Why is This Topic Important to Wealth Managers? This blogticle serves as a reminder and review of the treatment of deceased estates from 2010 (making an a section 1022 election).

Estate Tax

The IRS recently published guidance [1] with regard to the time and manner in which the executor of the estate of a decedent who died in 2010 elects, pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, [2] (TRA), to have the estate tax not apply and to have the carryover basis rules in section 1022 apply to property transferred as a result of the decedent’s death.

Generally, subtitle A of title V of the Economic Growth and Tax Relief Reconciliation Act of 2001, [3] (EGTRRA) enacted section 2210, which made chapter 11 (the estate tax) inapplicable to the estate of any decedent who died in 2010 and chapter 13 (the GST tax) inapplicable to generation-skipping transfers made in 2010.

On December 17, 2010, TRA became law, which reinstated the estate and GST taxes.  However, section 301(c) of TRA allows the executor of the estate of a decedent who died in 2010 to elect to apply the Internal Revenue Code (IRC) as though section 301(a) of TRA did not apply with respect to chapter 11 and with respect to property acquired or passing from the decedent (within the meaning of IRC section 1014(b)).  Thus, TRA allows the executor of the estate of a decedent who died in 2010 to elect not to have the provisions of chapter 11 apply to the decedent’s estate, but rather, to have the provisions of section 1022 apply (Section 1022 Election).

Even though an executor may elect out of the estate tax under TRA, the provisions of chapter 13 (GST tax) nonetheless continue to apply.  Nevertheless, TRA, provides that the applicable tax rate for each GST occurring during 2010 is zero.  [4]

TRA also retroactively repealed section 2511(c), which treated each transfer in trust during 2010 as a gift unless the trust was treated as wholly owned by the donor or the donor’s spouse.  Because of this retroactive repeal, this section does not apply even if a Section 1022 Election is made.

GST

The GST tax was retroactively reinstated by TRA and applies to the estates of all decedents who died after December 31, 2009, regardless of whether a Section 1022 Election is made.  The GST tax is computed by multiplying the taxable amount by the applicable rate. [5]

Under the TRA the maximum federal estate tax rate for purposes of computing the GST tax on such a transfer is deemed to be zero which, when multiplied by any inclusion ratio, will result in an applicable rate of zero.  As under the law applicable to GSTs occurring prior to 2010, the only way to achieve a zero inclusion ratio for the transfer is to make a timely allocation of GST exemption to the transfer.

Next week’s blogticles will discuss planning opportunities.

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

[2] See section 301(c) TRA, P.L. 111-312 (124 Stat. 3296)

[3] P.L. 107-16.

[4] Section 302(c) of TRA.

[5] IRC Section 2602.

Why is This Topic Important to Wealth Managers? This blogticle discusses the proper treatment of a partial exchange of an annuity contract for tax purposes. The information presented herein is useful for those wealth managers considering a tax-free exchange of annuities under Section 1035 for their clients.

The Internal Revenue Service recently released a revenue procedure addressing the tax treatment of certain tax-free exchanges of annuity contracts under Sections 72 and 1035 of the Internal Revenue Code. [1]

Generally, the Code provides that no gain or loss shall be recognized on the exchange of an annuity contract for another annuity contract. [2] The legislative history of IRC Section 1035 states that exchange treatment is appropriate for “individuals who have merely exchanged one insurance policy for another better suited to their needs.” [3]

The Income Tax Regulations provide that the exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under IRC Section1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees (beneficiary or beneficiaries) under the contract received in the exchange as under the original contract. [4]

If, in addition to an annuity contract, a taxpayer receives other property or money in exchange for a second annuity contract, then gain (if any) is recognized to the extent of the sum of money and the fair market value of other property received, but loss (if any) is not recognized to any extent. [5]

The Tax Court has held that the direct exchange by an insurance company of a portion of an existing annuity contract to an unrelated insurance company for a new annuity contract was a tax-free exchange under IRC Section 1035.  [6] Such a transaction is sometimes referred to as a “partial exchange.”

Notwithstanding, the IRS has determined that the receipt of a check under a nonqualified annuity contract and endorsement of the check to a second company as consideration for a second annuity contract treated as a taxable distribution rather than as a tax-free exchange under IRC Section 1035. [7]

Generally, Rev. Proc. 2008-24 set forth circumstances under which a direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract would be treated as a tax-free exchange under IRC Section 1035. Under the revenue procedure, a transfer was treated as a tax-free exchange if no amount was withdrawn from, or received in surrender of, either of the contracts involved in the exchange during the 12 months beginning on the date of the transfer, or if the taxpayer demonstrated that one of the conditions described by IRC Sections 72(q)(2)(A)-(J) or any similar life event “occurred between” the date of the transfer and the date of the withdrawal or surrender.

Revenue Procedure 2011-38, in sum amends Revenue Procedure 2008-24, and recognizes that generally a partial exchange (usually of cash value) of an annuity contract for another annuity contract is treated as a tax-free exchange under section 1035 if no amount is withdrawn from, or received in surrender of, either of the contracts involved in the exchange during the 180 days beginning on the date of the transfer.

Tomorrow’s blogticle will discuss additional tax issues relating to life insurance and annuities.

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

[2] IRC Section 1035(a)(3).

[3] H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).

[4] Treas. Regs. Section 1.1035-1 of the Income Tax Regulations

[5] Section 1035(d)(1) (cross referencing § 1031(b) and (c)); § 1.1031(b)-1(a); § 1031(c)-1.

[6] Conway v. Commissioner, 111 T.C. 350 (1998), acq., 1999-2 C.B. xvi.

[7] See Rev. Rul. 2007-24, 2007-21 I.R.B. 1282.

Why is This Topic Important to Wealth Managers? This blogticle discusses a situation that may disqualify a Section1035 exchange. Even though wealth managers may be familiar with the 1035 exchange generally, it is important to discuss the details of particular situations which may affect the tax treatment of certain life insurance and annuity contract exchanges.

If a Taxpayer receives a check from a life insurance company under a non-qualified annuity contract, does the endorsement of the check to a second company as consideration for a second annuity contract qualify as a tax-free exchange under § 1035(a)(3) of the Internal Revenue Code?

Illustration: A, an individual, owned a non-qualified annuity contract issued by IC1, a life insurance company. In 2011, A requested that IC1 issue directly to IC2, another life insurance company, a check as consideration for a new annuity contract to be issued by IC2. A intended the transaction to be treated as a tax-free exchange under § 1035. IC1 refused to do so and, instead, issued a check to A. A did not deposit the check, but instead endorsed it to IC2 as consideration for a new annuity contract. What result?

Generally, gross income includes any amount received as an annuity under an annuity contract. [1] The Code though provides that no gain or loss is recognized on the exchange of an annuity contract for another annuity contract.[2]

As a general matter Section however Section 1035 provides for the non-recognition treatment for taxpayers who have “merely exchanged an [annuity contract] for another better suited to their needs and who have not actually realized gain.”[3] Under, the Treasury Regulations the contracts exchanged must relate to the same insured, and the obligee or obligees under the contract received in the exchange must be the same as those under the original contract.[4]

Certain Revenue Rulings hold that exchanges under Section 1035 are allowed when an insurance contract or annuity, issued by one insurance company, is assigned to a second insurance company in consideration of the issuance of a new annuity contract.[5]

Nevertheless, in the above illustration, there was no actual exchange of annuity contracts; nor did A assign the IC1 contract to IC2; nor was there a direct transfer from IC1 to IC2 of the cash value of the old contract in exchange for the new contract. Instead, IC1 disbursed a check to A, which A, in turn, endorsed to IC2 as consideration for a new contract.

Neither § 1035 nor the regulations make any special provision for the purchase of an annuity contract with amounts distributed to the policyholder under another contract. Accordingly, the amount that A received from IC1 under the first annuity contract is taxable in 2011 to the extent set forth in § 72(e).

Held: If a Taxpayer receives a check from a life insurance company under a non-qualified annuity contract, the endorsement of the check to a second company as consideration for a second annuity contract does not qualify as a tax-free exchange under § 1035(a)(3). Instead, the amount received is taxable to the extent set forth in § 72(e).[6]

Tomorrow’s blogticle will continue to discuss relevant issues related to life insurance and wealth management.

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

[2] IRC Sec. 1035(a)(3).

[3] H. Rep. 1337, 83d Cong., 2d Sess. 81 (1954).

[4] See Treas. Reg. § 1.1035-1.

[5] See Rev. Rul. 72-358, 1972-2 C.B. 473; Rev. Rul. 2002-75, 2002-2 C.B. 812.

[6] See Rev. Rul. 2007-24.

Why is this Topic Important to Wealth Managers? This blogticle reviews the general requirements for the deductibility of donations for federal income tax purposes. Our goal is to provide information for wealth mangers to stay current on relevant topics including charitable contributions.

The Internal Revenue Code allows for deductions for federal income tax purposes of contributions or gifts made to or for the use of an organization that qualifies as a federally tax-exempt organization. [1]

For a charitable contribution to be deductible, the charity must receive some benefit from the donated property; [2] and  the donor cannot expect to receive some economic benefit (aside from the tax deduction) from the charity in return for the donation. [3]

However, a charitable deduction is not allowed for any contribution of a check, cash, or other monetary gift unless the donor retains a bank record or a written communication from the charity showing the name of the charity and the date and the amount of the contribution. [4]

Charitable contributions of $250 or more (whether in cash or property) generally must be substantiated by a contemporaneous written acknowledgment of the contribution supplied by the charitable organization. [5]

For contributions of property other than money, the taxpayer is generally required to maintain a receipt from the donee organization showing the name of the donee, the date and location of the contribution, and a description of the property. The value need not be stated on the receipt. [6]

A deduction for a contribution of property with a claimed value exceeding $500 will generally be denied to any individual, partnership, or corporation that fails to satisfy the property description and appraisal requirements. [7]

However, there are two exceptions to the general rule. Under the first exception, the appraisal requirements, for property valued at more than $5,000 and at more than $500,000, do not apply to readily valued property, such as cash and publicly traded securities. Under the second exception, the general rule does not apply if it is shown that the failure to meet the requirements is due to reasonable cause and not to willful neglect. [8]

As a general matter, in order for contributions to be deductible, the organization must qualify at the time of the contribution. Thus, it is the responsibility of an organization receiving contributions to ensure that its character, purposes, activities, and method of operation satisfy the qualification requirements under the Code in order for grantors and contributors to have the assurance that their contributions at the time made are deductible.

Generally, Publication 78 lists organizations that have received a ruling or determination letter from the IRS stating that contributions by grantors or contributors to the listed organization (or to the listed central (or parent) organization and those local (or subordinate) units covered by the group exemption letter) are deductible as provided in § 170.

Moreover the law has been interpreted so that grantors and contributors may generally rely on an organization’s ruling that the organization is described until the IRS publishes notice of a change of status (for example, in the Internal Revenue Bulletin or Publication 78), unless the grantor or contributor was responsible for, or aware of, the act or failure to act that results in the organization’s loss of public charity status. [9]

Tomorrow’s blogticle will discuss insurance topics related to estate and gift tax planning.

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

[2] See Winthrop v. Meisels, 180 F.Supp. 29 (DC NY 1959), aff’d 281 F.2d 694 (2d Cir. 1960).

[3] See Stubbs v. U.S., 70-2 USTC ¶9468 (9th Cir.), cert. den. 400 U.S. 1009 (1971).

[4] IRC Sec. 170(f)(17), as added by PPA 2006.

[5] IRC Sec. 170(f)(8)(A).

[6] Treas. Reg. §1.170A-13(b)(1).

[7] IRC Sec. 170(f)(11)(A)(i).

[8] IRC Sec. 170(f)(11)(A)(ii).

[9] See generally Temporary Regulations §§ 1.170A-9T(f)(5)(ii) and 1.509(a)-3T(e)(2), 73 Fed. Reg. 52,528 (Sept. 9, 2008).

Why is this Topic Important to Wealth Managers? This blogticle presents discussion on international estate planning considerations for non-resident aliens generally. We have provided this information for wealth managers with international clients who may have estate tax issues to contend with.

A now deceased individual who at the time of death was neither a resident nor citizen of the United States may nonetheless be subject to U.S. estate tax if at the time of death he or she owned property in the United States. In such a case, although the U.S. estate tax is applicable, only property located in the United States is includable in the gross estate and subject to tax.

An important distinction is made between who is subject to income tax and estate tax. For estate tax purposes, a nonresident alien is a person who is neither a domiciliary nor a citizen of the United States. Thus, an alien who dwells in the United States, but whose domicile remains elsewhere, is classed as a nonresident alien.[1]

Domicile here is used in the traditional sense. In other words, domicile generally requires presence and an intention to remain permanently.

For example, consider a decedent who lived in the United States six years before he died. However, he always intended to return to his native Netherlands, the location of his family and close friends, at the earliest opportunity. This man’s domicile was the Netherlands and therefore he had died a nonresident alien and was not subject to the traditional citizen or resident alien estate tax regime.[2]

The gross estate of a nonresident alien includes that part of his property which is situated in the United States at the time of his death.[3] For purposes of determining what property is situated in the United States, any property which the decedent has transferred, by trust or otherwise, which would be taxable within the provisions of Code §§2035 through 2038 (relating to termination of certain property interests within three years of death, transfers with retained life estate or to take effect at death, and revocable transfers), is deemed situated in the United States if it was so situated either at the time of the transfer or at the time of death.[4]

For a decedent who at the time of death was a nonresident alien, property is considered located in the United States if it falls into any of the categories listed below:

• Real property located in the United States.
• Tangible personal property located in the United States. This includes clothing, jewelry, automobiles, furniture or currency. Works of art imported into the United States solely for public exhibition purposes are not included.
• A debt obligation of a citizen or resident of the United States, a domestic partnership or corporation or other entity, any domestic estate or trust, the United States, a state or a political subdivision of a state or the District of Columbia.
• Shares of stock issued by domestic corporations, regardless of the physical location of stock certificates.[5]

When considering inbound international estate planning issues one question that should be addressed is if the decedent is a citizen or resident of one of the several countries with which the United States has an estate tax convention (treaty). This is because provisions of the applicable treaty may override the normally applicable Internal Revenue Code provisions. The United States is a party to estate or gift tax treaties with the following countries: Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Republic of South Africa, Switzerland, and the United Kingdom.

One final but very important point to note is that proceeds of insurance on a nonresident alien’s life are not includible in his gross estate.[6]This is true even though the proceeds are paid to a resident beneficiary.

For additional information on this subject see AMAFX: U.S. Estate and Gift Tax Consequences for Non-U.S. Citizens.

Tomorrow’s blogticle will discuss the qualified domestic trust.

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

[2] See Est. of Jan Willem Nienhuys, 17 T.C. 1149 (1952).

[3] IRC §2103.

[4] IRC §2104(b).

[5] Treas. Regs. §20.2104.

[6] IRC §2105(a).

Why is this Topic Important to Wealth Managers? Life insurance is an important tool in many areas of modern and advanced financial planning.  In many planning scenarios, the rationale of the transaction rests on gift and estate tax consequences. This means for wealth managers that it is crucial for planning purposes to understand how a life policy is valued at the time of transfer.

Generally the gift tax is an excise tax on the transfer, and is not a tax on the subject of the gift itself. [1]

The gift tax applies to a transfer by way of gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. [2]

For example, a taxable transfer may be effected by the creation of a trust, the assignment of the benefits of an insurance policy, or the transfer of other asset classes generally. [3]

The Code provides that if a gift is made in property, its value at the date of the gift shall be considered the amount of the gift. The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. [4]

Valuation of certain life insurance and annuity contracts

Generally, the value of a life insurance contract or of a contract for the payment of an annuity issued by a company regularly engaged in the selling of contracts of that character is established through the sale of the particular contract by the company, or through the sale by the company of comparable contracts. [5]

Examples

(1) A donor purchases from a life insurance company for the benefit of another a life insurance contract or a contract for the payment of an annuity. The value of the gift is the cost of the contract.

(2) An annuitant purchased from a life insurance company a single payment annuity contract by the terms of which he was entitled to receive payments of $ 1,200 annually for the duration of his life. Five years subsequent to such purchase, and when of the age of 50 years, he gratuitously assigns the contract. The value of the gift is the amount which the company would charge for an annuity contract providing for the payment of $ 1,200 annually for the life of a person 50 years of age.

(3) A donor owning a life insurance policy on which no further payments are to be made to the company (e.g., a single premium policy or paid-up policy) makes a gift of the contract. The value of the gift is the amount which the company would charge for a single premium contract of the same specified amount on the life of a person of the age of the insured.

(4) A donor purchases from a life insurance company for $ 15,198, a joint and survivor annuity contract which provides for the payment of $ 60 a month to the donor during his lifetime, and then to his sister for such time as she may survive him. The premium which would have been charged by the company for an annuity of $ 60 monthly payable during the life of the donor alone is $ 10,690. The value of the gift is $ 4,508 ($ 15,198 less $ 10,690). [6]

Tomorrow’s blogticle will continue our discussion on topics related to planning with life insurance.

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

[2] Id.

[3] Statutory provisions exempt bonds, notes, bills and certificates of indebtedness of the Federal Government or its agencies and the interest thereon from taxation are not applicable to the gift tax. Treas. Regs. § 25.2511-1.

[4] IRC section 2512; Treas. Regs. § 25.2512-1.

[5] Treas. Regs. § 25.2512-6.

[6] Id.

Why is this Topic Important to Wealth Managers? This blogticle provides discussion and analysis on the alternative minimum tax and how it’s calculated in 2011. For wealth managers who are closely integrated with client planning, knowledge of the AMT and how it affects clients is integral to overall wealth management.

Present law imposes an alternative minimum tax (‘‘AMT’’) on individuals. The AMT is the amount by which the tentative minimum tax exceeds the regular income tax.[1] An individual’s tentative minimum tax is the sum of (1) 26 percent of so much of the taxable excess as does not exceed $175,000 ($87,500 in the case of a married individual filing a separate return) and (2) 28 percent of the remaining taxable excess.[2]

The taxable excess is so much of the alternative minimum taxable income (‘‘AMTI’’) as exceeds the exemption amount.[3] The maximum tax rates on net capital gain and dividends used in computing the regular tax are used in computing the tentative minimum tax. AMTI is the individual’s taxable income adjusted to account for specified preferences and adjustments.[4]

The AMT exemption amount for taxable years beginning in 2011 is (1) $74,450, in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of other unmarried individuals; and (3) $37,225 in the case of married individuals filing separate returns.[5]

Generally, present law provides for certain nonrefundable personal tax credits (i.e., the dependent care credit, the credit for the elderly and disabled, the child credit, the credit for interest on certain home mortgages, the Hope Scholarship and Lifetime Learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, the credit for new qualified plug-in electric drive motor vehicles, and the D.C. first-time homebuyer credit).

Under Sec. 202 of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 [6] for taxable years including 2011, the nonrefundable personal credits are allowed to the extent of the full amount of the individual’s regular tax and alternative minimum tax.[7]

This extension of the use of nonrefundable credits replaces what would have been a much different tax treatment. In other words, the nonrefundable personal credits (other than the child credit, the credit for savers, the credit for residential energy efficient property, the credit for certain plug-in electric drive motor vehicles, the credit for alternative motor vehicles, and credit for new qualified plug-in electric drive motor vehicles) would have been allowed only to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax, determined without regard to the minimum tax foreign tax credit. The remaining nonrefundable personal credits would have been allowed to the full extent of the individual’s regular tax and alternative minimum tax.

For more information on the AMT see generally AMAFX Tax Facts How is the Alternative Minimum Tax calculated?

Next week’s blogticles will present interesting planning concepts for wealth managers.

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

[2] IRC Sec. 55(b).

[3] IRC Sec. 55(b)(1)(A)(i)(II).

[4] See IRC Sec. 55(b)(2).

[5] IRC Sec. 55(d).

[6] Public Law 111–312.

[7] See IRC 26(a).

Why is this Topic Important to Wealth Managers? This blogticle provides discussion and analysis on listed property generally and cell phones specifically. The new law provides for relaxed standards for the deduction requirements of cell phones used in a trade or business. Thus wealth managers who maintain their own trade or business will benefit from the information regarding the tax treatment of this technology equipment.

Property, including cellular telephones and similar telecommunications equipment (hereinafter collectively ‘‘cell phones’’), used in carrying on a trade or business is subject to the general rules for deducting ordinary and necessary expenses under IRC Section 162. Under these rules, a taxpayer may properly claim depreciation deductions under the applicable cost recovery rules for only the portion of the cost of the property that is attributable to use in a trade or business. Similarly, the business portion of monthly telecommunication service is generally deductible, subject to capitalization rules, as an ordinary and necessary expense of carrying on a trade or business.

In the case of certain listed property, special rules apply. Listed property generally is defined as (1) any passenger automobile; (2) any other property used as a means of transportation; (3) any property of a type generally used for purposes of entertainment, recreation, or amusement; (4) any computer or peripheral equipment; (5) any other property of a type specified in Treasury regulations; [1] and (6) formally any cellular telephone (or other similar telecommunications equipment).[2]

For listed property, no deduction is allowed unless the taxpayer adequately substantiates the expense and business usage of the property.[3] A taxpayer must substantiate the elements of each expenditure or use of listed property, including (1) the amount (e.g., cost) of each separate expenditure and the amount of business or investment use, based on the appropriate measure (e.g., mileage for automobiles), and the total use of the property for the taxable period, (2) the date of the expenditure or use, and (3) the business purposes for the expenditure or use.[4] The level of substantiation for business or investment use of listed property varies depending on the facts and circumstances. In general, the substantiation must contain sufficient information as to each element of every business or investment use.[5]

With respect to the business use of listed property made available by an employer for use by an employee, the employer must substantiate that all or a portion of the use of the listed property is by employees in the employer’s trade or business.[6] If any employee used the listed property for personal use, the employer must substantiate that it included an appropriate amount in the employee’s income.[7] An employer generally may rely on adequate records maintained and retained by the employee or on the employee’s own statement if it is corroborated by other sufficient evidence, unless the employer knows or has reason to know that the statement, records, or other evidence are not accurate.[8]

Section 2043 of the Small Business Jobs Act of 2010 [9] removes cell phones from the definition of listed property. Thus, under the provision, the heightened substantiation requirements and special depreciation rules that apply to listed property no longer apply to cell phones.

The provision generally does not affect the Treasury’s authority to determine the appropriate characterization of cell phones as a working condition fringe benefit under IRC Section 132(d) or that the personal use of such devices that are provided primarily for business purposes may constitute a de minimis fringe benefit, the value of which is so small as to make accounting for it administratively impracticable, under IRC Section 132(e).

Tomorrow’s blogticle will continue our series on tax law changes related to wealth managers in 2011.

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

[2] Cellular telephones (or other similar telecommunications equipment) were added as listed property as in section 7643 of the Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101–239 and subsequently removed by section 2043 of the Small Business Jobs Act of 2010, Public Law 111–240.

[3] IRC Sec. 274(d)(4).

[4] Temp. Treas. Reg. sec. 1.274–5T(b)(6).

[5] Temp. Treas. Reg. sec. 1.274–5T(c)(2)(ii)(C).

[6] Temp. Treas. Reg. sec. 1.274–5T(e)(2)(i)(A).

[7] Temp. Treas. Reg. sec. 1.274–5T(e)(2)(i)(A).

[8] Temp. Treas. Reg. sec. 1.274–5T(e)(2)(ii).

[9] Public Law 111–240.

Why is this Topic Important to Wealth Managers? This topic presents discussion on the child and dependent care credit. For those wealth managers who participate fully in clients planning decisions, it is helpful to understand the implication of tax credits generally. This particular blogticle explores one such credit, the child and dependent care credit.

In addition this blogticle presents an excerpted preview of new, updated material from Advanced Markets which will be available soon (see www.advisorfx.com). Over the coming 9 months, the entire AUS service is being revised and will be rolling out monthly. The updating will include many new areas and a sharper focus with practical explanations and client presentation aides for current areas. We look forward to helping you secure your next sale.

A credit is available for certain child and dependent care expenses incurred by a taxpayer as a result of employment.[1] Eligible taxpayers are allowed a credit of up to 35% of certain expenses incurred for the care of a “qualifying individual.” [2] However, the credit is subject to several restrictions.

First, the 35% is reduced (but not below 20%) by one percentage point for each $2,000 (or fraction thereof) by which the taxpayer’s adjusted gross income for the taxable year exceeds $15,000.[3] The effect of this reduction is that for taxpayers with adjusted gross income of more than $43,000 the applicable percentage is 20%.

A second restriction further reduces the credit by limiting the amount of expenses eligible for the credit to $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.[4]

A “qualifying individual” is defined as: (1) a child under age 13 for whom the taxpayer is entitled to take a dependency exemption, (2) a physically or mentally incapacitated dependent, or (3) a physically or mentally incapacitated spouse.[5]

Expenses for household and dependent care services are “employment related” if they are incurred to enable the taxpayer to be gainfully employed.[6] “Gainful employment” includes periods in which the taxpayer is employed full-time, part-time, or in active search of gainful employment.[7]

Expenses for services outside the taxpayer’s household qualify only if they are in respect to a child under age 13 or a qualifying individual who regularly spends at least eight hours each day in the taxpayer’s household.[8] However, no amount of any expenses for overnight camp will be considered “employment-related.” [9]

Payments for child or dependent care to a close relative qualify for the credit so long as: (1) neither the taxpayer nor his spouse is entitled to claim the relative as a dependent; and (2) the relative is not a child of the taxpayer who is younger than age 19 at the close of the taxable year. Taxpayers must provide the name, address and taxpayer identification number of the child care provider in order to claim the credit.[10]

The full material presented under this section will be available soon. Check back with Advanced Markets for more information. Tomorrow’s blogticle will continue to discuss important planning aspects of 2011.

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

[2] IRC Sec. 21(a)(2).

[3] IRC Sec. 21(a)(2).

[4] IRC Sec. 21(c).

[5] IRC Sec. 21(b)(1).

[6] IRC Section 21(b)(2).

[7] Treas. Reg. §1.21-1(c)(1).

[8] Treas. Reg. §1.21-1(e)(1).

[9] Treas. Reg. §1.21-1(d)(6).

[10] IRC Sec. 21(e)(9).