The number of electronic filing and payment options increases every year, which helps reduce your burden and also improves the timeliness and accuracy of tax returns. When it comes to filing your tax return, however, the law provides that the IRS can assess a penalty if you fail to file, fail to pay or both.

Here are eight important points about the two different penalties you may face if you file or pay late.

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty.The failure-to-file penalty is generally more than the failure-to-pay penalty. So if you cannot pay all the taxes you owe, you should still file your tax return on time and pay as much as you can, then explore other payment options. The IRS will work with you.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes.

If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes.

If you request an extension of time to file by the tax deadline and you paid at least 90 percent of your actual tax liability by the original due date, you will not face a failure-to-pay penalty if the remaining balance is paid by the extended due date.

If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Tips for Taxpayers Who Can’t Pay Their Taxes on Time

If you owe tax with your federal tax return, but can’t afford to pay it all when you file, the IRS wants you to know your options and help you keep interest and penalties to a minimum.

Here are five tips:

File your return on time and pay as much as you can with the return. These steps will eliminate the late filing penalty, reduce the late payment penalty and cut down on interest charges. For electronic and credit card options for paying see www.irs.gov. You may also mail a check payable to the United States Treasury.

Consider obtaining a loan or paying by credit card. The interest rate and fees charged by a bank or credit card company may be lower than interest and penalties imposed by the Internal Revenue Code.

Request an installment payment agreement. You do not need to wait for IRS to send you a bill before requesting a payment agreement. Options for requesting an agreement include:

• Using the Online Payment Agreement application at www.irs.gov, and
• Completing and submitting IRS Form 9465-FS, Installment Agreement
Request, with your return.

IRS charges a user fee to set up your payment agreement. See www.irs.gov or the installment agreement request form for fee amounts.

Request an extension of time to pay. For tax year 2011, qualifying individuals may request an extension of time to pay and have the late payment penalty waived as part of the IRS Fresh Start Initiative. To see if you qualify visit www.irs.gov and get form 1127-A, Application for Extension of Time for Payment. But hurry, your application must be filed by April 17, 2012.

If you receive a bill from the IRS, please contact us immediately to discuss these and other payment options. Ignoring the bill will only compound your problem and could lead to IRS collection action.

If you can’t pay in full and on time, the key to minimizing your penalty and interest charges is to pay as much as possible by the tax deadline and the balance as soon as you can. For more information on the IRS collection process go to www.irs.gov or see IRSVideos.gov/OweTaxes .

Valuation discounts are increasingly challenged by the IRS. Gone are the days when assets could be dropped into a family limited partnership with some transfer restrictions and forgotten about until a valuation discount was needed to reduce a gift or estate tax bill.  A recent U.S. District Court case, Fisher v. U.S., reminds us that times have changed.  Often, placing assets in a business entity is no longer enough to justify a valuation discount—the entity must be run like a business to justify the discount.   Read the analysis by our experts Robert Bloink and William Byrnes located at AdvisorFX Journal Valuation Discounts: Only for a Bona Fide Business

For some good news about valuation discounts, see our article in AdvisorFX Advisor’s Journal on the Jensen case.

From a tax perspective see Tax Facts Q 613. How is a closely held business interest valued for federal estate tax purposes?

After reading the analysis, we invite your questions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? Discusses how international planning can impact clients’ tax position domestically.  Provides discussion on a number of common international tax concepts as they relate to U.S. taxpayers.

In a previous blog, it has been briefly discussed that there may be a number of reasons a client may consider offshore planning, generally.  Today we will focus on one major component of offshore considerations, the impact of world-wide income on U.S. taxpayers. It is generally accepted that U.S. taxpayers are expected to pay income taxes on income earned from sources worldwide.[1] This concept is commonly referred to as “outbound” taxation. [2]

It is the case that many sovereign nations will also have taxes on personal and/or corporate income that an individual or corporation could become subject to, creating in effect “double taxation.”  And some foreign nations choose to have very low or no tax rate on certain types of income, or on corporations in general, thus allowing foreign income to potentially escape foreign taxation (and current U.S. taxation in the year that it is earned).

What are some rules that that Congress has attempted to avoid double taxation or subject foreign income to U.S. taxation?

Foreign Tax Credit

Under the foreign tax credit, the “United States allows its taxpayers to reduce their U.S. tax liability by some or all of the foreign income taxes paid on income earned outside the United States.” [3] The credit, created by Congress, reduces U.S. income by “foreign income taxes paid or accrued.”  “The credit is a dollar-for-dollar reduction of U.S. income tax liability.”  [4]

Controlled Foreign Corporations

As a general rule, “the income of a foreign corporation is included on the U.S. shareholder’s U.S. income tax return only when dividend income is received.” [5] Yet for certain situations when U.S. taxpayers have a shareholding in a foreign corporation, Congress has established special rules that “deem” a dividend to have been paid by the foreign corporation, regardless of whether it is actually paid or not.  These special rules are known as “anti-deferral” rules – rules that mitigate the tax advantages of taxpayers deferring U.S. tax until foreign income has been received.

In general the rules that most impact U.S. taxpayers with a shareholding in a foreign company are known as “controlled foreign corporation” rules (aka CFC rules).  A CFC exist when “any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned by U.S. shareholders on any day during the taxable year of the foreign corporation.” [6]

Not all income earned by a CFC will be deemed as a dividend to its U.S. taxpayers.  Congress does not want to stop U.S. taxpayers from investing or doing business overseas.  However, Congress is concerned that it is common that U.S. taxpayers will “shift the income-generating activity to a foreign entity where the income earned will not be subject to U.S. tax until repatriated.” [7] Congress considers that such business activities or investment activities could have or should have occurred in the United States, or at least should have been taxed in the United States regardless of where they occurred.

Thus, Congress has established complex rules to determine which types of income it will allow to be earned overseas without the U.S. taxpayers incurring current U.S. taxation on a deemed dividend, and correspondingly which types of income for which Congress will disallow deferral.  Income that Congress disallows deferral for is known as ‘tainted’ income.  It is this “tainted” income that is included in the gross income of its U.S. shareholders without regard to its actual distribution.

Income that is subject to current taxation from a CFC, “can be characterized as income that is easily shifted or has little or no economic connection with the CFC’s country of incorporation” [8] and may include, “foreign personal holding company income, foreign based company sales [and service] income, …as well as certain insurance income, …and certain other narrowly defined categories of income [including passive income, ‘such as interest dividends rents and royalties’[9]].” [10] Well, that’s a mouthful of legal terms that we will need to discuss in future blogticles.

---

[1] 26 U.S.C § 61; See also, Taxation of Business Entities.  James E. Smith, William H. Raabe, David M. Maloney.  Chapter 13.  2007 Annual Edition, citing 26 U.S.C § 61, “Gross income for a U.S. person includes ‘all income from whatever source derived’.  ”Source“ in this context means not only type of income (e.g., wages or interest) but geographic source as well (e.g., the United States or Belgium). Westlaw.

[2] Corporations, Partnerships, Estates & Trusts.  Chapter 9.  , 2007 Annual Edition.  Westlaw.

[3] Taxation of Business Entities. Ch 13

[4] Id.

[5] Id. citing, Subpart F, §§ 951-964 of Title 26 of the United States Code.

[6] Taxation of Business Entities.

[7] Id.

[8] Id.

[9] Id.

[10] 3 Legal Compliance Checkups § 20:35 (2009).  Westlaw.

Related articles by Zemanta

• Mark Hoban says CFC reform is coming closer (accountancyage.com)
• Foreign profits may help at home (washingtonpost.com)

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

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

Why is this Topic Important to Wealth Managers? Provides a view with respect to revocable trust concepts and estate planning. Presents identifying factors of the trust, what it’s commonly used for, as well as some of the benefits and detriments of its implementation.

This week has mainly discussed the use of trusts with characteristics of complete transfers by grantors. This edition will explore the revocable nature of trusts and how they are applicable to estate planning.

The main difference between a revocable trust and one that is not is that “the settlor reserves the right to terminate the trust and recover the trust property and any undistributed income.” [1] “The creation of a revocable living trust involves either the transfer of property to one or more trustees or the settlor’s declaration that he holds the property in trust for himself and that upon his death the property is to be held for other beneficiaries.” [2]

The revocable trust is frequently used “in estate planning, especially where a person wishes to relinquish title to property but to retain a right to reclaim it later should economic need arise.” [3] It allows for the “the swift and efficacious transfer of the grantor`s property to trust beneficiaries.”

One benefit of this arrangement is that revocable trusts avoid probate—“Upon the death of the grantor, assets that are owned by the trust, rather than by the decedent, will not be subject to the probate process.” Secondly, assets in a living trust are afforded “extra protection [because]…the trustee can be given the power to withhold distributions” along with spendthrift provisions enacted by state legislators.

However, the revocable trust income is taxed to the grantor[4], “and the trust assets will be included in his gross estate upon his death.”[5] In other words, the “decedent’s gross estate includes the value of any interest in property transferred by the decedent whether in trust or otherwise, if the enjoyment of the property transferred was subject to any change at the date of the decedent’s death through the exercise by him of a power to alter, amend, revoke or terminate.” [6]

The artificial construction of the law holds that “although the grantor has relinquished title to the trust property, trust income will still be taxed to him, and the trust property will be subject to estate tax.”  [7] Even though,  “a revocable trust yields no income tax advantages during the settlor’s lifetime, significant income tax savings may be realized after his death if the trustee is given discretionary powers in the payment of income and principal.” [8]

---

[1] Black’s Law Dictionary (8^th Edition 2004). Revocable Trust.  Westlaw.

[2] Bogert.  The Law Of Trusts And Trustees § 233 (2010).  Westlaw.

[3] AUS MAIN Libraries. 21 Trusts Guardianships, and Minors, A-Trust Terms –Use in Estate Plans, Subsection 8. “The Living Trust In Family Settlements”. Last Accessed 9/19/2010.

[4] Bogert § 233 citing, 26 U.S.C. § 676.

[5] Bogert § 233  citing 26 U.S.C. § 2038; Desmond, 116 Trusts & Est. 218 (1977).

[6] 34A Am. Jur. 2d Federal Taxation ¶ 143,402

[7] AUS Main Libraries Section 21.

[8] Bogert § 233

In December of last year, President Obama turned the standard estate plan upside down when he signed the Tax Relief Act of 2010. In addition to a record $5 million applicable exclusion amount and continued 35% top rate, the estate tax included a brand new concept that may force your clients to re-evaluate their estate plan.

That concept is the Deceased Spouse Unused Exclusion Amount (DSUEA). Advisor’s Journal covered the DSUEA shortly after the concept was introduced [Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122)]. In that article, we concluded that the DSUEA not only makes bypass trusts unnecessary, but may even hurt an estate’s beneficiaries by reducing the basis of assets they receive from the bypass trust. We hinted at one solution to the bypass trust problem—disclaimers. Here we’ll discuss a particular solution to the bypass trust problem, the so-called “A-B Bypass Trust.”

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 the new estate tax in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

The IRS has dropped the second shoe, giving taxpayers guidance through the complex procedural machinations they must follow to avoid the 2010 estate tax.

The IRS released two pieces of guidance for estates of 2010 decedents. Advisor’s Journal covered Notice 2011-66 in a previous edition [see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160)]. Today we discuss the second component, Revenue Procedure 2011-41, which provides a safe-harbor for executors of estates of 2010 decedents and beneficiaries of those estates. If the safe-harbor procedure is followed and the executor doesn’t take a contradictory position on a return, the IRS will not challenge the election against the estate tax or the basis allocations made by the executor.

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 estates of 2010 decedents in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), What Next? ILITs and Estates under 5MM (CC 11-114), & Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

When an estate is facing a liquidity crisis, why not tap the family limited partnership (FLP) for cash? After all, the decedent was a partner in the partnership and the partnership can make distributions to the estate, which is now a partner in the FLP.

No so fast. Although an FLP may look like a prime source of cash for paying an estate tax bill, the move can come back to bite the estate in a big way. Done the wrong way, it could jeopardize the valuation discounts and estate planning objectives your clients and their estate planning professionals worked so hard to secure.

The IRS is perpetually on the lookout for new weapons to use against FLPs, but Section 2036 of the Internal Revenue Code has been the IRS’s weapon of choice against FLPs over the past decade.

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 family limited partnerships in Advisor’s Journal, see Use Charitable Giving to Enhance Family Business Succession Planning (CC 10-76) and
Practical Succession Planning for the Family-Owned Business (CC 08-22).

For in-depth analysis of family limited partnerships, see Advisor’s Main Library: FF—Family Limited Partnership.

The rich are protected like “spotted owls” and other “endangered species,” wrote Warren Buffett in a recent New York Times op-ed piece. And despite Republican assurances that they will not approve any tax increases, they may be inevitable.

Buffett says that his effective tax rate is far lower than anyone else’s in his office. Citing the sacrifice of the poor and middle class who fight for the US in Afghanistan and who are struggling during the halting post-recession recovery, Buffett says that Washington spared him and his billionaire friends when it called for “shared sacrifice” in the recent debt limit discussion.

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 reverse mortgages in Advisor’s Journal, see Report Slams Reverse Mortgages (CC 10-121).