Distribute by March 6, 2014 to Reduce High Estate & Trust Income Taxes

Everyone’s talking about the new Net Investment Income (NII) Tax that applies to high-income individuals on dividends, interest income and capital gains. This new tax of 3.8% is in addition to increased income tax rates, the highest being 39.6%. This means that wealthy individuals pay a combined rate of 43.4% BEFORE adding state income taxes. If you are the executor of an estate or the trustee of a trust, you should know that these egregiously high rates apply to estates and trusts too, and not at the high income levels of individuals.

 In 2013, for estates and trusts, the 39.6% income tax rate as well as the 3.8% NII tax kicks in at $11,950 of income. That’s not very high. And don’t forget, you don’t need $11,950 of investment income to pay the NII tax. If the total income exceeds the $11,950 threshold, the NII tax might be due on all of the investment income.

Let’s say an estate has income of $211,950. The tax on the $200,000 (income in excess of the $11,950 threshold), at 43.4% equals a tax of $86,800. Ouch!

Help! Is there any hope?

Yes, the estate and trust only pays tax on what’s not distributed. Distributions lower the income tax for the trust and at the same time increase the recipient’s personal income tax. However, individuals do not pay the highest rates unless they are wealthy.  In our example, if there are four beneficiaries and each receive $50,000 (one-fourth of the $200,000) they may only pay 15% on that $50,000. That’s $7,500 per beneficiary for a total of $30,000 instead of $86,800 for a tax savings of $56,800.

It’s too late. I didn’t distribute anything in 2013.

It’s not too late. There’s a rule allowing distributions made in the first 65 days of the next year to be treated as made in the prior year. This year’s deadline is Mar 6, 2014. Executors and trustees have less than one month to consider this opportunity for substantial tax savings.

Israel now Taxing US Trusts with Israeli Beneficiaries

If you have family living in Israel for whom you set up an irrevocable trust, Israel now wants its share. Until 2014, irrevocable trusts settled by foreign residents in favor of Israeli resident beneficiaries weren’t taxed by Israel unless the beneficiaries exercised “control or influence” over the trust. This is no longer the case.

Beginning January 1, 2014, Israel is taxing any trust anywhere in the world that has an Israeli resident beneficiary. There are two types of Israeli Beneficiary Trusts.

A Relatives Trust (or Family Trust) is a trust where the settlor is the parent, spouse, child, grandchild or grandparent of the beneficiary.

A Non-Relatives Trust is all other Israeli Beneficiary Trusts.

If the trust is a Relatives Trust, the trustee must choose between two possible tax regimes. Israel will impose a tax rate of 30% of income distributed to beneficiaries. Alternatively, it’s possible to elect to be taxed at a rate of 25% on annual trust income regardless of distributions.  An irrevocable election must be made by June 30, 2014 to choose the tax regime.

An exception applies to new and senior returning residents (who lived abroad 10 years) who arrived after 2006. They enjoy a 10-year Israeli tax holiday regarding overseas income, gains and asset reporting.

Thinking about excluding Israeli resident beneficiaries? It’s not so simple. The new 2014 rules impose Israeli tax on all trusts that ever had Israeli resident beneficiaries since inception. Consultation with qualified and competent U.S. and Israeli tax professionals is critical to deal effectively with the new tax liability.

 

 

Avoid NJ DOL Audits- S-Corp Owners Should Take Reasonable Compensation

Wages vs. S Corp. Income

In an S-Corporation, a popular choice of tax entity among businesses, an owner who works for the company is required to take wages. How much of the company’s income is classified as wages versus S Corp. income (reported to the owner on Form K-1) is up to the owner. The net income will be taxed regardless of how it’s classified. The big difference lies in federal employment taxes, which are not paid on K-1 income. Another consideration is that K-1 income is exempt from the new 3.8% Medicare tax. So it would seem like a no brainer to take the lowest salary possible, right? Think again. There are significant downsides to consider before taking an unreasonably low compensation.

Risk of IRS Penalties

Let us assume Sam Success worked full-time as the manager of his staffing agency, which has net income of $200,000 this year. If he decides to avoid payroll taxes and classify $20,000 as wages and $180,000 as K-1 income, the IRS will probably notice. Using industry averages and other factors, it will argue that the compensation was unreasonable and will therefore impose steep penalties on top of the payroll taxes owed for the difference between the unreasonable $20,000 and what they determined is reasonable compensation.

Avoid NJ DOL Audits

Even if the IRS doesn’t take notice, the State of New Jersey has taken an aggressive stance with regard to unreasonable compensation. New Jersey is looking to collect state unemployment insurance (SUI), and if Sam Success’ salary is less than the SUI threshold ($31,500 in 2014) it will likely be scrutinized.  The number of such NJ DOL audits is on the increase. Moreover, New Jersey will inform the IRS after taking its share.

Less Disability Coverage

If Sam Success was injured by an insured party, he wouldn’t be able to argue that as manager of a staffing agency he deserves at least $100,000 for lost wages. Since he only classified $20,000 as wages, he cannot claim that his lost wages are greater.

Goodbye Social Security and Pension Benefits

The amount one receives from Social Security depends on one’s wage income or other income subject to Social Security tax. By minimizing his wages, Sam is also minimizing his potential benefits. In addition the company’s contribution to his pension is based on his wages. Lower wages equals lower pension benefits.

Keep it Reasonable

When it comes to determining wages from your S-Corporation, reasonable compensation is the way to go. Your tax professional can advise you in determining just the right amount to classify as wages in order to maximize the tax advantages, while avoiding the aforementioned pitfalls.  

Joint Account Holders Don’t Always Avoid Probate

The mere fact that someone held an account jointly with a decedent doesn’t necessarily mean he will avoid probate. While there is a statutory presumption that a right of survivorship is created when a party to a joint account dies, this presumption can be overcome with evidence showing that undue influence was used in the creation of the account, or that the account was solely for the convenience of the depositor. This was highlighted in a recent NJ appellate court case. 

In the Matter of the Estate of DeFrank, decedent Aurerlia Defarank left behind approximately $1.4 million dollars in non-joint accounts, and had joint accounts held with her daughter Diane DiDonato (defendant) totaling $259,407. Aurerlia’s other daughter, Lorraine Rubaltelli, initially lost a summary judgment to grant her a share of the joint accounts. The judgment was based on the assumption that a right of survivorship was created when Aurerlia died.

Plaintiff appealed, arguing that decedent did not intend to create a right of survivorship on the joint accounts. She proved this by highlighting evidence of an established pattern of equal treatment to the two children. This ran contrary to the assumption that the decedent intended to give one daughter more than $250,000 more than the other. There was also evidence that the jointly-held funds were used solely for the needs of the decedent, to pay her expenses and to make equal gifts to her children and grandchildren. This would indicate that the joint account was set up for convenience rather than intent to create a right of survivorship.

The appellate court ruled in favor of Plaintiff, finding the circumstantial evidence reason enough to rebut the statutory presumption of survivorship.  

 

How Does the IRS Find Foreign Account Owners?

Do you have income overseas you forgot to report? Did Grandpa leave you his foreign bank account when he passed away? If you have foreign bank accounts holding more than $10,000 in the aggregate anytime during the year, you are required to file an FBAR (Report of Foreign Bank Accounts) by June 30th of the following year. It doesn’t matter whether the foreign accounts generate income or not; just owning them, or having signature authority, requires you to file. (For more information regarding the FBAR, click here: Foreign Asset Reporting)

If the thought has crossed your mind to not file and hope for the best, think again. With the increasingly aggressive tactics being taken by the U.S. Treasury and Justice departments, this has become a very risky proposition. The U.S. is entering into settlements with many foreign banks that provide for fines in exchange for nonprosecution agreements for banks that facilitated American tax evasion.  As part of these settlements, the foreign banks hand over the names of their U.S. customers. Moreover, in July 2014 the Foreign Account Tax Compliance Act (FATCA) will go into effect, requiring international financial institutions to turn over all the information on their US account holders. Continue Reading »

Upcoming UA Seminar: Do You Know the Real Value of Your Medical Practice?

You probably think you already know the value of your business. After all, who would know it better than the owner? The reality is, however, that there are several factors that impact the value that many business owners are unaware of.  This topic will be addressed at the upcoming complimentary U&A seminar, the first installment in a four part series tailored to medical and healthcare professionals. Issues covered will include:

  • What elements and factors enter into the value of your healthcare practice?
  • How can you increase and maintain the value of your medical practice?
  • How and why CPT codes and RVUs impact value
  • Value for Divorce vs. Value for Buy-Ins/Buy Outs
  • Starker I and II: a brief overview of these fundamental laws 

 The seminar will take place in our office (1581 Route 27, Edison, NJ) on Tuesday morning, Dec. 10th, at 8:30 am to 10:00 am and will be presented by Jeffrey D. Urbach CPA/ABV (Accredited in Business Valuations). Jeff, who has co-authored Continuing Professional Education (CPE) courses in the field of business valuation, will explain the benefits of understanding your practice’s value. He will also highlight the various factors that can impact its value.

For more information, click here: Medical Seminar Flyer

 

 

Executors Beware: NJ Law Requires Child Support Search Prior to Distribution

If you are executor of an estate in New Jersey and intend to make a distribution to the beneficiaries, there’s one important step you need to take first. NJ law requires an executor/administrator to initiate a child support enforcement order for any beneficiary receiving in excess of $2,000 prior to the distribution. The executor is personally liable for making a distribution without initiating the order, as the Child Support Judgment is a lien against the net proceeds of any inheritance in NJ.

The search must be conducted by a private judgment search company that will verify results. Urbach & Avraham’s estate administration services include the performance of Child Support Searches. If you would like assistance with your Child Support Search, call us at 732-777-1158 or email Pamela at pma@ua-cpas.com. 

Good News for NJ Employers: Federal Unemployment Tax (FUTA) Surcharge Avoided

New Jersey employers can breathe a sigh of relief, as Governor Christie has announced that new fiscal management practices have brought New Jersey’s Unemployment Insurance Trust Fund into solvency for the first time since 2009. This spares businesses from a drastic tax surcharge, as Federal Unemployment Tax (FUTA) was set to increase from the base rate of 0.6% ($42 maximum per employee) to 1.5% ($105 maximum per employee).  The surcharge is imposed when a state has borrowed from the Federal Unemployment Trust Fund and increases each year. In 2012, NJ employers paid 1.2% due to the surcharge ($84 maximum per employee). By repaying the loan to the Feds, employers will not be subject to this surcharge on their 2013 FUTA wages and will only pay the base rate of 0.6% ($42 maximum per employee).   

Hit by the NJ Exit Tax for Selling Real Estate? Recover Your Money Quickly

If you’re a non-resident selling investment real estate in New Jersey, there’s a unique NJ tax you should be aware of. Both residents and non-residents always had to pay income tax on the gain upon the sale of real estate. This tax is required to be withheld for non-residents.  The “Exit Tax”, which came into law six years ago, requires the seller to file a GIT/REP form (Gross Income Tax form) in order to record a Deed for the transfer of his property. When a non-resident sells the property, New Jersey will withhold this income tax in the amount of either 8.97 percent of the profit or 2 percent of the total selling price, whichever is higher. Therefore, even if the property is sold at a loss, tax must be withheld to fulfill the two percent requirement.

You Can Recover Your Money

It’s important to realize that while the Exit Tax requires a substantial withholding, it doesn’t have any impact on the tax liability. When the seller eventually files his NJ tax return he is refunded the difference between what was withheld and what was owed. This recovery can be very significant when one factors in the selling costs and original purchase price, both of which reduce the taxable gain.

Estates Often Recover Most if Not All of the Tax Withheld

The recovery is often even greater in the case of real estate sold by an estate, as there is a step up in cost basis which would typically minimize a gain on the sale, often resulting in full recovery of the entire withholding. If a taxpayer has excess withholding it would be prudent to file Form NJ1040 (individual) or NJ1041 (estate) quickly to expedite the recovery of the excess withholding. 

 So who’s considered a “resident” and who’s a “non-resident” with regard to this tax? The law defines a resident taxpayer as one of the following:

  • An individual who is and intends to continue to maintain a permanent place of abode (home, residence) in New Jersey on/after the day of transfer
  • An estate established under the laws of New Jersey
  • A trust established under the laws of New Jersey

A nonresident is simply defined as “any taxpayer that does not meet the definition of resident taxpayer.”

 

Tax Planning Tips for the new 3.8% Net Investment Income Surtax

With a new 3.8% tax on “unearned” income kicking in in 2013, it’s very difficult to limit your tax to just “ordinary” income tax. If your income is earned, you pay 15.3% Self-Employment (Social Security) tax. If your income is un-earned, you now have the new 3.8% Net Investment Income (NII) tax to pay.

Profits from an S corporation are just about the only income that escapes Self-Employment tax as well as the 3.8% NII tax. The S corporation is now an even more attractive form of entity to minimize taxes for owners of certain businesses, depending upon the facts and circumstances. After paying reasonable compensation to the owners, the remainder of the profits flow through to owner’s personal tax returns subject only to income tax, not Self-Employment or NII tax.

 There are several areas you can address to possibly reduce your overall tax. Is your “Reasonable Compensation” unreasonably high? If it is, you may be paying Social Security tax on that compensation unnecessarily. Even if you are over the Social Security wage limit ($113,700 in 2013) you still continue to pay the Medicare tax of 2.9% coupled with the new 0.9% Medicare surcharge for high-wage earnings totaling 3.8%. Find out what is the standard of executive compensation for companies of your size, industry niche and profitability. Continue Reading »

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