Tax Relief Blog

Estate not taxed on transfer of decedent's pension to charitable beneficiary PLR 200845029

IRS has privately ruled that an estate will not be taxed on a distribution of the decedent's pension benefits to a charitable beneficiary of the estate.

Facts. An individual, whom we'll call, Smith, died owning an interest in a defined benefit pension plan (the Plan Interest) of which his estate (Estate) was the beneficiary. His will (Will) named Charity as a residuary beneficiary. The executor of Estate proposes to assign the benefit of the Plan Interest to Charity in partial satisfaction of Charity's share of the residue. The Will gave the executor the power to distribute property in kind and state law further allows distributions in kind without any requirement that they be made on a pro-rata basis.

Background. Income earned by an individual before death that isn't included on his final return because of his accounting method (usually income that has been earned or accrued but hasn't been actually or constructively received by a cash method taxpayer) is known as income in respect of a decedent or IRD. A decedent's IRD must be reported, for the tax year when received, by:

• the decedent's estate, if it acquired the right to receive the item of income from the decedent;
• the person who, by reason of the decedent's death, acquires the right to the income whenever this right isn't acquired by the decedent's estate from the decedent; or
• the person who acquires the right from the decedent by bequest, devise or inheritance, if the amount is received after distribution by the decedent's estate of the right to the income. (Code Sec. 691(a)(1))

If the estate of a decedent or any person transmits the right to IRD to another who would be required by Code Sec. 691(a)(1) to include such income when received in his gross income, only the transferee will include such income when received in his gross income. In this situation, a transfer within the meaning of Code Sec. 691(a)(2) has not occurred. (Reg. § 1.691(a)-4(b))

Under Reg. § 1.691(a)-4(b), if a right to IRD is transferred by an estate to a specific or residuary legatee, only the specific or residuary legatee must include such income in gross income when received.

Favorable ruling. The ruling concluded that the assignment of the Plan Interest to Charity in partial satisfaction of its share of the residue of Estate won't be a transfer within the meaning of Code Sec. 691(a)(2). Thus, only Charity will include the amounts of IRD in the Plan Interest in its gross income when the distribution or distributions from the Plan Interest are received by Charity.

Observation: Thus, while the pension benefits are included in Charity's income, as a practical matter, since Charity is a tax-exempt entity, this means the pension benefits will escape tax.

Year-end tax planning client letter with checklist

As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill this year and possibly the next. Factors that compound the challenge include the stock market's swoon, the difficult economic climate we're in right now, and the strong possibility that there will be tax changes in the works next year. In fact, there might even be another economic stimulus package carrying tax changes enacted before the end of this year.

The indisputably good news we are certain of is that Congress has acted to "patch" the AMT problem for 2008, has retroactively reinstated a number of tax breaks (such as the option to deduct state and local general sales tax instead of state and local income tax and the above-the-line deduction for higher education expenses), and has created new tax breaks that go into effect for the 2008 tax year (including a tax credit for first-time homebuyers, a nonitemizers' deduction for state and local property tax and a nonitemizers' deduction for certain disaster losses). For 2008, businesses enjoy tax breaks such as a beefed-up expensing option and a 50% bonus first-year depreciation write-off for most machinery and equipment placed into service this year and a reinstated research credit.

We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax saving moves to make:

• Increase the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year. Don't forget you can set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.
• If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2008.
• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
• Postpone income until 2009 and accelerate deductions into 2008 to lower your 2008 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2008 that are phased out over varying levels of adjusted gross income (AGI). These include IRA and Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2008. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year.
• If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into Roth IRAs if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2008.
• It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2009.
• If you own an interest in a partnership or S corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.
• Consider using a credit card to prepay expenses that can generate deductions for this year.
• If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2008.
• Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding.
• You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
• Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2008, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
• If you are thinking of making energy saving improvements to your home, such as putting in extra insulation or installing energy saving windows, postpone your move until 2009. A credit of up to $500 may be available for such improvements if made next year (but not this year).
• Substantial tax credits are available for installing energy generating equipment (such as solar electric panels or solar hot water heaters) to your home. The credits are available whether you spend the money this year or next, but if you're installing solar electric property, and will be spending more than $6,667, the credit will be larger for expenses made in 2009 rather than 2008.
• If you are thinking of buying a hybrid vehicle eligible for a tax credit, check to see if it's eligible for the credit, and, if so, purchase it before year-end.
• You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
• Businesses should consider making expenditures that qualify for the up to $250,000 business property expensing option for assets bought and placed in service this year; the maximum expensing amount will drop to $133,000 for assets bought and placed in service next year (higher expensing amounts apply to certain specialized assets). Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus write-off generally won't be available next year (some exceptions apply, such as for businesses affected by Presidentially declared disasters).
• You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
• If you are self-employed and haven't done so yet, set up a self-employed retirement plan.
• You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $12,000 in 2008 to an unlimited number of individuals but you can't carry over unused exclusions from one year to the next.
• If you're thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
• If you are age 70 1/2 or older, own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings.
• If you are receiving Social Security benefits, there are a number of steps you can take to reduce or eliminate tax on your benefits.
• Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2008 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
• Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2009, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.

How businesses are affected by tax changes in the Emergency Economic Stabilization Act of 2008

As I'm sure you're aware, on Oct. 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). Although virtually all of the press coverage of this law has concentrated on its hotly debated $700 billion financial industry bailout plan, the legislation also contains scores of mostly beneficial tax changes for business.

Most of the new law's tax changes for business fall into one of these categories: tax changes that apply to a wide range of businesses; special tax breaks for disaster areas; and tax changes for specialized industries (there are numerous tax breaks relating to alternative energy production, but they are highly specialized and so not covered in this letter).

Tax breaks that apply to a wide range of businesses. The major news for business is that the research tax credit has been extended through 2009. The new law also makes a number of important changes in the way the research credit is calculated, effective for tax years beginning after 2008.

Other, widely applicable tax breaks for business include the following:

• The FUTA (Federal Unemployment Tax Act) tax rate had been scheduled to drop to 6% after 2008, but under the new law it will remain at 6.2% through 2009 and will drop to 6% for 2010 and later.
• For property placed in service after Aug. 31, 2008, the new law permits 50% first year bonus depreciation for qualified reuse and recycling property. In general, this is machinery and equipment (not including buildings or real estate), along with associated property, including software necessary to operate the equipment, which is used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials. This break is not limited to businesses in the recycling industry.
• A two year extension through 2009 of enhanced charitable contribution deduction rules for gifts of certain types of food inventory, and corporate gifts of book inventory or computer equipment to schools.
• A two year extension through 2009 for the tax break that allows expensing of qualified environmental remediation expenses, namely cleanup of hazardous substances (including petroleum products) at qualified contaminated sites.
• The deduction for energy efficient commercial building property has been extended so that it applies through 2013.
• For purchases after 2008 and before 2015, taxpayers will be able to claim a tax credit for electric drive motor vehicles.
• After 2008, companies will be able to give employees who commute by bicycle a $20 per month tax-free reimbursement for reasonable bicycle related expenses.

Here's a summary of the new relief provisions:

• Qualified disaster expenses, such as cleanup (removal of debris, demolition of structures) and repairs, may be expensed.
• A 5-year net operating loss (NOL) carryback applies instead of the usual 2-year carryback.
• The maximum amount of machinery and equipment that may be expensed under Section 179 is increased by up to $100,000 for qualifying assets, and the investment-based phaseout of the expensing deduction is increased by $600,000.
• A 50% first-year bonus depreciation allowance applies to most types of machinery and equipment bought to rehabilitate or replace damaged property. A number of conditions must be met, and certain types of property are excluded (including property eligible for the more widely applicable 50% first-year bonus depreciation allowance enacted as part of the Economic Stimulus Act of 2008).

Tax breaks for specialized industries. Tax breaks in the new law mainly benefiting specific industries include the following:

• Financial institutions--may treat post-2007 losses on Fannie Mae and Freddie Mac preferred stock as ordinary losses instead of capital losses; for tax years ending after Oct. 2, 2008, the $1 million deduction cap on compensation paid to certain top officers is reduced to $500,000 if the company participates in the federal government's "troubled assets relief program" (TARP); and the "golden parachute" deduction restrictions apply to severance payments to certain top executives of companies participating in TARP. Finally, for securities acquired after 2010 (later dates apply to some specialized securities), brokers will have to report the customer's adjusted basis in the security sold, and whether any gain or loss is short- or long-term.
• Farming--there's a 5-year quick depreciation writeoff for most farm machinery and equipment placed in service after 2008 and before 2010.
• Real estate, retailers, and restaurants--the 15-year depreciation writeoff for qualifying leasehold improvements and qualifying restaurant property has been extended through 2009. What's more, for property placed in service after 2008 and before 2010, (a) buildings as well as building improvements may qualify for the quick writeoff for restaurant property; and (b) the 15-year depreciation writeoff also applies to qualifying retail improvement property.
• Construction companies--the $2,000 tax credit for building energy efficient homes ($1 million for manufactured homes) has been extended to apply to homes acquired through 2009. Note that construction companies also may benefit indirectly from the extended and enhanced tax breaks for real estate, restaurants, and retailers.
• Film and TV--the option to expense up to $15 million of qualifying film and TV productions ($20 million if produced in certain low-income areas) is extended so that it applies for productions beginning before 2010; also, the qualified domestic production activities deduction has been liberalized in several ways for this industry, effective for tax years beginning after 2007.
• Motorsports racing--the short 7-year writeoff for land improvements and support facilities at motorsports entertainment complexes has been extended to apply for property placed in service before 2010.
• Oil and gas--there are three significant changes: (1) the otherwise available domestic production activities deduction for companies that have oil-related income will be reduced after 2009 (a complex reduction formula will apply); (2) the rule providing that percentage depletion from marginal oil and gas wells isn't limited to 100% of income from these properties is extended though 2009; and (3) the rules relating to foreign tax credits for the oil and gas industry have been revised for tax years beginning after 2008.
• Mining--the tax credit for mine rescue training and the election to expense 50% of the cost of certain mine safety equipment both have been extended so that they apply through 2009.

Timely reminder for small businesses to steer clear of trouble on payroll tax and retirement plan contributions IRS Employee Plan News (Fall 2008)

In these trying times, with cash scarce and credit hard to find, a small business might be tempted to "temporarily" use money it deducts for taxes and retirement plan contributions from employees' wages. The Fall 2008 issue of IRS's Employee Plans News [http://www.irs.gov/pub/irs-tege/fall08.pdf] suggests that practitioners remind clients that failing to remit payroll taxes and retirement plan contributions in a timely manner not only would violate an employer's legal obligation, but also could subject them to heavy penalties.

Payroll taxes. IRS suggests that small business employers be reminded that when they deduct income and Social Security taxes from employees' wages, the money is not theirs to use, even for a short period of time. Deducted amounts must be remitted, along with their portion of payroll taxes, by the next scheduled Federal Tax Deposit deadline. An employer that doesn't deposit the money on time could be hit with:

• penalties for making late deposits and for not depositing the proper amount; and
• penalties for failing to file returns and pay taxes when due, for filing false returns, and for submitting bad checks.

Observation: Perhaps the most compelling argument to make is that a company owner could be personally on the hook for unpaid payroll tax. Under Code Sec. 6672, when an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from any "responsible person," i.e., a person who (1) is responsible for collecting, accounting for and paying over payroll taxes and (2) willfully fails to perform this responsibility.

IRS seeks to return $266 million in undeliverable refunds and economic stimulus payments to taxpayers [IR 2008-123]:

More than 383,000 regular refund and economic stimulus checks have been returned by the U.S. Postal Service as undeliverable, IRS said on Oct. 23. This figure included 279,000 economic stimulus checks totaling $163 million and 104,000 regular refund checks totaling $103 million.

The problem is more urgent for those who have not received their economic stimulus checks which, by law, must be sent out by Dec. 31, IRS said. The agency is urging individuals who have not received the stimulus payment to check on the status of their payment immediately and, if necessary, update their addresses by Nov. 28.

This can be done by going to the "Where's My Stimulus Payment?" tool on the IRS Web site at http://www.irs.gov/individuals/article/0,,id=181665,00.html .

Individuals without Internet access should call (866) 234-2942.

Taxpayers who have not received their refund can check on its status by going to the "Where's My Refund?" tool at http://www.irs.gov/individuals/article/0,,id=96596,00.html .

As I'm sure you're aware, on Oct. 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). Although virtually all of the press coverage of this law has concentrated on its hotly debated $700 billion financial industry bailout plan, the legislation also contains scores of tax changes, mostly beneficial, for individuals and businesses alike.

Here's a brief review of the tax provisions individuals need to know about right now.

AMT relief: In general terms, to find out if you owe alternative minimum tax (AMT), you start with regular taxable income, modify it with various adjustments and preferences (such as addbacks for property and income tax deductions and dependency exemptions), and then subtract an exemption amount (which phases out at higher levels of income). The result is multiplied by an AMT tax rate of 26% or 28% to arrive at the tentative minimum tax. You pay the AMT only if the tentative minimum tax exceeds your regular tax bill. Although it was originally enacted to make sure that wealthy individuals did not escape paying taxes, the AMT has wound up ensnaring many middle-income taxpayers. One reason is that many of the tax figures (such as the tax brackets, standard deductions, and personal exemptions) used to arrive at your regular tax bill are adjusted for inflation, but the tax figures used to arrive at the AMT are not.

For 2008 only, the new law provides some relief. It increases the maximum AMT exemption amount over its 2007 level by $3,700 for married taxpayers filing joint returns, and by $1,850 for unmarried individuals and married persons filing separately. However, after 2008 the maximum AMT exemption amount will drop precipitously to where it was in the year 2000 unless Congress provides yet another fix.

Another provision in the new law provides AMT relief for those individuals claiming certain "nonrefundable" personal tax credits (such as the credit for dependent care and the Scholarship and Lifetime Learning credits). For 2008, these credits may offset an individual's regular tax and AMT. After 2008, unless Congress acts, these credits will be allowed only to the extent that an individual has regular income tax liability in excess of the tentative minimum tax.

The new law also liberalized the AMT refundable credit amount that was first enacted in 2006 to help taxpayers who were stung by the AMT as a result of exercising incentive stock options (ISOs). The changes are highly technical but their essence is that for tax years beginning after 2007: (1) eligible individuals may claim this credit more rapidly (i.e., over fewer years) than would have been the case without the change; and (2) the AMT refundable credit amount no longer phases out at higher levels of adjusted gross income (AGI). In addition, the new law wipes out any tax underpayments (plus interest & penalties) outstanding on Oct. 3, 2008, that are attributable to pre-2008 phantom ISO income under the AMT rules.

Retroactively resuscitated and extended tax breaks: All of the following tax breaks had expired at the end of last year. The new law retroactively resuscitates them so that they apply for 2008, and also extends them for one year so that they will apply for 2009 as well:

• The option to claim an itemized deduction for state and local general sales taxes instead of the itemized deduction for state and local income taxes.
• The above-the-line deduction for qualified tuition and related expenses for higher education paid during the tax year.
• The up-to-$250 eligible educator's above-the-line deduction for books, supplies, computer equipment, etc., used by him or her in the classroom.
• The up-to-$100,000 annual exclusion from gross income for taxpayers age 70 1/2 or older who make direct transfers of otherwise taxable individual retirement account (IRA) distributions to qualified charitable organizations.

Deductions for energy saving home improvements extended and expanded: Two tax credits are available for taxpayers who make energy saving improvements to residences. They've both been extended by the new law and expanded as well:

(1) A generous tax credit is available to individuals who add solar energy equipment or fuel-cell equipment (new technology that converts fuel into electricity using electromechanical methods, and meets other detailed requirements) to their residences. The new law extends this credit through 2016. It also liberalizes the credit in an important way: For 2008, you can claim a tax credit of 30% of the cost of equipment that uses solar energy to generate electricity (photovoltaic property), up to a $2,000 maximum tax credit. After 2008, there's no dollar limitation on the credit. For example, suppose you spend $8,000 buying and installing solar heating panels on your residence. If you make the improvement this year, you may claim a maximum credit of $2,000, but if you make the improvement next year, you may claim a credit of $2,400 (30% of $8,000).

Additionally, starting with 2008, the new law makes the credit available for more-exotic energy generating/retaining equipment: wind turbines; and geothermal heat pumps.

(2) For equipment installed before 2008, you could claim a credit for the cost of buying an assortment of energy saving improvements and installing them in your main home. The credit depends on the type of improvement (e.g., 10% of the cost of energy efficient building envelope components, such as insulation and windows, and an up to $150 credit for a natural gas, propane, or oil furnace or hot water boiler) and there's an overall $500 lifetime dollar limit for all improvements.

The new law does not extend this credit for qualifying equipment bought and installed in 2008, but it does make it available once again for qualifying equipment bought and installed in 2009. Also, for 2009, the new law makes the credit available for certain types of energy efficient biomass fuel stoves and certain types of energy saving asphalt roofs.

New tax relief for victims of Presidentially declared disasters: Individuals may deduct personal casualty losses (e.g., unreimbursed damage to a car due to a storm) or personal theft losses only if they exceed a $100 limit per casualty or theft and only to the extent these losses in the aggregate exceed 10% of adjusted gross income (AGI). If the disaster occurs in a Presidentially declared disaster area, an individual may elect to take into account the casualty loss in the year immediately preceding the year in which the disaster occurs. Before 2008, only itemizers could deduct casualty losses.

The new law waives the 10%-of-AGI limit for victims of disasters declared to be federal disasters in 2008 and 2009, plus, for these years, permits nonitemizers to claim a deduction for federal disaster losses. However, for 2009 only, the new law boosts the $100 per casualty limit to $500 (which will have the effect of reducing deductions).

The new law also gives a number of extra tax breaks to victims of the storms and hurricanes that pummeled ten Midwest states during 2008.

More detailed reporting of securities transactions - after 2010: Stock brokers must file an information return (Form 1099-B) for securities transactions they handle. Currently, brokers report the name and address of the customer, when the sale took place, what was sold, and the gross proceeds of the sale. Starting with stocks (as well as bonds and several other financial instruments) bought after 2010 (a later date applies to some specialized securities), brokers will have to report the customer's adjusted basis (essentially cost for tax purposes) and whether a gain or loss on the transaction was short- or long-term.

This new information reporting requirement is designed to boost IRS's compliance efforts (e.g., help assure taxpayers properly report their gains and losses).

Please keep in mind that I've described only the highlights of how the new law affects you. If you would like more details, please call me at your convenience.