THE GLOBAL FOODBANKING NETWORK

TONI DIPRIZIO, ENGAGEMENT PARTNER CANNY CHEN, AUDIT MANAGER

Preparing your 2012 Income Tax ReturnTips and Traps

My Best Tax Planning Ideas in 2016“A few of my favorite things” – The Sound of Music

 

BRIAN T. WHITLOCK CPA, JD, LLMTAX PARTNER

SIMPLE INCOME TAX PLANNING1) IRA Conversion to ROTH

2) Section 529

3) Non-Grantor CLAT

STRAIGHT FORWARD ESTATE PLANNING4) ILITs (Crummey/Cristofani vs. Fully Funded)

5) Spousal Lifetime Access Trust

6) Working with IDIOTs

7) Split Interest Purchase

PLANNING FOR THE NIIT8) Where and how you invest? Plus the Personal Holding Company = M1

9) Shifting the focus of the Material Participation Rules

BUSINESS IDEAS10) Unfunded Non-Qualified Deferred Compensation

11) Unfunded Death Benefit Plan

12) Section 104 Income Injury Exclusion

13) Interest Charge –Domestic International Sales Corporation

Things You Should Know

Higher Individual Rates change the Game

• Marginal Income Tax Rates Married Filing Joint (MFJ) (indexed for inflation)Calendar Year 2016•- up to $ 18,550…………………10%•- $18,550 to $ 75,300…………..15%•- $75,300 to $151,900…………..25%•- $151,900 to $231,450…………28%•- $231,450 to $413,350…………33% (plus NIIT)•- $413,350 to $466,950…………35% (plus NIIT)•- over $466,950 ………………….39.6% (plus NIIT)

• Net Investment Income Tax (NIIT) - 3.8% if MAGI above $200,000 (single)/$250,000 (MFJ) 3.8% Obamacare Excise Tax on Investment Income for Even Middle Class

• Pease Amendment – Itemized deductions phased out at 3% of AGI in excess of $311,300 in 2016Itemized Deductions are limited for Middle Class

• State Income Tax Rates• Illinois Income Tax Rate – 5%• Top California Income Tax Rate = 13.3% over $500k Single; over $1 million MFJ

All Income Tax Rates are Higher

CONTRIBUTION LIMITSIn 2015 and 2016, you can contribute $5,500 ($6,500 if you are over 50 years of age) to a Traditional IRA if you have earned income in that amount.

DEDUCTION LIMITSYou can deduct the amount of the contribution made to a traditional IRA (or make a contribution to ROTH IRA) if your MAGI under $61,000 for 2015 and 2016 (single or Head of Household) or $98,000 if Married filing Joint and neither you nor your spouse participate in another qualified pension plan. Deductions are phased out above the limits.

NONDEDUCTIBLE CONTRIBUTIONS TO TRADITIONAL IRAs and CONVERSIONSYou can make non-deductible IRA contributions, without any MAGI limitation, if you have earned income of at least the amount contributed. Similarly, there are MAGI limitations on the conversion of an traditional IRA to a ROTH IRA.

CONVERSIONSWhen converting a Traditional IRA to ROTH you must pay tax on the difference between the FMV of the account converted less the tax basis of amount converted. CAUTION: Your Basis in the converted account may be diluted if you have other IRAs or ROLLOVER IRAs.

ROTH IRAs

PAYING FOR COLLEGESection 529 Accounts are a great way to save for college, but even if they are underfunded, if you pay for tuition using the 529 as an intermediary you save.

STATE OF ILLINOIS BRIGHT START PLAN• Illinois allows you to deduct $10,000 that is deposited in a Bright Start Account

• There is no minimum period that the funds must remain in the account

• $10,000 contributed on January 1 can be used to pay a portion of the tuition bill and a deduction of $10,000 may be claimed on IL-1040 = Savings $500

Section 529s

Non-Grantor Type Charitable Lead Trust (CLAT)

STEP 1: Gift assets to trust

CHARITY• IRREVOCABLE TRUST• NET INCOME AND CAPITAL GAINS ARE

TAXABLE TO TRUST, BUT TRUST GETS DEDUCTION FOR CURRENT CHARITABLE DISTRIBUTION

• PV OF REMAINDER INTEREST IS A GIFT OF A FUTURE INTEREST MAY USE GIFT/ESTATE TAX CREDIT

• CAVEAT: GST MAY NOT BE ALLOCATED TO GIFT OF REMAINDER

CLAT

STEP 2: Distribute required amounts to charity

REMAINDER BENEFICIARIES(OUTRIGHT OR IN TRUST) IF REMAINDER

BENEFICIARY IS PERSON OTHER THAN THE DONOR THEN GIFT

GIFT TAX IMPACT

FMV OF THE TRANSFERRED ASSETS- PV OF ANNUITY INCOME STREAM= GIFT OF A “FUTURE” INTEREST

INCOME TAX IMPACT

INCOME IS EXCLUDED FROM DONOR IRS FORM 1040 AND

STATE INCOME TAX

STEP 3: Upon termination, the remainder beneficiaries receive the balance of assets

INCOME TAX DEDUCTION NONE

NON-GRANTOR CLATs do not produce an individual Income Tax deduction for the Grantor/creator of the trust

NON-GRANTOR CLATs permits the creator of the trust to fund charitable gifts with “Pre-Tax Income”

Using Pre-Tax Income is more efficient then using taxable income and trying to offset the income with a deduction.

• Charitable deductions do not reduce NII

• Charitable deductions do not reduce State Taxable Income

• Charitable deductions are be limited by a % of AGI

• All deductions are phased out when AGI is more than $311,300

• Personal Exemptions are phased out for high income taxpayers.

Similar to Charitable contributions made from an IRA, Flexible Spending Accounts (FSA) for Medical Premiums and Childcare, or HSA for Medical Expenses

Income Tax Benefits of Non-Grantor CLATs

Example: Josephine has $350,000 of income. $100,000 is from interest, dividends, and rents. She gives $30,000 to charity each year.

The charitable gift do not reduce her 3.8% NII, or her 5% Illinois Income Tax in addition she loses $900 of itemized deductions and a portion of the personal exemptions for herself and her husband.

• Josephine transferred income producing assets into a CLAT that will receive $30,000 of investment income and transfer $30,000 to her Donor Advised Fund or various charities.

• The remainder interest in the CLAT passes to Josephine’s husband at the end of 5 years.

No gift and estate tax savings since the remainder passes to spouse, but

NOTE: Income tax savings = 10% or over $3,000 per year for 5 years = $15,000 by using pre-tax dollars instead of tax deductible dollars.

Income Tax Benefits of Non-Grantor CLATs

Irrevocable Life Insurance Trust (Super Trust)

STEP 1: Gift premium $ to trustAnnual Exclusion requires Crummey/CristofaniDONOR

• Irrevocable trust

• Trust is owner and beneficiary of Life Insurance Policies

• Net income and principal to Donor’s spouse (and Donor’s descendants if desired), at trustee discretion, for health education, maintenance, and support

• Testamentary Limited Power of Appointment for Donor’s spouse

• Upon spouse’s passing, unappointed assets are distributed outright or held in separate trusts for Donor’s descendants

ILIT

STEP 2: Trustee pays insurance premiumsDonor’s spouse can be the Trustee, but distributions should be limited to health, education, maintenance, and support.

DONOR’S BENEFICIARIES(OUTRIGHT OR IN TRUST)

GIFT AND ESTATE TAX

Donor may utilize lifetime exemption and may utilize

generation skipping transfer tax exemption for

transfer; gift tax return may be required

INCOME TAXTrust will be considered a

grantor trust for income tax

purposes, therefore all income will flow

through donor’s 1040

STEP 3: Upon the death of the Donor’s spouse, Insurance proceeds are not included in the estate of the Donor’s spouse for estate tax purposes.

The Donor’s beneficiaries receive the balance of assets.

Spousal Lifetime Access Trust (SLAT)

STEP 1: Gift major assets to trustUse portion of unified credit to move more DONOR

• Irrevocable trust

• Can purchase insurance, but can also hold other assets CONSIDER OVERFUNDING

• Net income and principal to Donor’s spouse (and Donor’s descendants if desired), at trustee discretion, for health education, maintenance, and support

• Testamentary Limited Power of Appointment for Donor’s spouse

• Upon spouse’s passing, unappointed assets are distributed outright or held in separate trusts for Donor’s descendants

SLAT

STEP 2: Trustee can make discretionary distributions of income and principal to the Donor’s spouse and Donor’s descendants if desired.

Donor’s spouse can be the Trustee, but distributions should be limited to health, education, maintenance, and support.

DONOR’S BENEFICIARIES(OUTRIGHT OR IN TRUST)

GIFT AND ESTATE TAX

Donor may utilize lifetime exemption and may utilize

generation skipping transfer tax exemption for

transfer; gift tax return may be required

INCOME TAXTrust will be considered a

grantor trust for income tax

purposes, therefore all income will flow

through donor’s 1040

STEP 3: Upon the death of the Donor’s spouse, the assets are not included in the estate of the Donor’s spouse for estate tax purposes.

The Donor’s beneficiaries receive the balance of assets.

Intentionally Defective Income Only Trusts - IDIOTs Similar to SLAT but with additional Leverage Grantor Retains Powers under Section 671 – 677 which are not included Section 2032 - 2044Sale of Stock to Intentionally Defective Income only Trust (IDIOT) Rev. Rul. 85-13Leveraged gifting vehicles – Take advantage of Low interest rates [Rev. Rul. 2016-1]

• Short Term interest rate - .75 for January 2016• Mid Term interest rate—1.81% for January 2016• Long Term interest rate – 2.65% for January 2016• Section 7520 rate – 2.2% for January 2016• Low to moderate risk for gift tax purposes for shareholders• Generation Skipping Tax is easier avoid with IDIOT

•Example – Shareholder transfers 10% of the nonvoting stock of a closely held S Corporation worth $5 million to an irrevocable trust that is treated as a Grantor Type Trust for Income tax purposes. If structured as a gift it would use up $5 Million of gift and estate tax credit equivalent. If structured as a sale in exchange for a $5 million note with interest payable at 1.81% that would balloon in the 9th year, no credit is used. Payments of interest and principal can be made using S Corporation distributions. After the note is paid in full, the stock would be inside of the trust for the benefit of the shareholder’s family. When the shareholder dies, the value of the nonvoting stock would escape gift and estate tax.

Push the envelope? Consider a SCIN or a Private Annuity

IntentionallyDefectiveIncome OnlyTrust(for benefit of family)

Grantor

Gift or Sell Income Producing Asset

1) Note with market rate of interest;2) SCIN with a premium; or 3) Private Annuity

Intentionally Defective Income Only Trust (IDIOT)

Note: Seed money required. The IDIOT should have a net worth before the sale of approximately 10% of the value of the assets being transferred by sale in order to avoid IRC Section 2036 claim that the grantor had a retained interest in the assets sold.

Split Interest Purchase of ResidenceThe FactsJack (70) and Jill (68) previously created an IDIOT their kids and grandkids, and they gifted a large amount of assets to the IDIOT in 2016 when it looked as if the $5 million exemption might disappear.

They want to purchase a $5 million residence in Lake Geneva. They have heard about Qualified Personal Residence Trusts but they are not interested in the concept of paying rent to their kids some day.

The StrategyInstead of either party purchasing the entire interest, the Jack, Jill and the idiot could each purchase a split interest in the real estate. Jack and Jill purchase the right to live in the residence and the IDIOT purchase the right to get 100% at the death of the survivor of Jack and Jill.

According to the 1990 Census and the Required Minimum Distribution regulations they have a joint life expectancy of between 18.4 and 22.7years. Jack and Jill would need to pay roughly $1,800,000 and the IDIOT would pay $3,200,000.

The ResultThe life estate is a wasting asset at the death of the survivor “Nothing” is included in the estate of the surviving spouse. $1,800,000 transfers estate tax free.

Manage Investment Goals with directed investments• Retirement - Save inside of Qualified Plans, IRAs, Roth IRAs• Education – Save inside of §529

Convert investment income to self-employment income (Schedule C)• Offset with contributions to Qualified Plans, IRAs, Roth IRAs• If already in excess of FICA limits - SE income is only being subjected to the Medicare Tax and

the Additional Medicare Tax

• BENEFIT: 50% of the SE tax would be deductible for income tax purposes

Personal Holding Companies – C Corporation• “Every Person is entitled to one good dog and one good C Corporation” – Blackman• C Corporations are not subject to NIIT but be careful

o Appreciating assets should not be owned by C Corporationo Portfolio investments and family loans as corporate assets

• WATCH FOR TAX TRAPS: • IRC §269 - Principal Purpose to Avoid Income Tax [Note: IRC §1411 is part of

Subtitle A – Income Taxes]• IRC §351(e) - Transfer of appreciated assets to an investment company =

recognition of gain

Avoiding the NIITPlanning for Individuals

Mastering the Trust Rules will save $$$$$

1) Who must satisfy the Trust Material Participation Test?• Grantor Trusts = Grantor

• (Sections 671 through 679 of the Internal Revenue Code)• Qualified Subchapter S Trust (QSST) Trusts = Beneficiary• Non-Grantor Trust (Complex Trust or ESBT) = Trustee

2) Can I change the taxable character of the Trust?• Convert Grantor Trust to a Non-Grantor Trust? Terminate Grantor Powers• Convert Non-Grantor Trust to a Grantor Trust? Make a Loan to the Grantor

• Convert a QSST to an ESBT? File ESBT Election

Avoiding the NIIT

15

Planning for Trusts

Unfunded NQDCDesign Variables for Non-Qualified Deferred Compensation•Age of Beneficiaries

•Amount and Number of Payments

• Interest Rate

Tax Characteristics of Payments•Estate Taxes

• Only Payments required after Death will be an Estate Asset

•Income Taxes• Deductible to Business and Taxable to Employee• Income in Respect of a Decedent, if payments survive death

•FICA and MHIT Taxes• Compensation for Past Services – Taxable when paid• Compensation for Present and Future Services – Taxable when earned and vested• KEY: If earned and vested year when compensation is above FICA limit only subject to MHIT.

Non-Qualified Plan Examples

Description Funded Public/Private FundingCash Bonus Plans No Both Not required

Secular and Rabbi Trusts

Yes Both Yes

Unfunded NQDC No Private Employer Liability

NQ Stock Options No Public Quasi

Stock Appreciation Rights

No Both Employer Liability

Phantom Stock No Private Employer Liabiltiy

Death Benefit Both Both Not required

Life Insurance Yes Both Yes

Long Term Care Insurance

Yes Both Yes

NQDC: Funded vs. Unfunded

Plan Type Coverage Taxation of Benefits

ERISA Creditor Protection

Unfunded Limited to select group of management or highly compensated employees

Benefits generally taxed when paid

Very limited application

Benefits subject to claims of employer’s creditors

Funded Any employee may be covered

Benefits generally taxed when vested

ERISA applies

Benefits protected from employer’s creditors

• Benefits subject to Payroll Tax as earned and vested• Prepay MHIT Tax

• Benefits not subject to income tax until received• Watch out for Section 409A

• Benefits not subject to second payroll tax when paid• FICA savings offsets early payment of MHIT in 2 ½ years

• If benefits paid for term certain, then unpaid balance is includable in estate and income taxable as IRD

• If benefits terminate at death, like an annuity, then nothing is includable in estate and no IRD

Unfunded NQDC For Owner

(1) The Death Benefit exclusion only applies to benefits paid under a life insurance contract (2) Exclusion does not apply to self funded Death Benefits (DBO Plans). However, a death benefit only plan (also called “survivors benefit”) is excluded from estate tax. Estate of Anthony F. DiMarco v. Comm., 87 TC 653 (1986), 7 EBC 2239, acq. in result in part 1990-2 CB 1; Rev. Rul. 92-68, 1992-2 C.B. 257.

Example: Under a DBO Plan, Company pays cash to the designated beneficiary of the employee. This amount is deductible to the company as compensation, and subject to income tax in the hands of the recipient. However, it is exempt from payroll taxes and estate tax.

Section 101 – Certain Death Benefits

Exclusions from Income & Estate Taxation

DBO Plans – The “Great Equalizer”

Income Tax ImpactDeductible to Business But Taxable to Recipient = Neutral •If S Corporation – Deduction will flow thru to shareholders•Caveat - Reasonable Compensation Test

• Past Service can be significant FactorPayroll TaxesPast Service and Salary History is Test•Not subject to payroll taxes since paid after death

Gift and Estate Taxes Liability reduces Taxable Value of Business, if unfunded

Benefit is excludable from the Taxable Estate of the Employee•Provided employee has not retained right to change beneficiary•Best to pay as a benefit to second generation than spouse

Section 104 – Compensation for accident or injury

Maxwell v Comm, 95 TC 107 (July 31, 1990)

Facts: TP and spouse were founders, controlling shareholders and principal officers of corporation. TP suffered fractured arm in mixing machine. Off work for 6 to 8 weeks. Spouse assumed duties.

TP retained attorney. Corp retained separate attorney. Plaintiff’s attorney sent a demand letter for $137,500. Settled for $122,500. No lawsuit was ever filed.

•Corp deducted as “Miscellaneous Office Expense” Section 162

•Employee excluded payment under Section 104

Exclusions from Income

• The IC-DISC first came about in 1984 • I.R.C. Section 991 – 997.

• Unlike other exporting incentives the IC-DISC has yet to be challenged by the World Trade Organization (WTO).• Extraterritorial Income Exclusion repealed American Jobs

Creation Act of 2004• With the current low dividend rates the IC-DISC is now an

attractive tax saving vehicle.

Interest Charge Domestic International Sales Corporation (IC-DISC)

Commissions paid by export Corporation to IC-DISC• Fully deductible at regular tax rate 39.6%

• Revenue not taxable income to IC-DISC

• Dividend taxed at 20% (15% Savings)

• Plus low rate of interest

• Save on Rate differential – 19.6%Ownership of IC-DISC

• Minors or Parents (dependents)

• Trusts, partnerships, corporation and foreign persons.

• Roth IRA? (Deduct at 35% taxed at 0%)• WARNING: Commissioner v. Summa Holdings (2015)

What are the Benefits of IC-DISC?

• Domestic Corporation• Formed by U.S. exporter/shareholder• One class of stock, with a par or stated value of at least $2,500

on each day of its fiscal year• Unanimous shareholder consent (See Form 4876-A)• Must maintain its own set of books and records• Not required to have:

• Office Space• Employees, or• Tangible assets

• Cannot be a member of a controlled group of corporations with a Foreign Sales Corporation

Requirements for an IC-DISC?

Questions?

Brian T. Whitlock, CPA, JD, LLMPlante & Moran, PLLC10 S Riverside Plaza

Chicago, IL 60606Phone (312) 207-1040

E-mail: brian.whitlock@plantemoran.com