Category Archives: Tax Information

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.

 
 

Sale of Personal Goodwill as Tax Savings Opportunity in Business Transactions

Generally, in a sale of a closely-held business, a buyer who desires to acquire a regular or “C” corporation, which is taxed separately from its shareholders, will prefer to purchase the assets of the C corporation rather than the stock from the individual shareholders in order to avoid any hidden or contingent liabilities associated with the corporation and to get a “step-up” in basis for the acquired assets. In such an asset sale to a third party buyer, the selling C corporation must recognize gain on the sale of those assets and pay corporate income tax on any such gain. In addition, if the C corporation liquidates and makes a final distribution of assets to its shareholders proportionately in cancellation of their stock, the shareholders must pay capital gains tax (20%) and net investment income tax (3.8%) (NIIT) on the amount of the liquidating distribution, minus their respective bases in their stock. Thus, the proceeds from the sale of the corporate assets will be subject to two levels of taxation: first, a tax at the 35% corporate rate on the C corporation’s gain on the sale of the assets, and second, a tax at the shareholder level on the liquidating distribution to the shareholders at the 20% capital gain rate plus the 3.8% NIIT.

In certain limited circumstances, the shareholders of the C corporation may be able to obtain long-term capital gain treatment for payments received by the shareholders directly from the buyer as a sale of shareholders’ personal goodwill without such amount being taxed at the C corporation level. The amount paid by the buyer for the personal goodwill would be amortizable over 15 years as a Section 197 intangible. The sale of personal goodwill has been recognized and approved by the federal courts in those limited instances where the shareholders selling their personal goodwill (1) have strong personal ties and relationships to the corporation’s customers and (2) have no pre-existing employment agreement or covenant not-to-compete with the corporation prohibiting them from transferring their strong personal contacts to any third party.

For example, suppose Acme Corporation, a C corporation for federal income tax purposes, sells its assets to Buyer for $1,000,0000 cash. Acme Corporation has been in the engineering consulting business for 15 years and is owned by two shareholders who have built strong personal relationships with their customers over the last 15 years. Neither shareholder has an employment agreement or a covenant not-to-compete with Acme. Acme’s assets consist of equipment valued at $200,000, a patent valued at $100,000, and customer lists. The parties agree to an asset purchase agreement that includes a two-year covenant not-to-compete between Buyer and the two shareholders. During negotiations for allocation of the purchase price of $1,000,000 to the purchased assets, the parties allocate $300,000 to the assets and the patent, $200,000 to the covenant not-to-compete, and the balance of $500,000 to the personal goodwill of the two shareholders. The two shareholders and the Buyer separately enter into an Agreement to Sell Personal Goodwill and a separate Bill of Sale for Personal Goodwill for $500,000. Based on the applicable case law, the $500,000 for the sale of the personal goodwill avoids the 35% corporate level tax because it is paid directly to the shareholders, and is taxed to them at the maximum long-term capital gains rate of 20% plus 3.8% NIIT.

In short, the sale of the corporate shareholder’s personal goodwill can result in long-term capital gain treatment for part of the purchase price paid directly to the shareholders and avoids the corporate level tax while entitling the buyer to amortization deductions under Section 197.

Contact Dennis M. Haase, Esq. at 973-744-0073 or at dhaase@dmhaaselaw.com for your tax, business planning, and estate planning needs.

 
 

Protecting IRA Benefits from the Beneficiary’s Creditors and Other Predators

On June 12, 2014, the United States Supreme Court held in Clark v. Rameker that “inherited IRAs” are not retirement funds in the Bankruptcy Code and are, therefore, not exempt from the claims of the IRA beneficiary’s creditors in bankruptcy. An “inherited IRA” is an IRA that is bequeathed by the IRA owner to the intended beneficiary of that IRA.

In Clark, the Supreme Court ruled that assets in an “inherited IRA” are not retirement funds for three reasons: first, the holder of an inherited IRA cannot contribute additional funds to the account; second, holders of inherited IRAs are required to receive distributions from the accounts regardless of their age; and third, the holder of an inherited IRA can withdraw the entire balance of the account at any time regardless of age and use the funds for any purpose without a 10% premature distribution penalty.  These reasons underlie the notion that the funds in the inherited IRA represent contributions made by the IRA owner for the IRA owner’s retirement, not for the retirement of the beneficiary. Continue reading

 
 

How to Probate a Will in New Jersey

Upon the death of an individual, the family or next of kin should determine whether the deceased person (referred to as the “decedent”) left a Last Will and Testament. If so, they should review the Will and identify the person named in the Will as the executor. It then becomes the legal duty of the executor to probate the Will by presenting the original Will, the death certificate, and a list of the names and addresses of the decedent’s next of kin to the New Jersey Surrogate’s Court in the county where the decedent resided at the time of death. The death certificate will indicate where the decedent resided at the time of death.    In most counties in New Jersey, the Surrogate will prepare the Application for Probate and other papers necessary to qualify the executor to act on behalf of the estate of the decedent.

After the Surrogate’s Court appoints the executor, which under New Jersey law can be no sooner than 10 days after the decedent’s death, the executor will receive the “Letters Testamentary” from the Surrogate. This authorizes the executor to gather the assets of the decedent, which constitute the estate, and pay the decedent’s funeral expenses, debts, and any income, estate or inheritance taxes, before distributing the remaining assets of the estate to the decedent’s beneficiaries named in the Will.  Within 60 days of probate, the executor must notify all beneficiaries named in the Will and all next of kin that the Will has been admitted to probate and state that a copy of the Will shall be furnished upon request.

The executor is under a legal and statutory duty to settle and distribute the estate in as expeditious and efficient a manner as possible. The executor is personally liable for filing and paying the decedent’s final income tax return and filing any estate or inheritance tax return and paying those taxes before making distributions to the beneficiaries. Before the estate is closed, the executor will have to render either a formal accounting to the Surrogate’s Court and beneficiaries or an informal accounting to the beneficiaries to explain the amount and nature of the assets received under the executor’s control and how those assets were used to pay expenses, debts and taxes before distribution to the beneficiaries under the Will.

Probate of a Last Will and Testament in New Jersey is often a relatively streamlined and uncomplicated process compared with other states, unless the Will is contested.

Dennis M. Haase, Esq. has 30 years’ experience in handling estate administration and estate litigation and Will contest matters.  Please call me at 973-744-0073 or email me at dhaase@dmhaaselaw.com for a consultation.