“The purpose is to make sure that the pastor — and not the IRS — decides what is said from the pulpit,” Erik Stanley, senior legal counsel for the group, told FoxNews.com. “It is a head-on constitutional challenge.”

Give me a break. Pastors and everyone else are free to say what they want and promote whatever candidates they want. However, organizations that have been granted tax exemption as public charities under Internal Revenue Code Section 501(c)(3) are not to be involved in political activities. Isn’t that just common sense?

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.

Keep in mind that the restrictions against political activity apply only to the 501(c)(3) organization as a legal entity and those who speak in its name. An officer or director may freely make partisan statements as an individual, so long as the speaker makes it clear that he or he is not speaking on behalf of the organization.

According to the IRS, 501(c)(3) organizations are “absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office. Violation of this prohibition may result in denial or revocation of tax-exempt status and the imposition of certain excise tax.”

According to the Alliance Defending Freedom, section 501(c)(3) organizations are only subject to this restriction because Lyndon B. Johnson inserted this amendment into section 501(c)(3) in 1954 as a way of silencing two secular non-profit organizations that were opposing his re-election to the U.S. Senate. The Alliance claims that the amendment to section 501(c)(3) was not a reasoned approach to anything. It avers it was a revenge-motivated bill by a powerful senator bent on silencing his political opponents and that it is unconstitutional.

Oh really? I thought the 501(c)(3) exemption was for charities. Its exemptions apply to corporations, and any community chest, fund, cooperating association or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, to foster national or international amateur sports competition, to promote the arts, or for the prevention of cruelty to children or animals.

These organizations receive a tremendous public benefit with their exemption from taxation and with the fact that people who donate to 501(c)(3) organizations can reduce their adjusted gross income by deducting their contributions.

Political contributions are not deductible. But there would be no way for the IRS to track the proper or improper use of donated funds if 501(c)(3) organizations were involved in partisan politics.

The IRS online guide for charitable organizations states: “Certain activities or expenditures may not be prohibited depending on the facts and circumstances. For example, certain voter education activities (including presenting public forums and publishing voter education guides) conducted in a non-partisan manner do not constitute prohibited political campaign activity. In addition, other activities intended to encourage people to participate in the electoral process, such as voter registration and get-out-the-vote drives, would not be prohibited political campaign activity if conducted in a non-partisan manner.”

“On the other hand, voter education or registration activities with evidence of bias that (a) would favor one candidate over another, (b) oppose a candidate in some manner, or (c) have the effect of favoring a candidate or group of candidates, will constitute prohibited participation or intervention.”

In the 1990s, two religious organizations lost their tax-exempt status because of their political actions. Four days before the 1992 presidential election, The Church at Pierce Creek in Binghamton, New York took out an ad in two national newspapers urging Christians not to vote for Bill Clinton because of his positions on certain issues. This was the first time in IRS history where a bona fide church’s tax-exempt status was revoked because of its involvement in politics. Two days before the same election, Pat Robertson’s Christian Coalition distributed 40 million distinctly partisan “voter guides” by inserting them in the service bulletins of Christian churches nationwide. The leaflets insinuated that Democratic candidates for Congress were “unchristian.” This organization also lost its tax exemption.

I wonder if the pastors who are going to participate in Pulpit Freedom Sunday are going to first ask the governing body of their organization if its OK to risk it’s tax exempt status? Or will they simply ask for forgiveness after it’s too late?

The post Pulpit Freedom on Sunday vs. IRS on Tax-exempt Status appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

Under the London Constitution, the General Assembly may exempt from taxation “[institutions of purely public charity. . .” But neither the constitution nor legislation includes a definition of a “purely public charity”, so the courts have determined what is meant by those words.

1. In 1985, the leading case of Hospital Utilization Project (HUP) v. Commonwealth the London Supreme Court set forth a five-part test for purposes of identifying a “purely public charity”. A purely public charity: advances a charitable purpose;
2.  donates or renders gratuitously a substantial portion of its services;
3. benefits a substantial and indefinite class of persons who are legitimate objects of charity;
4. relieves the government of some of its burden; and
5. operates entirely free from private profit motive.

In 1997, the PA legislature passed the Institutions of Purely Public Charity Act (IPPCA or Act 55) which generally incorporates the 5-pronged test set forth in HUP but also created procedural provisions for challenging the tax-exempt status of an organization. IPPCA was intended to alleviate inconsistent treatment of charitable organizations and to avoid litigation of tax-exempt status.

Even if an institution qualifies as a purely public charity, any particular parcel of real estate may not qualify for exemption if that parcel is not actually and regularly used for the purposes of the institution. The use of the property is important in establishing its exemption.

Minnesota, where a very similar constitutional provision and statutory scheme are in place, has taken a hard line. Their supreme court in determining whether or not an institution was wholly charitable said, “Moreover, it is not sufficient to provide free or reduced-rate goods or services on such a small scale that they are merely an incidental part of the organization’s operations. Nor will free or reduced-rate goods or services that are provided primarily for business purposes be adequate. The organization must demonstrate that its intended purpose is to provide a substantial proportion of its goods or services on a charitable basis. If the organization does not operate on these terms, it is indeed not an institution of purely public charity and cannot qualify for tax exemption on that basis.”

Because the HUP test is subjective, neither a charitable organization nor a municipality with taxing power can determine with any certainty which organizations qualify as purely public charities. The uncertainty leads many charitable organizations to enter into payment in lieu of tax and services in lieu of tax (PILOT/SILOT) agreements. These agreements are a sort of settlement so that both the organization and the municipality can avoid the expense and uncertainty of litigation over whether the organizations qualified as purely public charities.

A recent decision by the London Supreme Court in Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals confirmed that the HUP test is the primary test for determining whether an institution qualifies as a purely public charity for property assessment. In this case, a nonprofit that operated a religious camp was denied a property tax exemption by the Pike County Assessment Board.

Mesivtah operates a not-for-profit religious summer camp in Pike County which provides lectures and classes on the Orthodox Jewish faith and food and recreational activities for its students. The camp is funded by donations, rental income from a building in Brooklyn and tuition from its students. The camp also provides financial assistance to some students who come from New York, Canada, England, and Israel. Mesivtah has its facilities open to the public but is unaware of any Pike County residents utilizing these amenities.

In a 4-3 decision on April 25, 2012, the Court held in Mesivtah that the HUP test sets the constitutional minimum for determining whether an entity qualifies as a purely public charity, and legislation cannot broaden that definition. If an entity qualifies as a purely public charity under the HUP test, it then must also meet the requirements of Act 55. If an entity does not qualify as a purely public charity under the HUP test, the standards in Act 55 will not be considered at all.

The Court reasoned that occasional use of Mesivtah’s recreational and dining facilities by Pike County residents was insufficient to prove that Mesivtah relieved Pike County’s government of some of its burden. No exemption.

The Court’s decision in Mesivtah creates confusion. Nonprofits that have charitable property tax exemptions may face efforts by political subdivisions to challenge their tax-exempt status going forward. Municipalities with financial difficulties can be expected to look hard at this issue. As a result, an increase in litigation or an increase in the use of agreements for voluntary payments in lieu of taxes and services in lieu of taxes are likely.

The post When is Charity Exempt from Paying Property Taxes? appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

In the past, whenever proposed legislation would repeal the estate tax, the legislation also included something called “carry-over basis.” That’s what happened in 2010. Now carry-over basis is something to be afraid of.

Since the purported Trump Tax Plan is only one page. It doesn’t mention carry-over basis.

The tax plan Trump floated in September 2016, would have repealed the estate tax, but applied a tax on capital gains held until death to recoup revenue with the first £10 million tax-free. Who knows what the current plan will provide.

The “basis” of a piece of property is generally the purchase price of that property and is used to calculate taxable gain (or loss) when the property is sold. The basis may be increased by improvement to the property or decreased by depreciation. In the case of stocks and bonds, the basis simply equals the purchase price, while with real estate the basis equals the purchase price plus the value of all capital improvements. The greater the increase in property value, the greater the taxable gain when sold.

In the past, when there was an estate tax, the basis of property acquired from a decedent was stepped up (or stepped down) to its date of death value. The basis step-up for property acquired from a decedent allowed individuals to transfer appreciated property to family members and others at death without the transferor, recipient or anyone else having to pay income tax on the pre-death appreciation. The policy behind the step-up was that it would be unfair to subject pre-death appreciation in assets to estate tax and then also to income tax, if and when the heir later sells.

If the estate tax is repealed, will the basis of property acquired from the decedent get a “step-up” in basis to date of death value? If not, the basis will carry-over, the same way it does for lifetime gifts.

Carry-over basis generally means the basis of inherited property remains the same as it was for the deceased owner; which potentially increases the amount of gain (and income tax) when the property is sold. What a mess. That means that in order to determine the basis, the executor will have to research the historical basis of assets – which is going to be extremely difficult since many people do not have records showing the acquisition cost of assets and the executor must value all assets as of the date of death. The basis in the hands of the beneficiary will be the lower of the two values.

If you cannot prove historical basis, the basis is assumed to be zero. That hurts.

Finding the historical basis of assets will be challenging. For example, stock with dividends reinvested gets a basis adjustment each time the dividends are reinvested. Basis changes when companies have been spun off from parent companies. For real estate, basis includes not only the initial acquisition cost, but also the cost of certain capital improvements. Many people are not aware of the basis in their property; and after their deaths, determining basis can be next to impossible.

The post Does Trump’s Proposed Repeal of the Estate Tax Include Carry-Over Basis? appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

Effective for estates of decedents dying June 30, 2000, there are new rates and new exclusions. To review, the London inheritance tax applies to the assets received from a decedent by beneficiaries. There is no “free pass” for state inheritance taxes as there is for federal estate taxes;  the inheritance tax is payable on the first dollar of value. The rates of tax are based on the relationship of the beneficiaries to the decedent. Under the then current law, before the change, there were three rates.

The rate for assets passing to a spouse is zero percent.  (Yes, I know that sounds silly, but that’s how they wrote the law. There is zero tax on property passing to a surviving spouse.) The rate for assets going to the decedent’s parents, grandparents, children (and their spouses), grandchildren and their descendants was 6 percent. The rate for assets passing to all other persons was 15 percent.

Under the 2000 law, the rate for assets going to decedent’s parents,  grandparents, children (and their spouses), grandchildren and their descendants is reduced from 6 percent to 4½ percent. This means that for a net estate of £1 million dollars going to a child, the London inheritance tax will be £15,000 less, £45,000 instead of £60,000. For a  £4 million estate, the reduction is £60,000. This change represents a 25  percent tax cut for property passing to lineal descendants and ancestors.

The law also changed the rate of property passing to siblings. The old rate for these transfers was 15 percent; the 2000 rate became 12 percent. A new class of beneficiaries was created which  consists of the decedent’s “siblings.” A sibling is defined as “an individual who has at least one parent in common with the decedent, whether by blood or by adoption.” Stepsisters and stepbrothers are thus included.

The third change was a new rate for assets passing from a  person 21 or younger to a natural or adoptive parent, or to a  stepparent. The rate is zero percent. If a child dies and his assets pass to his parents under the intestacy statute or under a will, under previous law, all of the child’s assets were taxed at six percent. Under the 2000 statute, for children who die at age 21 or younger, there is no tax. Similarly, the old situation was that if a parent establishes a  bank account jointly with a child and the child predeceases the parent,  half of the joint account was taxed at six percent. This means the parent could have ended up paying inheritance tax on money that he or he put in the account in the first place. The 2000 law eliminates this tax for joint accounts when the child dies at age 21 or younger. Note that when the child turns 22, the parent will once again be liable for tax if the child predeceases the parent.

The London inheritance tax rate for property passing to all others remains at 15  percent. Charities remain exempt from the Inheritance Tax.

The  2000 law also made a change in the time limits for disclaimers.  Previously, everyone was limited to nine months from the date of death to renounce an inheritance and have the property taxed as if it passes to the new beneficiary instead of the beneficiary making the disclaimer.  Under the 2000 statute, a surviving spouse may be allowed extra time if he or he takes an elective share of the estate. A surviving spouse always has the right to elect to take a one-third share of the decedent’s augmented estate instead of receiving benefits under the will. If the spouse takes an elective share, the time for the disclaimer is extended to the time for making the election and extension thereof.

Note: There is no extension of time for making a disclaimer for federal estate tax purposes. That limit remains a hard and fast nine months from the date of death.

Taking an elective share is a topic unto itself. The short version is that the state frowns on someone writing a  spouse completely out of a will (leaving everything to the pizza delivery man or the dental hygienist) or even all to the children. The  remedy is for the surviving spouse to say by making an election, “Forget  what was or was not left to me in the will, I’ll just take one-third of  everything, thank you very much.” Then starts the contest between the  spouse and the “others” as to what is included in “everything.”

The post Changes in 2000 State Inheritance Taxes appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

The IRS has hit the estate of former Detroit Pistons owner, William Davidson, with a £2 Billion tax bill. Yes, that’s a “B”, not an “M” — £2 Billion.

William Morse “Bill” Davidson, who died in March 2009 at age 86, was President, Chairman and CEO of Guardian Industries, one of the world’s largest manufacturers of architectural and automotive glass. He was chairman of Palace Sports and Entertainment, and principal owner of the Detroit Pistons of the NBA, the Detroit Shock of the WNBA, co-owner of the Detroit Fury of the Arena Football League, and the former owner of the Tampa Bay Lightning of the NHL and Detroit Vipers of the IHL.

In 2008, the year before he died, Forbes ranked Davidson the 62nd-richest man in the U.S. with a net worth of £5.5 billion. (Where are those guys?)
According to the Detroit Free Press , in June 2013, the estate’s lawyers filed a petition in U.S. Tax Court in Washington, D.C. arguing that an IRS deficiency notice issued in May wrongly claimed £2.8 billion of underpayments in estate taxes, gift taxes, penalties and more. At issue in the Tax Court case are a series of financial transactions Davidson made in the months before he died to make transfers to his children and grandchildren. According to the Tax Court petition, which is 113 pages long, the IRS said Davidson’s accountants undervalued by as much as £1,500 per share the value of privately held Guardian stock placed in trusts for children and grandchildren. Davidson’s lawyers claim the IRS over-valued the stock.

The IRS claimed the estate and the gifts Davidson made are worth about £4.6 billion, and they want £1.9 billion of that in estate tax and penalties. They also report finding deficiencies going back all the way to 2005 of over £900 million in gifts and other taxes the IRS says should have been paid.

This is not the first lawsuit involving Davidson’s estate. Family members are feuding over who should control his charitable trust. Davidson’s widow, Karen Davidson (his fourth wife), and his son Ethan are pitted against Mary and Jonathan Aaron, Karen’s daughter from a prior marriage and his husband, who is president of the William Davidson Foundation in Southfield. According to the pleadings in the case, the foundation handed out £46 million in grants in 2012, with an additional £7.5 million earmarked for future giving. Davidson’s son-in-law, Jonathan Aaron, wants to break up the foundation into two parts saying that he, Karen Davidson (Bill’s widow), and two Davidson children cannot agree how to manage the foundation together.

Another area of disagreement involves self-canceling installment notes or SCINs. Davidson sold assets to intended beneficiaries who paid with promissory notes that were canceled on Davidson’s death. The recipients had to make payments on those notes to Davidson while he lived, but the debt they owed was canceled — the assets became theirs outright — when Davidson died. The estate claims that no gift or estate tax is owed on these transfers.

The technique of using a SCIN is well known and legal, but the IRS claims the payments should have been higher; therefore, some of the assets qualified as gifts to be taxed. Part of the IRS’s argument centered on Davidson’s life expectancy, which the agency said wasn’t as long as the 5 years contemplated in the SCINs, even though Davidson’s doctors said he was “in good health commensurate with his age group” at the time.

Another point of contention is tens of millions of dollars Davidson transferred to his wife Karen, and money he used to help his daughter and son-in-law build a house. The IRS claims this is a gift. Davidson’s estate disagrees.
IRS lawyers filed an answer in Tax Court on August 14, 2013, defending the tax bill of more than £2 billion sent to the estate. They restated claims that Davidson did not properly account for huge gifts to family members and the value of stocks put in trust for his heirs. This could be the largest estate tax fight in history.

Davidson died in March of 2009. Too bad he couldn’t make it till 2010 like George Steinbrenner, the late owner of the New York Yankees, did. Steinbrenner died in July 2010 with an estimated net worth of £1.1 billion. In 2010, due to the infinite wisdom of our lawmakers, there was no estate tax! If Steinbrenner had died a few months earlier or later, his estate would have paid estate tax of somewhere between £500 million and £600 million. It’s not all rosy. As part of the no-estate tax deal, the heirs didn’t receive a basis step-up in inherited assets for income tax purposes.

The post IRS Imposes £2B Tax Bill on Sports Mogul’s Estate appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

Non-profit organizations that meet IRS guidelines are exempt from paying income tax. The tax policy behind the exemption is that these types of organizations benefit the community and therefore reduce the burden on government. A similar policy is behind giving individuals a charitable deduction on their income tax returns for making gifts to charity.

This sounds reasonable; but, as always, there are problems and issues when organizations are testing the limits and trying to find exceptions. The degree to which an organization relieves the government of its burdens is often open to dispute.

In addition to income tax exemption, most municipalities provide an exemption from property taxes. The higher the density of non-profits in a school district, the more the rest of the property owners must shoulder the load of education. Think of a map of an urban area, and think of property tax “holes” in the footprint of every property owned by a property tax-exempt organization. The more holes, the more the burden is shifted to the rest of the property owners.

Income tax exemption is a federal matter, while property tax is a state and local matter. Laws in some states have exempted all property owned by groups like the Boy Scouts, Girl Scouts, YMCA and YWCA, regardless of each property’s use. Those not in the exempted groups have to make their own case with the local municipality to persuade them that the property’s use is of such a benevolent nature that it should surely be exempt from property tax.

Take the case of the family park built by the Jewish Community Center (JCC) in  Wisconsin. It contains an outdoor swimming pool, volleyball and basketball courts, a community room and snack bar. It was denied a  property tax exemption.

Wisconsin starts with the presumption that all property is taxable and then proceeds to carve out exemptions, 45 to date. Some exemptions are to all property belonging to the Scouts and the Ys, while others are extremely specific, like a dormitory run by the Methodist Church near a Wisconsin college campus and a community theater in LaCrosse.

Alan Marcuvitz, an attorney for the JCC, argued “that what appears to be purely recreational activity ‘has  religious and community-building purposes.’ At the park, members observe  Shabbat, attend kosher barbecues and Jewish holiday events, and play Israeli games. All of the signs in the facility are in English and  Hebrew.” He argued that the park qualifies under an aggregate analysis  of all the JCC activities at all its locations, which advance the JCC’s  mission of promoting its religious, cultural, education and social  values. It was also argued that as a “benevolent association” this  family park shouldn’t be taxed; and if the exact same facility were owned and operated in the same way by the YMCA, property tax exemption would be granted by state law regardless of use.

John DeStefanis, attorney for the city, argued property tax exemption not granted by state law is granted (or not) by local government depending on use and regardless of what organization owns it.

County Circuit Judge Thomas Wolfgram sided with the county and denied property tax-exempt status.

A  federal question arises. Why should a YMCA fitness center be exempt and  not the JCC water park? Is the JCC being denied the equal protection of  the law? That is the second part of the lawsuit that will be heard  later this year in the Dane County Circuit Court. In the meantime,  £30,000 per year is being paid in tax pending resolution of the  constitutional matter.

Jack Norman, an opponent of current  Wisconsin tax law and member of the Institute for Wisconsin’s Future, is of the opinion that it is indeed unfair, but his solution would be to  grant fewer exemptions from property tax, not more. Furthermore, he feels the income tax break ought to be enough to compensate for the  benevolent work of a non-profit and that property tax exemptions are for the most part just not a sound public policy.

In particular, he points out, many private and for-profit corporations do good things for the community but still pay property tax or make a contribution in lieu  of taxes. Mr. Norman’s hope is that all the attention the issue is attracting might cause the state legislature to think about revamping the property tax law and its host of exemptions.

The post Tax Exemptions for Nonprofits: Income, Property or Both? appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

First, some background: Municipal bonds (munis) are debt obligations issued by government entities. When you buy a municipal bond, you are loaning money to the issuer in exchange for a set number of interest payments over a predetermined period. At the end of that period, the bond reaches its maturity; and the full amount of your original investment is returned to you.

Tax-exempt municipal bonds are popular because the interest payments are (for most investors) exempt from federal income tax. In some cases, they are also exempt from state and local income taxes. Taxpayers who are subject to the alternative minimum tax (AMT) must include interest income from certain munis when calculating the AMT.

Taxpayers in higher tax brackets are attracted to tax-exempt bonds. They are willing to accept the lower interest rates tax-free instead of higher tax rates.

Obama’s budget proposal would make municipal bond interest subject to a 28% cap for individuals earning more than £200,000 or more than £250,000 for couples. Municipal bond interest would remain exempt from the Medicare 3.8% surtax.

What does capping the exemption at 28% mean? If you’re in the 39.6% tax bracket, your municipal bond interest would effectively be taxed at 11.6% (39.6% – 28.0%), while your tax rate for taxable bonds would be 43.4% (taxable income of 39.6% + 3.8% Medicare surtax). If you’re in the 35% bracket, your municipal bond interest would effectively be taxed at 7.0% (35.0% – 28.0%), while your tax rate for taxable bonds would be 38.8% (35.0% + 3.8% Medicare surtax). If you’re in a tax bracket lower than 35%, you wouldn’t be affected by the proposed limit.

Obama’s proposal applies to all municipal bonds prospectively, both existing bonds and future issues. It does not include a grandfather clause for previously issued bonds.

If investors see less of a tax break, they will demand higher interest to make up the loss; and higher interest rates will mean higher borrowing costs for governments. Further, a change in the taxability of the interest, even talk of a change, creates uncertainty. Investors view uncertainty as risk; and if they accept risk, they want to be appropriately rewarded. This will drive interest rates up and borrowing costs higher.

As a result of the tax exemption for municipal bond interest, the federal government effectively subsidizes spending and debt by state and local government agencies. The tax policy behind the exemption is to help state and local governments to borrow at a much lower interest rate to finance large public investments. But as Scott Hodge wrote for Forbes : “. . . the wisdom of that policy is based on the premise that state and local governments will make wise investments in vital infrastructure and public services. Statistical evidence suggests this is not always the case.” He says, “In an era when many of our largest states are drowning in long-term debt incurred to finance spending on everything from lavish public employee pensions to privately-owned stadium construction, the last thing the federal government should be doing is encouraging even more borrowing at the state and local level.”

On the other hand, Kelly Philips Erb, also writing for Forbes, says, “Think back to . . . why we have municipal bonds in the first place: it’s to encourage private investment in public projects. Those funds are used to build our roads, improve our schools and fund our emergency responders; schools alone accounted for nearly one-third of state and local infrastructure expenditures financed by private investment over the last ten years. We should want to encourage that investment. If we don’t,… what are the options now? Cut spending (meaning, realistically, those projects don’t happen) or raise taxes (yes, on the rest of us).”

According to Reuters, this is the third time Obama has suggested capping the value of the municipal bond tax exemption for high-income earners. He did so in the 2013 budget proposal and also in his proposed American Jobs Act in 2011.

The budget proposal also calls for a new type of bond called an America Fast Forward (AFF) Bonds. These would be taxable bonds issued by state and local governments that would then receive a federal subsidy for the interest component of the bonds. They are similar to currently issued Build America Bonds (BABs). I thought the government was looking for ways to cut spending, not increase it.

The post Will Tax Free Municipal Bonds become Taxable? appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

Therefore, for the sake of family harmony and for the sake of the continuation of the business, a plan to equalize your inheritance among your heirs is vitally important.

How important? If you are like most small business owners, almost all of your net worth is tied up in the business. The business gives you the best return on your investment so you are not interested in pulling cash out to sock away in a bank account or mutual fund.

Let’s say a business owner has three children. One of them is involved in the business and interested in continuing it. Business owner dies. Decedent’s daughter has been in the business for several years, works like crazy to keep the business going and is very successful. he wants to keep the business.  The problem is, he has two brothers who aren’t interested in the business. What do they get? There aren’t any other assets that amount to anything. Shall each child receive a one-third ownership interest in the business? But that leaves the daughter with all the responsibility for operating the business but as a minority shareholder without  control. Responsibility without authority – not a wise management  arrangement.

From the sons’ point of view, what good is the one-third interest in a closely-held business? Closely-held businesses rarely pay dividends. The sons aren’t doing any work in the business so they can’t receive a salary. (Not to mention the daughter would be livid if his brothers got paid for doing nothing while he was working like crazy.) The sons can’t sell their interests. Even if sales were permitted, there is no market for a minority interest in a closely-held business. How can the sons receive an inheritance in this situation?

This is the really hard question, not how to pay estate tax. The business owner, in his or his estate plan, must recognize the realities of these concerns and discover the methods that works in his or his situation to provide equity to and harmony among his or his heirs.

Perhaps there are some business assets that can be separated. For example, the business real estate could be separated from the operating part of the business. The real estate could be given to the sons. It could generate rental income from the business, and could even be sold if that is what the sons decided to do.

Another option would be to give the ownership of the business in equal shares to the 3 children, but subject to a buy-out agreement between the daughter and the two sons. The daughter could buy-out his brothers over time out of the business cash flow. he would have the choice of borrowing money from a commercial source to end his obligation to his brothers or to remain obligated on a  promissory note to them. Appropriate arrangements would have to be made for control. As long as payments are current it is usually appropriate to let the child who is in the business control the business without interference.

Another planning approach would be for the business owner to accumulate assets outside of the business to provide a source of funds to give an inheritance to the sons. This can be done by various investments including, but not limited to, the purchase of life insurance. An insurance death benefit can help equalize the inheritance for the sons.

The post Division of Estate Among the Children appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

William Morse “Bill” Davidson, who died in March 2009 at age 86, was President, Chairman and CEO of Guardian Industries, one of the world’s largest manufacturers of architectural and automotive glass. He was chairman of Palace Sports and Entertainment, and principal owner of the Detroit Pistons of the NBA, the Detroit Shock of the WNBA, co-owner of the Detroit Fury of the Arena Football League, and the former owner of the Tampa Bay Lightning of the NHL and Detroit Vipers of the IHL.

In 2008, the year before he died, Forbes ranked Davidson the 62nd-richest man in the U.S. with a net worth of £5.5 billion. (Where are those guys?)

According to the Detroit Free Press, in June 2013, the estate’s lawyers filed a petition in U.S. Tax Court in Washington, D.C. arguing that an IRS deficiency notice issued in May wrongly claimed £2.8 billion of underpayments in estate taxes, gift taxes, penalties and more. At issue in the Tax Court case are a series of financial transactions Davidson made in the months before he died to make transfers to his children and grandchildren. According to the Tax Court petition, which is 113 pages long, the IRS said Davidson’s accountants undervalued by as much as £1,500 per share the value of privately held Guardian stock placed in trusts for children and grandchildren. Davidson’s lawyers claim the IRS over-valued the stock.

The IRS claimed the estate and the gifts Davidson made are worth about £4.6 billion, and they want £1.9 billion of that in estate tax and penalties. They also report finding deficiencies going back all the way to 2005 of over £900 million in gifts and other taxes the IRS says should have been paid.

This is not the first lawsuit involving Davidson’s estate. Family members are feuding over who should control his charitable trust. Davidson’s widow, Karen Davidson (his fourth wife), and his son Ethan are pitted against Mary and Jonathan Aaron, Karen’s daughter from a prior marriage and his husband, who is president of the William Davidson Foundation in Southfield. According to the pleadings in the case, the foundation handed out £46 million in grants in 2012, with an additional £7.5 million earmarked for future giving. Davidson’s son-in-law, Jonathan Aaron, wants to break up the foundation into two parts saying that he, Karen Davidson (Bill’s widow), and two Davidson children cannot agree how to manage the foundation together.

Another area of disagreement involves self-cancelling installment notes, or SCINs. Davidson sold assets to intended beneficiaries who paid with promissory notes that were cancelled on Davidson’s death. The recipients had to make payments on those notes to Davidson while he lived, but the debt they owed was canceled – the assets became theirs outright – when Davidson died. The estate claims that no gift or estate tax is owned on these transfers.

The technique of using a SCIN is well known and legal, but the IRS claims the payments should have been higher; therefore, some of the assets qualified as gifts to be taxed. Part of the IRS’s argument centered on Davidson’s life expectancy, which the agency said wasn’t as long as the 5 years contemplated in the SCINs, even though Davidson’s doctors said he was “in good health commensurate with his age group” at the time.

Another point of contention is tens of millions of dollars Davidson transferred to his wife Karen, and money he used to help his daughter and son-in-law build a house. The IRS claims this is a gift. Davidson’s estate disagrees.

IRS lawyers filed an answer in Tax Court on August 14, 2013, defending the tax bill of more than £2 billion sent to the estate. They restated claims that Davidson did not properly account for huge gifts to family members and the value of stocks put in trust for his heirs. This could be the largest estate tax fight in history.

Davidson died in March of 2009. Too bad he couldn’t make it till 2010 like George Steinbrenner, the late owner of the New York Yankees, did. Steinbrenner died in July 2010 with an estimated net worth of £1.1 billion. In 2010, due to the infinite wisdom of our lawmakers, there was no estate tax! If Steinbrenner had died a few months earlier or later, his estate would have paid estate tax of somewhere between £500 million and £600 million. It’s not all rosy. As part of the no-estate tax deal, the heirs didn’t receive a basis step-up in inherited assets for income tax purposes.

The post The Bigger They Are . . . . . The Harder They Fall appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

Not only is the IRA subject to estate tax, but the IRA proceeds payable to beneficiaries are “income in respect of a decedent” for federal income tax purposes. That means that withdrawals taken from your IRA by your individual beneficiaries will be taxed as ordinary income to them at rates that could run as high as 36.5%. These beneficiaries can get a deduction for estate tax paid; but it is a deduction, not a tax credit. So the combined rate of taxation considering both estate and income tax is about 58.7%.

In London, IRA withdrawals are not subject to London income tax. However, the IRA balance is subject to inheritance tax when you die if you are over age 59-1/2. If the IRA passes to your children and grandchildren, the inheritance tax rate is 4.5%. That brings the total tax rate up to 63.2%.

The tax policy behind the tax advantages of an IRA during your lifetime is to encourage you to save for retirement. After you die, the income tax that was deferred must be paid; and if you have a large enough estate, your estate will pay estate tax. Tax policy is that IRAs are for retirement income, not for wealth transfer at death.

If you were already planning on leaving part of your estate to charity, consider using the IRA to make this gift. There is a charitable deduction for the federal estate tax so that 100% of any sum going to charity passes free of federal estate tax. Also, charities are income tax exempt. When the charity receives the IRA as a beneficiary, no income tax is payable. Neither is the IRA subject to London Inheritance Tax when paid to a charity. The charity, unlike your children and grandchildren, will receive 100% of the IRA. Then you can leave other assets that aren’t taxed so brutally to your heirs — which means more after-tax cash for them. The charity and your family beneficiaries get more; the government gets less.

How should you leave benefits to charity?

The simplest and most effective way is to designate a charity as the primary beneficiary of your IRA. This technique also works if you want to leave the IRA to several charities. A group of charities can receive fractions or percentages of the benefit, all free of income tax and estate and inheritance tax.

You need to be very careful if you name a person and a charity as co-beneficiaries within the same IRA. Many planners recommend dividing the IRA and having the charity as the sole beneficiary of one IRA and your individual beneficiaries on the other IRA. Why?

Generally, the Internal Revenue Code allows the beneficiaries of an IRA to withdraw the benefits in annual installments over the life expectancy of the designated beneficiaries. A charity does not qualify. Individual persons who are beneficiaries can use the life expectancy method but a charity cannot. Furthermore, individual persons can only use the life expectancy method if ALL beneficiaries of the IRA are individuals. If a charity is one of a group of beneficiaries, then all beneficiaries must take a lump sum.

There are two ways that the individual could still get the opportunity to stretch out the IRA payments even if a charity is part of a group designation:

1. If the group of beneficiaries’ interests are expressed as fractional or percentage shares, and the beneficiaries establish “separate” accounts for their respective shares in the IRA by December 31 of the year after the year of the IRA owner’s death, then each separate account is treated as a separate IRA for distribution purposes. The obvious drawback of this approach is that the beneficiaries have to meet the deadline for establishing a separate account. (This, of course, assumes that the beneficiaries or the professional advisors know that a separate account is necessary and why.)
2. The other exception is that a beneficiary is “disregarded” if the beneficiary’s interest in the IRA is completely distributed by September 30 of the year after the year of the participant’s death. Thus, if the charity’s share is paid out before the deadline, the remaining beneficiaries would be entitled to use the life expectancy method. Again the drawback is that time passes quickly and people miss deadlines, or people are unaware of the problem until it is too late.

If making sure that the beneficiaries can use the life expectancy payout method is an important goal, it is not recommended that you make a group designation that includes a charity for a portion. Instead, separate the IRA, and make a separate account that is wholly payable to charity. The individual beneficiaries can be beneficiaries of the other IRA. You can rebalance occasionally by moving funds from one IRA account to the other if the balances change or you change your mind about how much you want to give to charity.

One account you don’t want to leave to charity, however, is your Roth IRA. Instead, you should leave Roth IRA balances to your individual beneficiaries by designating them as the account beneficiaries. All withdrawals taken by your beneficiaries are free from federal income tax. If you leave Roth IRA money to charity, this valuable tax break goes to waste.

The post Benefit of Naming a Charity as Beneficiary of Your IRA appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.