This is the time of year when last year’s taxes weigh heavily on the minds of many. For most of us, there is not much we can do at this point to change last year’s tax picture, but it never hurts to consider how to manage affairs moving forward.
The tax code is an enormous body of law, and it is constantly changing. Many business decisions and life events can create significant tax implications, and it is difficult even for professionals to keep up with it all.
It is a good practice to touch base with your advisors, (i.e., your accountant or your lawyer, or both) periodically throughout the year, especially when you are facing a life change or a big decision. Though tax preparers (and Turbo Tax) can often work wonders with what you give them after the fact, sometimes the full extent of tax implications from activities conducted this year will not surface for several years. In that case, fixing them after the fact is usually costly.
Far from exhaustive, here are a few examples of situations where the tax issues can get tricky fast, and it is a great idea to do a little research or call your advisor(s) to make sure you are on solid footing as you proceed.
Estate planning. A “taxable estate” exists when the total value of all your property interests and the items you own exceeds the amount of the estate tax exemption. There is an exemption for Federal tax purposes (currently $5 million for 2012, which drops to $1 million in 2013 unless Congress acts) and each state has its own exemption level (in Oregon for 2012, it is $1 million). The Federal gift tax imposes a tax burden on gifts given “inter vivos,” which means “while living.” In 2012 the gift tax is exempted for cumulative gifts of up to $13,000 to another individual during the calendar year. Federal and state estate taxes operate on “testamentary” transfers (transfers of wealth by death). Gift and estate taxes have significant overlap and interplay, but operating together they essentially ensure that transfers of wealth beyond certain amounts to persons other than your spouse do not go untaxed.
Though tax issues often dominate estate planning considerations, estate planning is not just for wealthy people and it is not just about taxes. Besides the advanced planning strategies employed by the wealthy to minimize their tax burden, there are many practical tips and considerations which can be put into action today to ensure that the assets you have now pass to your loved ones according to your wishes. Without any estate planning instruments such as a will or a trust, much of your property will go through a public probate process, subject to the default rules of succession imposed by the State, which may or may not be the way you wish your assets to be divided.
Facing divorce. Planning for divorce is not an action item on many people’s to-do lists, and it shouldn’t be. But if it’s a reality for you or someone you know, you should discuss the situation and the potential financial and tax consequences with your respective advisors. One thing you should know is that spousal support payments, the payments one spouse pays to the other as part of a divorce settlement (known as alimony in many states), are treated as taxable income to the person receiving them, and a tax deduction for the person paying them.
An issue can arise if a portfolio of investment properties is being divided as part of a divorce settlement where some properties have a low basis. “Basis” is a tax term that determines what is taxable when the property is sold. Usually, the difference between the basis (which is adjusted downward by depreciation and upward by improvements to the property) and the sale price represents the “gain,” or what is taxable. The receiving spouse takes the property’s then existing basis when it is transferred between spouses or as part of the divorce. When property is purchased, its basis will usually be what is paid for it. The point here is that otherwise comparable property with a lower basis will result in higher taxes when you go to sell it. If there is a portfolio of investment properties being divvied up, factoring in the basis of the properties at issue will result in a fairer division of assets.
When you move to a different state. The structure of taxes between states varies greatly. Here in Oregon, we have no sales tax (currently), but we have a personal income tax, property tax, and an estate tax, as well as various minor consumption taxes (gasoline, liquor, etc.). In Washington, there is no personal income tax, but there is a sales tax on most consumer goods and an estate tax and consumption taxes on some goods. When you are anticipating moving, be sure to familiarize yourself with the structure of taxation in that state before you go. If you are being transferred for work purposes and have some bargaining leverage, raising the issue of a less favorable tax structure in your destination state could be worth some concessions in your favor. For an overview of taxes by state, click here.
Non-qualified deferred compensation. And just what is that? Deferred compensation is any compensation earned by you in one tax year but paid to you in a future tax year. Non-qualified deferred compensation is any form of deferred compensation that is not specifically exempted by other sections of the tax code, such as the special tax treatment given to common forms of employer-sponsored retirement plans.
If you are entering into any kind of deferred compensation arrangement with an employer besides a standard retirement plan, you should be sure to inquire as to whether it has been structured to comply with the provisions of §409A. Enacted in 2005 to limit executive compensation schemes, §409A applies to everyone, and it governs all deferred compensation arrangements. While it exempts many common business practices such as most types of retirement plans, bonuses given within 2 ½ months of the end of the tax year, etc., §409A carries with it significant tax penalties (20% plus interest) for the employee for noncompliance. You, not your employer, pay the penalty.
You don’t have to learn all the ins and outs, but if your employer offers you extra compensation to be paid in a future tax year for services you perform in the current year, §409A could apply. Even an informal, “I’ll pay you X dollars two years from now if you meet the Y goal this year,” could fall under §409A or promises made in employment offer letters or separation agreements. It is worth some due diligence.
Only pleasant springtime surprises. If you are in the habit of relying on your tax preparer or Turbo Tax to do the best they can with whatever you’ve got at the end of the year, it is a good habit to break. Even if you don’t get around to it much during the year, having a real conversation with your advisors on an annual basis about what’s coming up in your life will give them an opportunity to help you flag the tax consequences of upcoming situations− and avoid a future unpleasant springtime surprise.
May all your springtime surprises be pleasant ones.
Previously its business manager, Elliott has worked as a law clerk at SSJH since March 2011. He graduated from the evening program at Lewis & Clark Law School in December 2011. Pending admission to the bar, he will work as an attorney for SSJH practicing in the areas of banking and lending law, creditor’s rights, general business, and real estate.
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