Why Is This Topic Important to Financial Professionals? This article discusses the benefits and detriments of corporation business structures for use in financial planning.

Advantages

Perhaps the most advantageous reason for the formation of a corporation at the state level is the “corporate veil”—a term of art meaning that corporate shareholders are not held personally liable to the creditors of the corporation for any and all debts of the corporation.  On the other hand, a sole proprietor is personally liable for the debts of his or her business.  If the business incurs significant debts that the business does not satisfy, then the issue arises of who will the creditors pursue for the money?  A traditional corporation is one way to protect personal assets from the liabilities incurred by the business enterprise.

Another advantage of a corporation is the going concern concept.  A corporation, as a separate legal entity from its owners, will not automatically dissolve upon the death of the owner(s), unlike a sole proprietorship.  Succession planning often takes into consideration multiple generations, and the ongoing concern of the business is generally an integral part.

Access to capital is also an advantage of corporate structures.  Generally, investors are more likely to invest in a corporation that is a going concern than a sole proprietor.  Banks and other institutions may have separate lending standards for incorporated organizations.

Disadvantages

The most common concern with corporations for most people is the issue of double taxation.  This occurs when the corporation is required to pay corporate income tax on its profits each year.  Once distributions are made to shareholders, taxes are again levied on the personal income of the stockholder, which includes the distribution.  Therefore, a tax is levied at the corporate level and the personal level on the same income, hence the term double taxation.

To avoid this issue, in 1958 Congress “acted on President Eisenhower’s recommendation” and created a Subchapter S of the Internal Revenue Code.[1] Subchapter S-Corporations (commonly referred to as “S-Corps”) have several advantages for small businesses over traditional corporations (which are known as Subchapter C-Corporations), including the elimination of double taxation.

Generally, the expense to form and maintain a corporation will be higher than costs associated with sole-proprietorships.  Corporate filing fees in the first and subsequent years will be incurred.  As well, the costs related to the accounting and tax preparation will usually be higher with a corporation than a proprietorship.  (Financial planners with an accounting background may provide their clients the accounting and tax preparation services for additional fees).  Also, stockholder annual meetings and recording minutes can add additional costs to corporate structures.

Alternatives

Since there are limitations on the structure of an S-Corporation, most states now offer alternative structures that have several advantages over S-Corps.  These may include Limited Liability Companies (known as LLCs) and Limited Liability Partnerships (known as LLPs).  In general, for an LLC there is no limitation on the number of shareholders or classes of stock such as with S-Corporations.  The S-Corporation Association notes that “the number of LLCs has grown nearly ten-fold since 1995, rising from fewer than 120,000 to more than a million today.”

For a detailed analysis of the tax and non-tax Advantages of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations G—Professional And Executive Corporations

February 21, 2012

This week, Congress threatened to kill a valuable estate-planning tool by eliminating the inherited—or “stretch”—IRA. If your client inherits an individual retirement account or 401(k) he or she can choose to space the withdrawals over his or her lifetime instead of receiving the funds as a lump-sum today, a payment that’s immediately taxable. In this way, the tax advantages of the IRA can continue throughout lifetime (or until the account is depleted). Stretch IRAs can become even more valuable because, after the original beneficiary dies, the funds in the account can continue to be passed from generation to generation, thus prolonging the tax savings indefinitely.

In an effort to raise tax revenue, the Senate Finance Committee has proposed a measure that would eliminate these benefits entirely by requiring that the funds be withdrawn within five years of inheritance. Because these measures would apply only to individuals dying after 2012, this year may be the last opportunity to defer income tax through the use of a stretch IRA.

The Senate Finance Committee Proposal

The Senate proposal would eliminate the stretch IRA as an estate planning tool, generating approximately $4.6 billion in tax revenue. The proposal would require beneficiaries of inherited IRAs and 401(k)’s to liquidate these accounts within five years of receipt and pay the income taxes associated with the funds they receive.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

Estate Planning 2012 – Do I Need to Worry? Is there a Strategy Going Forward? by George Mentz, Esq.

You may think estate planning is just for the wealthy. If your assets are worth $1,000,000 or more, estate planning is still a pending and delicate issue. With most assets such as homes and stocks devalued at the moment, those prices and valuations may move up quickly in the coming months and years. You may not also be familiar with your spouse’s net worth or pending inheritances either.

With the tax changes for 2011 and 2012, you may not need to worry so much about estate taxation because of the 5 million that an individual can leave without estate taxes while the spousal exemption is still in force, but it will keep changing and taxes will probably go back up soon. Presently, the old trusts may or may not be needed depending on your net worth, spouse, health, children and other dynamics, so this is one of the most dynamic times in history for a review of estate planning documents.

Tax Year Tax Rate Exemption Equivalent
2009 45% $3,500,000
2010 N/A or 35% N/A or $5,000,000
2011 35% $5,000,000
2012 35% $5,120,000
2013 55% $1,000,000

The worst problem is that there is no guarantee that any large exemption will be available anytime in the near future.

Adding up the value of your assets can be an eye-opening experience. By the time you account for your home, investments, company value, retirement savings and life insurance policies you own, you may find your estate will end up in the taxable category.

The strategy that must be evaluated by yourself or your parent(s) is whether to use the large exemption NOW and make large gifts of your holdings to your loved ones in the short term.

By giving now, you can fund:
1. Pre-Fund Education of children and grandchildren
2. Home purchases or rental real estate in a low market for children.
3. Give away assets such as stock to loved ones.
4. Move large gifts of family stock to your children.

Further, it is always a good time for you or your clients to review:

1. Durable Power of Attorney
2. Wills
3. Medical Directives
4. Any Trusts (Some may want to be voided and replaced)
5. LLCs and Company Stock (operating agreements)
6. State Tax issues
7. Guardianship designations
8. Whether a professional trustee should be involved
9. Checking all of your designations and beneficiaries of your insurance, annuities, or other non-probated assets.
10. Document preservation.

The last challenge is document preservation. Make sure your important documents are: with a reputable or safe law firm, with a reputable trust department, in a bank deposit box that somebody knows about, or preserved in another type of lock box service that will notify your loved ones about your intentions.

All Rights Reserved – No legal advice is intended herein. Please consult with a qualified or licensed professional in your jurisdiction before making any important decision.

Why Is This Topic Important to Financial Professionals? Common estate plans may include a business structure.  Helping clients form and manage structures allows a financial professional to more fully participate in clients’ planning.

Do your clients’ business, income and estate plans include corporate structures?  Generally, a client’s business, income and estate plan will include a corporate enterprise.  When the benefits of incorporation can be understood and maximized, the range of the client’s planning may expand.  To begin, a basic understanding of private corporate affairs is essential.  This should include a general understanding of corporate structures, as well as the steps necessary to form and to administer corporations.

Traditionally, the business will apply for corporate status, file yearly forms and keep certain records.  However, there are other considerations for corporate formation and administration, such as form of the structure, state of incorporation, and the tax status.  Many states also offer at least one form of incorporation such as the Limited Liability Company, also known as an LLC, that may offer similar benefits of corporate ownership while avoiding some of the traditional downfalls, such as double taxation.

Establishing The Legal Structure. It is essential to learn how to incorporate a business in your state, including filings with state departments and with the Internal Revenue Service. There is usually a small state fee for the first year of incorporation which may increase in subsequent years.  Most fees and forms can be filed online through state divisions of corporations, taxation or revenue, or departments of similar name.  The forms are general and usually ask for the principal’s name and address, social security number, business name, address and purpose.  You should also have your client file an SS-4 with the IRS, which is an Application for Employer Identification Number.[1] Once the forms are filed with your state and the Internal Revenue Service, the business is technically open for business.

Clients Stay Here. By providing these services, financial planners have found success in not only dollars, but also client retention.  Ted Robinson, a Certified Financial Planner in New York, notes that this is because the client is forced to take his or her business elsewhere when these services are not offered in-house.  “I can do this,” said Robinson, before he started offering basic incorporation services to his clients.  “Why let business go out the door?” he said to himself.  Further, Mr. Robinson notes, it makes “little to no sense” to pass up lucrative business practices that can be accompaniments to your core business.  Therefore, by doing a little research and offering such basic services as filing forms, new doors have opened for financial planners looking to expand their businesses.

Additional Income and Diversify Sources of Revenue.  Some law firms charge thousands of dollars to incorporate.  However, there is not a law that requires only attorneys to incorporate organizations.  Some do-it-yourself websites list a price of merely $29 plus filing fees.  Nevertheless, there is a middle ground between the expensive legal fees and the cheap do-it-yourself service.  A reasonable fee can be charged for your time plus any costs associated with filing.  Financial planners in general can charge much less than what an attorney would to do the same job.  It is also the case that most states allow for easy access to processing facilities online with departments and knowledgeable individuals that can help over the telephone.

For a detailed analysis of the non-tax characteristics of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations A—Brief Survey Of The Corporate Form

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

As a professor and attorney who has been involved in e-learning for over a decade, I can only say that a college degree is available to all who are on the internet.There are superb accredited programs throughout the US and even internationally.

Regional & national accreditation bodies recognize many e-Learning programs. A long list of undergraduate and graduate online programs are delivered from traditional colleges by their professors and other programs are delivered by wholly online professors who typically have more practical experience in the business world.

The best news for online learners is this:
• Eligible students can still obtain loans and go to school
• Students need not commute
• You can stay at home and take care of family
• You can save gas and expenses to park
• You can be a road warrior and still be an online student
• Students can do it full time or part time toward an undergraduate, masters or doctorate.

The great thing about online learning is that the delivery platforms or learning technology such as: eCollege, Blackboard and others are very sophisticated. Moreover, the publishing houses of textbooks have now done all the hard work so that the texts, book, assignments, homework, videos, quizzes and exams can be integrated into the learning delivery platform for easy online viewing.

I have always encouraged adults to get the best in education, study their passion, and expand their horizons. Overall, degrees and diplomas help with securing jobs, pay scale, and access. Some degrees qualify you also for licensing in various areas that are regulated by the states. Keep in mind that some of the best ranked colleges and MBA programs in the world also offer online programs in which some are extremely expensive and competitive.

As of 2009, there were over 2,700 (4 year colleges) in the USA according to the U.S. Department of Education, National Center for Education Statistics. (2011). Digest of Education Statistics, 2010 (NCES 2011-015) Many of these colleges offer some online courses or a hybrid courses. Various colleges have a “so called” “City College or Adult Division” that also provides for online learning and degrees.

You need only to look at the stock charts for companies such as DeVry (NYSE: DV), American Public Education (NASDAQ: APEI), University of Phoenix – Apollo (NASDAQ: APOL), and other for-profit accredited institutions to see the phenomenal growth of online education in the USA and globally. According to a US News November 2011 report, the number of college students enrolled in at least one online course increased for the ninth straight year.

As for my experience, I have taught online for over a decade. I have truly enjoyed working with adult students, those who take care of family members at home, those who can’t commute, and also students with disabilities that limit travel. My best advice is to make sure that any online degree program that you attend is accredited by a CHEA recognized accreditation agency. For a list, go to www.CHEA.org As for business or law schools, it is generally best to attend a graduate accredited business or law program that is recognized by the ABA, ACBSP and AACSB.

Considering that this is the worst recession in 80 years, if you are unemployed and have the true luxury of time, then online education might be for you. Once you learn the online educational system & platform, you can do it from anywhere. I know because I have taught these classes from China, Latin America, Arabia and Europe. Further, my students have taken classes from all over the world and many were even serving in the military while attending my courses. Many corporations and governmental institutions will reimburse you for this type of education and many employers will respect your initiative if you are engaged in online education for a masters or other degree.

Additionally, you can even earn eligibility for a CPA or a law degree online these days and there are even great doctoral programs online too. As for graduate studies, I teach for an online graduate law program called TJSL Thomas Jefferson School of Law (Post JD Juris Doctorate program). They offer online programs that lead to the LLM Masters in Law, JSM Masters in Law for Bankers and Accountants, and they even have a JSD which is a PHD level research and teaching law degree. See: Online Law Degree We have some of the best professors with global experience. This is also an amazing way for lawyers, accountants and bankers to obtain a degree and specialization in tax, finance,compliance, and wealth management.

Overall, the online option is a perfect way to improve your credentials and hone your skills and there are many programs to choose from both in the USA and internationally.

Reference:US News – While online enrollment increases, the pace has slowed. By Ryan Lytle

TJSL http://llmprogram.tjsl.edu

All Rights Reserved – No legal advice is intended herein. Please consult with a qualified or licensed professional in your jurisdiction before making any important decision.

Guaranteed lifetime income is increasingly important for retirees in a post-pension world. But the primary vehicle for guaranteed benefits—annuities—can be a hard sell for many investors. It seems that every other day an article panning annuities is published in the mainstream media; and regardless of whether these attacks are unwarranted or uninformed, they have a real effect on those who need the protection of lifetime income the most.

Enter Stand-Alone Living Benefits (SALB).

Stand-Alone Living Benefits Basics

SALB offer a guaranteed stream of income without purchasing a traditional annuity. The product acts like an insurance policy on an investment account, with income benefits kicking in if the account is depleted during the insured’s lifetime. The product is sometimes referred to as a “hybrid annuity” product, although it is not an annuity in the traditional sense.

Here is how they work. The investor places assets in an investment account that is eligible for coverage by SALB. The SALB provide a 4 to 8 percent lifetime income guarantee, calculated over the Retirement Income Base—essentially the account value—in place when the SALB are purchased. The lifetime income guarantee will then continue payments to the insured if the account is depleted to $0 and can no longer support the payments guaranteed under the contract. Benefits typically are not available until the insured reaches sixty-five. Fees associated with SALB range from 75 to almost 200 basis points, in addition to advisory fees associated with the underlying account.

“The first attempt at a fire insurance plan in America was in Charleston, South Carolina in 1736 with the formation of the Friendly Society of Charleston (Charles Town).”[1] Disappointingly, in 1740 Charleston suffered a serious fire, and the “losses sustained by the Friendly Society were far too great for its fledgling operation and the organization failed.”  The next attempt of fire insurance in America however is by most accounts successful.

Under Benjamin Franklin’s efforts, the Philadelphia Contributionship issued policies on property and structures, for a “term of seven years upon the payment of a deposit, the interest of which, during the continuance of the policy, belonged to the company.” [2] Once source attributes Franklin’s group was “patterned after the Amicable Contributionship, an organization he may have become familiar with while working in England as a journeyman printer.”

Further, in “1768 the Contributionship adopted as a seal the ‘Hand in Hand,’ a badge or mark that was also placed on every property insured, that all contributors would be encouraged to save it from destruction by fire.”[3] The organization insured, by the end of its first year of operations, $108,360 (in today’s dollars that’s approximately $3,000,000 [using a CPI adjustment]) with premium reserves of $11,291.63 (worth today $310,000).[4] Accordingly, its premium reserve to liabilities ratio was approximately ten and a half percent.  Nevertheless, “[t]here never was a period when a loss of any extent disturbed the finances of the company” said Organization’s Director Binney during the 1852 centennial celebration.[5] The Company in 2009 had outstanding liabilities related to underwriting of approximately 180 million dollars and assets in terms of premium reserves of around 410 million dollars, giving them a ratio today of around two and a quarter to one.[6]

After the creation of the fire insurance companies, life insurance quickly followed suit.  Beyond the objections of assigning an actual dollar value to a human life, life insurance policies began to surface around the mid-eighteenth century.  In 1759 a charter was granted by, The Presbyterian Synods in Philadelphia and New York for “The Corporation for the Relief of Poor and Distressed Presbyterian Ministers, and of the Poor and Distressed Widows and Children of Presbyterian Ministers.”[7] The name would later be changed to the “The Presbyterian Annuity and Life Insurance Company.” It is the first known organization to underwrite life insurance in America.  The idea was to present an “[e]asy and certain means” for “the clergy of the church for making provision for themselves in old age, or for their families”, “by the payment of advances, in consideration of which the company entered into a contract with the individual for the payment of a stipulated amount to his heirs at his death, or to himself in his declining years.”

[2] Id.

[3] Id.  (A picture of the shield can be accessed through this link: http://www.contributionship.com/about.html, click “The Fire Mark” link on the right hand of the page, this badge was and is some places commonly known as “Jacob’s Chair”. [Mutual Assurance Society of Virginia]).

[4] History of Philadelphia, 1609-1884, Volume 3 Pg 1884.  By John Thomas Scharf, Thompson Westcott.  L.H. Everts & Co., Philadelphia, 1884.

[5] Id.

[6] The Philadelphia Contributionship “257^th Annual Report” http://www.1752.com/Comm/2009AnnualReport.pdf

[7] Economic History Association “Life Insurance in the United States through World War I”, Sharon Ann Murphy, http://eh.net/encyclopedia/article/murphy.life.insurance.us.

Every advisor knows that annuities offer retirees retirement income security. But there is less certainty about how much of a retiree’s nest egg should be allocated to an annuity to minimize the person’s probability of outliving their retirement income.

The Employee Benefits Research Institute takes some of the guesswork out of allocation in a studyreleased this month. The study analyzes the impact of longevity and immediate annuities on retirement income adequacy. The study finds that the “optimal level of annuitization and asset allocation that would provide a desired level of confidence that individuals will have sufficient retirement income, based on the three different types of risk: investment income, longevity, and long-term care.”

The study’s results offer a prescient guide for advisors looking to maximize their client’s retirement success through annuities. Although parts of the study are quite technical, wading through it to its results can be enlightening.

First we examine the study’s methodology and then conclude with excerpts from the study’s results. To see the full results, go to http://www.ebri.org/pdf/briefspdf/EBRI_IB_05-2011_No357_Annuities.pdf.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of annuities in Advisor’s Journal, see Drama Over the “Drawbacks” of Annuities (CC 11-62).

Presidential Politics and Income Tax Theory – The Super Rich & Tax Havens in the USA ? – By G. Mentz, JD, MBA

No matter how you slice and dice it, it is difficult to swallow when you see Warren Buffet’s taxes or Mitt Romney’s taxes. You may think, how did they get their income tax rates down to 15%? The challenge for many of us is not the tax rates, but the totality of taxes we pay or the type of income we receive or earn. As I have taught on the subject of tax and wealth management and also been a Wall Street Firm Wealth Management Advisor, the analysis of progressive tax rates can be deceiving and tricky.

If you buy and sell something for a long term capital gain, you can receive a low rate of 15%. If you receive dividends, you may be able to capture a low rate of 15%. If you can find bonds that pay tax free, you may also receive a low rates on passive income. If you use a tax deferred vehicle, you can also defer taxes till withdrawal, Examples are 401K, IRA, annuities and such.

Don’t forget that you can avoid state income tax if you reside in one of the 7 wonderful states such as: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. 41 states impose income taxes. New Hampshire and Tennessee apply it only to income from interest and dividends.

Some states actually limit the taxes on certain types of retirement income. Various states exclude Social Security benefits from state income taxes. 27 states & The District of Columbia who have income taxes provide a full exclusion for Social Security benefits — Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.

States are also prohibited from taxing benefits of U.S. military retirees if they exempt the pensions of state and local government retirees. Various other retirement exemptions apply to the value of property or the type of income. For example, all citizens of some states may have a exemption of the first 50 thousand dollars of property value.

Numerous states allow special tax benefits to military retirees. Some states, with conditions, which do not tax retired military pay are: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, , Ohio, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin and Wyoming. Mississippi, Missouri, Kentucky, Oregon, and North Carolina have conditions that apply.
Many states still have an estate tax on top of the federal estate tax: States that impose an estate tax are: Connecticut, Delaware, District of Columbia, Hawaii, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island, Vermont, and Washington.

The question of the day is how do the super-rich avoid the taxes that most of us pay? While the super wealthy may pay some of the “working class” W-2 style taxes, they avoid it on most of their income.

An example would be, how can Warren Buffet or Mitt Romney avoid self employment taxes? Well, the law allows business owners to pay self employment taxes on income, but most of the other income may be treated as pass-through, long term gains or non considered self-employment taxable such as interest, dividends, or sale of assets.

In the end, the middle class and upper middle class is getting hit with the bulk of the “nickel and dime” taxes in this country. Think about the taxes on: State income, state automobile taxes, school district taxes, gasoline taxes, utilities, electricity, water, phone, flight and transport fees, cellular, internet cable, luxury, alcohol, tobacco, and a myriad of other taxes and fees. The TOTALITY of these TAXES may put the average middle income taxpaying family in a 50% tax bracket if they earn a combined 60-100 thousand dollar per year.

Remember, the W-2 employee is the least likely to have the ability to deduct business related expenses as per our tax codes. In the end, high paid wage-earners who are employees such as: doctors, lawyers, government employees, pilots, and CPAs probably pay the highest tax rates on earned income.

In contrast, Mr. Buffet who has invested billions for his clients and himself owes no taxes on typical investments until he sells them. Viola, no taxes paid on long term holdings until you capture income from the sale. With that being said, if Buffet owns a company, that company or its employees will pay taxes on all money that comes in and goes out. In theory, corporate welfare is a myth in that even if a company pays -0- taxes at the corporate rate, the 500,000 employees all paid taxes and hopefully kept their jobs.

Tax breaks are for everyone, and I remember reading one of Russell Simmons’ recent success books. He claimed that he felt like he could have paid more taxes after the sale of a company. The capital gains rate allowed him to pay a low rate of 15-20% tax on the sale of the large company. He claims to have had an ah-ha moment and paid all of his employees who helped build the company an extra bonus as a result of the tax relief. In my humble opinion, this is the original intent of the lower tax rates “to begin with” where everybody involved can benefit.

You can theorize that lower long-term rates and lower dividend rates allow communities to benefit from more local income and for retirees to survive on their pensions or investments. Overall, when taxes are too high, investment is reduced because the reward is mitigated. This is probably why people like Buffett were long term holders is that the punishment for a sale was too large.

So, Mitt Romney may just have good quality tax advisors, and there is NO need for any taxpayer to pay more than the law requires as per the US Supreme Court cases. We all remember VP candidate John Edwards. He saved $600,000 in taxes by forming an S corporation. Edwards earned $26.9 million as a lawyer in 1995, and he minimized Medicare taxes by creating his own S corporation. Edwards paid himself a salary of $360,000 each year for four years and then he had the S corporation pay him the rest of the income in dividends. Salary was subject to Medicare taxation at a rate of 2.9%; however, dividends escape Medicare taxation. There is no wage base for Medicare, all wages or salaries are subject to the full tax. Social Security does have a wage base, which means wages above the limit are exempt from the Social Security tax.

In contrast, President Obama may have a different and much higher tax rate. Most of his income comes from his book sales and from his government employment. Book royalties and high government wages are generally taxed at a much higher rate.

If you remember, most NBA and NFL stars will attempt to maintain residence in a low income tax state like Texas or Florida; however, the state income tax authorities may show up to tax any players who visit their “higher tax” state to play a game. You must figure that some players may earn 1 million dollars per game and 8% of that income is nothing to balk at.

Historically, there has been so much wealth created in the last 30 years, it has been amazing. To watch Google and now Facebook go public is truly fantastic. I remember back in the 80s where people would complain that all of the property or wealth was controlled with no more to be had. However, when new property and wealth is created from thin air, it proves that creativity always trumps materialistic scarcity theory. And yes, most of the new wealth from Facebook will take residence in a lower tax jurisdiction before selling their stock. Let’s face it, 6-9 percent state tax on a large sale of stock with a low basis is a lot of money.

In closing, I recall in the late 70s somebody showed me a list the Forbes 400 wealthiest people in the USA. I distinctly recall that the bulk of the list of names inherited the money or started with wealth. In the recent 20 years, we now see that the bulk of the wealthiest are self-made. With that being said, the one thing that changed during this time was the reduction in long-term capital gains rates.

Are taxes good or bad? Everyone knows that those who benefit from society must chip in and everyone must have some skin in the game. However, the other extreme is that “100% taxation is pure economic slavery”. Thus, everyone is against slavery on any level. The major question that looms is : what is fair? And that, I will leave that to the government & politicians who are the servants of the customers, “We The People”.

**Financial, Legal or Tax Advise is not intended to be offered in any way. The Academic Exception is Claimed in this Article. If you need tax advice, legal counsel or financial advice, please see a licensed professional in your jurisdiction.
George Mentz, JD, MBA – All Rights Reserved 2012

Why is this Topic Important to Wealth Managers? Provides an introduction into the Internal Revenue Code so that tomorrow’s blogticle about specific sections of the Code may be better understood, in particular the taxation of life insurance companies.

How are the laws related to tax organized or in other words, what’s the general process in finding an answer to a tax question?

All federal laws of the United States arise out of the Constitution.  The Constitution has granted Congress certain enumerated powers, such as the power to regulate commerce among the several states.  Congress also has the power to create laws that are necessary and proper in governing based on its listed powers.  All powers not granted to the Federal government are reserved by the States through the 10^th Amendment – meaning only the States may enact laws in those areas (al least this is how it is supposed to work).

Once Congress passes a necessary and proper law to carry out its enumerated powers, that law becomes a United States Statute, or a Statute already existing is either amended or deleted.  The Statutes of the United States are called the United States “Code”.

The United States Code is divided into 50 different titles.  Title 26 is perhaps the most infamous, being the “Internal Revenue Code”.  The Internal Revenue Code, or Title 26 of the United States Code is further delineated, into Subtitles, Chapters, Subchapters, Parts, and finally Sections and Subsections.

Congress has delegated the power of enforcement of these laws, which lies with the executive branch, of Title 26 to the Secretary of Treasury to create Regulations or Administrative Interpretations of the Statutes.  The regulations are not in and of themselves laws but rather, direction from the Secretary of interpretation of the laws.  The regulations have legal authority, which means they may be presented in court.  In almost all tax cases, there is some Statute, that is called into question, therefore the Court’s exclusive job is to rule on interpretation of the Statute as it applies to the situation before the court, not to overrule any statute, unless it found the law unconstitutional.  Therefore, additional law is generated by courts’ interpreting Statutes.  This is known as “case law”.

Let’s look at a simple example to illustrate the concept.  To determine how much tax an individual will pay on a certain transaction say, the receipt of life insurance payments as a beneficiary of a policy. Where do we start?  It is generally unquestioned that since the issue is about taxes we can look in Title 26 of the United States Code to find out what amounts paid to the taxpayer are taxable as income.

Moreover, Subtitle A of Title 26 is entitled “Income Taxes”, so that is a natural place to continue looking to see what taxes will be owed, if any on this payment.  Within Chapter 1 “Normal Taxes”, Subchapter A is called “Determination of Tax Liability”.  Determination of tax liability sounds on point in consideration of what we’re trying to accomplish.  In that Subchapter, Part 1 concerns “Tax on Individuals”.  Here is where we will start.  Section 1 is titled, “Tax Imposed”, and states “There is hereby imposed on the taxable income of” and lists the different filing statuses and applicable rates.

A question should then naturally arise, if there is a tax imposed, what is it imposed on?  The answer is nearby.  The wording of the statute says there will be imposition of tax on the “taxable income” of different filing statuses.  Well we might want to know then what taxable income means for federal legal purposes.  Looking in the index, or though a common search, one will find that Part I of  Subchapter B “Computation of Taxable Income”, is entitled “Definition of Gross Income, Adjusted Gross Income, Taxable Income, Ect.”.  So there it is, and if we look at the sections under Part 1 of Subchapter B, we will see Section 63’s title of “Taxable Income Defined.”

Section 63 (a) states, in part, “the term ‘taxable income’ means gross income minus the deductions allowed.”  Well it would certainly be helpful to know then what “gross income” means.  Not too far away, in the same Part, one can find in Section 61, which is entitled, “Gross income defined”.  Section 61(a) states in part, “Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:

…
(3) Gains derived from dealings in property.”  Life insurance contracts are property, generally.

Notwithstanding the meaning of “all income from whatever source derived” we know if some item is “otherwise” excepted in Subtitle A, “Income Taxes”, that such item would not be included in gross income.  Further, if the item is not included in gross income, it will not be included in taxable income, and even further, if the item is not included in taxable income, the imposition of a tax on such item does not apply.

We now must look in Subtitle A to see what, if any items are excepted.  Part III of Subchapter B, is conveniently enough titled “Items Specifically Excluded From Gross Income.”  The first Section of this Part is entitled “Certain Death Benefits”.  Payments from a life insurance contract to a beneficiary is on point with this Section, so it should be read.  Section 101 states, in pertinent part, “gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.” So if life insurance payments are not included in gross income, the life insurance payments are not taxable income, and therefore are not subject to an imposition of income tax, or in other words – no tax is due.

In this simple example, there was no need to examine the Regulations or any court cases, as our issue was straightforward.  However, most issues will involve additional questions which then the practitioner will look to further sources, i.e., regulations and case law, to determine the answer to the question presented.

For further explanatory discussion of the structure and sources of federal tax law, please see the AdvisorFX Main Library Section 50.6  Sources And Structure Of Federal Tax Law: A—Sources And Structure Of Federal Tax Law

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