Wife Receives More Favorable Innocent Spouse Treatment from U.S. Tax Court Than IRS

When a husband and wife file a joint income tax return, they are each fully liable for the tax due on the return. Each is said to be “jointly and severally liable” for that tax liability. Joint and several liability can produce unfair results where one of the spouses engages in the fraudulent underpayment of income tax unknown to the other spouse. For example, where husband omits income or overstates a deduction on the return, thereby understating the tax due on the return, but does not disclose such omission or overstatement to his wife, the wife will be held liable for the understatement of tax unless the wife can show she is eligible for relief as an “innocent spouse.”
Internal Revenue Code Section 6015 provides relief from joint and several tax liability for an “innocent spouse” who can prove that he or she satisfies the requirements under Section 6015. One form of relief is found in Section 6015(b), which relieves a spouse of joint and several liability if that spouse meets the following requirements:

1. A joint return was filed for the taxable year
2. On the joint return there was an understatement of tax due to an erroneous item (omission of income or overstatement of deduction) of the other spouse
3. The innocent spouse can show that in signing the return she did not know, and had no reason to know, that there was such understatement
4. Considering all of the facts and circumstances, it is inequitable to hold the innocent spouse liable for the deficiency in tax attributable to such understatement, and
5. The innocent spouse elects the benefits of Section 6015(b) no later than two years after the date the IRS first begins collection of the tax deficiency

In a recent U.S. Tax Court case, Taft v. Commissioner, TC Memo 2017-66, the taxpayer husband liquidated his stock investment to fund an extramarital affair and hid these transactions from his wife. The husband instructed his accountant to prepare and electronically file the couple’s 2010 joint income tax return without his wife’s review or approval of the return. The return reported the stock sales but failed to report the taxable dividends from the stock. The IRS later assessed a tax liability for the unreported stock dividends, which the wife did not know about. In 2011 the wife discovered the affair and filed for divorce. After the divorce became final in 2013, she filed her 2012 tax return showing a refund. The IRS credited a portion of the refund toward the joint 2010 income tax liability. The wife filed a request for innocent spouse relief asking the IRS to relieve her from the tax liability for the unreported dividends and return the rest of her refund.

However, the IRS determined that the wife met the requirements for less favorable relief under Section 6015(c), which allocates the full tax liability to the husband but does not allow for refunds. The wife filed suit in U.S. Tax Court under Section 6015(b), which does allow for refunds. The Court awarded relief to the wife under Section 6015(b) because she was able to show that she did not know or have reason to know of the husband’s understatement of income. The Court evaluated several factors in making its determination. First, the wife had an associate’s degree in nursing and no background in business, tax, or accounting. Second, the couple maintained separate bank accounts which the other spouse could not access and each did not open the other spouse’s mail. Therefore, the wife did not know about the dividends and in general her limited financial role consisted only of paying certain household expenses. Third, the wife was unaware of the husband’s elaborate scheme of spending money on his extramarital affair and therefore, she did not benefit from that spending. Finally, the husband secreted the preparation and electronic filing of the tax return from his wife. All of these factors showed that the wife had no reason to know about the husband’s underreporting of the stock dividends and it would be unfair to hold her liable for the tax deficiency. The Court awarded the wife the return of her refund under Section 6015(b) even though the IRS argued she was only entitled to the less favorable innocent spouse treatment under Section 6015(c).

Please call (973-744-0073 or 973-509-1800) or email (dhaase@sweeneylev.com) Dennis M. Haase, Esq. at Sweeney Lev LLC for a consultation regarding any questions you may have about innocent spouse relief or other estate planning, tax planning, or tax controversy issues.

 
 

Use an Accumulation Trust to Hold Retirement Assets For Special Needs Beneficiaries

A previous blog posted on May 2, 2017 titled “Naming a Trust as Beneficiary of Retirement Benefits,” discussed the usefulness of a Conduit Trust (or “See-Through” Trust) as a beneficiary of one’s qualified retirement plan or IRA benefits for ultimate distribution to the trust’s named individual beneficiary (“designated beneficiary”). Under the Conduit Trust, the trustee would pay to the designated beneficiary the annual required minimum distribution calculated using the designated beneficiary’s life expectancy, while safeguarding the remaining benefits from the claims of the beneficiary’s creditors. Because the Conduit Trust requires an annual distribution to the designated beneficiary of the required minimum distribution, it would be an inappropriate vehicle for any special needs beneficiary.

An “Accumulation Trust,” another type of “see-through” trust, is the proper vehicle to use as a supplemental needs trust funded with one’s retirement benefits where the designated beneficiary of the trust is a special needs individual. A trust such as a Conduit Trust that requires the distribution of the annual required minimum distributions to the special needs beneficiary would disqualify that beneficiary from means-tested government benefits, such as Medicaid. The Accumulation Trust allows the trustee to accumulate, but does not require the trustee to distribute, the required minimum distributions to the special needs beneficiary each year. The trustee can actually hold on to the undistributed retirement benefits for future distribution to the special needs beneficiary or the remainder beneficiaries of the special needs trust.
The authority for creating the Accumulation Trust is found in Treasury Regulation Section 1.401(a)(9)-5, Q&A-7(c)(3), Example 1.
To be valid, the Accumulation Trust must satisfy the same four requirements as a Conduit Trust. Those requirements are:

1. The trust is a valid trust under state law, or would be but for the fact that there is no corpus until the participant’s death;

2. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the participant;

3. The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the participant’s benefit are identifiable from the trust instrument on the date of the participant’s death; and

4. Certain required documentation has been provided to the plan administrator.

The trustee may accumulate all or a portion of the retirement benefits, subject to the trustee’s unfettered discretion to make distributions. The trustee will be required to receive the required minimum distributions from the qualified plan or IRA based on the life expectancy of the special needs individual, who is the designated beneficiary of the trust. If, however, the trust has a remainder beneficiary whose life expectancy is shorter than that of the special needs beneficiary, the required minimum distributions will have to be paid to the trust over that shorter time period.

Where the parent or other third party desires to create as supplemental needs trust but only has retirement benefits to fund the trust for the special needs beneficiary, the Accumulation Trust will allow the trustee to receive the annual required minimum distributions from the qualified plan or IRA, as the case may be, preserve the assets from any creditor of the special needs beneficiary, and allow that beneficiary to continue to remain eligible to receive means-tested benefits from the government.

For a consultation to discuss how an accumulation “see-through” trust may benefit your estate and your loved ones, including special needs beneficiaries, please call (973-744-0073 or 973-509-1800) or email (dhaase@sweeneylev.com) Dennis M. Haase, Esq. at Sweeney Lev LLC for an appointment.

 
 

Naming a Trust as Beneficiary of Retirement Benefits

Under certain circumstances naming a conduit or “see-through” trust as the beneficiary of your 401(k) plan or IRA assets upon your death may be the best choice to make to ensure that after your death these retirement benefits remain available and continue to grow tax-free for your loved ones who might otherwise withdraw the funds immediately and dissipate them. Another reason to use a trust as beneficiary is to protect the retirement assets from the claims of creditors for those of your beneficiaries who do not reside in states like New Jersey, which has passed laws specifically exempting from creditors’ claims the assets in an inherited IRA or qualified retirement plan. See N.J. Stat. § 25:2-1. This blog will discuss how to use a conduit or “see-through” trust as the beneficiary of defined contribution plans, i.e., 401(k) plans, profit-sharing and money purchase pension plans, as well as IRA’s.

To understand why naming a conduit trust may be a good choice as beneficiary of retirement benefits, one must first understand the required minimum distribution rules that apply to the payout of benefits to the named beneficiaries after the account owner’s death.

Generally, an owner of either an IRA or 401(k) account must begin taking required minimum distributions (“RMD”) from these accounts in the year the owner attains age 70½, which may be postponed for that year only until April 1 of the following year (the “Required Beginning Date” or “RBD”). For each successive year during the owner’s life, the RMD must be taken by December 31. The RMD for any year is computed by dividing the account balance as of December 31 of the previous year by the individual’s life expectancy found in the IRS’s Uniform Lifetime Table or the Joint and Survivor Life Expectancy Table in IRS Publication 590.

If the account owner dies before his RBD (age 70½), and has no surviving spouse, each named beneficiary may demand immediate payment of the IRA or qualified plan benefits, or they may choose to receive the benefits over each beneficiary’s life expectancy while the undistributed funds continue to grow tax free. If the account owner dies after his RBD, then the IRA or qualified plan benefits may be paid over the longer of the account owner’s life expectancy or the life expectancy of the named beneficiary.

If, on the other hand, the account owner has created under his Will (or revocable trust) a conduit “see-through” trust, naming individuals as the beneficiaries of the trust, the IRA or qualified plan benefits must be paid out over the life expectancy of the oldest of the beneficiaries of the conduit trust, or, if separate shares are created for individual beneficiaries, the amounts in each share may be paid out over each individual’s life expectancy.

For example, assume John, age 53, is a widower with three children, ages 27, 14, and 11. On his IRA beneficiary designation form John named the conduit trusts created under his Will as the beneficiaries of his IRA with separate equal shares funding separate sub-trusts for each of his three children. Under the required minimum distribution regulations of Internal Revenue Code Section 401(a)(9), the children are referred to as “designated beneficiaries.” Assume John dies at age 53. Within one year after the year John dies, each conduit sub-trust must take the RMD calculated for each of the children by using the life expectancy of each child whose separate share is funding a separate sub-trust for that child. Without the conduit trusts the benefits would have been paid out over the life expectancy of the oldest of the three children, which is 56.2 years, instead of over each child’s separate life expectancy, which would be 56.2 years, 68.9 years, and 71.8 years, respectively. If John died after his RBD of 70 ½ the payout of the IRA benefits would still be over 56.2 years, which would exceed John’s remaining life expectancy of 31.4 years. The use of the conduit trusts allows the undistributed IRA benefits to grow tax free for a substantially longer period of time, compared to John’s life expectancy, while also protecting the benefits from the claims of creditors.

In the above example, to achieve the “stretch-out” periods for each child, the conduit trusts must satisfy the requirements in Treas. Reg. Section 1.401(a)(9)-5. These requirements are:

1.The trust must be valid under state law

2. The trust must be irrevocable or become irrevocable upon the death of the account owner

3.The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit must be identifiable from the trust instrument

4.The trustee must provide certain documentation to the plan administrator of a qualified retirement plan or, in the case of an IRA, to the IRA custodian or trustee

In addition, if the trust has multiple beneficiaries, each of the beneficiaries must be an individual in order for there to be a designated beneficiary under the minimum distribution rules to allow the payout over the life expectancy of the oldest beneficiary.

The conduit “see-through” trust may be used to safeguard the retirement benefits from a beneficiary’s creditors, future ex-spouses, and other predators for an extended period of time, at the same time giving the account owner peace of mind that the retirement benefits, after his or her death, will not be immediately dissipated by a prodigal beneficiary.

For a consultation to discuss how a conduit “see-through” trust may benefit your estate and your loved ones or how an “Accumulation Trust” may safeguard the retirement benefits for a special needs beneficiary, please call (973-744-0073) or email (dhaase@dmhaaselaw.com) Dennis M. Haase, Esq. for an appointment.

 
 

The IRS, Employers, and the Trust Fund Recovery Penalty

Any person operating a business with employees should be aware of the Trust Fund Recovery Penalty that may be imposed by the Internal Revenue Service for the failure to collect and pay over the withholding taxes on an employee’s earnings. This penalty is imposed on the employer and any person who is responsible for collecting and paying over withholding taxes on the earnings of an employee and who willfully fails to do so. The amount of this penalty is equal to 100% of the amount of taxes that were not withheld and paid over to the IRS by the responsible individual. Payment to the government of the withheld taxes satisfies the penalty. The penalty is typically imposed on persons who fail to collect and pay over withholding on employee earnings and the FICA taxes (social security and medicare) and FUTA taxes (unemployment contributions) on those earnings.

When the employer and the responsible person willfully fail to collect and pay over to the IRS the withholding on earnings, the government suffers a loss because the employee gets credit for the tax withheld even though the employer does not pay the tax to the government. The withheld taxes are deemed held “in trust” for the benefit of the employee until paid over to the government; but when the employer and the responsible person fail to do so, for example, by diverting them to other uses, they are held personally liable for their payment.

The Trust Fund Recovery Penalty is not a penalty that is imposed over and above the withheld taxes, but is a device for ensuring the taxes are properly paid to the government. Without this device for ensuring the collection and payment of the taxes to the government, the responsible persons charged with collecting the taxes could be easily seduced into using the funds for unauthorized purposes.

An individual is a “responsible person” if he or she has a duty, whether spelled out in the by-laws of a corporation or in a partnership agreement or operating agreement in a limited liability company, or even based on the facts and circumstances of each case, to collect and pay over the taxes. It may even be a third party who supplies funds to the employer to pay employees and who has knowledge that the employer will not be withholding taxes on the wages. The test for responsible person status is not holding a title or office but whether the person has actual management and control over the finances of the employer, such as the ability to write checks and decide which of various creditors is to be paid with available funds. Mere awareness of the unpaid withholding taxes, without more, is not sufficient to satisfy the criteria of responsibility, which is based on the totality of circumstances. Courts typically have relied upon a multi-factored test, focusing on duty, status and authority, to evaluate whether one or more individuals are responsible persons.

Determining that a person is “responsible” is not enough to make that person liable for the penalty. The responsible person must have acted “willfully” in failing to collect and pay over the withholding taxes. Willfully means a deliberate, voluntary, conscious choice to prefer another creditor over the United States government. The IRS has defined willful as intentional, deliberate, voluntary, reckless, know-
ing, as opposed to accidental. No evil intent or bad motive is required. Mere negligence is not sufficient to show willfulness.

After the responsible person, as identified by the IRS, receives notice of the proposed penalty, he or she should file a protest with the IRS Appeals Office within 60 days of receiving the notice. If the responsible person files no protest within the 60 days, the IRS may commence collection action by levying on bank or brokerage accounts, etc.

In Appeals, the best defense against the Trust Fund Recovery Penalty is to show that someone else bears ultimate responsibility for the failure to withhold and pay over the taxes, provided, of course, that you have documentation establishing that fact. Another possible defense to the penalty is to determine whether the penalty was incorrectly calculated, which sometimes happens with the IRS. You may need access to the IRS file to present this defense. If the Appeals Office is convinced by these or other defenses, Appeals will recommend non-assertion of the penalty. If the responsible person is not successful in Appeals, he or she may still make an offer of settlement based on the strength of the case. If no settlement follows, the IRS will assess the penalty but the responsible person will have no access to the U.S. Tax Court because no statutory notice of deficiency is issued.

Alternatively, instead of filing a protest, the responsible person may pay part of the withholding tax and file a claim for refund to contest the penalty.

 
 

Essential Elements of Your Estate Plan Including Planning for Digital Assets

Why You Should Have a Will and Title Assets Properly. According to a recent survey, 60% of Americans do not have a will or an estate plan, a general durable power of attorney, or a living will. This can be disastrous and costly for loved ones who have to deal with the aftermath of one’s disability or death.

For example, if you die without a will in New Jersey, the laws of intestacy will determine how your assets will be distributed, which most likely will not be in a manner you would have preferred. Of course, any jointly-owned assets such as bank or brokerage accounts and real estate, and assets such as life insurance, IRAs, and pensions (such as 401(k) plan accounts) and other employee benefits, in which you designated a beneficiary upon your death, will pass by operation of law to those surviving joint owners or by contract to those designated beneficiaries. But other assets titled in your name alone will pass by intestacy. Even if you named one child as joint owner of your financial accounts, this will not fulfill your wish to distribute those accounts equally among all of your children, which can create dissension, unwanted litigation between family members, and unnecessary expenses and legal fees to the family. You should periodically review your joint accounts and your designations of beneficiary for life insurance, pensions, etc. to make sure they are in accord with how you want those assets distributed to your loved ones.

By meeting with an experienced estate attorney to help arrange your affairs, draft your will and create an estate plan in accord with your desires, you should be able to avoid the often costly and time consuming problems associated with dying without a will or with improperly designated accounts that may lead to family members contending with each other over how your asserts should have been distributed. Careful and thoughtful deliberation and planning with an estate planning attorney about your will and estate plan can save your family thousands of dollars in unnecessary litigation costs and legal fees.

What Happens to Your Digital Assets. “Digital assets” include all internet activities such as online accounts (Amazon.com, PayPal, online banking, business accounts, etc.) and usernames and passwords that provide access to those accounts so that your executor can properly manage and dispose of them after your death.

Planning for digital assets accomplishes several goals. First, upon your incapacity or death, your executor of your estate, your agent under your power of attorney, or your guardian, and family members will have to search for access to your digital assets unless you make it easy for them to readily locate that information without undertaking a massive search. Preparing and storing a list of your digital assets with the usernames and passwords in a safe deposit box or other secure location is paramount. To complicate things, the law is not clear regarding the rights to access the digital assets by executors, agents, guardians, and surviving family members. Some companies may require court orders before granting access to those individuals. In any event, you should still be prepared to make this information available in a secure manner to those acting on your behalf during your lifetime and after your death.

A second goal in planning for and securing your digital assets is to help prevent identity theft after your death. Upon your death your executor should immediately send notice of your death to the companies maintaining your digital assets so they can take the additional steps necessary to update their records to prevent criminals from gaining access to your accounts.
A third goal is to safeguard the financial assets of your estate.

A fourth goal is to prevent the disclosure of private or confidential material that you want to be kept secret.

Planning Ideas for Digital Assets After Your Death. First, some companies maintaining digital assets may provide instructions on their websites for what happens to those assets after your death. You should download and read those instructions carefully and ether take steps to follow those instructions or notify the company of how you want your information handled, if the company permits that. For example, Google has a service known as “Inactive Account Manager” that will notify individuals you designate, after a period of inactivity on your account, regarding what to do with your account information per the instructions you gave Google during your lifetime. Alternatively, you can instruct Google to delete all your information following this period of inactivity.

Second, you can store all of your digital asset information in a separate flash drive (encrypted) and keep it secure in a safe deposit box and update it when necessary. To ensure safety, usernames and passwords should be kept on separate flash drives and kept in different locations and given to different individuals. You can prepare a memorandum, which can be referenced in your will, indicating which beneficiary receives which digital asset. You can change the memorandum as often as you like without having to change your will. The last dated and signed memorandum will control the disposition of your digital assets. The list of the asset information on the flash drive and the memorandum will assist the executor in administrating your estate and will also be helpful to your family members.

On September 12, 2016, legislation was introduced in New Jersey to approve the Uniform Fiduciary Access to Digital Assets Act, which would authorize the executor or administrator to take control of online accounts. The legislation is still in progress.

Why You Should Have a Financial Power of Attorney. If you become physically or mentally incapacitated rendering you unable to handle your affairs, you will need someone to take care of your finances including managing your bank accounts and paying your bills, signing documents on your behalf, and having access to your digital assets. No one, including your spouse, may perform any of these tasks if you are incapacitated, and you do not have a general durable financial power of attorney. Not having one in place before you become mentally incapacitated will result in costly and time consuming guardianship proceedings for your loved ones to appoint someone, with court approval, to handle your financial affairs. Having a general durable financial power of attorney in place can avoid this from happening. It is the simplest and least expensive estate planning tool available and should be part of everyone’s basic estate plan. Another consideration to plan for is to determine whether you will have sufficient financial resources to replace your income in the event that your disability renders you unable to work, which brings up the importance of disability insurance that you should discuss with your insurance agent.

Why You Should Have a Health Care Directive and Living Will. Appointing someone to make health care decisions for you in the event you are mentally incapacitated and cannot make them yourself is also an important estate planning tool. This is known as a health care directive or proxy directive. You only name the person to make those decisions but you do not specify your health care instructions. That is done in the Living Will, which states how you would want to be treated in certain health care situations. Both the proxy directive and the living will can be combined in one document known as an Advanced Medical Directive and Living Will. You can specify whether and what kind of extraordinary medical procedures should be taken for you in certain health care situations.

Hiring an estate planning attorney to guide you and prepare and implement the essential elements of an estate plan for you and your family should go hand in hand with your other family financial planning to preserve and protect your assets for future generations.

Please email (dhaase@dmhaaselaw.com) or call (973-744-0073) Dennis M. Haase, Esq. in Montclair, New Jersey for an appointment to discuss your tax, estate planning, or estate administration needs.