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New IRS Ruling May Rescue Estate Plans

President Trump’s campaign promise to abolish the federal estate tax may or may not be realized. Meanwhile, the “death tax” still exists, and it continues to be a major concern for high net-worth taxpayers, including the owners of successful small companies.

If a deceased taxpayer has a surviving spouse, the estate of the deceased spouse may make a portability election. If this election is made, the unused federal estate tax exclusion of the deceased spouse (called the deceased spouse unused exclusion, or DSUE) can be carried over to and used by the surviving spouse. The executor of the deceased spouse’s estate must make the portability election on a timely filed estate tax return that includes a computation of the DSUE.

IRS Revenue Procedure 2017-34, effective June 9, 2017, provides relief when a deceased spouse’s executor fails to make a timely portability election. The revenue procedure sets out a simplified method for requesting an extension of time to executors of certain estates of decedents who died after 2010 to make the election.

The portability extension offered by this revenue procedure would be until the later of January 2, 2018, or 2 years after the decedent’s date of death to make the election. Normally, the deadline is 9 months after death, or 15 months if the decedent’s estate requested an extension of time to file an estate tax return.

The new extension is permanent but applies only to estates of decedents who died after 2010, survived by a spouse, that are otherwise not required to file an estate tax return, except to make the portability election. In cases in which the surviving spouse died before a portability election was made, and the surviving spouse’s estate paid federal estate tax, a tax refund may result.

Doubling the exemption

The federal estate tax exemption has gradually increased from $5 million to $5.49 million in recent years. Thus, many estates have not owed this tax, and many executors have not filed a Form 706 federal estate tax return.

Example 1: Jim Cook died in 2012 when the estate tax exemption was $5.12 million. His estate was worth $4 million, all of which he left to his wife, Marie. Therefore, his executor was not required to file Form 706 and did not do so.

That could have been an error. Jim’s estate did not use any of that year’s estate tax exemption. By filing a Form 706, his executor could have elected portability of his DSUE. If the election had been made, Jim’s widow Marie’s estate could have used Jim’s DSUE in addition to her own at her death.

Example 2: Assume Marie dies in 2017 with a total of $8 million, including the assets inherited from Jim. Her estate would be over the $5.49 million estate tax exemption this year by $2.51 million. At a 40% estate tax rate, Marie’s estate would owe over $1 million to the IRS.

Now suppose that Jim’s executor had elected portability on Form 706. Because Jim had left all of his assets to Marie, his entire $5.12 million DSUE would be added to Marie’s $5.49 million exemption, for a total of $10.61 million. Marie’s $8 million estate would be under that threshold, and no federal estate tax would be due.

Filing the form

To obtain relief under Rev. Proc. 2017-34 from the failure to make a portability election, all the executor must do is file a complete and properly prepared Form 706 estate tax return on or before the later of January 2, 2018, or two years from the decedent’s date of death. On this return, the executor should explain that it is being “filed pursuant to Rev. Proc. 2017-34 to elect portability under § 2010(c)(5)(a).” If these requirements are met, the extension of time to elect portability will be granted, and the Form 706 electing portability will be considered to have been timely filed.

As previously noted, the IRS is providing this relief retroactively to estates of decedents who died after 2010, which have until next January 2 to obtain relief under Rev. Proc. 2017-34. Estates of decedents who died after January 2, 2016, have two years from the date of death. If the decedent’s surviving spouse has died, and the surviving spouse’s estate has already filed Form 706 and paid estate tax on which the statute of limitation on refund has not expired, the executor of that estate can file an amended Form 706, including the decedent’s DSUE, and get any resulting refund.

Good news for business owners

Rev. Proc. 2017-34 can benefit the estates of all wealthy decedents, but it may be especially valuable for business owners and their heirs. When the owner of a business dies, his or her interest in the company must be valued. A moderately successful firm can have a value well into seven or even eight figures. Counting the decedent’s other assets, the total can be in estate tax territory.

Generally, estate tax must be paid within nine months of death. In some cases, estates of the owners of closely-held companies may defer the tax over an extended time period. Still, the tax payments may be considerable, and the heirs of business owners may lack the liquid assets necessary for this obligation.

Such concerns might lead business owners and others into sophisticated tax planning tactics to deal with future estate tax. These tactics may be helpful, for various reasons, but the presence of portability may reduce the need, as a married couple now can easily pass on nearly $11 million worth of assets to the next generation with portability.

Prepare Your Kids for Financial Independence

An AICPA survey discovered that parents are more likely to talk with their children about manners, eating habits, school grades, and substance abuse than about finances. All these topics are important, but it’s also vital to teach your kids the basics of handling money.

This conversation can begin when children are very young—even before they start kindergarten. One tactic is to give each child a piggy bank, which might hold spare change and even dollar bills. Once the children reach the age when they start learning counting skills, you can explain how five pennies make a nickel, two nickels make a dime, and so on, until you have dollars that can buy things in a store.

Parents also can open up bank accounts for youngsters; banks may have low or no minimums for children’s savings accounts. Parents can take their kids to the bank to make deposits and show them the results on bank statements. If the child’s account earns interest, that can offer another teaching opportunity.

Personal finance

At some point, children may receive an allowance, earn money for doing household chores, or both. Parents might explain the choices they’ll then face. Do they want to spend the money on something they want right away, put the money in their piggy bank to save for a larger purchase, or put it in the regular bank for a long-term goal? Yet another possibility is to give some of their income to those who are less fortunate. Altogether, such an exercise can give your kids the idea that there are many options for handling money, and they should consider the alternatives carefully.

Taking your child with you when you go to the supermarket, pharmacy, or hardware store can also be an educational experience. Children can see goods that are available at different prices; for example, buying a larger package often will require more money. Again, kids can see that handling finances involves making decisions. Even at a young age, children might be allowed to pick out one cereal from the rest or one type of treat for the family pet.

As children grow older, their desired items likely will become more expensive (such as an electronic device or an article of clothing). Through online, catalog, or in-store shopping, you can show them the price of the thing they’ve requested and explain that this is so many weeks of allowance or hours of household chores. You might set up a plan to save for this outlay, with a parental match as an incentive.

One worthwhile activity is to have your child keep a record of all the things he or she would like to have. The child can then organize those items based on “need” or “want.” New shoes might be needed, for instance, but a smartphone might be wanted.

From this list, you could lead into a discussion of what’s needed versus what’s wanted for you as a parent. Milk and juice from the supermarket might fall into the needed category, but a new car every year may be wanted yet not necessary. Explain that it’s fine to have things you want, but you may have to save for them over a time and forgo other items on the want list.

With preteens and teens, other topics can be discussed. You might show your child your checkbook, for example, and describe how you balance it every month. As they approach college, it’s time to talk about college costs at various schools and the results of using student loans to pay for higher education. When children get their first credit card, they should be told how credit scores are calculated and the importance of maintaining a good record of debt repayment.

Talking taxes

Preparing children for financial independence also means preparing them to be taxpayers. Some taxes are very visible; if you live in an area with a 5% sales tax, for instance, a $10 purchase winds up costing $10.50.

Other taxes might be illustrated by showing a pay stub to your son or daughter. Federal income tax will be withheld, usually along with state and local income tax. The same pay stub may also reveal payroll taxes withheld, such as those for Social Security and Medicare. (Eventually, a discussion of payroll taxes can lead to conversations about retirement planning and health insurance.) The key here is to make your children aware that a first job that pays $3,000 a month won’t provide $3,000 to spend every month. Only what’s left after taxes can be spent, with needs coming before wants.

2017 Social Security and Medicare Taxes  

  • The Social Security tax rate is 6.2% each for the employee and employer.
  • The Social Security wage base limit is $127,200. Wages in excess of this amount are not subject to Social Security tax.
  • The Medicare tax rate is 1.45% each for the employee and employer.
  • There is no wage-based limit for Medicare tax, which applies to all earned income.
  • An additional 0.9% Medicare tax is paid by employees on earnings over $200,000 for single taxpayers or over $250,000 for married taxpayers filing jointly.

Tax on Tenant Improvements

 

Leasehold improvements, commonly referred to as tenant improvements, are structural modifications or permanent fixtures placed in the interior of a rented space.  Examples include changes made to ceilings, flooring, and interior walls.  Alterations to the exterior of the building or modifications that benefit other tenants, such as new roof, upgraded elevators, and repaved walkways, are not leasehold improvements.

Generally, leasehold improvements are capitalized and depreciated over the life of the asset as determined by Revenue Procedure 87-56.  Because most leasehold improvements become part of the building, they are depreciated using the straight-line method over 39 years.  An exception exists for “qualified leasehold improvements”.  Qualified leasehold improvements (“QLI”) are depreciated using the straight-line method over 15 years.  In addition, qualified leasehold improvements placed in service after 2015 may be eligible for bonus depreciation and §179 deduction.   For an improvement to be a qualified leasehold improvement, the following requirements must be met:

  1. The improvement has to be made to the interior of the building;
  2. The landlord and tenant must not be related;
  3. The improvement must not impact any other tenants, including any common areas; and
  4. The improvement is placed into service more than three years after the date that the building was first placed into service.

For assets placed in service on or after January 1, 2016 the category of bonus depreciation for qualified leasehold improvements is replaced with “qualified improvement property”.  Qualified Improvement Property (“QIP”) is defined similarly to QLI except that QIP does not need to be placed in service pursuant to the terms of the lease or more than three years after the improved building was placed in service by any person.  Lastly, QIP may include assets that are structural components that benefit an internal common area.

In general, there are three main options for structuring leasehold improvements.  The landlord can pay, the tenant can pay, or the landlord can offer an improvement allowance.  Each of these options has different tax benefits and detriments.

Landlord Pays

If the landlord pays for the improvements, they will capitalize and depreciate the improvements per the discussion above (straight-line 39 years; straight-line 15 years with possibility for bonus and §179 deductions if QLI or QIP).

Landlords that dispose or abandon leasehold improvements upon termination of a lease after June 12, 1996, may take the adjusted basis of the improvement into account for purposes of determining gain or loss on disposal.  Prior to June 13, 1996, landlords were required to continue to depreciate leasehold improvements in the same manner as the underlying real property, even if the improvements were retired at the end of the lease term.

Tenant Pays

If the tenant pays for the improvement, they will capitalize the improvement and depreciate the improvement per the discussion above (straight-line 39 years; straight-line 15 years with possibility for bonus and §179 deductions if QLI or QIP).

Upon termination of the lease, any unrecovered basis in the leasehold improvement may be deducted as a loss if the improvement is not retained by the tenant.  If the lessee is paid to terminate the lease and forfeits the improvements, the unrecovered basis is used to reduce the gain associated with the termination payments.

Improvement Allowance

The landlord can offer the tenant an improvement allowance.  Section 110(a) protects the tenant from income recognition if the following requirements are met:

  1. The tenant is under a short term lease (15 years or less); and
  2. The amount received is for the purpose of constructing or improving qualified long-term real property for use in the tenant’s trade or business.

When Section 110(a) does apply the allowance is not income to the lessee and the lessee does not own the property.  The landlord would capitalize the improvement and depreciate it for 39 years or 15 if the improvement meets the qualified leasehold improvement or qualified improvement property definition.

In the case that Section 110(a) does not apply the allowance would be considered a cost to acquire the lease and the landlord would amortize the cost over the life of the lease.  The allowance is taken into income by the tenant and the improvement is capitalized by the tenant and depreciated as applicable.

For more information on leasehold improvements and how they can affect your business, contact a member of our Real estate Team.

Recognized by IPA for Highest Percentage of Female Owners

HLB Gross Collins, P.C. has been recognized by Inside Public Accounting for defying a trend within the profession and having one of the highest percentages of female owners among the largest accounting firms in the nation. IPA is recognizing 30 firms across the country for doing things differently and changing the profession for the better.

The honor is an important one, as the profession has long struggled with increasing the number of women in its ranks of partners. In the largest firms, on average, one in six owners are women, a statistic that is not significantly different than a decade ago, according to IPA benchmarking data.

HLB Gross Collins, P.C. is pleased to have earned this recognition from Inside Public Accounting.

All of Georgia Now Eligible for Disaster Tax Relief

Hurricane Irma victims in the entire state of Georgia now have until Jan. 31, 2018, to file certain individual and business tax returns and make certain tax payments, the Internal Revenue Service announced today.

This includes an additional filing extension for taxpayers with valid extensions that run out on Oct. 16, and businesses with extensions that ran out on Sept. 15. It parallels relief previously granted to Irma victims throughout Florida and in parts of Puerto Rico and the Virgin Islands, and Harvey victims in parts of Texas.

For taxpayers in Georgia, this relief postpones various tax filing and payment deadlines that occurred starting on Sept. 7, 2017. As a result, affected individuals and businesses will have until Jan. 31, 2018, to file returns and pay any taxes that were originally due during this period.

This includes the Sept. 15, 2017 and Jan. 16, 2018 deadlines for making quarterly estimated tax payments. For individual tax filers, it also includes 2016 income tax returns that received a tax-filing extension until Oct. 16, 2017. The IRS noted, however, that because tax payments related to these 2016 returns were originally due on April 18, 2017, those payments are not eligible for this relief.

A variety of business tax deadlines are also affected including the Oct. 31 deadline for quarterly payroll and excise tax returns. Businesses with extensions also have the additional time including, among others, calendar-year partnerships whose 2016 extensions ran out on Sept. 15, 2017 and calendar-year tax-exempt organizations   whose 2016 extensions run out on Nov. 15, 2017. The disaster relief page has details on other returns, payments and tax-related actions qualifying for the additional time.

In addition, the IRS is waiving late-deposit penalties for federal payroll and excise tax deposits normally due during the first 15 days of the disaster period. Check out the disaster relief page for the time periods that apply to each jurisdiction.

The IRS automatically provides filing and penalty relief to any taxpayer with an IRS address of record located in the disaster area. Thus, taxpayers need not contact the IRS to get this relief. However, if an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date falling within the postponement period, the taxpayer should call the number on the notice to have the penalty abated.

Individuals and businesses who suffered uninsured or unreimbursed disaster-related losses can choose to claim them on either the return for the year the loss occurred (in this instance, the 2017 return normally filed next year), or the return for the prior year (2016).

The tax relief is part of a coordinated federal response to the damage caused by severe storms and flooding and is based on local damage assessments by FEMA. For information on disaster recovery, visit disasterassistance.gov.

For information on government-wide efforts related to Hurricane Irma, visit www.USA.gov/hurricane-irma.

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