NJ Estate Tax Repeal: How Does This Affect You?

It's official.  According to NJ.com, Governor Christopher Christie has signed a a bill to repeal the New Jersey Estate Tax.  The new law is part of a larger package deal that increases the gas tax, reduces the sales tax slightly, gives the working poor a larger tax credit, gives a tax cut on retirement income and gives a tax exemption for veterans who have been honorably discharged.

Under prior New Jersey law, a person may leave an unlimited amount to a spouse or charity. However, any money going to anyone else above $675,000 (the "exemption amount") is subject to an estate tax. This rule will remain in effect for the rest of 2016.  

For calendar year 2017, the estate tax exemption amount for NJ will increase to $2,000,000.  The tax rate will generally start at about 7.2% and go up to 16% on estates over $10,000,000.

There will be a full repeal of the NJ Estate Tax starting January 1, 2018.  

We have confirmed that New Jersey will NOT be repealing its inheritance tax. Accordingly, money that is left to a non-class A beneficiary will still be subject to a tax.  In other words, there will still be a tax if you leave money to anyone other than a spouse, your descendants, your ancestors or a charity upon your death.

So the big question for many might be how does this affect you.  I will break this down into 5 categories:

1) People who have prepared existing estate planning documents;
2) People with assets between $675,000 to $5,450,000 (for individuals) and married couples with assets less than $10,900,000;
3) Married couples with assets in excess of $10,900,000; 
4) Snowbirds; 
5) Widows and widowers who are the beneficiary of a credit shelter trust; and
6) People who wish to consider Medicaid planning.

1) For people who have already prepared their estate plans, most likely this will not adversely affect your plans.  However, the modification of the tax law likely gives you the opportunity to simplify your documents.  In particular, it is common practice in New Jersey to create a trust for a surviving spouse (often referred to as a Family Trust, Bypass Trust, Credit Shelter Trust or A-B Trust) to double the $675,000 exemption among spouses.  

There still may be other reasons to have a trust for a surviving spouse (such as in second marriage situations), but starting 2018, doubling the NJ exemption amount will no longer be necessary.

2) For New Jersey domiciliaries who have assets above $675,000 (the NJ estate tax exemption limit in 2016) and below the federal estate tax exemption limit ($5,450,000 for individuals and $10,900,000 for married couples in 2016), it was a common part of estate planning for a person to make deathbed gifts to minimize the NJ estate tax liability.  Once the NJ estate tax gets repealed, it will generally be much more beneficial for a person to keep all of their assets until their death rather making substantial gifts during lifetime.

Until 2018, deathbed gifting can be very tax efficient because New Jersey has an estate tax but it does not have a gift tax.  Accordingly, there is the opportunity to substantially minimize the estate tax.  The problem however, is that many people make the mistake of gifting substantially appreciated assets such as stock or real estate. You often want to keep appreciated assets until death to obtain a step-up in basis.   

So before you make a gift, you would need to weigh the potential NJ estate tax consequence of keeping an asset versus the potential capital gains tax if an asset is sold after the gift is made.

Now with the repeal of the NJ estate tax, unless a person is likely to die prior to 2018, you don't need to worry about making the calculation as to whether the NJ estate tax or the capital gains tax will be higher.  It will almost always be better to keep the asset.

3) For married couples with assets in excess of the federal estate tax exemption amount, I have read a number of studies that indicate that a couple can usually transfer wealth in a more tax efficient manner by establishing a credit shelter trust for the surviving spouse rather than relying on portability.  

There are few reasons why wealthier clients may want to continue to use traditional credit shelter trust planning.  The first is that while the estate tax exemption is portable, the generation skipping transfer tax (GST Tax) is NOT portable to a surviving spouse.  Many wealthy clients often wish to make sure the money goes not just to their children, but also to more remote descendants.

Another benefit to traditional credit shelter trust planning is that it acts as freeze for the assets inside the trust.  Specifically, let's assume that we have a married couple with exactly $10,900,000.  If we put half of those assets in trust on the first to die, then regardless of how much that goes up or down, it passes tax free on the surviving spouse's death.  So if the value of the trust goes up at faster rate than the inflation adjustment on the exemption amount, the beneficiaries are basically saving about $0.23 on the dollar because the estate tax is a 40% tax and the capital gains on the appreciation is only taxed at 23%.

While none of this planning will be different after the NJ Estate gets repealed compared to now, it makes the planning much easier to justify because right now we have a dilemma as to "HOW MUCH" we fund the credit shelter trust with.  To avoid any tax on the first to die, a credit shelter trust can only be funded with $675,000.  For some, this hardly makes it worth setting up. However, as the estate tax in NJ goes away, we no longer have this concern.

4) For snowbirds and other people who wish to avoid a "death tax", very simply, starting 2018 the tax incentive to move will be dramatically reduced.  Back in 2009, I wrote a post discussing the tax benefit of relocating to Florida.  Once the NJ estate tax gets repealed, for many it will make little difference from a tax perspective where their domicile is.

That being said, there are still significant differences between being domiciled in New Jersey vs. Florida.  After all, if you own real estate in both places, you still will need to pay property tax in both locations.  The biggest differences that people should be aware of are:

• Florida does not have a state income tax, whereas NJ does.  (Note NJ will start exempting a substantial portion of retirement income from the state income tax); 
• Florida property has homestead protection only if you are a domiciliary of Florida.  This can provide asset protection and it usually stops the property tax from increasing; and
• NJ is keeping its inheritance tax.  So if you plan to leave your assets to nieces, nephews, friends or other non-class A beneficiaries, there could be a substantial tax savings upon your death.

5) If you have a husband or wife who passed away leaving money to you in trust, come 2018 it may be beneficial to consider options for terminating the trust.  Imagine a scenario where husband dies in in 2004 leaving $675,000 in a credit shelter trust (often called a Family Trust or Bypass Trust) for his surviving spouse.  It is likely that these assets in trust have appreciated to over $1,000,000.  If these assets stay in trust until the surviving spouse's death, it will not receive another step-up in basis.  However, if the trust is terminated and assets are distributed to the surviving spouse after 2018, it could be very beneficial from a tax perspective.  

There are many caveats to this plan.  First, you would not want to terminate the trust if the first spouse to die wanted to protect the money in trust for his/her surviving children - so you would not want to terminate the trust in second marriage situations.  Second, you may not want to terminate the trust if the surviving spouse has substantial assets or debts.  It may also not be beneficial to terminate a trust if the value of the trust assets have gone down in value.  

Nevertheless, it would be advisable to consider terminating a trust to make life easier for the surviving spouse and avoid the hassle of having to file an extra income tax return for the trust. 

Please note that a trust can only be terminated if the trust allows it, so you should have the trust looked at to see if the document allows the trust to be terminated.  If the trust does not allow for termination, consider whether it should be modified under the New Jersey Uniform Trust Act.

6) While I don't do Medicaid planning, I do engage in tax planning, and tax planning just got much easier.  The problem with Medicaid planning is that there is so much bad information out in the public sphere.  

I frequently get clients with millions of dollars who want to do Medicaid planning.  They don't realize that to do this type of planning, they actually need to give away most of their assets.  This might work well with someone who has a few hundred thousand dollars.  However, the more money you have, the less sense it usually makes to do this type of planning.

For example, if you have a $500,000 IRA, stock with a basis of $100,000 and worth $400,000, and a house with a basis of $50,000 and now worth $600,000, let's talk about the tax impact of most Medicaid planning.  In order to "give away" everything to qualify for Medicaid (a total of $1.5M here), the person would have to withdraw their entire IRA, causing a federal and state income tax of over $175,000.  Additionally, the transfer of the stock and real estate now would be subject to a built in capital gains of $850,000, resulting in about another $175,000 in capital gains taxes when sold.  

All told, this planning will likely cause about $350,000 in taxes.  This does not even factor in the planning fees and the loss of opportunity to grow the IRA in a tax deferred form.  At $10,000/month in a nursing home, that is about 3 years in a nursing home.  According to the non-profit Life Happens, the average stay in a nursing home is almost 2 and half years and about 70% of the population winds up spending some time in a nursing home.  A $350,000 tax could have paid for 3 years of nursing care home... and in a non-Medicaid facility.  

Prior to the change in the estate tax law, an argument could be made that the increase in income taxes was somewhat offset by a decrease in estate taxes. Until the end of 2016, with an estate of $1.5 million, there was the potential estate tax of over $60,000.  Repeal of the estate tax obviously changes the equation.  Under the new tax law, it is generally more prudent to keep assets in your name rather than giving them away ahead of time.  So while Medicaid planning can certainly be appropriate for some, the larger your estate, the less financial sense it makes to engage in this type of planning.  

The Biggest Danger of a Roth IRA Conversion

After speaking with a client who did a ROTH IRA conversion last year, I realized that there is a major danger to these conversions. You cannot assume that the financial instituion will designate the same beneficiaries on the ROTH IRA as had been named under the traditional IRA. Many financial instituions will send out beneficiary designation forms separately, long after the converison has been done. If the owner is not expecting it, he or she may just throw away the form.

It is very important for anyone who has done a ROTH IRA conversion to double check the beneficiaries on the new account to ensure they are what you want. This is particularly true if you want to name an IRA Stretch Trust.

Understanding What "Per Stirpes" Means

Sometimes it's easier not to reinvent the wheel. Back in 2006, Debra M. Simon, CPA wrote an excellent article about Understanding the Pitfalls of Beneficiary Designation Forms. Included in that article is a clear explanation what it means to name your issue, "per stirpes" compared to naming your issue, "per stirpes by representation" as beneficiaries under a retirement account, Will or life insurance policy.
I strongly recommend anyone who has more than one child read this article because if one of your children passes before you, you may inadvertently be cutting your grandchildren out of your estate plan.
Thank you to Robert Kenny, Esq. for bringing this article to my attention.

A Comparison of the Pennsylvania and New Jersey Inheritance Tax Laws

Some states, including New Jersey and Pennsylvania, have an inheritance tax. Other states, like Florida and New York, do not have an inheritance tax. An inheritance tax is a tax on the person who receives money from a decedent.

The inheritance tax rate itself depends upon the relationship between the person receiving the money and decedent. For example:

1. In both New Jersey and Pennsylvania, if the person receiving the money is a spouse (or a charity), there is no tax.
2. If the person receiving money is a sibling, there is a flat 12% tax in PA. In NJ it is a bit more complicated - the first $25,000 is exempt; beyond that there is a tax of 11-16% depending upon on the amount of the bequest.
3. Generally, if the person receiving money is anyone else (besides a child, parent or same sex partner), then there is a 15% flat Pennsylvania inheritance tax and a 15 or 16% New Jersey inheritance tax depending upon the amount of the bequest.
4. The first BIG DIFFERENCE is that Pennsylvania taxes bequests to all lineal descendants and certain lineal ascendants at 4.5%. New Jersey does not charge an inheritance tax to any lineal descendants or ascendants. (Note: Pennsylvania does not charge a tax on the bequest to a parent if the decedent was under 22 years of age.)
5. The second BIG DIFFERENCE is that Pennsylvania has a 15% inheritance tax on bequests to a same sex partner. In New Jersey, as long as the partners are in a civil union or domestic partnership, there is zero inheritance tax. If the partners are not in a civil union or domestic partnership, then there is a 15 or 16% tax, depending upon the amount of the bequest. For more information, see my blog on Estate Planning for Same Sex Couples.
6. In NJ, a bequest to a son-in-law or a daughter-in-law is taxed at the same rate as a bequest to a sibling. N.J.S.A. Section 54:34-2c. In PA, such transfers are taxed at the same rate as a bequest to a child. 72 PS 9116 (Note: If the son-in-law or daughter-in-law later remarries, this does not apply.)
7. In both NJ and PA, step children and adopted children are taxed in the same manner as natural children. New Jersey also allows inheritance tax free transfers to mutually acknowledged children in certain circumstances. N.J.S.A. Section 54:34-2a.
8. The only other significant difference in the rates is that New Jersey exempts transfers that are less than $500. Pennsylvania exempts certain transfers of up to $3,000.

New Jersey and Pennsylvania also have similarities and differences between the types of assets that they will tax. This is not a complete list, but as an example:

1. Neither state taxes life insurance, real property located outside of the state or business interests located outside of the state;
2. Both states will fully tax cash and brokerage assets of individuals who died while domiciled in their state.
3. Both states will fully tax real estate and business interests located inside the state of resident and non-resident domiciliaries.
4. Joint property held with rights of survivorship are fully taxed in New Jersey unless the recipient can prove he or she contributed to the joint property. In Pennsylvania, only the portion of the property owned by the decedent is taxed.
5. IRAs, Annuities, 401(k)s, 403(b)s and other retirement assets are taxed in New Jersey, but not in Pennsylvania, provided the account owner passes away before having the right to withdraw the money free of penalty (generally before retirement age of 59.5) AND provided that a person was named as beneficiary of the retirement plan. In PA, if the owner of the 401(k) has the right to close down the account it will also be subject to a tax, this is generally age 62 or 65.
6. Retirement plans, annuities and other benefits payable by the federal government to a beneficiary are not subject to an inheritance tax in NJ or PA.
7. In Pennsylvania, transfers made within one year of death are taxable, but each such transfer is subject to a credit of up to $3,000 per recipient. In New Jersey, transfers "made in contemplation of death" are taxable for inheritance tax purposes. There is a presumption that transfers made within three years of death are made "in contemplation of death".

Note: An inheritance tax is not to be confused with an estate tax. A state can have either an inheritance or an estate tax, both, or neither. Additionally, many of the assets that are exempt from inheritance tax (such as life insurance) are subject to an estate tax.

The NJ inheritance tax is due within 8 months from the date of death. In PA, the inheritance tax is due within 9 months of the date of death, but there is a 5% discount if the tax is paid within 3 months from the date of death.

The NJ Inheritance tax statute can be found at N.J.S.A Section 54:34-1, et. seq. The PA Inheritance tax statute can be found at 72 PS 9101, et. seq.

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Edited on January 20, 2011 thanks to input from Patricia Picardi.

IRA Planning in Light of Robertson v. Deeb

In December of 2009, the Florida Court of Appeals concluded in Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d DCA 2009), that the beneficial interest that a person owns in an inherited IRA may be subject to garnishment. In other words, an IRA that you inherit may be taken by your creditors. This is different from an IRA that you establish yourself, or a retirement plan like a 401(k) or 403(b), which are all protected against creditors.

The result itself did not surprise me much until I read and article by Kristen M. Lynch and Linda Suzzanne Griffin in the April 2010 Florida Bar Journal. Intuitively, it made sense that a creditor can go after an asset that you inherit. Usually, the rule of thumb is that unless an asset is specifically exempted, a creditor can sue to get it.

What made this case unusual, and what I was not aware of, is the fact that there was a specific statute on point, F.S. Section 222.21, which seems to indicate that money payable to the "beneficiary" of an IRA is exempt from all claims of creditors. The Court, however, stated that a beneficiary who inherits an inherited IRA is not entitled to the same protection as a beneficiary who contributes to his or her own IRA.

I do not wish to argue the merits of the Court's decision, but I will point out that as a result of this case, anyone who has a substantial IRA should seriously consider establishing a trust for their loved ones which has "stretch" and asset protection provisions.

For many people, their IRAs are their biggest asset. It is clear, now more than ever, that if you wish to protect your IRA from creditors, you cannot simple name your loved ones as the beneficiaries without risking it being taken. Moreover, you cannot simple name a traditional trust as the beneficiary without incurring large income taxes. You need to do comprehensive IRA planning.

A Good Time to Buy that First House – But How?

Many experts think this is a great time to buy a new house, especially if you are a first time home-buyer. Interest rates are low and home values are depressed. The problem, however, with this credit crunch is having enough cash for the down-payment. There are programs out there so that you can buy a home with almost no money down, but that can lead to the monthly payment of Private Mortgage Insurance (PMI), which is expensive, and opens the homeowner to the possibility of owing more than the home is worth if the value declines.

In order to put have an adequate down-payment, many prospective homeowners will consider dipping into their IRAs, 401(k)s or 403(b)s for the down payment. Tapping into these retirement accounts options have significant drawbacks and the cost of such withdrawals should be carefully considered.

IRAs

Best features:

* You can withdraw up to $10,000 without a 10% early withdrawal penalty. (A husband and wife can each withdraw $10,000 to make a $20,000 down-payment.)
* You may withdraw for immediate family such as a spouse, child, grandchild, parent or other ancestor.

Pitfalls:

* The withdrawal amount will be taxable as ordinary income.
* There is no ability to re-contribute money.
* Funds can only be used towards: buying, building or rebuilding the primary residence; and any usual or reasonable settlement, financing or other closing costs.

401(k)s/403(b)s

401(k)s and 403(b)s function in very similar fashion to each other. There are 2 ways to access your retirement fund to purchase a home: withdrawing it outright, or taking a loan out against it. It is usually a far better option to borrow against a 401(k)/403(b) than to withdraw from it due to the pitfalls.

1. If you withdraw money from your 401(k)/403(b):

Best features

* You do not have to be a first-time homebuyer to withdraw 401(k)/403(b) funds (any financial hardship as described by the IRS will suffice).

Pitfalls

* You need to be purchasing a primary residence, as withdrawals are only permitted under “hardship” circumstances. (The government considers the need to purchase a primary residence as a hardship circumstance.)
* The withdrawal amount will be considered taxable income.
* You will be assessed a 10% early withdrawal penalty if you are under age 59.5.
* You lose the compounding interest.
* You may also be prohibited from making any additional contributions for a period of one year.

2. If you borrow against your 401(k)/403(b):

Best Features

* You may borrow the lesser of $50,000 or ½ of your account balance. However, if ½ your account balance is less than $10,000, it may be possible to borrow $10,000.
* A loan from a 401(k) allows you time to pay it back. (This is usually at prime + 1% and the typical payback period is 10-15 years, but it may be as long as 30 years.) A 403(b) typically has a payback period equal to the duration of the first mortgage. However, you should check the specific payback period identified in your plan.
* There is no penalty for borrowing against your 401(k).
* Assuming that you pay the loan back in a timely manner, there are no adverse income tax consequences to receiving the loan.

Pitfalls

* If you lose your job, any unpaid loan amount would either be due in a period as short as 60 days. If you do not pay back the loan, the unpaid amount will be considered income, which is then both taxable and possibly also subject to a 10% early withdrawal penalty.
* Most plans prevent you from contributing extra savings until the loan is repaid.
Conclusion

While IRA, 401(k) and 403(b) funds could be used to fund the deposit on a first time home purchase, the tax drawbacks and risks are significant. You will want to consider how use of these funds will affect your retirement and your estate and the tax implications before taking such drastic measures. Obviously, if you are in your 20s with many years until retirement, and perhaps not at the peak of your earning potential, the use of your IRA and/or 401(k) and/or 403(b) funds can help you buy a piece of the American dream. However, if you are looking towards retirement or the rate of return on these funds makes withdrawing funds a particularly costly proposition, it is best to look elsewhere for your down-payment.

Special thanks to Nancy McMillin in the preparation of this post.

No MRD for most IRAs in 2009

In case you hadn't heard already, there is a recently enacted law in which most beneficiaries of an IRA (inherited or otherwise) can choose to NOT take their minimum required distribution (MRD) for calendar year 2009. (There are some exceptions for people who were supposed to take their MRD in 2008 and were postponing it until 2009.)

Note, this law also applies to beneficiaries of ROTH IRAs, 401(a),401(k) and 403(b) plans. The purpose is to help people save money in this dreadful economy. (Although, as a practical matter it seems to be a benefit only to the wealthiest few as poorer beneficiaries will likely have withdraw it anyway. So, the government may have been better off not offering this tax break as it could really use the revenue.)

You should consult with your plan administrator if you have any questions regarding your ability to avoid taking your MRD this year.

'Tis the Season to be a Snowbird

Ah, the weather outside is frightful.
And Florida is so delightful.
You've packed up your things to go...
Let it snow, let it snow, let it snow.

Seriously, weather aside, have you ever wondered why so many older wealthy people retire to Florida. Well, maybe this answer will help - a relatively affluent person can buy a second house in Florida with the tax savings ALONE!

Let me give you an example: Let's assume that you have a couple in their 70's with about $4 Million in Assets. They have an IRA of $1 million, brokerage assets of $1,000,000, Life Insurance of $1,000,000, a house worth $600,000 and miscellaneous other assets of $400,000. They are leaving everything to their children.

If this couple died as residents of New Jersey, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a NJ estate tax of about $210,000 on the second to die of the husband and wife.

If this couple died as residents of Pennsylvania, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a PA inheritance tax of about $135,000 on the second to die of the husband and wife. (Note, with a $4 million dollar estate, a small state inheritance tax may be due on the first to die in order to avoid a much larger federal estate tax on the second to die.)

If this couple died as residents of New York, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a NY inheritance tax of about $190,000 on the second to die of the husband and wife.

If this couple died as residents of Florida, then there is ZERO Florida estate or inheritance tax.

Now, factor in the additional benefits. In addition to lower property taxes in Florida, Florida is also the only one of these three states not to have an income tax. (It should be noted though that Pennsylvania does exempt IRA distributions from the state income tax.) So, let's make an additional assumption that this couple lives another 20 years and that they take out about $1 million dollars from the IRA during that time. (I'm not going to get into the time value of money.) This would produce an aggregate state income tax of approximately $70,000 for NY and $65,000 for NJ.

In total, moving to Florida would help save:

• $275,000 for a NJ resident;
• $260,000 for a NY resident; and
• $135,000 for a PA resident.

Now, these savings may not purchase a mansion, but you can certainly find a nice house (especially in this real estate market) with the tax savings from moving. Obviously, the wealthier you are, and the more you have in your IRA, the better the result.

An attorney licensed to practice in Florida plus your home state can help you move down to Florida in a way that will be most cost efficient. This includes preparing the appropriate estate planning documents in Florida, mitigating the necessity for ancillary probate in the your original home state, and properly setting up your other legal documentation to prove that you are a Florida domiciliary.

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DISCLAIMER: All the usual disclaimers found elsewhere on this Blog plus a disclaimer that all tax calculations are approximate and made for tax year 2009.

IRA Stretch Trusts

What is a Stretch IRA Trust?

Trusts in General - A trust is a legal relationship that exists when one person or an entity (the Trustee) holds title to money or property for the benefit of one or more people (the Beneficiaries). The terms of the relationship are decided by the person providing money to the trust (the Grantor), and are usually in writing.

Stretch IRA – The term Stretch IRA refers to a plan, following the death of the IRA holder, to withdraw only the minimum amount allowed by law. This amount is known as the required minimum distribution. The resulting benefit of this plan is that the assets inside the IRA can continue to grow tax-deferred over the lifetime of the named beneficiaries. Either a traditional IRA or a ROTH IRA may be stretched.

Design of a “Stretch IRA Trust” - A “Stretch IRA Trust” is a flow-through trust designed to guarantee the extension of payouts of your IRA for as long as possible after your death. This is accomplished by allowing the trustee of the Stretch IRA Trust to take out the required minimum distribution, absent emergency. The trust is specially created for the sole purpose of being named as the Designated Beneficiary of an IRA. The reason a special trust is needed is because the provisions of most trusts will not qualify as a flow-through trust. In contrast, should a non-qualified trust be named as the Designated Beneficiary, all the income tax would be due in year one and there would be no further opportunity for tax deferred growth – the worst outcome possible.

What are the Benefits of a Stretch IRA Trust?

Guarantees Deferred Payout of IRA – A plan to stretch out an IRA is merely a plan until the person you name as your beneficiary decides to withdraw the entire amount, creating a huge income tax. Naming a Stretch IRA Trust as the beneficiary of your IRA will ensure that your loved ones defer the built in tax for as long as possible. This is especially useful for young or irresponsible children/grandchildren.

Allows for Control of Assets After You Die – You can set the terms of an IRA Stretch Trust so that your heirs receive money over time, rather than in a lump sum. You can also control where the money goes at the death of the beneficiary if the beneficiary should die before all the money is distributed.

Asset Protection - A trust can protect your money from creditors and make it less likely your heirs will fritter away their inheritance.

Allows for Post-mortem Planning – It is difficult to do much planning with IRAs, but in the event your children do not need the money, creating a trust structure will permit your children to transfer the IRA to their heirs, via disclaimer, without fear that the money will be squandered.

Avoids Over-funding of Spouse for Estate Tax Purposes - A trust structure can both provide income for a surviving spouse and allow both spouses to make proper use of their tax exemptions, thereby minimizing federal and state estate taxes upon the second to die.

Who Should Consider an IRA Stretch Trust?

Individuals with Significant IRAs or ROTH IRAs - Individuals with substantial wealth trapped in their IRA or ROTH IRA may benefit from a Stretch IRA Trust as a way to guarantee that income taxes are reduced, the assets continue to grow on a tax deferred basis, the assets are protected from creditors, and your wealth is preserved. This is particularly helpful for individuals who have young or irresponsible children/grandchildren.

Couples in a Second Marriage – An IRA which names a second spouse as a beneficiary, rather than children of the first marriage, can frequently lead to unintended results - like the money going to the children of your spouse rather than to your children! Giving the money to your spouse in trust will ensure that the money is available for spouse, but also provide for any remainder to go to the people you truly wish to benefit.

What Is Involved In Creating an IRA Stretch Trust?

Hiring an Attorney – When choosing an attorney to prepare your IRA Stretch Trust, you should choose an attorney who is knowledgeable in estate planning, retirement planning, current tax law and asset protection law.

Choosing a Trustee – You can hire either a corporate trustee or an individual trustee. Many people simply have their spouse or a relative act as trustee. You may also have a corporate fiduciary and another person act as co-trustees.

Cost - The cost of an IRA Stretch Trust varies from practitioner to practitioner as well as each client’s needs. How complicated you wish to make the trust and how many beneficiaries you wish to name may also be a factor in the cost. Nevertheless the cost will almost always be far less than the anticipated savings.

Beneficiary Designation Forms – Whether you create an IRA Stretch Trust or plan to stretch an IRA without a trust, it is imperative that you correctly fill out the beneficiary designation forms associated with your IRA to avoid one or more of your loved ones from being inadvertently left out or to avoid paying unnecessary taxes.

Maintenance – An IRA Stretch Trust generally requires no maintenance until after the death of the IRA holder.

SEP IRA is a protected asset in NJ

I was asked earlier today whether a SEP IRA is protected against creditor lawsuits. Without doing a lot of in depth research, I have found that the answer is generally yes. The answer is not the same in all states as it is dependent upon state statute.

New Jersey exempts the claims of creditors from qualifying trusts. See N.J.
STAT. ANN. § 25:2-1. Qualifying trusts include trusts created or qualifying under the Internal Revenue Code §§ 401, 408. (i.e. IRAs, SEP IRAs and 401(k) plans)

Additionally, there is a New Jersey bankruptcy case on point. See In re Lamb, where the court held that 25:2-1 exempts IRAs. See In re Lamb, 179 B.R. 419, 427 (Bankr. N.J. 1994).

Since SEPs are a type of IRA, all of the IRA requirements and benefits, other than the contribution limits, apply to SEP-IRA accounts as well.

The protection is limited by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which does not protect IRAs in excess of $1,000,000.

I also found this interesting site which appears to have a lot of information on the topic: http://www.aicpa.org/pubs/jofa/jan2006/altieri.htm

As always - if a transfer of assets is made prior to a lawsuit, it's good planning. If you do it afterwards, its FRAUD.

The Pension Protection Act

THE PENSION PROTECTION ACT

Overview

In addition to requiring corporations to more fully fund their pension plans, the Pension Protection Act (“PPA”), which was passed on August 17, 2006, provides or extends numerous tax benefits that could affect you or your employer. The PPA recognizes the reality that the government and many companies are pushing the responsibility of saving for retirement on to individuals. To help us take on that responsibility, the PPA provides greater tax deferred savings opportunities for all and offers favorable tax treatment for certain beneficiaries named under a Retirement Savings Account.

Estate Planning – Additional Opportunities for Your Loved Ones to Stretch Your Retirement Savings after your Death

From a planning perspective, perhaps the most important new provision of the PPA is to allow non-spousal beneficiaries to “roll over” assets inherited from a qualified retirement plan into an IRA. The beneficiary will avoid tax on the rollover, and will be taxed only when the assets are withdrawn. Previously, this tax treatment was available only for people who inherited retirement assets from a deceased spouse. The new law extends treatment that already exists for IRAs and will primarily benefit children, grandchildren domestic partners and non-traditional couples.

Specifically, the surviving beneficiary will now be able to “roll over” the decedent’s retirement funds into an Individual Retirement Account (IRA) and either draw down the benefits over a five-year period or over such beneficiary’s own life expectancy. Since the terminology in this particular field is imprecise and confusing, it must be clearly stated that the term “roll over” as used here does NOT allow a non-spousal beneficiary to merge the decedent’s qualified retirement plan with their own. It merely allows the beneficiary to take withdrawals over the beneficiary’s life expectancy rather than being forced to withdraw the entire amount as a lump sum and incur immediate tax charges. This particularly important because this forced withdrawal often bumped the survivor into a higher tax bracket as the withdrawal is counted as taxable income to the beneficiary.

In order for your loved ones to benefit from this new law, you MUST properly designate a beneficiary under your retirement account. If you have not done so, contact your employer’s benefits coordinator and fill out a beneficiary designation form, otherwise they will not receive the benefit of this new law. Unfortunately, the pension plan that your employer uses still determines who you can name as beneficiary. If the pension plan currently does not allow distributions to anyone other than to a spouse, this provision in the PPA will not help you.

The amendments made by this section of the PPA shall apply to distributions after December 31, 2006

Note: The transfer to the beneficiary must be done as a direct rollover, also known as a Trustee to Trustee transfer, otherwise the tax benefits of this rollover will be lost! The direct transfer must go to a properly titled inherited IRA, which means the inherited IRA must be maintained in the named of the deceased plan participant. For example, “Grandpa’s IRA (Deceased March 1, 2007) FBO grandson”.

Retirement Planning Opportunities

The new law extends a number of retirement benefits. The contribution limit for IRAs will be $4,000 in 2006 and 2007, $5,000 in 2008, and adjusted for inflation after 2008. Catch-up contributions for individuals age 50 or older will be $1,000 for IRAs, $2,500 for SIMPLE-IRAs, and $5,000 for 401k plans. IRA catch-up contribution limits, however, will not be adjusted for inflation. SIMPLE and 401k catch-up contributions will be adjusted in $500 increments based on inflation.

The new law permanently allows for Roth 401k and Roth 403b plans. Under the sunset provisions of the previous tax law, Roth-type 401k and 403b plans were not allowed after 2010. The new law removes this sunset provision. Like a Roth IRA, an individual makes post-tax contributions to a Roth 401k or Roth 403b plan, up to the plan limits. The assets grow tax-deferred and may be withdrawn tax-free in retirement.

If you are in a low income tax bracket, you may wish to take advantage of a provision in the PPA that allows a direct rollover from a 401k to a Roth IRA, with the rollover treated as a Roth conversion.

The new law also permanently allows the Retirement Savings Tax Credit, which would have expired at the end of 2006.

How the PPA may affect an Employer

Employers may now automatically enroll their employees into a 401(k) retirement plan using default contribution levels. Employees will need to opt-out of the 401(k) if they don't want to utilize the 401k plan.

Military Personnel

Military personnel who are called to active duty between September 11, 2001 and December 31, 2007, may now take a penalty-free withdrawal from their 401(k) or IRA. However, these individuals must re-deposit the withdrawal within two years from time their active duty ends in order to avoid paying income tax on the withdrawal.

Hardship Withdrawals

The PPA makes it much easier to make hardship withdrawals from 401k plans including allowing hardship withdrawals "with respect to any person listed as a beneficiary under the 401(k) plan." Beneficiaries such as siblings, parents, same sex couples, and children may now draw on a retirement fund in the case of a qualifying medical or financial emergency. In the past, the federal law covered only the spouses or dependents of employees when it came to accessing retirement funds during an emergency.

Stricter Rules for Charitable Donations

Under the new law, taxpayers must keep records of all cash donations to charity. Individuals must show a receipt from the charity, a canceled check, or credit card statement to prove their donation. No charitable tax deduction will be allowed if the taxpayer cannot provide any supporting documentation. Taxpayers will not need to mail in the receipts with their tax return. Instead, taxpayers will need to keep receipts and other documentation with their copy of the return in the event of an IRS audit. The Law Office of Kevin A. Pollock LLC strongly recommends that you maintain all such records for a minimum of seven years.

The new law also toughens the rules for non-cash donations. Donated items, such as clothing, cars, and household goods, must be in good condition. Unfortunately, the new law does not offer any guidance as to what “good condition” means.

Charitable IRA Donations

The Pension Protection Act allows taxpayers to donate up to $100,000 to charity directly from their IRA account in 2006 and 2007. The distributions will be tax-free and avoid the penalty on early withdrawals. Taxpayers are allowed to donate up to $100,000 per year from their IRA. Since the distribution will not be included in taxable income, individuals will not be able to claim a tax deduction for the charitable contribution.

Qualified Charitable Distributions from IRAs Allowed

· Under pre-Act law, there was no provision permitting the tax-free distribution from an IRA where the distribution was to be donated to a charity. The Act provides a favorable new rule that permits an exclusion from gross income, not to exceed $100,000 per year for otherwise taxable distributions from a traditional IRA or a Roth IRA that are made:

o directly by the IRA trustee to qualified public charities and certain private foundations (but not to most private foundations, supporting organizations and donor advised funds);

o on or after the date the IRA owner attains age 70½; and

o only for distributions made in 2006 and 2007, without carryover to any subsequent year.

· Distributions that are excluded from gross income are not taken into account in determining the IRA owner’s deduction for contributions to charity, but are counted as part of the IRA owner’s required minimum distribution for that year.

· The benefit arises from not including the IRA distribution in adjusted gross income, those affected by limitations on itemized charitable donation deductions, and for taxpayers who do not itemize their deductions.

Section 529 College Education Plans Made Permanent

· Withdrawals from Section 529 Plans for qualified college expenses have been completely exempt from Federal income taxes since 2002. However, this valuable tax benefit was set to expire in 2011. The new Act makes permanent the tax benefits of Section 529. Distributions for qualified educational expenses (including special needs services) and certain rollovers Section 529 plan accounts, will continue to be permitted under the new law. This benefit is particularly welcome for those saving for college in light of recent changes to the “kiddie tax” provisions which were the subject of our June 2006 Alert.

Gifts of Fractional Interests in Tangible Personal Property

· The Pre-Act law allows a charitable deduction for a contribution to charity of a fractional interest in tangible personal property if the contribution satisfies requirements for partial and future interests, and in later years the donor makes additional charitable contribution of interests in the same property. A common use of this provision was to make a gift of a percentage interest in a painting or other artwork to an art museum; in theory, the museum must have use and possession of the art for part of each year commensurate with its percentage interest.

· For contributions, bequests and gifts made after August 17, 2006, the Act limits the charitable deduction for such fractional interest contributions, provides rules for valuing the donor’s additional fractional interest contributions and provides for recapture of the tax benefits under certain circumstances.

· The Act requires that the charitable entity receiving a fractional interest must take complete ownership of the item within 10 years of the gift, or the death of the donor, whichever first occurs. Further, the entity must take possession of the item at least once during the 10-year period as long as the donor is living, and use the item for the entity’s exempt purpose. Failure to comply results in the recapture of all tax benefits plus interest and imposition of a 10% penalty. The more restrictive 10-year rule is likely to deter many younger donors from making fractional interests gifts, since enjoyment during the balance of the donor’s lifetime is no longer possible.

· There are also special rules for deductions of future gifts of partial interests in the same property. In general, for items that are contributed to further a donee’s exempt purposes, the deduction will be equal to the fair market value of the interest. The fair market value of an additional contribution of a partial interest in this case is the lesser of the item’s fair market value at the time of the initial contribution or the fair market value at the time of the current contribution. The additional rules that limit the charitable deduction which apply for income tax purposes, also apply for gift and estate tax purposes. There is a potential gift and estate tax trap when the donor makes a transfer of his remaining interest in the property if the property has appreciated in value from the time of the initial contribution, since the interest that remains in the donor’s estate at the time of his death is valued at its full value, while the estate tax deduction is limited to the value of the property at the time of its contribution.

Tougher Record Keeping Required for Charitable Gifts of Money

· The Act disallows any charitable deduction for contributions of cash, check or other monetary gift made after December 31, 2006, unless the donor maintains a written record of the contribution, regardless of the amount. For a contribution of cash, the donor must maintain one of the following (i) cancelled check, (ii) receipt (or letter or other written documentation) from the entity showing the name of the entity, the date and amount of the contribution or (iii) other reliable written records showing the name of the entity, the date and amount of the contribution. The existing rule for requiring a written receipt from the charity for cash contributions of $250 or more remains in effect.

Limitations for Charitable Gifts of Clothing and Household Items

· The Act restricts the charitable deduction for donations of clothing or household items unless they are in good used or better condition. Thus, effective after August 17, 2006, items donated in poor condition will not result in a charitable deduction.

Tougher Rules for Donated Tangible Personal Property

· For contributions made after September 1, 2006, there is a recapture of the tax benefit for charitable contributions of tangible personal property exceeding $5,000 for which a fair market value deduction is claimed unless the charity uses the property for its exempt charitable purposes. If the charity disposes of the donated property within 3 years from contribution, the donor is subject to an adjustment of the tax benefit arising from the contribution. However, there is no adjustment if the donee entity makes a proper certification to the IRS, a copy of which must be given to the donor.

Conservation Property

· To encourage charitable contributions of real property for qualified conservation, the Act increases the percentage limitation applicable to qualified contributions of real property from 30% to 50% (100% for qualified ranchers and farmers) and increases the carryover period for qualified conservation contributions that exceeded percentage limitation from 5 to 15 years. This provision is effective for contributions in 2006 and 2007.

New Taxes on Prohibited Benefits Received from Donor Advised Funds

· In order to close a perceived loophole under current law, the Act provides that if a distribution from a donor advised fund results in a donor, donor advisor, or a related person receiving, directly or indirectly, more than an incidental benefit as a result of the distribution, then: (i) a tax is imposed on the fund manager equal to 125% of the amount of the benefit is imposed on the advice of any related person to have a sponsoring organization make the distribution and such person who advises that the distribution be made or who receives the benefit pays the tax; (ii) a tax equal to 10% of the amount of the benefit is imposed on the agreement of any fund manager who makes the distribution that confers a benefit up to a maximum of $10,000. This provision is effective for tax years after August 17, 2006.

Benefit to S Corporation Shareholders for Charitable Contributions

· Under the Act for tax years beginning in 2006 and 2007, if an S corporation makes a charitable contribution, its shareholders will now reduce their basis in the stock of the S corporation only by their pro rata share of the adjusted basis of the contributed property. Under the prior law, their stock basis had to be reduced by their pro-rata share of the entire charitable contribution. This provision now treats S corporation shareholders the same as partners in a partnership. For example, if an S corporation having a sole shareholder makes a charitable contribution of stock with a basis of $200 and a fair market value of $500, the shareholder will be treated as having made a $500 charitable contribution and will reduce the basis of his or her stock by $200. This is only a temporary tax incentive to encourage S corporations to make charitable donations of appreciated assets in 2006 and 2007.

Enhanced Taxpayer Penalties for Valuation Misstatements

· For returns filed after August 17, 2006, the Act increases the accuracy-related penalties imposed on taxpayers for income, estate or gift tax understatements of value. Under the Act, a “substantial” estate or gift tax valuation misstatement occurs when the claimed value of the property is 65% (previously 50%) or less of the correct value. A “gross” estate or gift tax valuation misstatement exists when the claimed value is 40% (previously 25%) or less of the correct value.

Filing Requirements for Split-Interest Trusts

· The Act increases the penalty on split-interest-trusts (e.g. charitable remainder annuity and unitrusts and pooled income funds) for failure to file a return and failure to properly report required information. The penalty is $20 for each day the failure continues up to $10,000. For trusts with gross income in excess of $250,000, the penalty is $100 per day up to $50,000. If any officer, director, trustee or other individual under a duty to file or include required information, knowingly fails to file the return or include required information, such person is personally liable for such penalty, in addition to the penalty imposed upon the entity. This provision is effective for taxable years after December 31, 2006.