SHARE OF APPRECIATION NOT GRANTED IN PRENUPTIAL AGREEMENT

A recent Florida appellate court decision provides a drafting lesson in prenuptial agreements - if a spouse is to receive an interest in appreciation in an asset, the agreement should be specific on that.

In the case, a valid prenuptial agreement provided that:

6. Agreements Concerning Fran's House. The parties hereto intend to reside in Fran's house . . . . The House shall be and remain titled in Fran's name alone and, except as specifically provided in Section 6, Rudy shall have no right, title or interest in and to the House or any of Fran's Separate Property contained herein. Further, with respect to the House, the parties agree as follows:

(a) If a petition for dissolution of marriage is filed by either of the parties hereto after the date the parties are married, upon the entry of an order dissolving the marriage of the parties, Fran shall pay to Rudy a sum equal to one-half of all principal payments and any capital improvements made with respect to the House between the date of the marriage of the parties and the date on which a petition for dissolution of marriage was filed.

The parties divorced, and Rudy claimed that he was entitled to one-half of the appreciation in the House that occurred after marriage. The trial court agreed with him and awarded him that portion of the appreciation.

The court was reversed on appeal, since the plain language of the agreement only contemplates that Rudy was to receive a dollar amount equal to one half of the principal payments and capital improvements made.

It is unclear from the opinion whether Rudy thought that he was entitled to the appreciation at the time he entered into the agreement, or he just threw that argument in at the time of divorce to see if it might stick. The result here is not surprising based on the language of the agreement. The only surprising thing is that the trial court agreed with Rudy, and had to be reversed on appeal.

If it is intended that a party is to benefit by post-marriage appreciation in an asset, this should be made explicit in the agreement to avoid disappointed parties and unnecessary litigation.

Heiny v. Heiny, 38 Fla.L.Weekly D200g (2nd DCA 1/25/13)

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APPLICABLE FEDERAL RATES–FEBRUARY 2013

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MOM & POP TAX PREPARERS RESCUED BY D.C. DISTRICT COURT

In 2011, the IRS began regulating non-attorney, non-CPA tax-return preparers. New regulations require them to pass an exam, pay an annual fee, and take fifteen hours of continuing-education courses each year. The new rules threaten to drive many preparers out of business, and raise costs to others.

There IRS has only one small obstacle to implementing these new rules – the U.S. Constitution. Congress has never given the IRS and Treasury authority to regulate tax preparers.

The IRS argued that an 1884 statute gave the requisite authorization when it allowed the IRS to regulate “representatives” who “practice” before it. The court did not agree that tax return preparers are representatives practicing before the IRS, and issued an injunction against the new rules.

The Institute for Justice represented the preparers in this case. Depending on where they are on the political spectrum, many can’t stand the Institute for Justice, while others celebrate their efforts to confront unconstitutional government action.

Loving v. Commissioner, Case No. 12-385, January 18, 2013, U.S. District Court for the District of Columbia

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SOONER RATHER THAN LATER FOR GIFT TAX RETURNS

Late 2012 saw an unprecedented amount of gifting, as taxpayers sought to use up their unified credit before it was slated to shrink up in 2013. As a result, the IRS should be swamped with gift tax returns for 2012. Taxpayers looking to reduce audit exposure should think about the timing of their gift tax return filing.

The return is due on April 15, 2013, but can be extended for up to six months automatically. Normally, from an audit perspective, it probably does not make much of a difference when the return is filed.

Let’s look ahead to 2016 when the normal 3 year statute of limitations for 2012 gifts will be expiring. Because of the large number of expected 2012 filings, it is reasonable to predict that the IRS will be understaffed to some degree in its ability to give its normal review to all of the filings. Taxpayers who filed by April 2012 will have their statutes expire in April 2016. Those who do not file until October 2012 will be giving the IRS an extra six months to examine the return. If the IRS is short-staffed, that extra six months may be the difference between the IRS having the time to review the return or not.

Now, of course, professionals will be swamped with trying to get the Form 709’s done by April. Thus, even if clients may want to get the return filed timely, their CPAs and attorneys may be unable to accommodate them. But at a minimum, clients should get their materials over to their tax preparer sooner rather than later, to get the process started.

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IT’S OFFICIAL–EXCLUSION AMOUNT CONFIRMED AT $5.25 MILLION

For federal estate and gift tax purposes. This was the figure projected by some tax service publications – now the IRS concurs.

I have also updated all of our rates, exemptions, etc. for 2013 on our firm’s website – visit www.floridatax.com if you would like to review the adjusted figures.

Annual Inflation Adjustments for 2013

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WHEEL OF PAIN

U.S. wage earners are feeling the pain this week as they receive smaller paychecks due to the elimination of a 2% tax break on social welfare taxes under the recent tax act. A new 3.8% tax is also imposed on the investment income of higher-earners for Obamacare, as well as an extra 0.9% tax on earned income.

It is getting too difficult to remember the number and computations without a scorecard, so I have prepared one. Click on the image below or here to open a larger  PDF version that is readable. Of course, these taxes are separate and apart from (that is, are in addition to) income taxes.

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TWITTER FEED

At the request of a few readers, I have created a Twitter feed for Rubin on Tax. Whenever I make a new posting, a tweet will go out to my followers to alert them. Click the Twitter “follow@RubinOnTax” below to start following this blog.

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TAXPAYERS CAN DOUBLE UP ON DIRECT IRA DISTRIBUTIONS TO CHARITY IN JANUARY

Taxpayers with IRA balances incur income when they are required to take minimum distributions from their IRAs. Oftentimes, the minimum distributions can be quite large, if their IRA has a large balance from a rollover of pension assets to the IRA.

If the taxpayers don’t need the funds, they may want to contribute them to charity (since the minimum distribution rules require the participants to receive them). They will still incur income from the IRA distribution, but then hope to offset the income with a charitable deduction. Since the Internal Revenue Code contains limitations and phase-outs on the charitable deduction, they may not be able to completely offset the income.

Since 2006, Congress has allowed, on a temporary basis, direct payments to charities from IRAs of up to $100,000 per year. Such a direct payment bypasses the above problem, since the payment is not taxed to the IRA participant at all (and thus the charitable deduction is not needed to avoid income). This provision has expired and then been renewed several times. Most recently, it expired at the end of 2011.

Under the American Taxpayer Relief Act of 2012 ("ATRA"), Congress has again extended this provision, retroactive to January 1, 2012, but only through 2013. As part of the provision, a special feature of ATRA will allow a taxpayer to make a direct contribution in January 2013 and have it treated as a 2012 contribution to be applied to the 2012 $100,000 limitation. This allows the taxpayer to make another distribution in 2013 under a second $100,000 annual limitation. Taxpayers who want to take advantage of this provision will need to complete the transfer by January 30, 2013.

Note that these rules only apply to IRAs and not other qualified plans. They also apply only to taxpayers who are over age 70 1/2. Taxpayers interested in using these provisions should consult with their tax advisor to assure that other applicable limitations do not apply.

Normally, these direct contribution rules require that the IRA payment pass directly to the charity – that is, they cannot pass through the participant’s hands (or bank account). However, ATRA also has a special rule that is applicable only to December 2012 IRA distributions. Participants who received an IRA distribution in December can treat it as a direct contribution to a charity for these purposes, if the participant pays over the funds to a charity by January 30, 2013.

These provisions of ATRA are welcomed by charities and taxpayers alike. What would be even more welcome would be a permanent implementation of the direct contribution rules, instead of rolling two year extensions (which often occur after the prior period has expired).

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DON’T FORGET ABOUT THAT OTHER 0.9%

Much ink has been spilled about how wage earners are getting a 2% haircut in their take-home pay. This arises from the failure of the new tax bill to extend the temporary 2% cut in employees’ share of social security tax.

What is not often mentioned is that high earners will also be subject to an additional 0.9% Medicare surtax. This additional levy will apply to wage earners and those earning self-employment income once total earnings exceed $200,000 for single persons and heads of household, and $250,000 for married couples filing jointly. Employers will start to withhold once wages go over the threshold. This tax was part of the health care law in 2010, but its effective date was deferred until 2013.

This tax is in addition to the 3.8% Medicare surtax on net investment income, which also begins this year.

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KEY PROVISIONS OF THE AMERICAN TAXPAYER RELIEF ACT

Below is a summary of many of the key provisions of the Act. Interesting how the Act, when netted with the repeal of the Bush tax cuts, results in a large increases in income taxes – yet Congress still calls the this a “relief” act!

1. Individual Income Tax Rates. Retained at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred under the EGTRRA sunset). A 39.6% rate applies to income above a certain threshold (specifically, income in excess of the “applicable threshold” over the dollar amount at which the 35% bracket begins). The applicable threshold is $450,000 for joint filers and surviving spouses, $425,000 for heads of household,  $400,000 for single filers,  and $225,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013.

COMMENT: There is  a MAJOR marriage penalty here. Two single people living together would get two $400,000 exemptions (one each). A married couple gets hit when combined income exceeds $450,000. Perhaps some of those same-sex couples that are married under state law will not be happy now if the Supreme Court rules that they should be subject to the same tax rules as other married persons.

2. Personal Exemption Phaseout. Personal exemptions begin to phase out for those making $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. The total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. This is inflation-adjusted for tax years after 2013.

COMMENTS: Another big marriage penalty here. This phaseout, along with the itemized deduction phase-out, will increase the income taxes of persons below the $400,000/$450,000 amounts being bandied about in the media.

3. Itemized Deduction Phaseout. Itemized deductions are reduced by 3% of the amount by which the taxpayer's adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The starting thresholds are $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Inflation adjustments apply after 2013.

COMMENTS: See 2. above.

4. Capital Gain and Dividend Rates. The top rate for capital gains and dividends will permanently rise to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends.

COMMENTS: Don’t forget that the new 3.8% Obamacare taxes will also now apply to these items. The retreat from the threatened imposition of ordinary income rates on dividends is a big break here. The permanent nature of the lower dividend rate also encourages further use of the IC-DISC for those engaged in export transactions. Another hidden marriage penalty here, too.

5. Estate and Gift Tax Rates. The maximum rates are increased to 40%.

COMMENT: Well, its much better than the 55% rate that was scheduled to apply.

6. Unified Credit for Transfer Taxes/GST Exemption. Retained at $5 million, as adjusted for inflation. For 2013, this amount has been estimated at $5.25 million. Portability of unused credit between spouses has also been retained.

COMMENT: An unexpected “gift.” For those that feel they should not have entered into late 2012 gifting to use their credit before it was scheduled to be dramatically reduced, remember that for most of you good planning still resulted - future income and growth on those assets you gave away has been removed from your future taxable estates. The retention of the high credit amount makes prior concerns about “clawback” on prior gifts pretty much moot for now.

7. AMT Relief. Relief has been made permanent by a permanent increase in exemption amounts, and the index of those amounts with inflation. This should minimize the creep of more and more taxpayers into the AMT.

COMMENT: At last! However, getting rid of the AMT or higher exemption amounts would have been even better.

8. Extension through 2013 (and to include 2012) for tax-free distributions from individual retirement plans for charitable purposes.

COMMENT: Thanks, but what the heck is with these temporary extensions? Permanent relief here would be most appreciated.

9. Extension to January 1, 2014 for Subpart F exception for active financing income for controlled foreign corporations.

COMMENT: Again with the temporary extension?

10. Extension of look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules.

COMMENT: Again with the temporary extension?

11. Extension of 5 year built-in gains tax period for S corporations through 2013.

COMMENT: Again with the temporary extension?

12. Payroll Tax Cut Allowed to Expire. While technically not part of the new law, Congress has let the temporary reduction in payroll taxes expire.

COMMENT: Wage earners in all brackets will feel the pain of this expiration in their take-home pay starting now.

MORNING UPDATE

For those waking up this morning (January 2) wondering if the House passed the Senate bill, the answer is yes, they did. Thus, the country goes over the tax portion of the fiscal cliff, albeit a lower cliff than it was a few days ago.

Other fiscal cliffs remain – the debt ceiling cliff is coming in a month or two, the sequester cliff in March (the current bill puts off the automatic sequester cuts for two months), the farm bill cliff in September, and the expiration of jobless benefits in December. So the spectacle continues.

Details on the new law to follow later.

WAITING ON THE HOUSE OF REPRESENTATIVES

Yesterday, the Senate avoided the fiscal cliff by passing a bill to limit the raise in rates to single persons with more than $400,000 of income and $450,000 for married couples, although deduction phase-outs start at lower levels.

At this time (2:50 pm on Tuesday), we are awaiting action by the House of Representatives. Passage by the House is by no means assured (nor whether the Speaker will even bring it to the floor for a vote) – one report I read indicated that for each $1 of spending cuts, there are $40 of new taxes. This is a problem for many Republicans who are looking for more balance.

We will see how this pans out. If the House passes the bill, I will be back with more info on the new law law which presumably would be signed into law by President Obama.