As a result of the recent United States Supreme Court decision upholding substantially all of the healthcare legislation, all of the tax portions of this legislation will become effective as scheduled.  

If action is not taken, interest rates on federally subsidized Stafford Loans are slated to rise shortly.  It appears that responsible members of Congress are seeking to come up with a mechanism to avoid this.  However various members of Congress have just introduced the above proposed legislation.  The intent is to prevent an interest rate hike for only one year.

As part of the American Jobs Creation Act of 2004, to encourage production of products within the United States, Congress enacted IRC Section 199, allowing for the Domestic Production Activity Deduction (“DPAD”).  

In our most recent firm newsletter, I outlined a relatively hot topic in the political arena related to the taxation of a partnership “carried interest”.  For a further explanation of how a carried interest works, please see my article in our February 21, 2012 publication of the Focus.

On February 13, 2012, President Obama released his proposed budget for 2013.  This proposed budget included a provision to tax “carried interest” income at ordinary tax rates.

In addition, on February 14, 2012, Ways and Means Committee Ranking Member Sander Levin introduced the “Carried Interest Fairness Act of 2012”.  Congressman Levin has unsuccessfully introduced similar legislation regarding carried interests in both 2007 and 2009.  The most recent 2012 proposed legislation is being presented as a refinement and revision of its previous versions.

This proposed Legislation would tax at ordinary income rates, income received by partners for performing investment management services for a partnership.  As a result, managers of investment partnerships who receive carried interests as compensation would pay ordinary income taxes, rather than capital gain rates on that compensation.  Under the proposed legislation, the capital gain rate would continue to apply to the extent that a manager’s allocation of capital gain income represents a return on capital that they invested in the partnership.

Under Congressman Levin’s proposed Legislation, partnerships subject to the new “carried interest” rules would include partnerships holding securities, real estate held for rental or investment, interests in other partnerships, commodities, cash or cash equivalents, or options or derivative contracts with respect to such securities and real estate partnership interests.

It should be obvious from the above that this proposed Legislation is broad and far reaching.  As with the prior proposed carried interest Legislation, there is likely to be heavy concern over this broad applicability, which may cause unintended results.  Undoubtedly, the Service will find it necessary to provide detailed regulations regarding this Legislation, assuming it is ultimately passed, particularly with respect to delineating between a “carried interest” and a “capital interest” of a partner who is both providing management services, and has a financial investment in the partnership.

The other day I discussed the Administration's proposal related to grantor trusts which is contained in its Green Book. 

For many years, estate and financial tax planners have recommended that insurance be owned by a trust. If the trust is structured properly and other formalities are adhered to the insurance proceeds they are not subject to Federal estate taxation. This allows insurance proceeds to remain intact, untaxed and provides funds to help support the decedent's survivors (including widows and children).  This also helps to pay for estate taxes and help replace assets that are paid to taxing authorities on account of estate tax liabilities.

There is substantial authority for treating an insurance trust as a grantor trust. Based upon this authority, should the administration's proposal become enacted into law, the IRS could and probably would contend that insurance proceeds received by an insurance trust are subject to estate taxation. This could avoid the application of another Internal Revenue Code section that includes insurance proceeds in the taxable estate when the decedent had "incidents of ownership" over the insurance policy. (Insurance trusts are structured to avoid incidents of ownership.)

This result would be harmful to the insurance industry, which is another industry that is being subject to attacks, would be detrimental to the interests of survivors and would disrupt long established tax policy.

One of the Administration's proposals, contained in its 2013 revenue proposals, (the Green Book) that has received little publicity, is designed to coordinate certain income and transfer tax rules applicable to grantor trusts.

A grantor trust is one whose legal existence is ignored for income tax purposes, thus subjecting the grantor to tax on the trust's income. The trust and the grantor are treated as one person. If the grantor were to sell an asset to the trust, any gain on the sale would not be recognized. Contrary to this treatment, under current law, for transfer (estate) tax purposes, the assets of a grantor trust, if the document is drafted properly, it will be excluded from estate taxation.

This disparity of treatment has led to the frequent use of the sale to a defective trust. Here assets are sold to a trust, for their fair market value, in exchange for a note. No gain is recognized on the sale; interest paid on the note is not deductible by the trust nor taxable to the grantor. The grantor pays tax on the trust's income. In effect the grantor is making a "gift" of the tax paid while the trust's beneficiaries may receive cash flow from the trust. An IRS revenue ruling has sanctified this concept under proper trust drafting circumstances.

The administration's proposals would change this treatment by including the assets of the trust in the grantor's gross estate for estate taxation purposes. It would also treat any distributions to a trust beneficiary made during the grantor's life as a gift.

This proposal is a blatant attack on the use of the "Sale to an Intentionally Defective Trust" (IDGT). It ignores the fact that most grantor trusts are already subject to estate taxation. It will cause estate tax inclusion in circumstances that are unfair. For example, where one spouse creates a trust for the benefit of another spouse.

One commentator has said "This provision is using an elephant gun to shoot a squirrel". He goes on to say that if the administration is concerned about sales to defective trusts it should  limit the scope of the proposal and not overly expand estate tax inclusion rules. (Chuck Rubin in Steve Leimberg's Estate Planning Newsletter).

At a time when the estate tax produces relatively little revenue and serves merely as a devise to redistribute wealth and significant segments of Congress and the American people are calling for a repeal of the death tax; is it wise to call for its expansion?

In his State of the Union Address, as well as in recent speeches, President Obama laid out a number of tax provisions related to his “Blueprint for America” plan.  In general, the tax plan for business focuses on economic stimulus as well as international tax reform.

Among the various business tax proposals put forward by the President are the following:

1. Making the Research and Development Credit permanent.
2. Extending the allowance for 100% bonus depreciation.
3. Enacting a Manufacturing Communities Tax Credit. This credit, with a suggested budget of $6 billion, would be used to encourage manufacturing companies to move and expand in areas of the United States where local manufacturing plants have been closing.
4. Imposing a new minimum tax for overseas profits.  This would discourage companies from seeking to do business outside the United States in jurisdictions with low tax rates.
5. Creating a 20% tax credit to cover moving expenses for companies that close production overseas and return to the United States.
6. Reforming Code Section 199 Domestic Production Activities Incentive.  This change would eliminate the incentive for oil producers, but would enhance the incentive for advanced manufacturing technologies.

Conventional wisdom believes that President Obama’s proposals have little chance of being passed in the current year. During the past several years, the United States has lost many manufacturing jobs to foreign countries, as manufacturers have taken advantage of lower labor costs and in some cases more favorable tax rates abroad.

Although it appears that President Obama’s proposals will not get through Congress, changes which would address the loss of manufacturing jobs in the United States are necessary to allow the United States to compete in the current competitive global environment.  Whether or not Democrats and Republicans can come together on these provisions, they do present some good ideas to help boost our economy. I’d look to see some of these proposal picked up again after the Presidential election in early 2013.

Governor Christie has signed into Legislation a new jobs tax credit which is intended to attract and retain businesses with at least 100 full time employees in New Jersey.  Those businesses who qualify will be allowed a credit of up to $8,000 per new or retained full time employee per year, for a period of up to 10 years.

In general terms, to qualify for the credit, a business must make, acquire or lease a capital investment of at least $20 million at a qualified business facility at which it will employ at least 100 full time employees in an industry which is identified by the New Jersey EDA as desirable for the state to maintain or attract. Both businesses which are looking to move to New Jersey, as well as businesses which have a specific opportunity to move out of the state, but which choose to stay within the state, may qualify for these credits.

Businesses who wish to take advantage of this credit must apply for the credit before July 1, 2014, and submit documentation for certification of the credits no later than July 28, 2017.

This is an effort by the state to retain and attract large businesses to New Jersey, which have the capability of hiring and retaining large amounts of full time employees.  Although the credit may not apply to many small or midsized businesses either already in the state or looking to move to New Jersey, the credits are substantial for those businesses that qualify.

Due to its high tax structure New York State has seen many taxpayers change or attempt to change their tax status to more favorable jurisdictions such as Florida. As a result, New York State (and City) for many years have launched aggressive campaigns to locate so called tax avoiders. They have issued extensive guidance in this area which other states have or will follow to determine domicile and or residence.

Many taxpayers believe that if they structure their affairs so that they are outside of New York for one half of the year their have avoided New York taxation on non New York source income, this is incorrect.

New York law provides that if you are a domiciliary of New York and maintain a permanent place of abode in New York and are present in the state for 30 days New York will subject all of your income to taxation. (A discussion of domicile is beyond the scope of this blog).

In its guidance, New York defines a permanent place of abode as "a residence... that: you maintain, whether you own it or not; and that is suitable for year-round use."

This definition is explained by the following statement: ..."you are considered to be maintaining it if you are making contributions to the household, in the form or money, services, or other contributions". Thus if you work in New York City but reside in New Jersey, for example, and your child has an apartment in New York City, and you help to defray the rent payments you are maintaining a permanent place of abode in New York City.

New York goes on to say that if you maintain a permanent place of abode, "and you can stay there whenever you want, you are maintaining a permanent place of abode, even if you stay there only occasionally." Thus in one situation an individual, residing in Connecticut, owned a home on Long Island which his in laws occupied for most of the year. The taxpayer stayed at the house for only 11 days during the year. New York successfully argued that the taxpayer was now subject to New York tax on all of his income.

New York's position often results in findings that could be considered egregious and unfriendly to taxpayers.

Being aware of New York's positions and working with your tax advisor to avoid potential adverse consequences is accordingly extremely important.

In a December, 2011 Tax Court Memorandum decision, the Court ruled that a shareholder in a closely held S corporation was subject to tax on the value of stock received when a nonqualified option was exercised. In addition, the Court ruled that the S corporation was entitled to a corresponding compensation deduction.

Although these findings are not surprising, there were some interesting issues in this case:

1. The IRS issued “whipsaw” deficiency notices to both the S corporation shareholders and the employee option holder, arguing that the option exercised was compensation income to the option holder, but not fully deductible by the corporation.
2. The IRS argued that the option exercise compensation was unreasonably high, and therefore not fully deductible by the corporation or its shareholders. In the S corporation arena, IRS is usually arguing that compensation is unreasonably “low”, not “high”.
3. The Court shot down the option holder’s argument that the value of the stock awarded should be discounted for lack of marketability, even though this was a closely owned (family) S corporation.