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For more than three decades, our goal at Schwan Financial Group, LLC, has been to transcend the concept of merely creating value for our clients into one of being valuable. We are committed to three simple philosophies: give people a good listening to, put everything in writing, and manage the Master Plan towards each client s objectives. We appreciate the relationship we have with you and hope you find this newsletter to be a valuable resource. John P. Schwan The Planning Priority Pyramid Clarity Would you if you could? Your Heirs Proper people, proper time Yourselves Financial independence Vision, Values Why to plan
Estate Planning Modification of IRA Periodic Payments Results in Interest and Penalties Summary. In a private letter ruling, 1 the IRS ruled that an unintended, improper modification of substantially equal periodic payments from an IRA resulted in application of a ten percent penalty tax, plus interest, back to when the payments began. Background. Unless an exception exists, an individual retirement account (IRA) owner who takes a distribution from his or her IRA prior to reaching age 59½ is subject to a ten percent penalty tax on any income recognized, generally, the entire amount of the withdrawal. 2 There are several exceptions to the ten percent penalty, but the exception that is addressed in this ruling is for distributions that are part of a series of substantially equal periodic payments for the individual s lifetime. For our purposes, it is important only to know that once periodic payments have begun, they must generally continue unmodified until the longer of five years or age 59½. If the payments are modified before that time, the entire series of payments will be taxable and subject to a ten percent penalty tax, plus interest. Except for a permissible one-time election to change the calculation method or a modification that occurs due to death or disability, no modification is permitted for the SEPP payments. Facts. In 2001, Taxpayer, using one of the approved methods of calculation, began taking a series of substantially equal periodic payments (SEPP) from his IRA. In 2008, when Taxpayer s financial advisor moved to a new firm, Taxpayer moved his IRA to the new firm, too. However, the new custodian was unable to accept one of the assets from the old IRA, so that asset was not transferred to the new IRA but continued to be administered by the old IRA. Also, the new custodian made distributions without withholding income taxes while distributions from the old custodian were made subject to withholdings. The amounts distributed to Taxpayer each year were the same, but the difference in withholding methods had the effect of making total distributions from the new IRA lower than those from the old IRA. When the underpayment was discovered, the unpaid amounts were distributed in a later year. All distributions were made from the new IRA after the transfer, with none coming from the old IRA. At age 58, Taxpayer sought two rulings from the IRS through a private letter ruling request. Requests. Taxpayer requested that: (1) The underpayment and subsequent repayment were not an impermissible SEPP modification under Section 72(t) (4) that would result in application of the ten percent penalty tax; and (2) failure to transfer the entire IRA to the new custodian was not an impermissible modification. Ruling. The IRS ruled that an impermissible modification occurred, both because of the underpayment and later repayment and because of the partial transfer. It noted that under Rev. Rul. 2002-62. Sec. 2.02(e), a modification to the series of payments will occur if, after such date, there is (i) any addition to the account balance other than gains or losses, (ii) any nontaxable transfer of a portion of the account balance to another retirement plan, or (iii) a rollover by the taxpayer of the amount received resulting in such amount not being taxable. As a result of the impermissible modifications, Taxpayer was required to pay a ten percent penalty tax for each year of distributions under the SEPP arrangement, plus interest due on the tax underpayment. Comments. This ruling shows that the SEPP rules are applied mechanically, with little margin for error. Care should always be taken when setting up a SEPP arrangement or transferring the underlying IRA from one custodian to another once SEPP payments have begun. 1 PLR 201323045 at http://www.irs.gov/pub/irswd/1323045.pdf, March 14, 2013 2 IRC 72(t).
Business Planning Income Taxes Basic Federal Income Taxation of Corporate Owned Life Insurance Summary: Corporations that purchase life insurance generally enjoy the same federal income tax preferences afforded other purchasers of life insurance, including the potential to receive the death benefit proceeds income tax free, the potential for cash value growth on a tax deferred basis and the ability to access policy cash values on an income tax free basis. But consumers who are considering purchasing life insurance through a corporation should be aware of some conditions corporations must meet to preserve the income tax free nature of the death benefit, potential for triggering gain from the policy s cash value under certain events, and potential exposure to the alternative minimum tax. Death Benefit: With few exceptions, corporations purchasing life insurance on the life of an employee must meet the following requirements in order to receive the death benefit income tax free. Before the issuance of the policy, the employer must notify the insured employee in writing that the employer intends to purchase insurance on the employee s life and provide notice of the maximum face amount the employer intends to secure on the insured s life and that the corporation will be the beneficiary of the policy. Additionally, the employee must consent to the insurance and to the continuation of the coverage under the policy after termination of employment. If the insured employee dies while an employee, the corporation will receive the death benefits income tax free if the notice and consent requirements were met before the issuance of the policy. If the insured dies later than twelve months following termination of employment, the death benefit would generally be income taxable to the corporation unless the insured was a director or highly compensated employee at the time the policy was issued. Additionally, the employer must annually file IRS Form 8925 along with its corporate federal income tax turn, reporting the information specified in the form about the policies it owns on its employees lives. Tax Deferred Cash Value Growth: Cash values in a life insurance policy grow on an income tax deferred basis, including life insurance held by a corporation. Additionally, a corporate owner of a cash value policy that is not a modified endowment contract ( MEC, as defined by the Internal Revenue Code) would have income tax free access to the policy s cash value through withdrawals or surrenders of paidup additions up to the amount of the corporation s basis in the policy, and through policy loans thereafter as long as the policy remains in force until the insured s death. If after withdrawing the corporation s basis in the policy, the corporation takes additional cash from the policy through policy loans and then later surrenders the policy or allows the policy to lapse, the corporation will recognize ordinary income in the amount equal to the outstanding policy loans. If the policy is a MEC, withdrawals, surrenders and policy loans will trigger ordinary income to the corporation to the extent of any untaxed gain in the policy s cash value, with an additional 10% penalty tax assessed on the taxable portion of the cash values withdrawn. Distribution of a policy by a corporation to a third party regardless of how that distribution may be characterized will trigger immediate recognition as ordinary income of any untaxed gain in the cash value of the policy. Policy loans and cash withdrawals reduce the death benefit and cash value of the policy. Outstanding loans accrue interest and may result in tax consequences. Alternative Minimum Tax: Corporations are potentially subject to alternative minimum tax (AMT) in part based on the corporation s adjusted current earnings ( ACE, as defined by the Code). Although death benefits received by a C corporation or growth in a policy s cash value will not necessarily in and of themselves subject the corporation to AMT, death benefits received in excess of the corporation s basis in the policy will be included in the corporation s ACE for the taxable year in which the death benefit is received and impact the corporation s potential exposure to AMT. Inside build-up of policy cash value also is included in a corporation s ACE each taxable year to the extent of the cash value growth occurring in that year.
Taxation - Income Life after DOMA: Certain Federal Tax Implications The US Supreme Court recently declared Section 3 of the Defense of Marriage Act (DOMA) unconstitutional with its decision in United States v. Windsor. Consequently, same-sex couples married and residing in one of 14 jurisdictions in the United States that currently recognize samesex marriages will now be entitled and subject to the same federal tax benefits and obligations historically afforded to married couples of the opposite sex. Below are highlights of some of the key federal tax provisions affecting same-sex married couples before and after the Windsor decision. (Dollar amounts and rates referenced below are applicable during 2013, unless otherwise indicated.) Federal Income Tax Laws Under DOMA After DOMA Income Tax Return Filing Status Single taxpayer. Married filing jointly. Married filing separately. Taxable at Highest Marginal Income Tax Bracket Long Term Capital Gains and Qualifying Dividends Net Investment Income Tax (NIIT) Alternative Minimum Tax (AMT) Standard & Itemized Deductions Gain Exclusion from Sale of Principal Residence Qualified Plan & IRA Beneficiary Options Unlimited Marital Deduction Annual Exclusion Lifetime Exemption / Applicable Exclusion Amount Unlimited Marital Deduction Applicable Exclusion Amount Determined individually, taxable income above $400,000. Determined individually, taxable at 20% when taxable income exceeded $400,000. Determined individually, net investment income exposed to 3.8% NIIT when modified adjusted gross income (MAGI) exceeded $200,000. Determined individually, AMT exemption amount of $51,900. For each individual, standard deduction of $6,100. Phase out of itemized deductions began when individual s adjusted gross income (AGI) exceeded $250,000. For qualifying dispositions, up to $250,000 of gain excluded from income for each individual. Spousal beneficiary would have only had distribution options available to a nonspousal beneficiary of an inherited IRA Not applicable. Donor spouse allowed to gift up to $14,000 to spouse annually w/o gift tax. Donor spouse allowed to use all or a portion of unused applicable exclusion amount to gift up to $5,250,000 to spouse without gift tax. Not applicable. A decedent spouse would have been allowed to leave up to the unused applicable exclusion amount of $5,250,000 to a surviving spouse without imposition of estate tax; amounts left to a surviving spouse above the unused applicable exclusion amount would have been subject to a 40% estate tax rate. Married filing jointly, taxable income above $450,000. Taxable at 20% when taxable income exceeds $225,000 when married filing separately. Taxable at 20% when taxable income exceeds $450,000 when married filing jointly. Taxable at 20% when taxable income exceeds $225,000 when married filing separately. Net investment income exposed to 3.8% NIIT when MAGI exceeds $250,000 when married filing jointly. Net investment income exposed to 3.8% NIIT when MAGI exceeds $125,000 when married filing separately. AMT exemption amount of $80,800 when married filing jointly. AMT exemption amount of $40,400 when married filing separately. Standard deduction of $12,200 when married filing jointly (itemized deductions of both spouses allowed to be combined), with phase out beginning when AGI exceeds $300,000. Standard deduction of $6,100 when married filing separately, with phase out beginning when AGI exceeds $150,000. For qualifying dispositions, up to $500,000 of gain excludible from income when married filing jointly even if residence is owned by only one of the spouses. Up to $250,000 of gain excludible from income per spouse when married filing separately. In addition to distribution options under an inherited IRA, spousal beneficiary may effect a spousal rollover and choose distribution options available as owner of the IRA. A spouse may gift unlimited amounts to the other spouse as long as the donee spouse is a U.S. citizen. If donee spouse is a U.S. citizen, unlimited gifts allowed using unlimited marital deduction. If donee spouse is a U.S. citizen, donor spouse may gift unlimited amounts to donee spouse without using the applicable exclusion amount. A decedent spouse may leave an unlimited amount of wealth to a surviving spouse without imposition of estate tax as long as surviving spouse is a U.S. citizen. See Unlimited Marital Deduction above; a decedent spouse will be allowed to use the unused applicable exclusion amount to leave assets to other non spouse beneficiaries and/or certain trusts for the benefit of a surviving spouse and other heirs without the imposition of estate tax. The 14 jurisdictions currently recognizing same-sex marriage include: California, Connecticut, Delaware, the District of Columbia, Iowa, Maine, Maryland, Massachusetts, Minnestoa, New Hampshire, New York, Rhode Island, Vermont and Washington.
Retirement Planning Take Care When Drafting for Blended Families Summary. The North Dakota Supreme Court permitted reformation of trusts for the grantors deceased grandchild so that the trusts would benefit only descendants of the grandparents who established the trusts and not halfblood siblings of the grandchild, who were not descendants of the grantors. Facts. The Clairmonts established various trusts for their grandchildren, one of whom was Matthew Larson, who was the son of their daughter, Cindy, and her husband, Greg Larson. Greg and Cindy had four children, including Matthew. Many years later, Greg and Cindy divorced; however, Greg remarried and had two children with his second wife. The trusts established by the Clairmonts for their grandchildren provided that assets in the trusts would be paid to the beneficiaries at specified ages. However, if a grandchild died before the assets were fully distributed, the assets would pass as the beneficiary appointed; unappointed assets would pass first to the beneficiary s issue by representation; if none, then equally to the beneficiary s brothers and sisters by representation. Matthew died in 2011 without issue and without exercising his power of appointment. Therefore, the assets were to be distributed equally to his brothers and sisters. The Clairmonts filed a petition in a North Dakota District Court requesting that the court interpret brothers and sisters in the trust documents as Matthew s brothers and sisters who were descendants of the Clairmonts, and not his father s (Greg s) children from his second wife. In the absence of such an interpretation, the Clairmonts asked the court to reform the trusts to be consistent with their intended interpretation. Issue. Should the trust documents be interpreted or reformed so that the term brothers and sisters not include the children from Matthew s father, Greg, and his second wife and include only those brothers and sisters who were descendants of the Clairmonts who established the trusts? Decision. The District Court determined that Greg Larson s children from his second marriage were considered beneficiaries of the trusts established by the Clairmonts because, under North Dakota law, the term brothers and sisters, includes relatives of the halfblood. The Court also dismissed the petition for reformation because there was not sufficient proof of an error of fact or law that would compel the court to reform the trusts. On appeal to the North Dakota Supreme Court, the court affirmed in part and reversed in part, finding that, although the Clairmonts desired interpretation of the trust language could not be made under North Dakota law, they are entitled to reform the trusts because a mistake of law occurred due the Clairmonts misunderstanding of the terms brothers and sisters under North Dakota law. The case was remanded to the District Court for reformation of the trusts. 1 Comments. This case involves North Dakota law; however, it has general application for attorneys who draft estate planning documents. As divorce and re-marriage increasingly occur in our society, families often include children who are full-blood and half-blood relatives, as well as those who are not related by blood. Ex-spouses and their children from other marriages may need to be included (or excluded) in the estate planning process when a divorce decree so provides. This case shows how important it is to know the legal effects of terms that describe family relationships and how carefully documents must be drafted. Although the Clairmonts eventually achieved their objective of benefiting only their descendants, it would have been easier, and cheaper, if that restriction had been clearly stated when the trust documents were drafted. 1 In re Matthew Larson Trust Agreement, 2013 ND 85, Docket: 20120319.
Schwan Financial Group, LLC We Help People John P. Schwan Founder, President, & CEO Michael A. Duch, MBA, RFC, CFS Vice President, Partner Sarathi Giridhar, CPA, CFP Vice President, Partner The Ideal Plan Process (The three Cs) Clarity to Understand your Current Plan We provide vivid clarity of your current situation through listening and modeling so you realize the difference between where you think you are, where you actually are, and discover what your ideal plan is for the future. Confidence to Act on Your Complete Plan By providing you with a defined starting point and developing measurable situations, you will gain the confidence to act on your complete plan. Without acting, without doing, your ideal plan remains just an idea. Capability to Manage Your Master Plan We provide you with knowledge, support and control to manage your Master Plan. Recognizing your achievements on a regular basis continues to help you manage your plan and understand expectations.
John P. Schwan, CEO, Partner 320 6 th Ave. SE Aberdeen, SD 57401 t: 605.225.1047 www.schwanfg.com