Tax and Business Alert - July 2004

The Federal Gift Tax

The federal gift tax is an excise tax imposed gifts you make during your lifetime.
However, the annual gift tax exclusion allows you to transfer up to $11,000 (in 2004) annually to any individual (there can be more than one) without incurring a gift tax liability. The amount of the gift is the fair market value of the property on the date of the gift.

Gifts for Educational and Medical Purposes.
You can pay unlimited amounts directly to educational or medical providers for qualified tuition and medical expenses for the benefit of one or more individuals without having to pay gift taxes on these amounts. These exclusions are in addition to the annual gift tax exclusion and represent an excellent opportunity for you to transfer property to benefit your children or grandchildren with no gift tax effects.

Cumulative Nature of the Gift Tax.
The gift tax is computed on a cumulative basis that takes into account taxable gifts you made in prior years. Generally, transfers that were taxable gifts under the applicable gift tax laws at the time you made the gifts, net of exemptions and deductions for those years, are added to your current year taxable gifts to arrive at your total taxable gifts. The tax is calculated on this amount, but is offset by the applicable credit amount ($345,800 in 2004 and discussed below) and other qualifying taxes and credits, where appropriate.

The Applicable Credit Amount.
One of the credits deductible against the gift tax is the applicable credit amount. The applicable credit amount for 2004 is $345,800, which completely shelters $1 million (i.e., the applicable exclusion amount) from the gift tax. Therefore, if you make cumulative taxable gifts totaling $1 million or less in 2004, you will not pay any federal gift taxes. However, as indicated, the $1 million is for cumulative gifts. Thus, if in prior years you used your applicable credit amount to shelter $400,000 of gifts from the gift tax, in 2004 you can only shelter an additional $600,000 of gifts from the tax.

Remember, the $11,000 annual exclusion and qualifying educational and medical gifts do not count toward the $1 million limit. Thus, for example, in 2004 you could make gifts of $11,000 each to 20 different people without having to use any of your applicable exclusion amount.

Planning Tip:
Giving away property during your lifetime is a powerful way to accomplish wealth planning goals. In addition, significant transfer and income tax savings can be generated from a properly structured lifetime giving program. Please call us to discuss tax effective gifting strategies.

August 2     

 --For those with employees, a federal unemployment tax (FUTA) deposit is due if  your employment taxes (FICA and withheld income taxes) liability is $2,500 or more and the FUTA liability through June 30 exceeds $100.

--The second quarter Form 941 (Employer's Quarterly Federal Tax Return) is also due today (except that you have until August 10 to file if you deposited all taxes for the quarter when they were due).

August 16 

--Personal returns extended in April need to be filed or extended (to October 15) by today.

September 15 

--Third quarter estimated tax payments are due for individuals, trusts, and calendar-year corporations.

--If a six-month extension was obtained, calendar-year corporations
should also file their 2003 income tax returns by this date.

The IRS recently issued a warning concerning an email-based scheme that attempts to trick taxpayers into revealing personal information, such as social security numbers, driver's license information, and bank and credit card numbers. Unsuspecting taxpayers receive an email claiming they are under investigation for tax fraud and are subject to prosecution. To help the investigation and dispute the charge, taxpayers are instructed to submit detailed personal information to an official-looking website. Identity thieves can then use this information to open bank and credit card accounts and file fraudulent tax returns.

The IRS indicated they do not use email to contact taxpayers about account related issues. Instead, official taxpayer contact usually includes a letter on IRS stationery, in an IRS envelope, with an IRS contact phone number.

Access America at www.accessamerica.org is a U.S. Chamber of Commerce program initiated to help provide access to capital markets for women and minority business owners. Access America also facilitates strategic alliances and investments for these entrepreneurs.

Through this program, women and minority business owners obtain access to and assistance from Chamber organizations and partnerships, major corporations, and government agencies. Online resources include extensive information on financing, government resources, international trade, minority business organizations, procurement and purchasing certification, public policy advocacy, publications, research and statistics, training and technical assistance, and women's business organizations.

Adult children can obtain home ownership or acquire a more expensive home than they might otherwise afford by using a shared equity financing arrangement. With a shared equity financing arrangement, parents or other relatives share in the purchase and cost of maintaining a house used by the children as a principal residence. The nonresident owner" rents his or her portion of the home to the resident-owner and obtains the annual tax benefits of renting real estate if the statutory requirements are satisfied. Since the child does not own 100% of the home, he or she is the relative's tenant as to the portion of the home not owned and rents that interest from the relative at a fair market rate.

A shared equity financing arrangement is defined as an agreement by which two or more persons acquire qualified home ownership interests in a dwelling unit and the person (or persons) holding one or more of the interests is entitled to occupy the dwelling as his or her principal residence, and is required to pay rent to the other person(s) owning qualified ownership interests.

Under the vacation home rules, personal use of the home by a child or other relative of the property's owner is normally attributed to the owner However, an exception to the general rules exists when the dwelling is rented to a tenant for a fair market rent and serves as the renter's principal residence. When the tenant owns an interest in the property, this exception to the general rule applies only if the rental qualifies as a shared equity financing arrangement.

Example: Shared equity financing arrangement facilitates child's home ownership

Mike and Laura have agreed to help their son, Bob, purchase his first home. The total purchase price is $100,000 consisting of a $20,000 down payment and a mortgage of $80,000. Mike and Laura pay half of the down payment and make half of the mortgage payment pursuant to a shared equity financing agreement with Bob. Bob pays them a fair rental for using 50% of the property, determined when the agreement was entered into.

Under this arrangement, Bob treats the property as his personal residence for tax purposes, deducting his 50% share of the mortgage interest and property taxes.
Because his use is not attributed to his parents, Mike and Laura, they treat the property as rental. They must report the rent they receive from Bob, but can deduct their 50% share of the mortgage interest and taxes, the maintenance expenses they pay, and depreciation based on 50% of the property's depreciable basis. If the property generates a tax loss, it is subject to, and its deductibility is limited by, the passive loss rules.

Note that the nonresident portion of any gain will not qualify for gain exclusion when the residence is subsequently sold. The result will be a taxable gain for the portion related to the deemed rental. If excluding all potential gain is a major consideration, the taxpayer (typically the child) should consider having a creditworthy relative guarantee or cosign the mortgage instead of outright joint ownership. This should allow the resident owner to exclude the gain (up to $250,000 single and $500,000 married filing jointly), subject to specific requirements.

If it is anticipated that the resident owner (typically the child) will ultimately purchase the equity of the nonresident owner (typically a parent) and the rental will generate losses suspended under the passive loss rules, the suspended passive losses normally allowed at disposition are not allowed when the interest is sold to a related party.

A testamentary letter, also referred to as an estate planning letter, should be a part of your estate plan. It is written to your executor, heirs, or both as a supplement to your will. It is not binding on your executor, but provides guidance concerning your wishes.

The testamentary letter can provide invaluable assistance to your executor and family members. An explanation in layman's terms of the workings of the will and estate plan in general should help the readers understand your desires and objectives. A description of the estate plan found in the testamentary letter should be consistent with your will. The letter may not be probated in lieu of your will but may be admissible in probate court to clarify an ambiguity in the will. The will and other legal documents will be controlling if any inconsistency arises. It is advisable for an attorney to review the testamentary letter to ensure its accuracy.

Personal desires and requests that are inappropriate in a will fit well in a testamentary letter.

These include discussion of preferences or previously made arrangements for last rites and burial services, directions for the disposition of personal property, and other matters of a personal nature.

This letter assists the executor in administering the estate, supplying as much information as possible regarding the location of important documents (e.g., will life insurance policies, and burial policies), your assets and liabilities, and professional advisors and other individuals to consult during administration.

Like other parts of the estate plan, the testamentary letter should be reviewed and updated periodically. It should be kept in a safe place other than a safe-deposit box so the executor may gain quick access to it. This is particularly true if burial instructions are included with the testamentary letter. The funeral may occur before it is possible to gain access to a safe-deposit box (e.g., if death occurs on a weekend or holiday).

Note that it is important that the testamentary letter be consistent with the overall estate plan. If the letter contains directions that appear contrary to the will, it may provide impetus to an unhappy beneficiary's desire to contest the will. It is possible that the testamentary letter could be argued to be a revocation of the will if it is signed after the execution of the will and is inconsistent with the will. For this reason, the attorney drafting the will should help prepare the testamentary letter in order to ensure consistency.