5 Million Dollar Strategies – Exclusions and Planning by George Mentz JD MBA CWM

With less than 3 weeks before the Estate and Gift Tax rates change, Americans are speedily transferring assets so as to benefit from the existing tax fairness rules.

There are 2 key objectives in wealth management. There are rules and then there is strategy. The purpose must be effectively intertwined with the laws on the books, and then mixed with the products and services available. And, it all must be documented effectively.

This all makes you think about the options available under the “so called” 5 million dollar exclusion. Here are examples:

1. Gift money to a trust and use a trust department while creating trust documents that have various provisions such as “spend thrift” or education, welfare, and living sustainability clauses.
2. Gift cash to multiple 529 plans to benefit several if not dozens of heirs for educational purposes.
3. Move stock or member interests in small to medium companies to heirs.
4. Create a dynasty trust with a wide array of beneficiaries who are descendants of children or relatives.
5. Buy homes or apartments for loved ones. Have the homes in trust where they are sustained & can’t be encumbered or legally attacked.
6. Set up UGMA or UTMA accounts for grandchildren, nieces, nephews and so forth.
7. Move income producing assets into your children’s name so as to capture a better tax rate.
8. Donate appreciated assets or stock to your children and have them move to a tax free state such as Texas and capture the low capital gains rate before year end.
9. Sell a business for stock, and immediately gift the stock to heirs or loved ones.
10. Borrow the money against your assets such as stock or real estate, and gift it to loved ones.
11. Release loans to family members as a gift.
12. Fund a major insurance trust immediately with a single premium policy.
13. If you demand that family behave and receive a lot of money later, create trust where beneficiaries only receive a portion of the money until they turn 35 or 45 years old.

*It is generally best to consult with a Chartered Wealth Manager and then use a licensed attorney who specializes in your county or state with trusts and wills. Moreover, it is advisable to consider using a lawyer or trust department to manage your estate, trusts and wills. Trust departments offer a lot of services to evaluate and can manage the assets of a trust while also paying bills, insurance, managing successions, and even running a business.

The TJSL Thomas Jefferson School of Law has an LLM program in international tax and finance.  To enroll or tell your staff about the program, view here: www.llmprogram.org

About the Author: Dr. George Mentz is a world recognized consultant and award winning professor who has authored several revolutionary books. Prof. Mentz, an international lawyer, has been a keynote speaker globally in Asia, Arabia, USA, Mexico, Switzerland, and in the West Indies. Mentz can be contacted for speaking engagements at www.gmentz.com or www.managementconsultant.us or www.selfhelpbook.org  Mentz is a licensed attorney and CWM Chartered Wealth Manager who resides in Colorado Springs Colorado USA
*No tax, insurance, investment or legal advice provided herein. Please consult with a licensed professional in your jurisdiction before making any important financial or legal decision.

The Economic Issues and Some Defensive Strategies and Ideas
According to the WESP World Economic Situation and Prospects Report from the United Nations, the US and global economy is in a rut and having extreme difficulty moving forward. The report recommends that governments must be innovative and think of new strategies to cooperate with business and the workers to stimulate the economy.

As per the United Nations Report, the US economy still remains weak and without direction. The report states that, “In the United States, despite recent improvements, the unemployment rate remains well above pre-crisis levels, at over 8 per cent. In the euro area, it increased to a historic high of 10.9 per cent in March 2012. It reached alarming heights in the debt-ridden euro area countries: in Spain it had jumped to 24.1 per cent in March 2012 (up 8.6 in 2007), 21.7 per cent in Greece (up from 8), 13.5 in Portugal (up from 8.5), and 14.5 per cent in Ireland (up from 5). In developing countries, in contrast, employment rebounded more strongly.”

USA Economic Woes – The Highlights
1. In a May 9th ABC news report, the number of highly educated professionals or PhDs on public aid or welfare has tripled in recent months.
2. In total, 44 million people were on food stamps in the US on a monthly basis in 2011, compared with 17 million in 2000, according to the U.S. Department of Agriculture. – Source ABC News
3. Moreover, Business Week reported on May 31st that The number of Americans on Social Security disability has jumped 23 percent since 2007.
4. Presently, The level of employment is about five million jobs lower than where it was in 2008, when the economy slipped into recession.
5. A record 5.4 million workers with their dependents have signed up to collect federal disability checks since President Obama took office.
6. CNN now reports this May that 12.7 million are unemployed in the United States not including the 4 million who have may have given up looking for work.
7. Economists forecasts and estimates reveal that about another 4 million workers have simply stopped looking for work, and so do not show up in the Dept. of Labor tally used for the unemployment rate
8. Japan’s stock markets fell again with the broader Topix index hitting a 28-year low.
9. To make things worse in 2012, Wall Street Stocks ended down a whopping 2 percent, extending May’s rout. The DJI Dow Jones industrial average also dipped into negative territory for the year which is the biggest insult to injury to a potential recovery and to workers’ 401K Plans.
The United Nations States that there are Four major weaknesses continue to conspire against economic recovery:
1. Deleveraging by banks, firms and households, which continues to restrain normal credit flows and consumer and investment demand;
2. Unemployment remains high, a condition that is both cause and effect in preventing economic recovery;
3. Fiscal austerity responses to rising public debts deter economic growth and make a return to debt sustainability all the more difficult; and
4. Bank exposures to sovereign debt perpetuate fragility in the financial sector, which in turn spurs continued deleveraging.

The UNs Ban Ki-Moon said, “Worldwide, more than 400 million new jobs will be needed over the next decade. That means that policy-makers must get serious, now, about generating decent employment,” said Secretary-General Ban Ki-moon at the high-level thematic debate on The State of the World Economy and Finance and its Impact on Development, held on 17 May. “It is time to recognize that human capital and natural capital are every bit as important as financial capital,”

In conclusion, there needs to be new, bold, and efficient ways to stimulate hiring, employment and consumer spending. Governments should begin to look at ways to treat the working professional and the employers as the customer and determine what types of simple benefits and tax reform could be imparted upon the hardest working and the most steadfast contributors.

There needs to be greater incentives to: compete, to create, to invest, and to participate. If the cash, food, and health benefits of “not working” outweigh the rewards of: hard work, risk and job stress, then the entire system is totally broken. In sum, because the markets and investment yields are not advancing in recent years, the pensions and government obligations grow larger while the available money gets smaller. In the end, the state, federal and city governments are not using sustainable business practices or budgeting, and if costs are not constrained, then debts will become unmanageable and insurmountable.

Defensive Market Tips: Some Stock Sectors that were resilient this week were: Verizon VZ, WalMart WMT, AT&T Symbol T, Sara Lee SLE, AmerisourceBergen ABC, Johnson and Johnson JNJ, Pfizer PFE, ristol-Myers Squibb, Wellpoint WLP, or you can find ETFs that are defensive in nature that own gold, silver, or other commodities Gold/DGP or Silver/SLV
Other Typical Defensive Stocks may include: Microsoft MFST, Mastercard MA, Monsanto MON, Walgreens WAG, Merck MRK, VISA symbol V, Chevron CVX, Exxon XOM, Lowes LOW

George Mentz is a world recognized wealth management commentator who has authored several revolutionary books. Dr. Mentz, an international attorney, has been a keynote speaker globally in Asia, Arabia, USA, Mexico, Switzerland, and in the West Indies. Mentz can be contacted at www.gmentz.com

References & Citations:

http://www.un.org/en/development/desa/newsletter/desanews/feature/2012/06/index.html#3974

http://abcnews.go.com/Business/growing-number-americans-phds-receiving-food-stamps-aid/story?id=16310858

http://www.businessweek.com/articles/2012-05-31/federal-disability-insurance-nears-collapse

http://finance.yahoo.com/news/job-growth-falters-may-123604088.html

http://www.ssa.gov/policy/docs/quickfacts/stat_snapshot/

http://news.investors.com/article/608418/201204200802/ssdi-disability-rolls-skyrocket-under-obama.htm?p=full

http://money.cnn.com/2012/06/01/news/economy/europe-unemployment-jobs/index.htm

http://online.wsj.com/article/SB10001424052702304065704577424492946765620.html

http://www.reuters.com/article/2012/06/04/markets-japan-stocks-idUSL3E8H42LZ20120604

*No tax or investment advice is implied herein. Before making any important investment, tax, or legal decision, please speak to a licensed professional in your jurisdiction.

As a wealth management consultant and professor for over a decade, it is that time again to file our taxes. With tax filings, we must document our income, expenses, deductions, exemptions, retirement contributions and so forth. Some of us must file our taxes for partnerships or corporations.

Wealth management comprises various subjects including: Economics, Banking, Investments, Risk Management, Investment/Asset Management, Estate Succession, Taxation, and Trust Planning and Retirement Planning.

Many of us simply receive W-2 and employment income and traditional company benefits primarily, but others who are self-employed or contractors are doing their best to utilize the system to declare income, pay for insurance, take mortgage deduction and so forth.

The good news is that that the tax code has become more amicable to the self employed over the last decade. Self employed individuals are able to write off or deduct more of their health care expenses while also setting aside more money pre-tax into their self directed retirement accounts.

Here are some thoughts related to Wealth Management 2012

Investments: While we are not sure what will happen with taxes going forward, several of today’s tax rates on income such as dividends and long-term capital gains are reasonable. If they go up, many people may sell out of dividend stocks or other related holdings. Dividend stocks have been particularly popular for retirees and those who don’t want CDs with the rates so low.

Thus, dividend stocks have been the alternative for income producing investments because the tax rates are at 15%. Overall, if income taxes go up on dividend stocks at this time, the hardest hit may be seniors and those who live on a fixed income.

Retirement and Education: In light of the present situation, we hope you are able to maximize your contributions to your retirement before April 15th each year. Also, setting aside money in a 529 plan is a good way to fund a child or grandchild’s education for the future. The annual gifting rules and estate and gift tax rules allow you to gift cash to others during life or at death. Therefore, now may be a good time to consider large gifts due to the generous estate & gift tax exemption for 2012.

Estates and Succession: As for estate taxes, those rates right now are the most generous ever. However, the large exemption may be reduced again to the Clinton era rates if nothing is done by Congress before 2013.

The other major estate management issues are succession documents. Do you have a valid will? Do you have health care directives? Have you considered limited powers of attorney for your financial affairs or health care affairs? Have you arranged for the guardianship of your children if something happens to you? All of these issues can be dynamic and very important?

Insurance: Other topics are risk management related. Do you have proper life, health, and home insurance? Have you considered an umbrella policy or disability policy? Again, protecting yourself and your family in this way is imperative. However, you must remember that insurance contracts have beneficiaries and that each policy can have primary beneficiaries or secondary beneficiaries. Further, these assets are not controlled by your will and the beneficiary receives regardless of what your will says. Providing the policy numbers and information to your loved ones may also be a good exercise.

Banking and Investment Accounts: Additionally, if you have bank or brokerage accounts, you should consider listing your spouse or loved one as person who receives the account upon death. TOD “Transfer on Death” and POD “Payable on Death” accounts are typical choices for your accounts and this allows a loved one to have access to cash immediately if something happens to you. Sometimes, rolling over or consolidating accounts is a great exercise so as to help create a better view of the totality of your investments.

Taxation: The IRS has a tax tips section which is interesting and resourceful. Moreover, there are many great tax software programs out there to chose from that you can use privately on your computer. Thus, with good information coming from the Treasury Department and quality software, all of us have a fair opportunity to get our tax paperwork done on time.

Economics: Keep in mind that there has been a number of economic cycles in the last 20 years in the USA and Internationally. That means that we should all keep an eye on our risk tolerance and our investing time horizon. When you are getting closer to retirement, you should be moving out of riskier investments and into more stable investments or stocks with less volatility if possible. Other related problems such as an election year and global debt crisis issues domestically and abroad are also now part of the macro-economic effects.

In the end, most people are concerned with financial security. During our earning years, all of us want to work in a labor of love, earn what we can, protect our children and retirement, and worry about taxes later. In the end, the key is doing what you want to do, and have the experts handle your legal, tax and wealth management for you.

*No investment, legal or tax advice is intended to be given herein. Please see a licensed professional before making any important decision.

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.

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[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.

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• 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.

Everyone on both sides of the political spectrum says that corporate tax reform is a priority. But no one in Washington seems ready to make the tough choices necessary to develop a system that forces multinational corporations to pay their fair share without hurting US competitiveness in the world markets. Overtax multinational corporations and they’ll move their operations overseas; under-tax and you’ll reduce revenue that is sorely needed by the US government.

As part of the ongoing debate and investigation of the US corporate tax system, the U.S. House Committee on Ways and Means is hearing testimony from tax experts on the US tax system and alternatives.

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 corporate tax reform issues in Advisor’s Journal, see Obama’s Blue Ribbon Debt Commission Proposes Complete Overhaul of the Tax Code (CC 10-95).

For in-depth analysis of US Corporate Tax, see Advisor’s Main Library: A – The Corporate Income Tax.

Why is this Topic Important to Wealth Managers?  As the end of the calendar and personal tax year approaches, Advanced Market Intelligence will focus on end-of-the-tax-year issues that every wealth manager may relay as helpful information to his and her clients.

“How are business expenses reported for income tax purposes?” may initially seem like an easy question for many wealth managers.  But normally, the easiness of answering this question is a result of referring to an information pamphlet by a service provider or perhaps a newspaper article.  Unfortunately, these public sources of information are not always accurate.  Also, because they are trying to present very complex information in understandable terms, these types of sources gloss over finer, yet very important elements, that if known, would impact a decision.

Seldom does the wealth manager take the initiative to undertake his own initial research of the actual rules and how the rules may be applied.  Advanced Market Intelligence has been committed to empowering the wealth manager with the necessary information to efficiently find the important rules and provide examples of how the rules are applied to various example scenarios.  Thus, let us first turn to the legislative rule applying to business expenses.

The Internal Revenue Code (the “Code”), legislated by Congress, establishes rules regarding ‘if and when’ a taxpayer may choose to deduct certain expenses from income.  Congress grants the authority to the Treasury department to write corresponding “Regulations” to address the administration and enforcement surrounding the ability of taxpayers to take such deductions allowed by the Code.  Business expenses are one type of such expense Congress has established for a taxpayer to reduce his gross income.

The Code section establishing the ability of a taxpayer to deduct a business expense is Section 162.  The first part of the first paragraph of Section 162 reads:

(a) In general

There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including— …

In that most taxpayers do not hold a degree specialized in taxation, many will find the Code’s terminology and sentences confusing. An obvious example of a term and a phrase in the first part that may confuse a taxpayer is “ordinary” and “necessary”.  What makes an expense “ordinary” instead of “not” ordinary?  The same can be asked of “necessary”.  And the phrases contains the word “and” which normally is a ‘conjunctive’ (recalling back to high school grammar lessons), meaning that the taxpayer must determine if an expense is both ordinary “and” necessary in order to claim it as a deduction.

The Federal government’s business portal Business.gov provides the following response to the question of what is an ordinary and a necessary expense:  ”An ordinary expense is one that is common and accepted in your field of business.  A necessary expense is one that is helpful and appropriate for your business.”

We can spend a week just digesting the terms “ordinary” and then “necessary”.  But that’s just the start of our investigation and the exercise of assisting a client.  We would require several days examining the terms “paid” or “incurred”; another few days on “taxable year” and finally “trade” or “business”.  By example, because Congress includes the possibility of deduction for either a “trade” or a “business”, a taxpayer will be inclined to ask: “What’s the difference between a trade and a business?”  A taxpayer may think Congress is being repetitive, but normally each word has its own, even important, significance on the application of the Code Section to the taxpayer’s specific situation.

And it quickly goes downhill from there.  The Code Section evolves from this, albeit not simple, somewhat manageable part into a morass of limitations, exceptions to the limitations, and exceptions to the exceptions.  This Code section continues for more than 5,000 words and more than 10 pages to establish when a taxpayer may deduct a business expense.

So by example, immediately following the above part, Congress includes:

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and

(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.

Over this next week, Advanced Market Intelligence will distill this Code Section in relation to  some of the common scenarios that a wealth manager and his client will face.  By example – when is my travelling the “travelling” that Congress includes under (2) above?

Fortunately, for the 173,000 insurance industry and wealth management subscribers of National Underwriters publications and information services, they can obtain access to Advanced Market Intelligence (AdvisorFX) to be able to present to clients and prospects opportunities for deduction of business expenses, and respond to clients and prospects questions before bringing in the tax expert (and the costs associated).

Read the key information you need to know and relate to your client 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):

Tax Facts 7537. How are business expenses reported for income tax purposes?

Main Library - Section 19. Income Taxes B4—Business Income And Deductions

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 brief discussion on the difference between tax avoidance versus evasion, the former earns wealth managers checks and the latter can send them to jail.  Knowing the difference, when to spot it, and how to “avoid evasion” is essential to any wealth manager’s tool kit.

Tax avoidance is “The act of taking advantage of legally available tax-planning opportunities in order to minimize one’s tax liability.” [1] On the other hand, tax evasion is the “willful attempt to defeat or circumvent the tax law in order to illegally reduce one’s tax liability. [2]

From the above definitions, and the function of the tax code itself, the line becomes blurred between taking advantage of legally available planning opportunities and a willful attempt to circumvent the tax law.  A well known quote often attributed to Will Rogers speaks to this point.  “The income tax has made more liars out of the American people than golf has. Even when you make a tax form out on the level, you don’t know when it’s through if you are a crook or a martyr.” [3]

Today’s advanced transactions are even more difficult to understand in regards to an ever expanding tax code.  Even over 50 years ago, (well before the Revised 1983 Code) it was said by one of the world’s most famous scientists, Albert Einstein, “The hardest thing in the world to understand is the income tax.” [4] So if Einstein had trouble with calculation of income tax liability, in the 30s-40s what can wealth managers do to not only keep their clients safe, but also maximize every opportunity?

• Stay Informed – A plan that may have been okay last year may be under attack currently.  Some forms of retirement plans were the classic example of this.
• Ask an Attorney and/or Accountant– If a wealth manager is planning a transaction that he/she is not absolutely sure of the consequences, in other words willing to risk licensing and professional liability, then it would be prudent to seek tax and/or legal advice for the client.  A small amount of billable time now can go a long way later, even if to just confirm initial conclusions.
• Don’t Stay too Limited – If a wealth manager hears of a beneficial concept for a client that makes sense, it may be worth exploring.  As we continue further into a global economic climate, many more international opportunities are becoming available.  Just with any other investment opportunity, risk levels vary based on various factors.
• Don’t Cheat – Know the rules of the game, and play the game the best it can be played within those rules.  Take for example, the recent “Father & Son” Cohen tax evasion case in South Florida.  The Times reported [5], “Prosecutors said the Cohens used offshore companies, friends and family posing as owners, and forged documents to cheat on their taxes. They said the Cohens should have declared income from their use of mansions and luxury cars that the father and son said were owned by corporations.”

Whomever was advising the Cohens, based on the information provided, was not doing a good job.  The Cohens were convicted at trial of “hiding a $33 million hotel sale from federal tax authorities while living a lavish lifestyle.”

It should be quite clear from the above example that forged documents are obviously illegal and wealth managers should make every attempt to avoid participating with anyone who has an intent to defraud.  There is always a line in the law, and although what the line is, or where it lies is not always clear, wealth managers should be able to distinguish clearly illicit activity.  With that in mind, it has long been the reasoning of the High Courts that for the reason and in favor of the “astuteness of taxpayers in ordering their affairs so as to minimize taxes we have said that ‘the very meaning of a line in the law is that you intentionally may go as close to it as you can if you do not pass it.’ ” [6]

Tomorrow’s blogiticle will discuss tax advantageous solutions such as bonds.

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

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[1] Black’s Law Dictionary (8th ed. 2004), tax avoidance.

[2] Black’s Law Dictionary (8th ed. 2004), tax evasion.

[3] See generally, Charlie Kelliher, PhD.  Associate Professor, Dixon School of Accounting – University of Central Florida.   http://www.bus.ucf.edu/ckelliher/tax_5015/examples/tax_quotes.htm.  Last Accessed 10/6/10.

[4] Id.

[5] “Father and Son Found Guilty of Tax Evasion.” New York Times crediting Bloomberg News.   http://www.nytimes.com/2010/10/07/business/07tax.html?_r=1&src=busln.  Published: October 6, 2010.  Last Accessed 10/6/10.

[6] Atlantic Coast Line R. Co. v. Phillips 332 U.S. 168, 172-173, 67 S.Ct. 1584, 1587 (U.S. 1947) citing,  Superior Oil Co. v. State of Mississippi, 280 U.S. 390, 395, 396, 50 S.Ct. 169, 170, 74 L.Ed. 504.

Why is this Topic Important to Wealth Managers? Provides insight into relevant taxation issues regarding the ownership of a foreign insurance company, premium payments made to a foreign insurance company, and foreign insurance company income taxation. Discusses information wealth managers may find relevant in regards to advanced family and business estate plans.

What are the U.S. tax implications, generally, for a United States Corporation that owns a foreign insurance company?

To begin, a well known rule is that premiums paid to a foreign insurance company are subject to a federal income premium tax. The tax is due even though the U.S. parent may own the foreign insurance company, either in part or in full.  The tax is remitted by the premium payor who “must file Form 720 to pay the tax at the time of the premium payment.”[1]

For casualty insurance policies the tax is 4% of the total premium payment to a foreign insurer and for life insurance and annuity contracts the tax is 1% of the premium paid.[2] The tax only applies to premium payments to a foreign insurer.

If a foreign company carrying on an insurance business within the United States qualifies as a life or casualty insurer under the Code, “if it were [otherwise] a domestic corporation,” then the company is “taxable under such part on its income effectively connected with its conduct of any trade or business within the United States.” [3]

To determine what income then is effectively connected with a trade or business within the United States, one must know what a trade or business within the United States means.  “Neither the Code nor the regulations fully define the term ‘trade or business within the United States.’ ” [4] Most “cases hold that profit oriented activities in the United States, whether carried on by the taxpayer directly or through agents, are a trade or business if they are regular, substantial, and continuous.” [5] Additionally, an insurance company “makes contracts over a period of years”, which leads one to believe the issuance of insurance contracts on persons or activities in the United States is continuous. [6]

A foreign insurance company is subject to the tax rates under I.R.C. § 11 and income from the insurance operations is calculated as if it were a domestic corporation.  See yesterday’s blog on the general income determination process of domestic insurers.  Furthermore, once the tax is paid from on the trade or business activity, “residual FDAP” in the form of dividends or branch profits is paid by the foreign insurance company based on income from sources within the United States.[7] The amount of “residual FDAP” withheld at a rate of 30% from the source making payment, [8] “but the tax is often reduced or eliminated by treaty.” [9] In the case with the United Kingdom and U.S. tax treaty, the rate can be as low as 0% for a wholly owned subsidiary. [10]

Additionally, as a general rule, shareholders of a company will pay a tax on dividends received at the normal dividend tax rates.  Since the owner of the foreign insurance company is a domestic corporation, the domestic corporation can make an election to have the Dividends Received Deduction apply, which would eliminate the tax on dividends paid back to the domestic corporation. [11] However, when the domestic corporation pays a dividend, general taxation of dividends will apply to the shareholders of the domestic corporation.

Lastly, the insurance company, owned by the U.S. parent may be considered a Controlled Foreign Corporation. Insurance companies are CFCs when it is owned by 25% or more by U.S. corporations.  Under the CFC rules, the parent corporation recognizes it’s pro rata share of income each year. [12]

See also our discussion on CFCs from last month (Sept 28^th), Offshore Planning’s Impact on Calculation of U.S. Income Tax Liability.

Tomorrow’s blogticle will discuss the financial considerations and comparisons generally of Section 953(d) elections, (election of foreign insurer to be taxed as U.S. insurance company) versus foreign insurance company taxation.

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

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[1] “Private Placement Life Insurance and Annuities: Applications for U.S. and Non-U.S. Taxpayers”. By Leslie C. Giordani and Michael H. Ripp, Jr. and Robert W. Chenser, Jr. and Mari M. Reed.  SS020 ALI-ABA 569 (200).  Lexis Nexis.

[2] 26 USCS § 4371 (1), 26 USCS § 4371 (2).

[3] 26 U.S.C.A. § 842.

[4] TAXES—THE TAX MAGAZINE, CCH Draft.  “Income Effectively Connected with U.S. Trade or Business: A Survey and Appraisal”.  Pg. 62.   Lawrence Lokken .  March 2008. 

[5] Id.

[6] Id. at 63.

[7] 26 U.S.C. § 871; 26 U.S.C. § 884

[8] 26 U.S.C. § 1441; 26 U.S.C. § 1442.

[9] “Income Effectively Connected with U.S. Trade or Business: A Survey and Appraisal”  at 61.

[10] United Kingdom Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland tor the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains. Art. 10, Para. 3,.  (2001).

[11] 26 U.S.C. § 243(b)(3).

[12] 26 U.S.C. § 953(b), 26 U.S.C. § 951 (a)(1)(A)(i).