Changing a Will After Death

The newspapers are full of high profile instances whereby an adult child or relative is furiously fighting to have their parent's Will changed, after they have died. Modern family structure, internal politics and whirling emotions built up over years can all add up to an almighty battle - even after one of the parties dies. However, not all cases where a change of Will has been requested are acrimonious - most of them aren't. As a good working example, if, after a person has died, you wish to change their Will - to try and reduce the Inheritance Tax amount which will be incurred for example, or an important person has been left out for some reason, you can do so, usually with the minimum of fuss.

However, all beneficiaries of the Will must agree to this change in the first instance. If this is the case, then you can go ahead and have a "Deed of Variation" created, which must be signed by all the beneficiaries within two years of the person's death, for it to be effective. Remember, time can progress unfeasibly quickly so don't be caught out.

Remember that changing a Will means the amount of Inheritance Tax payable may change, as may the Capital Gains Tax fee. If the Deed of Variation includes a statement that it is to take effect for either Inheritance Tax, Capital Gains Tax or both, then the arrangements will be considered as if the deceased person themselves had made them.

The Difference Between Capital Gains and Ordinary Income

Most long-term capital gains are taxed at 15% for 2010. This rate is scheduled to increase to 20% in 2011. Unfortunately, we need to say "most" because there are some exceptions as follows:

Taxpayers in the 10% and 15% ordinary bracket-0%
Certain depreciation recapture on real estate-25%
Collectibles-28%

A long-term gain is from the sale of a capital asset held longer than a year. A capital asset includes stocks, bonds, mutual funds, and real estate (other than residence).

Short-term gains are those that are held one year or less. Short-term gains are taxed at ordinary income tax rates. Ordinary income tax brackets for married couples filing joint for 2010 are projected as follows:

Taxable Income Tax Rate

0€-16,750 - 10%
16,750€-68,000 - 15%
68,000€-137,300 - 25%
137,300€-209,250 - 28%
209,250€-373,650 - 33%
Over 373,650 - 35%

The highest ordinary income tax bracket is also scheduled to increase in 2011 to 39.6%.

Capital gains and losses are netted against each other. If this results in a net loss, this loss is limited to a $3,000 tax deduction for a married couple filing a joint return. Any loss above this is carried into future years.

However, be cautious. Some taxpayers may be subject to an Alternative Minimum Tax ("AMT"). Taxpayers need to calculate their income two ways. First, calculate the income tax under the regular method, and second, under the AMT method. Then pay the higher of the two taxes. For taxpayers subject to the AMT, it may make their effective tax rate on long-term capital gains higher than the stated rate of 15%.

It is important to know the holding period for any capital assets and whether the sale will result in a gain or loss.

Thomas F. Scanlon, CPA, CFP.

Tax Tips on a C Corp Asset Sale

First, unless you are planning on going public or have hundreds of stockholders do not form a C Corp to begin with. Use an S Corp or an LLC. If you currently are a C Corp ask your attorney or tax advisor about converting to an S Corp. If you sell your company within a 10 year period of converting to an S Corp the sale can be taxed as if you were still a C Corp.

Here is what happens when there is an asset sale of a C Corp. The assets that are sold are compared to their depreciated basis and the difference is treated as ordinary income to the C Corp. Any good will is a 100% gain and again is treated as ordinary income. This new found income drives up your corporate tax rate, often to the maximum rate of around 34%. You are not done yet. The corporation pays this tax bill and then there is a distribution of the remaining funds to the shareholders. They are taxed a second time at their long term capital gains rate.

Compare this to a C Corp stock sale. The stock is sold and there is no tax to the corporation. The distribution is made to the shareholders and they pay only their long term capital gain on the change in value over their basis. The difference can be hundreds of thousands of dollars.

Secondly, keep all assets that may appreciate in value outside the C Corp and in an LLC. Your real estate, patents, intellectual property, etc. should be held in a pass through entity so you avoid the potential high C Corp corporate tax rate and the double taxation if you do an asset sale.

Let's say that you are a C Corp and the buyer refuses to do a stock sale. If you can get the buyer to move as much of the transaction value to a covenant not to compete, you will be much better off. That will be taxed to you personally at the long term capital gains rate and not the corporate tax rate and the gain can be spread out over the non-compete period.

Another approach you can use is "Personal Good Will". This is where the seller's reputation, expertise, and relationships are in effect separated from the assets of the company and account for as much of the good will value as possible from the business. So let's say that the company sells for $8 million dollars and the amount allocated to the hard assets is $6 million. That leaves $2 million that can be classified as good will. If that good will is assigned to the C Corp, it will be taxed at the 34% rate and then taxed again when it is distributed to the shareholders at 15%.

If you can move that amount to personal goodwill for the owner, it is paid directly to him and he gets taxed at the 15% rate only. The calculation looks like this: If the good will is $2 million and is allocated to the C Corp. They pay $680,000 in corporate income taxes. The $1,320,000 remaining gets distributed to the shareholders and an additional 15% tax is paid or $198,000 for a total tax on that $2 million of $878,000. Moving it all to personal goodwill results in a total tax on that $2 million of $300,000, a savings of $578,000. This approach was pioneered in a classic IRS case called the Martin Ice Cream Case.

There is a built in bias on the part of buyers with the advice of their attorneys to avoid doing stock sales because you buy everything including any hidden liabilities. You as the seller want to convince the buyer to do a stock sale by demonstrating that there are no hidden liabilities. Another argument you can use is that most contracts are not assignable without the consent of the other party. In an asset sale it could be problematic to get assignments of a large quantity of contracts. An example is if your company is in a favorable long-term property lease the landlord will never agree to an assignment of that lease. If you have a long-term contract with a government entity, a change in ownership can trigger a contract end. In a stock sale these are not issues.

There are many variables in a business sale negotiation. Price, Cash at close, Stock versus Asset Sale, and allocation of purchase price. The IRS does not allow the buyer's allocation of purchase price to be different than the seller's. It also must be noted that from a tax standpoint, something favorable for the seller is correspondingly less favorable for the buyer. An experienced buyer will structure the deal in the most favorable way for himself. Sellers must get good advisors to help them negotiate to achieve the maximum after tax proceeds.

Self Directed Installment Sale Vs 1031 Exchange - When a SDIS Makes Sense (Part II)

In the last article, I pointed out when, as a real estate investor, doing a 1031 Exchange on the sale of a Real Estate Property may not be your best option.

So, let's assume you do want or need to sell a real estate investment, don't want to do an exchange, and don't want to pay a huge lump sum capital gains tax payment of 15-40% on your gains. Now is the time to see how a Self Directed Installment Sale can save you money.

It's important to know that you don't avoid paying your capital gains tax obligation, you just get to spread out the obligation over many years. The total of years is typically between 10 to 30 and it is possible to defer taking payments for a while depending on your circumstances.

So, how does that help you? Well, if someone were to offer you a 0% interest loan on let's say $300,000.00 for the next 30 years, and you only had to make minimum payments, would you jump at the chance? Most people sure would. Think of how you could invest that 300K so that you could enjoy the benefit of the interest it accrued. This is effectively what a Self Directed Installment Sale does for you. It allows you to keep most of your gains working to your advantage, while paying back the money owed to the IRS over a long period of time.

This also holds for the depreciation recapture if you owned your property for a long period of time and depreciated it according to a schedule to realize annual tax advantages of owning investment real estate. This is not true for accelerated depreciation taken.

If you do not put a tax strategy in place and sell outright, not only do you owe capital gains tax, but you also owe depreciation recapture, which can be another 25-35% of your total depreciation taken over the ownership cycle of your investment.

And, you will avoid the possibility of the dreaded Alternative Minimum Tax trap. This is something else that may catch you by surprise when you least expect it triggered by your outright sale of property. This could mean having other legitimate tax deductions disqualified and a higher tax payment owed by you.

As you can see, it's definitely worth it to consult with an expert in Capital Gains Tax saving strategies before you make the decision to sell your real property.

The SDIS can also work with the sale of a second home, vacation home, business, collection, or even your primary residence. With these assets, a 1031 exchange is not an option.

Federal Income Taxes - Top 10 Things To Like About The Tax Relief Act Of 2010

President Obama just signed into law the Tax Relief Act of 2010. The full name of this legislation is the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. But for purposes of this article, let's just call it the Tax Relief Act.

There are plenty of good things in this bill. Here are some of the highlights:

1. Personal income tax rates will remain the same for the next two years. If this bill had not been passed, individual tax rates would have increased on January 1, 2011 to 15, 28, 31, 36 and 39.6 percent. Instead, they will remain at the levels of 10, 15, 25, 28, 33, and 35 percent for 2011 and 2012.

2. Maximum capital gains tax rates will also remain unchanged for 2011 and 2012. The maximum rate of 15 percent (zero percent for folks in the 10 and 15 percent tax brackets) stays in effect instead of increasing to 20 percent (10 percent for those in the 15 percent bracket).

3. Maximum dividend tax rates also stay the same for the next two years - 15 percent rather than ordinary income tax rates.

4. The child tax credit of $1,000 is extended for the next two years, rather than returning to $500 per qualifying child.

5. The American Opportunity Tax Credit (a credit to offset qualified higher education expenses) remains in effect for 2011 and 2012.

6. Employers can continue to provide tax-free educational assistance to their employees up to $5,250 per year in 2011 and 2012.

7. Several tax breaks that had expired on December 31, 2009 have been extended for 2011 and 2012. These include the teacher's classroom expense deduction, the higher education expense deduction, and the state/local sales tax deduction.

8. The deduction for qualified mortgage insurance premiums has been extended for 2011.

9. The dependent care credit remains as is for the next two years.

10. Social Security taxes have been reduced by 2 percent for 2011. This reduction applies to both employees and the self-employed.

Of course, there's at least one thing to dislike about this bill - all these provisions are temporary. A few exist for only one year (2011). Most of them will expire at the end of 2012, and so in two years, we get to watch Congress and the President have yet another debate on what to do about tax rules that change repeatedly because our politicians created them that way. So enjoy these tax breaks while they last.

Reducing Your Capital Gains Tax (CGT) Liability

Capital Gains Tax (CGT) applies when chargeable assets are disposed of and is applicable to individuals and trustees but not to limited companies, although Limited Companies do pay Corporation Tax on the gains that they make.

Chargeable assets includes all forms of property unless it is specifically exempt. The main assets it tends to apply to are land and buildings, shares and business assets including goodwill. CGT can be very complex and the rules are far more detailed that can be explained in this brief blog post, so read the Helpsheet after this post.

How a Capital Gain occurs

A capital gain occurs when the value of an asset at the date it is disposed of is higher than when it was first acquired. An asset can be disposed of either by sale or by gift. If you give away an asset in an uncommercial transaction, the market value will replace any actual consideration paid.

For assets acquired before 31 March 1982 the cost usually taken to be the value on that day, although actual cost can be used in some circumstances.

The following also reduce the amount of the chargeable gain...

Incidental costs of acquisition
Expenditure to enhance the value of the asset
Incidental costs of disposal, and
Tax reliefs and allowances (see below)

Rate of Tax

From 23 June 2-1- a new CGT rate of 28% was introduced where the total taxable gains and income are above the income tax basic rate band. Prior to that and below that limit, the rate is 18%. For trustees and personal representatives of deceased persons the rate increased from 18% to 28% on all gains from 23 June 2010.

Tax Reliefs

There are several different tax reliefs which can reduce the chargeable gain, including...

Rollover/holdover relief on replacement of business assets - allowing you to defer the CGT on a gain of a business asset where this is matched with a replacement of a new business asset in the period commencing one year before and ending three years after the disposal.

Business incorporation relief - available when you transfer your business into a Limited Company in exchange for shares

"IRS Approves New Tax Deferment Program" - 1031 Exchange Without a Replacement Property?

For years, investors have taken advantage of the 1031 exchange as a method to delay or defer capital gains taxes on the sale of an investment property. By completing an exchange, the investor can sell or dispose of an appreciated investment property, use all of the equity to buy a like-kind property of equal or greater value, defer the capital gains tax and leverage all of their equity into a replacement property. The 1031 exchange is one of the last great vehicles to build wealth and save on taxes.

There still exists the investors who do not acquire a replacement property. Maybe the next move may be difficult to find the right property. The specific time-frame or an undesirable market is not conducive to executing an exchange? That investor may just want to move on with life, dispose of the asset without a replacement, but still not pay all of the capital gains upfront. Is there a solution?

There was such a solution called the private annuity trusts (PATs) which could be used to avoid capital gains taxes by transferring the title of a property to a trustee prior to the sale. Once the trustee sold the property, the proceeds from the sale would fall into the trust and then payments would be paid to the beneficiary. Most often, the trustor and beneficiary would be one and the same, therefore allowing the beneficiary (the original title holder) a method to collect payments while avoiding any upfront capital gains tax. In the fourth quarter of 2006, however, the IRS ruled that PATs were being used inappropriately to defer capital gains and estate taxes and could no longer be used in this manner.

The deferred sales trust (DST) has become the replacement strategy for the private annuity trust. Very similar to the PATs, the deferred sales trust, recognizes capital gain, but it is deferred over a predetermined period of time that is planned in advance of the sale.

Here is a breakdown of the process for a DST:
1- Private third-party company forms a trust
2- Owner sells the property to the trust
3- Trust and owner (beneficiary) put together an installment contract
4- Contract promises to pay beneficiary predetermined amount over an agreed period of time

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Example of DST vs. a Typical Sale (California)
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Assumptions:
Owned for 8 years
Purchase Price: $ 2,750,000
Sale Price: $ 4,100,000
Loan Amount: $1,750,000
Recapture Depreciation $ 800,000
Basis: $1,950,000
Taxable Gain: $2,150,000

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Standard Sale Transaction:
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Net Sale Proceeds: $ 2,350,000
Federal Tax (15%) $ 322,500
State Tax (9.3%) $ 199,950
Proceeds after tax: $ 1,827,550
Annual Interest of $ 146,204

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DST Transaction:
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Net Sale Proceeds: $ 2,350,000
Annual Interest of $ 188,000

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DST income difference of 22% or $41,796
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As you can see, the deferred sales trust can be a vehicle to defer taxes without having to acquire a new property and in the long run may actually be a more viable and lucrative choice than other tax deferment methods. To find out more information, contact a commercial real estate broker or tax professional in your area.