This area of the law has taken on greater importance as the IRS has now begun an aggressive campaign in auditing taxpayers for gifts of real estate interests.  This is a must read for anyone contemplating a gift or death-bed transfer of real estate as well as real estate agents and real estate attorneys recommending gifting real estate.  Without insight into the gift and income tax implications huge tax mistakes may result.  

Bottom Line:  Before making any gift taxpayers would be well served  to discuss this strategy with their tax attorney or tax accountant to see if it really makes practical, financial and tax sense in your particular situation. 

The Internal Revenue Service announced on February 8, 2011 a special voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes.  Here are some of the basic provisions of this program.

This second new voluntary disclosure initiative will be available to taxpayers through Aug. 31, 2011.

The retirement plan laws have always required that plans be updated for tax law changes.  Before 2003, the IRS allowed plans to be periodically restated for tax law changes that occurred over many years.  This resulted in large, periodic major plan restatements.  However, since 2003 the IRS has required amendments to retirement plans for each new tax law resulting in more frequent “interim amendments.”  [For those of you interested in a more detailed discussion of these required interim amendments since 2003, please go to my questions answered at my Linked-In profile.]  For many plans, the deadlines for many of these plan restatements or interim amendments have now expired.  Current rules provide that plans that have not been redrafted to comply with required prior restatements or interim amendments cease to be qualified as of their applicable deadlines.

In the worst case scenario, the IRS may demand that the plan be retroactively disqualified.  If the IRS is successful in disqualifying the plan, the plan sponsor’s tax deductions for contributions taken in the year of disqualification and in later years would be disallowed.  The taxes owed by the plan sponsor due to the disallowance of previously claimed retirement plan deductions plus applicable interest and penalties could be enormous.  In addition, participants of the plan would have to treat as taxable income the value of their plan account as of the date of such disqualification.  The taxes, interest and penalties to the participants from the date of plan disqualification could be equally exorbitant. This would be a truly disastrous and harsh result for both the employer plan sponsor and participants in the disqualified plan.

However, in most cases, the current policy of the IRS is to impose monetary penalties instead of the more severe penalty of plan disqualification.  Even so, when the IRS raises these failures as the result of an audit the penalties can be quite severe.   Penalties can range from $2,500 to $80,000 depending on the failures involved and the size of the plan.  It is worth noting that in recent years, the IRS has increased its auditing of retirement plans.

 Here is Good News: How to Solve This Looming Problem 

The IRS has a voluntary remedial program called the VCP (voluntary compliance program) to correct these plan document deficiencies.  The IRS position is that retirement plans may be re-qualified only by having the plan sponsor voluntarily come forward before an IRS audit by submitting the newly drafted delinquent restatements and/or interim amendments to the IRS in accordance with some very detailed procedures and documentation pursuant to Revenue Procedure 2008-50.  Once the IRS reviews and hopefully approves the application and the newly drafted required documentation, the plan is deemed to be in full compliance with applicable law and such plan is retroactively tax qualified.

Instead of paying a steep monetary penalty, the VCP submission results in the paying of a filing fee to the IRS.  Sometimes, if the violation is quite limited the filing fee can be as low as $375.  (Remember, you will still need to pay for documentation services associated with plan restatements and interim amendments.  However, these costs would have been incurred in any event to keep your plan in full compliance with the law.)  The important point here is that the use of the VCP program avoids the risk of plan disqualification or the imposition of a large monetary penalty.

 How We Can Help:

Numerous VCP program applications under the applicable Revenue Procedure 2008-50 have been submitted by this office.  This application along with the needed plan restatements and interim amendments must be carefully drafted to ensure efficient negotiations and a successful outcome with the IRS.

The Bottom Line:

Plan sponsors should immediately and voluntarily move to correct plan deficiencies pursuant to the more taxpayer friendly and cheaper VCP program before the IRS audits your plan.  Once the IRS commences an audit, the VCP submission strategy is no longer an option and your plan is exposed to disqualification and/or severe monetary penalties.

Looking forward, you must establish a program with your plan adviser to ensure that your plan is kept in compliance with the laws concerning plan restatements, interim amendments and the changing IRS submission requirements and deadlines.  This will avoid having to deal with all of these problems again in the future.  In fact, the Revenue Procedure requires a disclosure in the VCP application as to what new procedures the plan sponsors will use to avoid this problem in the future.

 Do Not Wait

Do not wait for the IRS to audit your retirement plan as it then will be too late to get the cheaper and less painful VCP deal.  For a free initial consult to assess your retirement plan situation, please do not hesitate to call me, Steven J. Fromm, Esquire at 215-735-2336.  All consultations are confidential and covered by attorney-client privilege.

Copyright © 2009, Steven J. Fromm

Many of us procrastinate, minimize our personal need or the legal importance of drafting wills, trusts, living wills, and durable powers of attorney. The complexities of combining and coordinating diverse assets such as individual assets, jointly held assets, retirement plans, life insurance, annuities and business interests seem just too daunting for some. For others, they do not realize the importance of looking at all of their assets from an overall perspective; namely, when all is said and done who ends up with what.  Is the division of assets fair and equitable to all concerned after the payment of taxes, debts and estate administration costs?

For many, Michael Jackson’s untimely death has raised these and many other estate planning issues. At this point, no one knows whether he had a will and/or trust for his kids, or whether his estate plan was up to date. But by looking at his situation (and speculating a bit), some important estate planning considerations for the rest of us can be explored:

Guardianship: It is unclear what provisions Mr. Jackson had in his will (assuming there is a valid will) for his children. The early word from the media is that this will be a messy battle in the courts over the issue of guardianship of his children, even if his will indicated his preference for guardian.  Even if  challenged, the designation of guardian in a will would still be a very significant factor in any court challenge and laying out your wishes is always a prudent thing to do in any event.  The object lesson is clear: Parents with young children clearly should see the need for a will that indicates their choice of guardian for their children.

Trusts: No one knows whether Mr. Jackson had set up trusts for his children. Although it appears that his estate is now insolvent, this situation will probably change with post-mortem sales of his music someday providing assets and wealth for his children (think after-death income of the Elvis Presley estate).  Hopefully, he set up trusts that will protect and manage his assets.  To increase the possibilities of becoming competent adults, perhaps he drafted provisions in his trust in a way that develops their sense of personal initiative and responsibility yet still provides for their basic needs.  Experienced estate planning attorneys explore this type of forward looking planning when it comes to dealing with children and their anticipated needs if parents die prematurely.

Specific Bequests: The media has speculated that a very large asset of his estate (his Beatles song rights) was gifted to Paul McCartney. This generosity may be commendable, but from an estate planning perspective this bequest may raise problems. First, if his estate is in fact insolvent, this bequeathed asset would not be available to his estate to be sold and the proceeds used to pay down estate debts and/or benefit his children. Secondly, generally, bequests like these are often times given in a way that they bear no estate taxes. This could distort how the assets are divided between beneficiaries. The point here is that this bequest may have made sense when the will was originally drafted when Mr. Jackson was wealthy, but this bequest could be quite problematic in the current situation. The lesson here is that an estate plan needs to be looked at periodically as the family needs and financial situations change over time.

Special Needs Trusts: Farrah Fawcett died leaving a son who is in jail with addiction problems. The issues for people with children with special needs is often minimized, overlooked or not fully considered. As her only child, did she leave all of her wealth to her son? Did her will provide that he was to get his inheritance at her death or did she provide for a trust for his benefit? If she established a trust, what kind of provisions and conditions did she make in providing benefits to him? These tough questions arise not only for children with addiction issues, but for children with cognitive impairments, physical disabilities and emotional issues.  In addition, special needs trusts may be required where children are receiving public assistance from state and local governments.

The Bottom Line: Protect your family and protect your hard earned wealth. Spend the time to plan your affairs with an experienced estate planning attorney.  Remember, if you die without a will and trust, your state intestacy laws will control who will get your assets and how they get your assets. When young children are involved, courts generally place the children’s inheritances in trust in accordance with what a judge deems appropriate.  In addition, the judge will determine who will be the trustee of any trust they impose on your children and they will determine who should be the guardian of your children. These and other important considerations should be determined by you and not by a court of law, so do it and do it now so you do not leave problems like the ones Michael Jackson and Farrah Fawcett may have left behind.

© Steven J. Fromm, 2009

For example, some businesses have senior family members who own all or most of the shares of the outstanding stock of their corporation.  With the value of the business being down right now, more shares could be gifted to younger family members involved in the business.

Example:  Mr. Senior owns 80% of Deflated, Inc., while his two sons who work in the business own 10% each.  Deflated was worth $3,000,000 in 2007.  By the end of 2008, it was worth $2,500,000.  Mr. Senior talks to tax counsel and after exploring the tax strategies and planning tools discussed below decides to gift 20% of his shares worth $500,000 to each of his sons, leaving him with a 40% stock interest.

The tax advantages are as follows:

1.  The stock gifted to each son was previously worth $600,000. The current market value of such stock to each son is now only $500,000.  If Deflated, Inc. goes back to its value once the economy recovers, then Mr. Senior has just transferred $200,000 ($100,000 to each son) to his sons estate and gift tax free.  At a current marginal estate tax rate of 45%, Mr. Senior’s family can save $90,000 (45%*$200,000).

2.  The gifts to each son are gifts of a minority interest in Deflated, Inc. and such gifts lack marketability due to the limited market for such shares.  Estate and gift tax rules allow discounts for these factors that reduce the value of assets transferred.  (Caveat: There are some legislative proposals being floated in Washington seeking to limit this tax strategy. Stay tuned.) These discounts for minority interests and lack of marketability conservatively can be 25%, sometimes more.   With such discounts the gift of each $500,000 is reduced by $125,000. At a current marginal estate tax rate of 45%, Mr. Senior’s family can save another $112,500 (45%*$250,000).

3.  Outright gifts of stock are eligible for the annual donee exclusion of $13,000.  In addition, Mr. Senior has a spouse who will join in this gift, which will allow for a second $13,000 exclusion.  So the taxable gift to each son is now reduced by $26,000 (Mr. Senior’s annual exclusion of  $13,000 and his spousal joinder of another $13,000).  Additional savings to the family is $23,400 (45%*26,000*2 sons).

4.  If Mr. Senior makes no further gifts and dies with his reduced ownership interest of 40%,  his estate can claim the minority interest and lack of marketability discounts against his remaining shares.  If Mr. Senior dies in 2014, when deflated is worth $4,000,000, his family can take a 25% lack of marketability/minority interest discount, saving his family another $180,000 (45%*$400,000 marketability/minority interest discount[$1,600,000 forty-percent interest*25%]).

Bottom Line:  Mr. Senior can take advantage of the lousy economy, the lack of marketability and minority interest discounts and the annual donee exclusions with a spousal joinder to save his family a tremendous amount of future estate and inheritance taxes.

Caveat:  Remember that this type of planning depends on the particular factual setting of each client.  One difference in the facts can change the outcome.  Also, be aware that state inheritance taxes have not been considered in the above example.  Finally, the above should not be considered as legal advice.  Please consult with tax counsel to discuss your particular factual situation.

Copyright © 2009, Steven J. Fromm.