy the S corporation’s tax-favored Section 125 cafeteria benefit plan. If you participate in the Section 125 plan, you disqualify the plan and make it taxable to yourself and all employee participants.

Warning No. 2—Beware of employees. The S corporation can pay for or reimburse your individual owned insurance because you are a shareholder who owns more than 2 percent. But your S corporation may not pay for or directly reimburse your employees for individually owned health insurance

An S corporation that directly pays for or reimburses employees for employee-arranged health insurance premiums (as opposed to paying premiums for company-arranged group coverage) faces the Affordable Care Act penalty of $100 a day per affected employee per day ($36,500 per employee per year).

2. Health Reimbursement Arrangements (HRAs)

As a shareholder-employee who owns more than 2 percent, you don’t gain any extra benefit from a Section 105 plan or other HRA. If the S corporation reimburses the more than 2 percent shareholder-employee using a health reimbursement plan or account, it simply creates W-2 treatment for the shareholder. If health insurance costs are included in the reimbursement, the shareholder treats the health insurance costs included in his or her W-2 as discussed in No. 1 above.

For medical reimbursements other than health insurance that the S corporation reports on the W-2, the shareholder itemizes those deductions on Schedule A of the Form 1040.

3. Health Savings Accounts (HSAs)

The S corporation treats contributions to the more than 2 percent shareholder-employee’s health savings account (HSA) as W-2 income exempt from FICA and Medicare, and the shareholder-employee deducts the HSA on his or her Form 1040.

4. Disability Insurance

The S corporation treats the premiums paid for an income replacement disability policy on a more than 2 percent shareholder-employee as wages for withholding tax purposes that are exempt from FICA and unemployment taxes. Under this requirement, the more than 2 percent shareholder-employee actually paid the disability premiums personally because of the W-2 treatment, and that means he or she collects the disability income tax-free.

 

Six Stinky Fringe Benefits

What makes a fringe benefit stinky? The stinky fringe benefit gives your S corporation a tax deduction for the compensation that it includes on your W-2. Effectively, this gives you a zero tax benefit from the stinky fringe benefit. The stinky fringe benefit increases the corporation’s FICA taxes on the compensation it has to add to your W-2 and the stinky fringe benefit increases your personal FICA taxes because of the compensation added to your W-2.

In summary, the stinky fringe benefit is absolutely NO benefit to you, and it increases both your and your corporation’s FICA taxes. That’s really stinky.

Stinky No. 1: Group Term Life Insurance

Your S corporation treats the cost of any company-provided group term life insurance coverage as wages to you SUBJECT TO FICA. You, the shareholder-employee, have no tax code section that allows you to deduct the group term life insurance on your personal tax return.

To see how good or bad the idea of having the group health insurance cover a more than 2 percent shareholder-employee is, you need to compare the cost savings (if any) of the group insurance with the additional FICA taxes paid by both you and your S corporation. For your S corporation’s regular employees, you can provide up to $50,000 of group term life insurance tax-free.

Stinky No. 2: Qualified Moving Expense Reimbursements

For tax years beginning January 1, 2018, and before January 1, 2026, tax reform eliminates both the fringe benefits and tax deductions for moving expenses. This applies both to employees and to shareholder-employees who own more than 2 percent. If your S corporation provides moving expense reimbursements to a more than 2 percent shareholder-employee, the corporation treats the reimbursement as wages subject to FICA. Having your S corporation reimburse you, the more than 2 percent shareholder-employee, for moving expenses was and is a bad idea because both your S corporation and you, the employee, pay FICA taxes on the amounts included on your W-2.

Planning tip. Pay the moving expenses yourself. That way you save the corporation its FICA, which increases the S corporation income that flows through to you. And second, you save yourself the FICA taxes that apply to you, the W-2 employee.

Stinky No. 3: Qualified Transportation Fringe Benefits

Your S corporation has to treat as wages subject to FICA and FUTA any qualified transportation fringe benefits it pays to you, the more than 2 percent shareholder-employee. As you’ve seen, the inclusion of the monies on your W-2 does more than just eliminate the benefit—it makes you and your corporation pay additional FICA taxes. So, forget this fringe benefit for the shareholders who own more than 2 percent.

Instead, and especially if you are the sole owner of the S corporation, follow a strategy that allows your S corporation to deduct your cost of transportation and more without creating wages for you, as detailed in S Corporation? Office in the Home? Learn How to Escape Taxes.

Rank and file. Note that tax reform has made transportation fringe benefits granted to employees a less attractive offering from the employer perspective.

Stinky No. 4: Meals and Lodging

Meals and/or lodging that are provided by the company to a more than 2 percent shareholder-employee for the company’s convenience (for example, because the shareholder-employee must be on the company premises for overnight duty) are treated as wages subject to FICA. The amounts included in the shareholder-employee’s income are not deductible by the shareholder-employee on his or her personal tax return.

Rank and file. The S corporation may provide lodging and meals for the convenience of the employer to employees who are not shareholders who own more than 2 percent.

Stinky No. 5: Qualified Employee Achievement Program

Your S corporation treats the cost of a qualified employee achievement award given to a more than 2 percent shareholder-employee as wages subject to FICA at both the corporate and employee levels. The more than 2 percent shareholder-employee may not deduct the value of an employee achievement award on his or her Form 1040.

Rank and file. The S corporation may deduct the cost of qualified achievement awards given tax-free to employees other than shareholder-employees who own more than 2 percent.

Stinky No. 6: Qualified Adoption Assistance

If your S corporation pays you, the more than 2 percent shareholder-employee, the adoption assistance fringe benefit, the corporation has to put that payment on your W-2 as wages subject to FICA. You may, of course, claim the adoption tax credit allowed by the tax code on your personal tax return (your IRS Form 1040).

Planning tip. Pay the adoption expenses yourself. Don’t let your S corporation pay the monies and then put those monies on your W-2. By paying the monies yourself, you save both the corporation and yourself the FICA taxes.

Rank and file. Your S corporation may establish an adoption assistance fringe benefit that’s tax-free to employees who are not shareholders who own more than 2 percent.

 

Three Maybe (but Maybe Not) Fringe Benefits

The three fringe benefits in this section face special tax code disallowance rules that often take these benefits away from the S corporation shareholder-employee who owns more than 2 percent.

Maybe No. 1: Qualified Educational Assistance Program

The qualified educational assistance program fails as a qualified program and is not tax favored for ANY employee when more than 5 percent of the benefits are provided to shareholder-employees who own more than 2 percent or their spouses or dependents.

You may, however, be able to provide this benefit to your child if he or she is an employee and certain other conditions are met. For more on this, see Business Tax Deductions with Section 127 Plan for Child’s College.

Rank and file. The qualified educational assistance program is relatively easy to implement when all the benefits are going to employees who are not shareholder-employees who own more than 2 percent of the S corporation.

Maybe No. 2: Qualified Dependent Care Assistance Program

Your S corporation can implement a qualified dependent care assistance program, but if more than 25 percent of benefits paid for dependent care assistance during the year are provided to those who own more than 5 percent, the program fails as a tax-favored program and the benefits are taxable for all participants.

Maybe No. 3: Working Condition Fringe Benefits

Your S corporation’s ability to provide a working condition fringe benefit to all employees—including you, the more than 2 percent shareholder-employee—is found in tax code Section 132(d), which states:

For purposes of this section, the term “working condition fringe” means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167.

Tax reform adds a fly to the ointment because it does not allow miscellaneous itemized deductions (where you claim employee business expenses) for any taxable year beginning after December 31, 2017, and before January 1, 2026. Does this mean that working condition fringe benefits are not deductible by your S corporation during this period because of tax reform? Maybe, but maybe not.

Planning tip. We think you should proceed as if the working condition fringe benefit requirements were unchanged by tax reform. To us, sloppy drafting of the Tax Cuts and Jobs Act inadvertently overlooked IRC Section 132(d) when disallowing employee business expenses, and we expect that oversight to be corrected.

Working condition fringes that your S corporation can provide to you, the more than 2 percent shareholder-employee, and/or your employees include:

• Use of the corporate-owned car for business purposes
• A smartphone, when provided for non-compensatory reasons
• Job-related education

 

Four No-Problem Fringe Benefits

Your S corporation can provide you, as a shareholder-employee who owns more than 2 percent, and its other employees with the following fringe benefits, which are tax-free to the employees and deductible by the S corporation:

1. De minimis fringe benefits. De minimis fringe benefits include occasional use of the company copy machine, holiday and birthday gifts with a low value, occasional parties and picnics for employees and their guests, and occasional tickets to the theater or sporting events.
2. No-additional-cost services. No-additional-cost services are excess capacity services, such as airline, bus, or train tickets; hotel rooms; or telephone services provided free, at a reduced price, or through a cash rebate to employees working in those lines of business.
3. Qualified employee discounts. This exclusion applies to a price reduction you give your employee on property or services you offer to customers in the ordinary course of the line of business in which the employee performs substantial services. The employee discounts can be up to 20 percent on services and the gross profit percentage on merchandise.
4. On-premises athletic facilities. Your S corporation can exclude the value of an employee’s use of an on-premises gym or other athletic facility from the employee’s wages if substantially all use of the facility during the calendar year is by the corporation’s employees, their spouses, and their dependent children.

Takeaways

As you have learned, you need to pay attention when it comes to the fringe benefits that your S corporation is going to offer you, the shareholder-employee who owns more than 2 percent. And of course, you have to pay attention when your S corporation offers fringe benefits to rank-and-file employees, too.

In “Four Beneficial but Somewhat Crazy Fringe Benefits,” you learned that the corporation puts the fringe benefit on your W-2 free of FICA taxes so that you can obtain a tax deduction on your personal income return.

In “Six Stinky Fringe Benefits,” you learned how to make both yourself and your S corporation pay extra FICA taxes on non-benefits to you. You can think of this as shooting yourself in the foot. It’s unnecessary and painful.

In “Three Maybe (but Maybe Not) Fringe Benefits,” you learned how special benefit rules can (and likely do) rob you of both the educational assistance and the dependent care assistance programs. With the working condition fringe benefits, you found a fly in the ointment caused by the recent tax reform—and why we think you can ignore it.

In the final section, you finally got to smile as you learned about the four no-problem fringe benefits that your S corporation can give tax-free to you and all your corporation’s employees. That’s really what a fringe benefit is supposed to be—a tax-free benefit.

Four Medicaid Rules that will Save you Money

Many couples face an uphill battle when one spouse has a catastrophic health crisis and needs long-term care. Most people are uninsured for the risk of the Medicaid spenddown and often the healthy spouse is faced with sticker shock when the nursing home bills start coming in. There are four rules that – when used together – can help the community spouse avoid financial devastation.

                               RULE 1: THE 5-YEAR LOOKBACK

In every state but California, Medicaid uses a 60-month lookback rule on the transfer of assets. When a nursing home patient applies for Medicaid, the state will look at five years of bank and account statements. As part of the eligibility review process, the state makes the applicant account for any gifted funds or any assets transferred without receiving full consideration. For instance, a gift of $50,000 would trigger a transfer penalty for the full amount. But if the applicant sold a $150,000 house to his granddaughter for $100,000 they would treat that the same as gifting the $50,000 in cash.

Penalties are prospective from the date of application. Assuming the average cost of care is $10,000 a month. Medicaid determines the penalty by dividing the average cost of care into the total gift. The applicant who gave away $50,000 would be ineligible for nursing home care for five months after the application was filed with the department. What confuses a lot of people is the idea that there is no way to help the healthy spouse protect assets because it would have had to have been done prior to the 5-year lookback window. That’s simply not true. Most asset protection techniques are designed to work AFTER the patient enters the nursing home.

                                RULE 2: THE SNAPSHOT DATE

When a married couple has one spouse in the nursing home and another spouse living at home (called the “community spouse” by Medicaid), the amount of money they are required to spend down is governed by a formula. States either use the one-half deduction formula or the straight deduction formula, both of which are confusing to the average community spouse. In 2018, the maximum a community spouse can keep is $123,600. This is known as the Community Spouse Resource Allowance (“CSRA”).

The CSRA is determined based upon the value of the assets on the snapshot date. The snapshot date is typically tied to the date of institutionalization that proceeds the first thirty days of care. Some states make it the actual date in time and others make it the first of the month when that occurs. Countable assets (i.e., assets which count towards the spenddown) are added up on the snapshot to determine how much the community spouse can keep and what amount must be spent to achieve Medicaid eligibility. Many nursing homes DO NOT disclose this to the nursing home patients or their spouses because there is hope that they will private pay longer than is required.

A married couple with $400,000 in countable assets would only be able to keep the CSRA of $123,600 and would be on track to have to spend down $276,400 before Medicaid eligibility can be established. That amount represents the couple’s total exposure to the spenddown. Given the high cost of care, this couple is likely to spend down three-fourths of their retirement savings on the cost of care in slightly over two years. When determining the assets available on the snapshot date, Medicaid counts assets owned by both spouses and does not care if there is a prenuptial agreement in place.

                RULE 3: THE ASSET-TO-INCOME RULE

Excess recourses can be converted into income. This is known as the “asset-to-income rule” although it’s not called such in the Medicaid statutes. Medicaid has specific rules on the use of promissory notes and certain Single Premium Immediate Annuities (SPIAs) that it deems to be compliant with strict rules on payout and revocability. These annuities are known as the Medicaid safe harbor annuities because of the safe harbor language protecting these annuities written right into the federal Medicaid statute in 2006. The purchase of a Medicaid safe harbor annuity converts countable assets into income. These are typically purchased on behalf of the community spouse who is not required to contribute her income towards the cost of her husband’s care in the nursing home once he’s on Medicaid. As long as the annuity meets all safe harbor rules, the purchase is NOT considered a transfer for less than fair market value and the five-year lookback rule does not come into effect.

Because there is typically a desire to maximize the amount of money a community spouse can keep liquid, the purchase of the annuity often takes place after the patient goes into the nursing home in states that use the one-half deduction formula. This way the community spouse can have all of the countable resources available on the snapshot date to maximize the CSRA. Then the excess resources are placed into the Medicaid safe harbor annuity and the couple applies for Medicaid. The purchase of the annuity brings the couple’s countable assets below the resource limit IMMEDIATELY!

                                RULE 4: ONLY ONE MARITAL SPENDDOWN

Many people – advisors included – falsely think that the CSRA is an ongoing asset limit for the healthy spouse. However, the last rule to note here is that there is only ever one spenddown for a married couple when the CSRA is set. Once the assets have fallen below the CSRA, the couple applies for Medicaid for the institutional spouse. On the first Medicaid application they look at both spouse’s assets held individually or jointly to determine if the couple has spent down below the resource limit. Once the Medicaid department determines that they have, Medicaid is approved for the spouse in the nursing home. On subsequent redeterminations, Medicaid no longer inquiries about the community spouse’s assets except to make sure that assets held jointly were given exclusively to the community spouse. Those assets can no longer be held in the name of the institutional spouse whose assets will be limited to the state’s individual countable resource allowance (usually $2,000 or thereabout depending on the state).

The community spouse can re-accumulate funds from the annuity or promissory note and re-invest those funds. Because the community spouse’s countable assets do not factor into future eligibility for the nursing home spouse, she does not need to keep her countable assets below the resource limit.

                

    

 

 

 

April 2018 Market Recap: Where Do We Go From Here?

I’m confused.  We’re enjoying a highly unusual financial “cocktail” these days that combines one part low inflation, one part low unemployment, one part strong earnings and one part low interest rates.  We should be happier – share prices should be moving up – but they’re not.  Do you share my concerns?

First quarter real GDP growth came in at a respectable 2.3%, easing slightly from the robust growth experienced throughout 2017. Markets have experienced heightened volatility so far in 2018 compared to 2017. Geopolitical headlines continue to play a significant role in perceived risk, with particular focus on tariff negotiations with China and tensions in Syria. Coupled with uncertainty over the role of Iran in the international community, oil prices rose 7% over the month. As a result, commodities were the top performing asset class (up 2.2% YTD and 2.6% in April). The oil price rallied. The International Energy Agency announced that the excess oil inventories that had kept prices low have now disappeared thanks to the production cuts put in place by the Organization of the Petroleum Exporting Countries (OPEC) and the strength of global oil demand. According to consensus estimates the oil price could rise further, also boosted by the prospect of sanctions on Iran.

Despite market volatility, economic readings continue to support a healthy expansion (According to Bloomberg, 180 companies in the S&P 500 Index that have reported first-quarter earnings have seen their effective tax rate drop by an average of 6%). The consumer remains confident with the US consumer confidence reading exceeding analysts expectations in April, rebounding from a slight decline in March. The Department of Labor’s initial jobless claims report came in at 209,000, marking the longest sub-300,000 recording since 1967. Meanwhile, the unemployment rate held steady at 4.1% for the sixth consecutive month. The manufacturing side of the economy continues to perform well.

The S&P 500® Index followed two consecutive months of losses with a slim gain of 0.22% in April. While most of the 11 sectors of the S&P 500 had modest gains or losses, the Energy sector enjoyed one of its largest monthly gains in years. Energy was up 9.36% in April, as oil prices continued to stage a strong recovery. Investor fervor for “growth” stocks appears intact, as the technology-laden NASDAQ Index remains by far the best performing domestic index year-to-date. Investors also appear to be favoring companies less exposed to geopolitical concerns and tariff issues. As such, small-capitalization stocks (Russell 2000) posted a relatively strong April, while the Dow Jones Industrial Average is trailing year-to-date. Internationally, worries of a Eurozone economic slowdown eased in April, resulting in a rebound in the MSCI EAFE Index.

With the U.S. 10-year yield pushing past 3% and reaching its highest level since January 2014 investors are wondering why are yields rising now? As I highlight in the below chart for the last few years two anchohave been weighing down on the back-end of the yield curve: demand from international investors for U.S. fixed income and a lack of inflationary pressure. In 2018 both of these anchors have begun to lighten.
Rising hedging costs have eroded the relative attractiveness of U.S. fixed income to overseas investors. Falling demand from overseas has pushed U.S. bond prices down and forced yields higher. Inflationary pressure is driven higher by the falling U.S. dollar, which increases to the price of imports into the U.S. and oil prices moving higher. With inflation now back on investor’s radar, bond yields have begun to grind higher. The takeaway for investors is that higher bond yields are likely here to stay as both anchors continue to lighten in 2018. We encourage investors to remain flexible when managing duration, sectors and geographies during this tough time for fixed income markets.

Despite some risks related to trade restrictions, geopolitical noise and expectations of tighter monetary policy, markets remain on track thanks to signs that the global economy continues to expand, inflation is only rising gradually and earnings growth is healthy.

The Scam within a Scam

One of my clients recently sent me a newspaper ad for CDs with surprisingly attractive rates. This CD promoted by Sun Cities Financial Group touted a 4.85% rate on an FDIC-insured CD with a 6-month term.

According to Bank rate, the current national average for a 6-month certificate of deposit is 0.27% APY, with their top yield being 2.00% APY. So how can a tiny local non-bank that you’ve never heard of beat the rates of even online banks by over 2.5%?

The firms running the ads are quick to state they are not banks. Instead, they “help consumers locate insured banks nationwide” or are “a leader in locating superior banking and insurance products.” Technically, they are “CD brokers.” The Sun Cities website explains the company is “engaged in the business of placing deposits or facilitating the placement of the deposits of third parties with FDIC-insured depository institutions.” The FDIC and SEC have some words of warning about this type of activity, which we’ll get to shortly. It turns out that the advertised rate isn’t the CD rate. I did some research and found a few other ads. One ad hinted at this by stating, “Yield may include a bonus.” The other was more explicit, stating: “Yield includes an interest bonus of 3.00%, plus 1.25% annual percentage yield.” These non-bank salespeople are supplementing bank CDs from other FDIC-insured banks with their own money to reach the advertised rate. Questionable? Yes. Scam? Well, maybe not.

Here’s how it works…

1. You have to go to the company’s office (taking a page from the time-share marketing playbook).
2. While you’re in the office availing yourself of the company’s “superior bank product location service,” you’ll be pitched on life insurance or an annuity. From their perspective, you’re a perfect candidate for such high-commission products. You’re in the market for a conservative, guaranteed rate of return and you’ve proven by buying the CD that you have money to invest. The fact that it’s a short-term CD means it won’t be long before you have that money available for the product they’d prefer to sell you.
3. There you will be told about two or three banks they have “located” offering CDs at attractive rates (more in line with what you’ll find through com) Once you open a CD at one of the banks, the company promoting the high rate will pay you the difference in the form of a bonus, in some cases sending the bonus money along with your check to the bank where the CD will be held. For example, say they locate a bank offering a 6-month CD paying 1.25% APY. If you deposit $10,000, in six months, you will have earned $62.50 ($10,000 x 1.25% = $125, which is then divided in half based on the 6-month term). The CD broker covers the remaining 3.6%, or $180.
4. You write the check for the CD directly to an FDIC-insured bank, with which the sales office is not officially affiliated with. This CD has a realistic rate, say 1.5% APY or similar.
5. After a week or two, enough to make sure your funds cleared, the insurance people will cut you a check which together with the bank’s interest, add up to the advertised APY (assuming they are still in business).

Of course, the company hasn’t made any money from you yet. In fact, they’ve spent $150. When we asked one such company about this, the CD was described as a “loss leader.” They compared it to a grocery store that promotes $2 steaks with the hope that you’ll buy other things while you’re there. And what might those “other things” be in a case such as this? Insurance products.

According to the FDIC, a deposit broker “can be anyone from one person working alone from home to someone affiliated with a major financial-services firm. There is no federal or state licensing or certification process to become a deposit broker, and the FDIC does not examine, approve or insure deposit brokers.” It adds, “CDs sold by brokers can be complex and may carry more risks than traditional CDs sold directly by banks,” and “There have been a few cases reported of unscrupulous deposit brokers allegedly misleading or defrauding investors.”

The SEC agrees: “Since brokered CDs are sold through an intermediary, you’ll need to take extra steps to avoid fraud.” Recommended precautions include: thoroughly check the background of the deposit broker, identify the issuer (CBS’ Roth found the bank he was steered to had the lowest “Safe & Sound” rating from Bankrate.com, only one out of five stars), ask about your deposit broker’s record-keeping, and find out what happens if you need to withdraw your money early.

Next, you should check if the extra interest is worth it since you’ll have to deal with paper checks. If you are writing a check from a bank account that isn’t earning interest, that is some lost days of interest right there. Since you’ll be receiving the CD funds as a check as well, that’s another few business days of potential lost interest. Finally, you should be sure only to write the check to an FDIC-insured institution. You should interact with them directly to ensure a safe transfer of funds and proper opening of an account. Double-check the CD renewal guidelines, so you are not stuck rolling the CD over for another 3 months.

Better yet, say no to any CDs that come with sales-pitch strings attached. The small interest bonus you’ll get in exchange for hearing them out likely isn’t worth your time—or the risk of them convincing you to buy their high-commission products. Deceptive financial advertisements, and bait and switch tactics, existed well before the Wall Street collapse and still do. I wouldn’t wait for regulators to start protecting the consumer, as this may not happen in our lifetimes. It’s up to us to practice little financial self-defense. Always be skeptical of any financial product, as well as the tactics that people use to sell them. Here’s a list of other companies that I found offering similar ads. Some are pretty shady in my opinion and pretend to be an elite broker supplying high-yield bank CDs. Others are pretty transparent about the fact that they are offering a carrot for you to listen to their pitch.

• Sun Cities Financial Group (http://www.scfg.com)
• First Fidelity Tax & Insurance (http://www.firstfidelityamerica.com)
• American First Assurance (http://americanfirstassurance.com)
• Integrifirst USA (http://integrifirstusa.com)

I wouldn’t trust any of these guys with a $9.99 cut-n-paste GoDaddy website and a rented office with any of my details.

 

 

7 Estate Planning Strategies for Changing Interest Rates

It still comes as a surprise to so many people that the outcome of key estate planning strategies often hinges on fluctuations in interest rates. So, changes in rates should sway the choice, or timing, of these strategies. Some estate planning strategies generate more benefits when interest rates are low, while others provide more benefits to you and your loved ones when rates are higher. With interest rates rising and set to rise more, you should consider interest rate trends when deciding whether to accelerate or delay the implementation of your estate plan.

Let’s look at the six major strategies that are affected by rate changes.

1. Family Loans

These are very flexible and simple ways family members can make loans between each other. They’re very popular because these loans typically carry no interest rate or very low-interest rates, which is why they’re often called interest-free or low-interest loans. This strategy is better when interest rates are low. Keep in mind that the loan must be a real loan (expect the principal to be repaid at a certain time). There should be a written agreement that lists the interest rate charged and a payment schedule. Otherwise, the IRS might treat the transfer as a gift or other transaction.

There are two main reasons to consider the family loan:

• A family member wants to arbitrage the investment. That is borrowed at a lower rate than the income and/or capital gains generated from the principal and keep those benefits.
• A family member wants to pay a lower interest rate than a commercial lender would charge, while the lender might earn a higher yield than is available through a safe investment, such as a money market fund. Picture a parent or grandparent sitting on significant cash earning 1% at the bank. They could carry the mortgage of their grandkid or refinance their 7-9% student loan and get a better return.

One way to make a family loan is to charge at least the minimum interest rate required by the tax code. When you do that, there are no special income or gift tax consequences. As loan repayments are made, the interest portion is income to the lender, and the rest of the payment is tax-free. The Internal Revenue Service (IRS) publishes a monthly update to the applicable federal rates (AFRs) and 7520 rates. The AFR is calculated by the IRS under Section 1274(d) of the Internal Revenue Code (Code) and is used for many purposes. One of its most common applications is to establish the minimum interest rate that can be charged on an intra-family loan without income or gift tax consequences. Planning professionals and their clients should take note of fluctuations in these rates and be mindful of planning opportunities that come with rate changes. The AFR rate for March 2018 and the preceding six months, for a 10 year and longer loan (compounded annually) is 2.88%. This is huge savings. For example:

• If Jim was looking to purchase a home in Southern California and needed $500,000 in lending, he could pay 4.5% for the current cost of a 30-year fixed mortgage or he could reach out to his grandfather, Paul, who has more money than he needs due to a pension and rental income. Paul could charge him 2.88% and save Jim ~$450/month and over $150,000 in total interest!

Another way to make the loan is to charge no interest or less than the IRS minimum rate. In that case, the interest not charged is a gift from the lender to the borrower. If the interest plus other gifts to the borrower for the year are less than $15,000, there are no real consequences, because that’s the amount of the annual gift tax exclusion. Any excess over the $15,000 exclusion will reduce the lender’s lifetime estate and gift tax exemption, or will be a taxable gift. Details of those exceptions are in IRS Publication 550, beginning on page six under the heading “Below-Market Loans.”

2. Grantor Retained Annuity Trusts (GRATs)

A grantor retained annuity trust (GRAT) is a good way to transfer the gains from appreciating assets to loved ones. It generates more benefits when interest rates are low. In a grantor retained annuity trust, you set up an irrevocable trust (removed from your estate) funded with assets you expect will have a fairly high appreciation rate. This can be technology stocks or a closely held business.

The trust pays you annual income over a period of years. The total income payments equal the original trust principal plus the IRS minimum interest rate. The AFR rate for March 2018 and the preceding six months, for no longer than 3 year (compounded annually) is 1.96%. At the end of the trust term, whatever remains in the trust is transferred to the other beneficiaries after the trust expires, usually your children or grandchildren. A grantor retained annuity trust usually should be short-term. Most tax advisors say a two to three years trust term is best.

Your loved ones receive the investment return of the trust that exceeds the minimum interest rate, and there are no estate or gift taxes due. For example:

• Grandma Sue, 65, puts her $5 million of Apple stock in a GRAT with a three-trust term. During that three year period, the Apple stock had an annualized return of 22%. The investment gains from Apple above the annual annuity of principal and IRS minimum interest rate of 1.96% is transferred from the trust to her grandkids.

To make incurring the costs of creating the trusts worthwhile, they should be funded with at least $250,000 of assets that are expected to generate a total return well above the IRS minimum interest rate. If the trust assets don’t earn more than the minimum rate, your heirs won’t receive anything. The result will be the same as if you hadn’t created the trust, minus the fees related to it.

3. Charitable Remainder Trusts

These trusts come in two forms: charitable remainder unitrust (CRUT) and charitable remainder annuity trust (CRAT). Both of them provide more tax benefits when interest rates are higher because a higher APR will result in a higher income tax deduction for the remainder interest in a charitable remainder trust. For either trust, you create an irrevocable trust and fund it with money or property, preferably appreciated long-term capital gains property. The trust pays you income for life or a period of years. The charitable remainder unitrust pays you a percentage of the trust’s value each year as income. The charitable remainder annuity trust pays you a fixed amount each year, regardless of the trust’s value. After the income period, the remaining property in the trust is transferred to charity. Hence the name Charitable Remainder Trust.

Two main reasons to set this up:

• You don’t owe capital gains taxes on appreciated property transferred to the trust, because it is a charitable trust.
• You receive a charitable contribution deduction when the trust is funded. The deduction is the present value of the property the charity is expected to receive at the end of the trust.

The amount of the deduction depends on how long the trust is expected to last and on the current IRS interest rate. There are assumptions that will need to be made and is best to run different scenarios factoring cost basis, marginal tax bracket, and expected return

4. Charitable Lead Annuity Trust (CLAT)

The CLAT is sort of the opposite of the charitable remainder trusts. In the CLAT, you create an irrevocable trust and fund it. The trust pays fixed annual income to a charity for years. After the period ends, the assets that remain in the trust are transferred to a beneficiary you named. It could be you, your spouse, a child, or a grandchild.

You might receive a charitable contribution deduction for the charity’s stream of income from the trust, depending on the details of how the trust is structured. If the remainder beneficiary is someone other than you and your spouse, the present value of the remainder interest is a gift from you. If the trust earns more than the IRS minimum interest rate, the excess will pass to the beneficiary free of estate or gift taxes.

So, a lower IRS interest rate means better results for you and your beneficiary. Also, the lower the applicable interest rate (APR), the higher the charitable contribution deduction because the lower APR will provide a higher present value and thus greater tax deduction

5. Qualified Personal Resident Trust (QPRT)

This trust is used to minimize estate and gift taxes when transferring a residence or vacation home to the next generation. The tax results are better when interest rates are higher. You transfer the title of the real estate to an irrevocable trust. You reserve the right to use the home as your own for certain years. After that period expires, the property belongs to the beneficiaries of the trust, who usually are your children or grandchildren. If you want to continue using the property, you’ll have to pay a fair market rent. That’s why it’s best to use the QPRT for a second home, not your principal residence.

The property will be out of your estate after the term of years ends. When the property is transferred to the trust, you’ll be treated as making a gift of the property’s present value when the trust terminates to the beneficiaries. The higher current interest rates are, the lower that value will be. So, you’ll either use less of your lifetime estate and gift tax exclusion or pay less in gift taxes as rates rise.

If you pass away before the trust term ends, the property will be included in your estate and treated as though the trust wasn’t created.

6. Charitable Gift Annuities

In a charitable gift annuity, you transfer money or property to a charity in return for a promise that you will be paid a fixed annual income for the rest of your life. The annuity payments will be less than from a commercial annuity, and the difference is your gift to the charity. There’s a tradeoff with charitable annuities, but they probably have more benefits when rates are higher.

There are two tax benefits of the charitable annuity that fluctuate with interest rates.

• You receive a charitable contribution deduction when you transfer money or property to the charity. The deduction is the present value of the charity’s eventual gift.
• The second benefit is that, when the charity makes payments to you, part of each payment is tax-free as a return of your principal. The rest of each payment is taxable income.

The main benefit is the charitable contribution deduction, and it is greater when interest rates are higher. Lower interest rates at the time the annuity is created, however, increase the tax-free portion of each annuity payment.

7. Long-term Property Sales

There are several estate planning strategies used to transfer property to the next generation while minimizing estate and gift taxes. They are installment sales, private annuities, and self-canceling installment notes. They usually are used to transfer interests in businesses or real estate from parents to their children or later generations. What they have in common is the estate tax planning benefits are greater if they are implemented when interest rates are low.

Generally, under these strategies, the parents sell the property to the younger generation by transferring the property in return for promises from the younger generation to make payments to the parents over time. Each of the strategies has detailed rules that must be followed, and there are different situations in which each is more appropriate. If you have a business or valuable real estate, talk to an estate planner about the options.

8. Real Estate

Rising interest rates often signal a healthy economy (assuming that inflation is stable), which usually bodes well for the real estate industry. This is important those who are executors or trustees that are monitoring commercial property and those that cannot sell their real estate due to significant tax consequence (depreciation recapture).

If interest rates continue to rise and lenders sense the need to protect themselves against a potential decrease in property value, they could eventually tighten lending standards further and require more equity from borrowers as they seek to increase their loan-to-value ratios. Lenders can tighten lending standards in a variety of ways, such as requiring more equity or collateral from the borrower, limiting lending for borrowers deemed less creditworthy and reducing exposure to riskier properties, markets or types of financing (such as construction lending vs. refinancing). This is critical when attempting to refinance before a payment balloon.

Cost of capital is a major consideration, as higher rates mean that the “rental price of money” has gone up. This could lead to borrowers paying more interest to lenders (a good thing for financial institutions). However, it could also lead borrowers to get smaller loans in the first place if they calculate that they would not be able to keep up with interest payments on a larger loan, forcing them to either put up more equity or target lower-priced properties. Further, riskier loans (like construction loans) and riskier assets may be even harder to finance efficiently, given the added risk premiums.

Higher capital costs could also increase default risks. These may be bad for lenders, too… that is unless they are non-traditional “vulture” players employing a loan-to-own strategy and secretly hoping for defaults to seize properties. In an extreme situation, if these defaults start to spread, they can ultimately be bad for the economy as a whole.

 

“Slow money better than no money” – 4 Ways to Get Rid of a Judgment.

If a creditor sues you and gets a judgment, it has a whole host of collection methods available to get its money from you, including wage attachments, property levies, assignment orders. There are only 3 ways to get rid of judgment: 1) Vacate it; 2) Satisfy it, or 3) Discharge it. In your analysis of which approach is best for you, you should follow that same order: First, can I vacate the judgment? If not, can I satisfy the judgment? If not, can I discharge the judgment in bankruptcy? The judgment will be filed with the court, and once that happens, it is public record. That means it will likely end up on your credit reports as a negative item.

Unpaid judgments can remain on your credit reports for seven years or the governing statute of limitations, whichever is longer. Once judgments are paid, they must be removed seven years after the date they were entered by the court. Beginning last July 2017, the credit bureaus will exclude judgments that don’t contain complete consumer details or have not been updated in the last 90 days. Lastly, if a judgment was entered against you in California, it can show up on your credit report for ten years, or even 20 years if the creditor renewed it on time.

1)      Is vacating the judgment an option for me? If you contested the case (answered the lawsuit) and the court entered a judgment against you, vacating the judgment will be very unlikely. If however a default judgment (you did not answer the lawsuit) was entered against you, you should determine if you can have the judgment vacated (or what is sometimes referred to having the judgment “set aside”). In order to vacate a judgment in California, You must file a motion with the court asking the judge to vacate or “set aside” the judgment. Among other things, you must tell the judge why you did not respond to the lawsuit (this can be done by written declaration).

The reason and the timing of your motion are very important and really should not be done without the assistance of a lawyer. Generally speaking, if you had no actual notice of the lawsuit (for example, you were not served properly), you have two years from the date the judgment was entered against you to make the motion. If you knew about the lawsuit but did not timely respond, you have 6 months to make the motion based on “excusable neglect.” Missing the court date because of a serious illness or because a court officer gave you incorrect information, for example, would be considered excusable neglect. Forgetting about or ignoring the case does not qualify as excusable neglect. The horror story I hear all too often is that the judgment is more than 2 years old, the consumer never knew about it, and now nothing can be done about it. The 2-year limit is a law that needs to be changed.

If your motion is successful, the judgment is vacated, and you then get to contest the case. When you can contest the case, you have a lot more options regarding how to resolve the case. Settlements of contested cases are usually far better than settlements of judgments. You may even be able to win the case. Either way, the judgment creditor no longer has the ability to levy your bank accounts, garnish your wages, or lien your property.

2)      How do I satisfy the judgment? This means to settle the judgment and have the judgment creditor file a “Satisfaction of Judgment” with the court. Around the courthouse there is a saying, “Slow money is better than no money”. Judgment creditors routinely settle judgments for less than the full balance.

So you may be able to negotiate a discount on the debt, in return for a lump sum payment. If a large payment isn’t financially possible, a stipulated judgment allows you to pay in monthly installments, shielding you from garnishment, levies, and liens on your property. Most creditors are happy to do that, rather than get an uncollectible judgment. This is a lot easier than having to chase down your assets and avoids the possibility that your income and property is exempt from seizure. For example, seizing your car will mean hiring a towing service and, in some jurisdictions, paying for 30 days of bonded storage.

Many post-judgment debt settlements are concluded with a phone call from a bankruptcy attorney, giving the debtor more leverage. When creditors’ lawyers hear from a bankruptcy attorney’s office, they understand that bankruptcy is a reality, which ratchets up the pressure on them to make a deal. Settlements may wipe out as much as 75 percent or 85 percent of the debt if most or all of the payment can be made promptly.

Do not make payments unless you have a clear WRITTEN agreement that states exactly how much is to be paid and when. Never enter into an agreement that states something to the effect: “we will review/reassess this payment arrangement in 6 months”. Once a settlement is complete, get a satisfaction of judgment signed by the creditor, and make sure it is filed with the court and reflected on your credit reports.

3)      Should I Discharge the judgment through bankruptcy? Among the choices for dealing with a judgment, declaring bankruptcy is the nuclear option. Notable exceptions are judgments based upon fraud and elder abuse. Bankruptcy is a powerful weapon for wiping out debt but comes with serious consequences for the debtor who pushes the button. Having assets and income to protect are an important hallmark of a need to file bankruptcy. According to the Office of U.S. Courts, the average Chapter 7 consumer bankruptcy case filed in 2012 had nearly $116,000 in total assets and median monthly income of $2,764. In fact, California is one of the few states that gives you two separate lists of assets you can exempt (http://www.courts.ca.gov/documents/ej155.pdf).  You can’t mix and match between the two exemption schemes, however, so you’ll want to scrutinize each and select the list that will work best for you.

Filing a bankruptcy petition will place an automatic stay on the judgment and any enforcement actions, including wage garnishment, while you work with the court to reorganize your finances.

In a Chapter 7 bankruptcy, the trustee will sell the property you can’t exempt and use the funds to pay unsecured debts—such as credit card balances, personal loans, and utility bills. In Chapter 13 bankruptcy, the trustee doesn’t sell your nonexempt property (the more property that is exempt, the less you have to repay). Instead, you keep it and pay the value of it to your unsecured creditors through your three- to five-year repayment plan. Before you can wipe out debt in a Chapter 7 bankruptcy, you must meet income qualifications by passing the “means test.” You’ll provide your family income on the means test forms. If it exceeds the median income of your state, you can subtract particular expenses. The needed income charts and pre-set expense guidelines are on the U.S. Trustee’s website (select “Means Testing Information” in the left column). The same data gets used to determine the length and amount of a Chapter 13 bankruptcy payment.

California, being a large state, has four bankruptcy courts, most of which have multiple locations serving various geographical areas. Each office often has a webpage where you can access information. The Central District serves Los Angeles (http://www.cacb.uscourts.gov/). Costs for legal fees are typically around $1,500 or more, limiting the bankruptcy option. Other drawbacks include restrictions on filing bankruptcy again — such as an eight-year wait for filing another Chapter 7 case — and a 10-year demerit on your credit report. For those reasons, bankruptcy may be more useful as a bargaining tool in settlement talks than as a plan of action.

If bankruptcy is not an option for you, and the judgment is more than 2 years old, the only real option you have is to satisfy/settle the judgment. Until you are able to do that, do everything you can to frustrate the judgment creditors ability to enforce the judgment. For example, do not leave your money in the bank to be attached.

4) Am I Judgement Proof? People with few assets and modest income may be “judgment-proof,” because legal protections exempt them from collection. But that does not mean you can ignore a judgment. It takes work to determine that your wages and belongings are protected from seizure by a complex web of state and federal exemptions. And you should take steps to head off wrongful collection attempts on your exempt property before they happen. It is important to know that, even if you’re judgment proof, you may be made uncomfortable by having your employer told to deduct sums from paycheck.

Most importantly, just because a judgment creditor levies on your property or attaches your wages, it doesn’t mean that the creditor is entitled to take the property. California law limits the amount that a creditor can garnish (take) from your wages for repayment of debts. California’s wage garnishment limits are similar to those found in federal wage garnishment laws (also called wage attachments). For most debtors, creditors cannot garnish more than 25% of their wages after deductions (http://www.courts.ca.gov/11418.htm). If your wages are low, however, California law protects even more of them (and even more than does federal law). Be careful if you are self-employed. With non-earnings garnishments, a creditor can seize one-hundred percent of an expected compensation, such as sales commissions, contract payments, or receivables. However, this is a one-time seizure of income. Non-earnings garnishments are not ongoing like wage garnishments. While traditional wage garnishments are limited by law to disposable income from paychecks, creditors seeking compensation through a non-earnings garnishment can levy your bank accounts, income received from rental properties, and other sources.

Every state exempts certain property from creditors (https://saclaw.org/wp-content/uploads/lrg-exemptions-from-the-enforcement-of-judgments.pdf). This means that creditors simply cannot have that property, no matter how much you owe. Also, you may be able to keep property that isn’t exempt if you can prove to the court that you need it to support yourself or your family. When filing for Chapter 7 or Chapter 13 bankruptcy, California allows you to choose between two different sets of exemptions (you must choose one system or the other). Exemptions protect your property in any bankruptcy chapter that you file. Generally, debtors with substantial home equity prefer System 1 while System 2 is more beneficial for debtors who have valuable property other than home equity. Be sure to compare each set and choose the one that works best for your situation. In addition to the exemptions found in System 1 or System 2, you might also use any applicable amounts in the federal non-bankruptcy exemptions.

Any time the sheriff or marshal levies against your property, you must be notified. You can request a hearing, which is usually called something like a claim of exemption hearing, to argue that it will be a financial hardship on you if the property is taken, or that your property is exempt under state law. If you lose that hearing and your wages are attached, you can request a second hearing if your circumstances have changed, causing you hardship (for example, you have sudden medical expenses or must make increased support payments).

When you are notified of a property levy (such as a bank account attachment) or an assignment order, you will be told in writing how to file a claim of exemption — that is, how to tell the judgment creditor you consider the property unavailable. The period in which you must file your claim is usually short and strictly enforced — don’t miss it.

Complete and send a copy of your claim of exemption to the judgment creditor. In some states, you’ll also have to serve it on the levying officer, such as the sheriff. The judgment creditor will probably file a challenge to your claim. The judgment creditor may abandon the attachment, levy, or assignment order, however, if it’s too expensive or time-consuming to challenge you. If the creditor does abandon it, your withheld wages or taken property will be returned to you. If the judgment creditor doesn’t abandon the attachment, levy, or assignment order, the creditor will schedule a hearing before a judge and you’ll have to convince the judge that your property is exempt or that you need it to support yourself or your family. This is your opportunity to defend yourself from having your wages or other properties taken. You must do all that you can to prepare for this hearing if you want to keep your property. If you have high income one month, bring in pay stubs to show that you usually make less. Or, if your bills are higher than average, bring copies. Think carefully about your income and financial situation. There may be other creative but truthful ways to show the judge that your property is exempt or necessary to support yourself or your family.

The judge will listen to both you and the judgment creditor if the judgment creditor shows up. Sometimes the judgment creditor relies on the papers already filed with the court. The judge may make a ruling or may set up an arrangement for you to pay the judgment in installments.