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Domestic Partners: Do it New Jersey’s way or NJ says, “No Way”

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The Tax Court ruled against a plaintiff that claimed she was a domestic partner of the decedents and exempt from Inheritance Tax as a Class A beneficiary. The Story:
Claudette Lugano and Armin Lovi lived together from at least 2003 until his death in 2011. They had filed a Declaration of Domestic Partnership with the Federal Reserve Bank (FRB) but not an Affidavit of Domestic Partnership with any local registrar as required by NJ law per the provisions of the Domestic Partnership Act.
Because they had filed with the FRB, she was entitled to benefits under their retirement plan. However, NJ refused to treat her as a Class A beneficiary and to exempt her from NJ Inheritance Tax.

Bottom line; She’s a domestic partner as far as the Federal Reserve Bank is concerned but not for NJ purposes.

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Creative Advanced Divorce Tax Tip – Monetizing NOLs

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All family law attorneys understand the basics of income taxation as it relates to a marital dissolution: Alimony is taxable to the recipient and deductible by the payor and child support is not taxable.

In complex cases with closely held businesses, it’s important the attorney (or an expert) review not only the business tax returns, but, the personal income tax returns as well.

If one spouse owns all or part of a pass-through entity such as a Subchapter S or Partnership, there may be hidden assets not usually found on the marital balance sheet. Those assets are called Net Operating Losses (NOLs) carry-forwards.

Taxpayers can carry back these losses two years (and get refunds) and/or elect to carry them forward against future income. (NOLs can be carried forward twenty years.)

Well, guess what? When assets are split, the NOLs travel with the business owner. And, assuming its material, they have a value which needs to be monetized. Why does it have value? Because it will save the business owner spouse $ X amount of taxes over the next twenty (or less).

A very, very simple example. The couple divorces and a $1,000,000 NOL travels with the husband. (No you can’t split the NOL) The non-titled spouse’s lawyer never thought to monetize the NOL (or even the expert CPA, who is a generalist without matrimonial litigation experience).

Two years after the divorce the company turns around and the owner spouse has income of $200,000. Pick your bracket, whether it’s 28% or 35% or 40% (I rounded.). The NOL was could be worth somewhere between $56,000 and $80,000. Three years after the divorce, the owner spouse has income of $200,000. Another $56,000 to $80,000. You get the picture. What if all the NOL is used? That can be a savings of possibly as much $400,000.

Failure to monetize this asset and award the non-titled spouse an off-set, can be the basis of a malpractice suit!

New Options for Foreign Bank Account Owners

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What is the Offshore Voluntary Disclosure Program?
Since 2009, the IRS has announced various initiatives for taxpayers with unreported foreign assets. The Offshore Voluntary Disclosure Program (OVDP) requires filing 8 years amended tax returns and 8 years of Foreign Bank Account Reports (FBAR). In addition to paying 8 years of taxes, taxpayers must pay a 20% “accuracy” penalty on the tax plus interest. Taxpayers must also pay a 27 ½ % “FBAR-related” penalty on the highest balance of their foreign assets in the 8 year period (includes investments other than bank accounts).

What are the Changes?
On June 18, 2014 the IRS announced major changes to the OVDP which results in three possible “routes”: First, U.S. residents who did not report foreign income or assets but who certify that their non-compliance was not “willful”, do not need to enter the OVDP, but are now able to address the issue by filing only 3 years amended returns and 6 years of FBARs. No income tax penalty and only a 5% “FBAR-related” penalty are due.

Second, those who cannot certify that their non-compliance was not “willful” can still join the OVDP. The June 2014 changes create a third category of those who enter the program after it becomes public that their foreign bank is under investigation by the IRS or Dept. of Justice. For these taxpayers, the June 2014 changes increase the 27 ½ % penalty to 50% of the highest balance (of the taxpayer’s foreign assets during the preceding 8 years). This 50% penalty can be avoided only by completing the detailed preclearance filing procedures before August 3, 2014.
For those who can’t certify non-willful non-compliance, the OVDP is the only way to cap their civil tax exposure and to avoid criminal prosecution and possible jail time.

What are the Risks?
For those who choose to certify that their non-compliance was not “willful”, be aware that there is NO protection against criminal prosecution if the IRS finds the Taxpayer’s certification of non-willful conduct not to be true. Furthermore, the taxpayer will then be considered ineligible to participate in the OVDP.

What Should I Do Now?
Taxpayers need to ask themselves some hard questions in order to determine if they are eligible to claim that their non-compliance was “non-willful”. Non-willful conduct is defined by the IRS as conduct that is due to negligence, inadvertence or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

Time is Running Out
The 2014 OVDP does not have a final end date. However, the IRS has reserved the right to end the program at any time. We work with several law firms who specialize in this area. Together with your legal counsel we can help you evaluate the most suitable alternative.

Israel now Taxing US Trusts with Israeli Beneficiaries

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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

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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.