May 2017 - Gordon Fischer Law Firm

Retirement Benefit Plans: A Case Study of Four Beneficiaries

Estates & Estate Planning, Wills, Trusts & Estates

With regard to charitable giving, not all assets are equal. For tax reasons, some assets may be better to pass on to heirs, while others may be better to give to your favorite causes. Consider the potential tax treatment of retirement benefit plans such as IRAs, 401(k)s, etc. A simple story illustrates why, for example, an IRA may make a better charitable gift, while other assets may be better for heirs, based on tax provisions.

Old Man Lear and his Four Beneficiaries

Consider the simple story of old man Lear and his four beloved daughters: Cordelia, Goneril, Regan, and Ashlee. (Feel free to take a break and go brush up on your King Lear!)Lear, no fool, engages in estate planning with the intention of helping each of his daughters in the future. He has four major assets: his house, stock, a painting, and his IRA. Each asset is worth roughly the same (plus/minus just a few dollars).

Lear’s house is worth $100,003. He purchased it for only $20,000.
Lear owns shares of stock in Acme Company, valued at $100,002. He bought the stock for just $50,000.
Lear has a famous painting of a castle. It’s valued at $100,009; he purchased it for $35,000.
Lear has dutifully paid into an IRA that’s now up to $100,020.

Nothing if not fair, Lear divvies up the four assets to each daughter. Do all four daughters get more or less the same deal?

Three Tax Concepts

Before answering, we need to consider three important tax concepts:

(1) Inheritance as income

(2) Income in respect of a decedent

(3) Step-up in basis (also called, stepped up basis)

The interplay of these concepts may make charitable gifts of retirement plan assets more attractive to your clients than charitable gifts of other kind of assets.

Inheritance as Income

Under our federal income tax rules, receipt of almost every type of asset counts as income. One of the rare exceptions in inheritance of property. Generally speaking, inheritance is not income, for federal tax purposes. Most inherited property passes tax-free. (It’s true there is an Iowa inheritance tax. To keep this article simple(r), I’ll focus on federal tax).

Income in Respect of a Decedent (IRD)

Of course, with every rule in federal tax law, there’s an exception. Most inherited property passes tax-free, but not all. IRD is income that the deceased was entitled to, but had not yet received, at time of death. IRD can come from various sources, including:

(1) Unpaid salary, fees, commissions, and/or bonuses;

(2) Deferred compensation benefits;

(3) Accrued but unpaid interest, dividends, and rent; and

(4) Distributions from retirement benefit plans

That’s right – retirement benefit plans are IRD.

Federal tax law provides for IRD to be taxed when it’s distributed to the deceased’s beneficiaries. IRD retains the character it would have had in the deceased’s hands.

Step-up in basis

Step-up in basis is a critically important concept. It refers to the readjustment of value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is determined to be the market value of the asset at the time of inheritance, and not the value at which the original party purchased the asset.

Four Beneficiaries and Four Assets

Cordelia’s inherits the house. As we discussed, there’s no federal tax on inheritance. Cordelia sells the house for $100,003. Still, no federal tax. Although Lear purchased the house for only $20,000, recall that Cordelia receives a step up in basis. Cordelia’s basis is $100,003, the fair market value (FMV) of the house. Since she sells it for $100,003, there’s nothing to tax.

When Goneril inherits the stock, there’s no tax—as there’s no taxable event. Soon, Goneril sells the stock. Although Lear purchased the stock for just $50,000, Goneril receives a step up in basis. Goneril’s basis is $100,002, the stock’s FMV. Since she sells the stock for its new stepped-up basis, there’s nothing to tax.

Regan inherits the painting, with the same result. There’s no federal tax on inheritance of the painting. When Regan immediately sells the art for FMV, there’s nothing to tax, as the FMV, and step-up in basis, are the same.

How about Ashlee and the IRA? If Ashlee withdraws money from the IRA, it’s a different story. Ashlee will have to pay federal income tax of up to 39.6 percent. (It is true that Ashlee could defer withdrawals from the IRA for a long time, and of course such deferral reduces the impact of taxes.)

To sum up, in this hypothetical, the house, stock, and art passed to the beneficiaries without any taxable event, and the daughter were able to sell without tax consequences. The IRA passed to the fourth daughter, but she will have to pay taxes when she withdraws funds.

When considering charitable gifts, also consider the tax code. And, considering talking to your kids about these issues. After all, not all assets are equally beneficial to heirs. In this case, retirement benefits plans may make an ideal gift to your favorite cause.

May 25, 2017/by Gordon Fischer

GoFisch: May Edition

From Gordon's Desk..., Newsletter

This month’s issue of GoFisch is out! Give it a read, subscribe, and pass it along to someone you know who could benefit from the information.

Missed past issues? Here are the April and March editions.

May 19, 2017/by Gordon Fischer

Bountiful Harvest: Charitable Giving Using Gifts of Grain

Charitable Giving

For donors who actively engage in farming on a cash basis [1], significant tax savings can be found through donating grain directly to a favorite charity such as a public library, church, or university. Yes, you read that right. Grain. In short, the charities make money by selling the donated grain and the donors get tax deductions at a better rate than just cash donations.

Who Qualifies?

Keep in mind the tax benefits of gifting grain don’t apply to everyone, so not everyone who works in agriculture may qualify. As discussed more fully below, only cash basis farmers are able to reap these benefits.

Crop Share Landlords Not Eligible

There are two major kinds of farm leases: cash share leases and crop share leases (as well as hybrids of the two) [2]. A crop share landlord would not be eligible to receive the tax benefits discussed here. A crop share landlord’s share of crops is considered rental income and must be reported as such on the landlord’s tax return.

Tax Benefits

Tax Savings

Cash gifts to a charity are deductible if a donor itemizes deductions on Schedule A. Many farmers, however, take the standard deduction [3].

As many farmers take the standard deduction, no tax benefit is gained by making charitable gifts of cash. However, by directly donating grain to a charity organization the cash basis farmer can exclude the sale of the grain from income, which can result in a triple tax savings. The tax savings can include:

Federal income tax savings (up to 39.6 percent)
State income tax savings (up to 8.98 percent in Iowa)
Self-employment tax savings (15.3 percent)

Expenses Related to Production

For most farm operators, the expenses related to the production of the donated grain are deductible on Schedule F [4]. The charitable donation of grain reduces the income that is reportable on Schedule F.

No Charitable Contribution Deduction

Donors of grain should not report the donation on Schedule A. There is no additional deduction allowed since the tax benefit comes from the deduction of production expenses and not reporting a sale on Schedule F.

Timing of Gift

Another great benefit of donating grain is that it doesn’t matter if the donation is made in the year of production or a later year. Gifts of grain can be donated from the current year or previous years’ harvests.

Fewer Forms

Yet another great benefit of donating grain: fewer forms! Generally speaking, if the total of your donated property is more than $500, you have to file an additional form with your return, Form 8283: Noncash Charitable Contributions. For property valued at more than $5,000, generally, you have to produce a qualified appraisal by a qualified appraiser.

However, with gifts of grain, as mentioned above, there is no charitable deduction taken. Therefore, the donor of grain doesn’t need to provide Form 8283 or a qualified appraisal. So, gifts of grain can be easier gifts than other types of property.

Cautionary Notes

Take note of these few considerations regarding prior sale commitments; physical delivery; giving up control; and storage, transportation, and risk.

No Prior Sale Commitment

To receive the tax benefits discussed in this article, farmers cannot sell the grain and then order the sales proceeds to be sent to the charity. The gift must be from unsold grain inventory with no prior sale commitment.

Physical Delivery

This is similar to the point made directly above regarding no prior sale commitment. The commodity should be put into the name of the charity when it is delivered to the elevator and a warehouse receipt should be issued in the name of the charity. For grain stored on the farm, the farmer should deliver to the charity a notarized letter of transfer.

Giving Up Control

The farmer must give up dominion and control over the grain and cannot offer any guidance as to when to sell the grain. The charity must direct the sale and the original sales invoice must list the charity as the seller.

Storage, Transportation, and Risk

After the transfer, the charity assumes the full costs of storage, transportation, and marketing, and bears completely the risk of any loss.

Use Professional Advisors

Donors should always consult with their professional tax and/or legal advisors to determine tax implications specific to their situation prior to making the gift.

Case Study of Tax Savings from Gift of Grain

Pat, a cash-basis grain farmer who takes the standard deduction every year, donates 1,000 bushels of corn to her favorite charity, a local hospital. Her cost of production is $2,000, and the proceeds from the sale of the corn by the hospital is $5,000.

Pat is entitled to deduct her $2,000 of production expenses on Schedule F. In addition, she will not be required to report the proceeds from the sale of the corn as income. Assuming that Pat is in the 25% federal and 8.98% Iowa tax bracket, the following are the tax savings that result when Pat reduces her taxable income by making a gift of the corn to a charity:

$1,250 Federal income tax ($5,000 x 25%)

$449 State income tax ($5,000 x 8.98%)

$765 Self-employment tax ($5,000 x 15.3%)

=$2,464 Tax savings

By donating the corn rather than selling it outright and making a cash gift, Pat saves $2,464 in taxes. In addition, she can still deduct the $2,000 of production expenses she incurred to grow the corn.

(Note: If Pat itemizes her deductions rather than claiming the standard deduction, her additional tax savings through making a gift of corn rather than cash would be limited to the savings on self-employment tax.)

Steps to Make a Gift of Grain to Your Favorite Charity

Be sure to consult with your tax preparer or financial advisor to determine the tax implications prior to making a charitable gift of grain. Staff of potential recipient charities are also usually more than happy to assist!

Contact the intended charity recipient of their intention to make a gift. (Some charities actually has forms specific to gifts of grain.)

Donors will deliver the grain to the elevator and tell the elevator of the wish to transfer ownership of X number of bushels (or X fraction of the load) to the donee charity.
Clients will need to request the elevator to issue a warehouse storage receipt in the name of the charity and send it to them. The donor should instruct the elevator not to sell the grain until they are contacted by the receiving charity.
The receiving charity should be notified that the grain is at the elevator.The charity will then contact the elevator to direct the sale of the grain and will send the farmer (donor), an acknowledgment letter.

As you can see, it is very important for professional advisors and the recipient charity to be consulted before making the gift.

Every Iowan and every farm is unique. Be sure to consult with your own professional advisor. This article is not to be construed as legal advice, and is provided merely as general information.

Additional Information

[1] There are several methods of accounting for income. Farmers have been given an advantage in the Internal Revenue Code by being allowed to use the cash method of accounting. Most farmers choose the cash method because of the tax advantages. The cash method of accounting allows (many) farmers to claim the expenses of the current year’s crops while postponing the recognition of income. Under the cash method, all income is included in the year it is actually or constructively received. Farm business expenses are deductible in the year in which they are paid. For much more on farming, income issues, and the IRC, find a wealth of information here on IRS.gov.

[2] In a cash rent lease, generally, the tenant usually pays a fixed dollar amount in rent (either on a per acre or whole farm basis). These types of leases may be modified depending on crop yield (i.e., increase in good years and decrease in bad years). With cash rent leases, the landlord is not as involved in crop production, thereby giving the tenant more autonomy.

In a typical crop share lease, the landlord will share input costs (including but not limited to seed, fertilizer, and fuel), while the tenant provides all of the labor and remaining input costs. Once harvested, proceeds will be divided according to the agreement (which may range from, say, 25/75 to 50/50). With crop share leases, most often both parties share the risks.

Of course, there are hybrid arrangements. In any case, it’s important for both parties to make sure they have competent legal and tax counsel drafting the lease agreements.

[3] You can either claim the standard deduction or itemize your deductions—whichever lowers your taxes the most. The standard deduction is a fixed dollar amount that reduces the income you’re taxed on. Your standard deduction varies according to your filing status.

Three noteworthy items about the standard deduction:

Standard deduction allows you a deduction even if you have no expenses that qualify for claiming itemized deductions.
It eliminates the need to itemize deductions, like medical expenses and charitable donations.
The standard deduction allows you to avoid keeping records and receipts of your expenses.

The benefit of itemizing is that it allows you to claim a larger deduction that the standard deduction. However, it requires you to complete a Schedule A attachment to your return and to maintain records of all your expenses.

Itemized deductions include a range of expenses that are not otherwise deductible. Common expenses include the mortgage interest you pay on up to two homes, your state and local income or sales taxes, property taxes, medical and dental expenses that exceed 7.5 percent of your adjusted gross income, and the charitable donations you make. Itemized deductions also include miscellaneous deductions such as work-related travel. Once you decide to itemize, you are eligible to claim all of them.

[4] If you earn a living as a self-employed farmer, then you most probably need to include a Schedule F attachment with your tax return to report your profit or loss for the year. The IRS defines “farmer” in a very broad sense and can apply whether you grow crops, raise livestock, or even breed fish!

In addition to money earned from selling crops and livestock, Schedule F also reports other types of farming income, such as any crop insurance payouts, including: federal disaster payments; money you earn through a farming cooperative; and payments you get from an agricultural program.

Cash basis farmers can deduct any cost incurred that’s an ordinary and necessary expense of farming on Schedule F to reduce the profit—or increase the loss—on which you’ll owe taxes. Some of the expenses farmers commonly deduct cover the cost of livestock and feed, seeds, fertilizer, wages paid to employees, interest paid during the year on farm-related loans, depreciation to recover a portion of equipment costs, utilities, and insurance premiums.

May 18, 2017/by Gordon Fischer

What recordkeeping is required for charitable deduction?

Charitable Giving, Taxes & Finance

Save $$$ and help your favorite charities even more.

Some say it’s better to give than receive. I say, it’s better to give and receive. You can both give and receive by using the federal income tax charitable deduction.

A gift to a qualified charitable organization may entitle you to a charitable contribution deduction against your income tax if you itemize deductions. Assuming the gifts are deductible, the actual cost of your gift is reduced by your tax savings.

Charitable deduction tax savings

In short, as of March 2017, there are seven federal income tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. (For a general discussion of tax brackets, see my post called bracketology.)

The charitable deduction can result in significant tax savings. For example, assume a donor in the 33% tax bracket gives to her favorite qualified charitable organization a donation of $100. The charity still receives the full gift of $100. But, for the donor, the actual out-of-pocket cost of the gift is only $67, and the donor saves $33.

Let’s make these assumptions for all tax brackets and see the savings which result:

Bracket Donation Savings Actual cost
10% $100 $10 $90
15% $100 $15 $85
25% $100 $25 $75
28% $100 $28 $72
33% $100 $33 $67
35% $100 $35 $65
39.6% $100 $39.60 $60.40

This is a good deal for you and a good deal for your favorite causes. So why not consider using the charitable deduction?

The charitable deduction requires you to be organized in your giving and maintain records. Generally speaking, the greater the deduction, the more detailed the records you are required to keep.

The basics of substantiation of your charitable deduction

Here’s a simple explanation of IRS record keeping rules for the charitable deduction:

Gifts of less than $250 per donee — you need a cancelled check or receipt
$250 or more per donee — you need a timely written acknowledgement from the donee
Total deductions for all property exceeds $500 — you need to file IRS Form 8283
Deductions exceeding $5,000 per item — you need a qualified appraisal completed by a qualified appraiser

Wait, you ask, is it really that simple? Actually, no, not really. Let’s go through these categories and dig deeper.

Substantiation requirements for monetary gifts less than $250

A federal income tax deduction for a charitable contribution in the form of cash, check, or other monetary gift is not allowed unless the donor substantiates the deduction with a bank record or a written communication from the donee showing the name of the donee, the date of the contribution, and the amount of the contribution.

Meaning of “monetary gift”

For this purpose, the term “monetary gift” includes, of course, gifts of cash or by check. But monetary gift also includes gifts by use of:

credit card;
electronic fund transfer;
online payment service;
payroll deduction; or
transfer of a gift card redeemable for cash.

Meaning of “bank record”

Again, to claim the charitable deduction for any monetary gift, you need a bank record or written communication from the donee. The term “bank record” includes a statement from a financial institution, an electronic fund transfer receipt, a cancelled check, a scanned image of both sides of a cancelled check obtained from a bank website, or a credit card statement.

Meaning of “written communication”

The term “written communication” includes email. Presumably it also includes text messages. But, again, the written communication, whether paper or electronic, it must show the name of the donee, the date of the contribution, and the amount of the contribution.

Substantiation of gifts of $250 or more

For any contribution of either cash or property of $250 or more, a donor must receive contemporaneous written acknowledgment from the donee. Two keys here: “contemporaneous” and “written acknowledgement”; both have very specific meanings in this context.

Requirements of written acknowledgment

The written acknowledgment must include:

The date of the gift and the charity’s name and location.
Whether the gift was cash or a description of the noncash gift.
A statement that no goods or services were provided by the organization in return for the contribution, if that was the case.
A description and good faith estimate of the value of goods or services, if any, that an organization provided in return for the contribution.
A statement that goods or services, if any, that an organization provided in return for the contribution consisted entirely of intangible religious benefits, if that was the case.

“Contemporaneous”

For a written acknowledgment to be considered contemporaneous with the contribution, a donor must receive the acknowledgment by the earlier of: the date on which the donor actually files his or her individual federal income tax return for the year of the contribution or the due date (including extensions) of the return.

Noncash gifts of more than $500

If you make a total of more than $500 worth of noncash gifts in a calendar year, you must file Form 8283, Noncash Charitable Contrib utions, with your income tax return.

You’ll only have to fill out Section A of Form 8283 if:

the gifts are worth less than $5,000, or
you’re giving publicly traded securities (even if they’re worth more than $5,000).

Otherwise, you’ll be required to fill out Section B of Form 8283 and all that entails.

Noncash gifts of more than $5,000

If you donate property worth more than $5,000 ($10,000 for stock in a closely held business), you’ll need to get an appraisal. The information goes in Section B of Form 8283, “Noncash Charitable Contributions.”

An appraisal is required whether you donate one big item or several similar items which have a total value of more than $5,000. For example, if you give away a hundred valuable old books, and their total value is more than $5,000, you’ll need an appraisal even though you might think you’re really making a lot of small gifts. The rule applies even if you give the items to different charities.

Requirements for “qualified appraisal” and “qualified appraiser”

Again, noncash gifts of more than $5,000 in value, with limited exceptions, require a qualified appraisal completed by a qualified appraiser. The terms “qualified appraisal” and “qualified appraiser” are very specific and have detailed definitions according to the IRS.

“Qualified appraisal”

A qualified appraisal is a document which is:

made, signed, and dated by a qualified appraiser in accordance with generally accepted appraisal standards;
timely;
does not involve prohibited appraisal fees; and
includes certain and specific information.

Let’s further examine each of these four requirements.

“Qualified appraiser”

Appraiser education and experience requirements

An appraiser is treated as having met the minimum education and experience requirements if she is licensed or certified for the type of property being appraised in the state in which the property is located. In Iowa, for a gift of real estate, this means certification by the Iowa Professional Licensing Bureau, Real Estate Appraisers.

Further requirements for a qualified appraiser include that she:

regularly performs appraisals for compensation;
demonstrates verifiable education and experience in valuing the type of property subject to the appraisal;
understands she may be subject to penalties for aiding and abetting the understatement of tax; and
not have been prohibited from practicing before the IRS at any time during three years preceding the appraisal.

Also, a qualified appraiser must be sufficiently independent. This means a qualified appraiser cannot be any of the following:

the donor;
the donee;
the person from whom the donor acquired the property [with limited exceptions];
any person employed by, or related to, any of the above; and/or
an appraiser who is otherwise qualified, but who has some incentive to overstate the value of the property.

Timing of appraisal

The appraisal must be made no earlier than 60 days prior to the gift and no later than the date the return is due (with extensions).

Prohibited appraisal fees

The appraiser’s fee for a qualified appraisal cannot be based on a percentage of the value of the property, nor can the fee be based on the amount allowed as a charitable deduction.

Specific information required in appraisal

Specific information must be included in an appraisal, including:

a description of the property;
the physical condition of any tangible property;
the date (or expected date) of the gift;
any restrictions relating to the charity’s use or disposition of the property;
the name, address, and taxpayer identification number of the qualified appraiser;
the appraiser’s qualifications, including background, experience, education, certification, and any membership in professional appraisal associations;
a statement that the appraisal was prepared for income tax purposes;
the date (or dates) on which the property was valued;
the appraised FMV on the date (or expected date) of contribution;
the method of valuation used to determine FMV;
the specific basis for the valuation, such as any specific comparable sales transaction; and
an admission if the appraiser is acting as a partner in a partnership, an employee of any person, or an independent contractor engaged by a person, other than the donor, with such a person’s name, address, and taxpayer identification number.

Appraiser’s dated signature and declaration

Again, a qualified appraisal must be signed and dated by the appraiser. Also, there must be a written declaration from the appraiser that he/she is aware of the penalties for substantial or gross valuation.

The charitable deduction can result in significant tax savings. But, substantiation rules, as you’ve seen, can be complicated. Also, all Iowans are unique, so be sure to contact the appropriate tax professional for personal advice and counsel.

I provide trainings for nonprofits and their staffs, board members, and stakeholders. Reach out to me any time by emailing me at gordon@gordonfischerlawfirm.com or call 515-371-6077. I’d love to hear from you!

May 10, 2017/by Gordon Fischer

Upcoming Event: Professional Advisor Continuing Education Program

Events, From Gordon's Desk...

The Community Foundation of Carroll County, along with the Kuemper Catholic School, New Hope Village, and St. Anthony Foundations, teamed up to sponsor the Professional Advisor Continuing Education Program, in Carroll, Iowa. And, I’m excited to say I’ll be the featured speaker!

Lawyers, accountants, insurance agents, and financial advisors are invited to attend.

This seminar was approved for 2.0 CE Credits by the Iowa Insurance Division, course #10168.
This seminar was approved for 2.0 CE Credits by the CFP Board, program #238762.
Thisevent was approved for 2.0 total hours of Continuing Legal Education (CLE) credit, including .5 hours of ethics. The CLE Activity ID is 257823.

My presentation will include example of tools and concepts advisors can utilize with clients such as the Endow Iowa Tax Credit Program (now available through the Community Foundation of Carroll County).

There is no charge for the lunch or program and all area professional and financial advisors are invited and encouraged to attend! Please RSVP to foundation@stanthonyhospital.org or call Stacey Vonnahme at (712) 794-5287 so the event organizers can prepare adequately for lunch and handout materials.

Details

Who: Professional & financial advisors

Date: Wednesday, May 24, 2017

Time: 10:30 a.m.-1:15 p.m.

Where: St. Francis & Clare Meeting Rooms*, St. Anthony Regional Hospital. Park in the St. Anthony parking garage and take an elevator to the 4^th floor of the Surgery Center. (Note: do not enter the main hospital building.) Event hosts will greet you as you exit the elevator.