“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” — Bill Gates

Retirement Plans and Bankruptcy

The new bankruptcy act contains different protections for various retirement plans of a bankrupt individual:

• Funds held in an employer-sponsored qualified retirement plan (ERISA) are immune from creditors’ claims in an unlimited amount.
• Funds held in a conventional IRA or Roth IRA are immune from creditors’ claims, but only up to $1 million.
• Funds held in a rollover IRA from an employee sponsored qualified retirement plan are immune from creditors’ claims in an unlimited amount.

CAUTION: None of the plans’ assets are immune from the claims of the Internal Revenue Service.

Don’t Even Try This

Many of the super-lucky lottery winners later sell their stream of payments for a lump sum. Then, they try and claim that the lump sum payment results in a long-term capital gain (15% maximum federal tax) instead of ordinary income (35% maximum federal tax). Nice try!

To my knowledge, nobody has ever won such a case, but the cases still keep popping up. The Tax Court has said over and over, “If you sell the right to receive ordinary income, what you get in exchange is ordinary income.” Stop and think. If this were not the case, you could sell your rights to receive your salary and declare the payment as capital gain. Fuggedaboudit!

Estate Tax Returns

For the year 2004, the IRS received taxable estate tax returns as follows:

• Less than $2.5 million — 22,205 returns
• $2.5 million to less than $5 million — 5,630 returns
• $5 million to less than $10 million — 2,166 returns
• $10 million to less than $20 million — 808 returns
• $20 million or more — 520 returns

This so-called “Death Tax” is currently hitting only about 30,000 people a year, out of a population of nearly 300,000,000. That’s about 1/100th of 1% of the people — and that’s really what all the Death Tax hysteria is about. But all the publicity from Washington has convinced most Americans that it applies to them.

MY SUGGESTIONS: Increase the current estate tax exemption of $2 million to $5 million ($10 million for a married couple) — and about 2,000 or fewer estates would annually be liable for the federal estate tax (and they can’t all be Congressmen). Finally, increase the lifetime gift tax exemption from its present $1 million to $2 million or $3 million — and everybody will be happy.

Independent Contractor or Employee?

Recently, it was disclosed that the IRS is in a fight with one of the two largest package delivery services in the country because they are treating their drivers/delivery persons as independent contractors. Meanwhile, the other (virtually identical competing service) is treating their people as employees. If such huge corporations can’t even agree at their high level — how is the average small business supposed to always make the correct decision?

I have written about this problem from time to time, for more years than I can count. The IRS now has a one-page summary to help employers make this decision. Here is my summary of their new summary. It states that the facts on which to make your decision fall into three main categories.

1. Behavioral Control. Is there a right to direct or control how the worker does the work? The business does not have to actually direct or control how the work is done — as long as the employer has the right to do so if it chooses. This control indicates the person is an employee. Following are control examples:

• Extensive instructions as to how or where to work.
• What tools or equipment to use in performing the work.
• Where to purchase supplies and services.
• If the business provides training about required procedures and methods.

2. Financial Control. Is there a right to direct or control the business part of the work, or not?

• If the individual has a significant investment in the work, this is a good indication of an independent contractor. (However, a significant investment is not a requirement to be an independent contractor.)
• If you are not reimbursed for all or some of your expenses, this is a good sign one is an independent contractor — especially if the unreimbursed expenses are high.
• If you can realize a profit or loss in working in the position, this suggests you are in business for yourself and may be an independent contractor.
• The reverse of the three preceding conditions is an indication you are an employee.

3. Relationship of the Parties. There are facts that illustrate how the business and the worker perceive their relationship.

• If you receive benefits such as insurance, retirement plan, or paid leave — this is an indication that you are an employee. (Such arrangements are similar in nature to the previous one about reimbursement of expenses.) All such coverage is typical of those that may be offered an employee — but are extremely rare in dealing with a true independent contractor.
• A written contract is tremendously important in establishing an independent contractor relationship! We recommend it in every such case. Says the IRS: “This (written contract) may be very significant if it is difficult, if not impossible, to determine status based on other facts.” So forget the handshake verbal agreement and do it right!

Your Home Insurance

When you insure your home, you are insuring two separate things: (1) the structure and (2) the contents inside. Just because the first is adequately insured, does not mean that the second is also. Contents coverage (“personal property coverage”) is usually estimated as a percentage of the value of the structure — typically 50% to 70%. But what if that’s not enough?

A general definition of “contents” coverage includes ordinary furniture, rugs, window treatments, clothes, books, tools, sports equipment, and appliances. But what about very expensive: appliances, custom furniture, designer clothing and similar? In many cases the total contents value could exceed the estimated contents coverage — and you are stuck for the difference! So even if your coverage is adequate to replace your home, it may not be enough to replace your contents.

One can easily purchase additional contents insurance with higher limits than the “normal” estimated amounts. This requires that you take a realistic inventory and it is also suggested that you videotape the entire contents of your house (or have it done professionally).

Exclusions. Even if you increase your contents insurance, standard personal property coverage limits maximum coverage to very low dollar amounts for jewelry, watches, furs, money, coins, precious metals, firearms, and items used for a home business. In such cases you need to purchase additional insurance (frequently called a “floater” policy) in the form of “scheduled” coverage (for each item of particular value, such as jewelry); or “blanket” coverage (for groups of items such as rare books); or special coverage for a home business.

Finally, you should be aware of the difference between “actual cash value” and “replacement cost” coverage. Most homes’ structures are insured for replacement cost — the actual amount it would cost to rebuild the home the way it was. But most home contents standard policies only cover actual cash value. That’s for the amount an item cost, less depreciation. So a $2,000 men’s suit might net you $400 if destroyed; or a $2,000 refrigerator could get you $800; etc. You don’t want actual cash value coverage — you should get replacement cost coverage for contents as well as for your home itself! Or you will be sorry….

(All information in this section supplied by Marsh Private Client Services.)

Disaster Mitigation Grants

These grants are paid by FEMA (Federal Emergency Management Agency) “to prevent or mitigate damages from future natural disasters.” (I wonder how these grants will be affected by, or interplay with, the New Orleans disaster?) The grants average $83,000. In June 2004, the IRS ruled that these grants were taxable. In April 2005, the President signed a bill declaring that they were not taxable — retroactively. So for some lucky taxpayers, you can file for refunds. (Gee, I wonder if our annual “tax season” qualifies as a natural disaster? Then we could ask FEMA to help us prevent it — by paying us $83,000 tax-free!) And to repeat that famous quote about FEMA and the New Orleans disaster: “Heck of a job, Brownie!”

Non-Commercial Air Travel

This only applies to those of you traveling around in a corporate-owned or leased jet. (We do hope you are enjoying your $50 million Gulfstream V or similar, while the rest of us are standing in the security line at LAX for about two hours each trip!) Anyway, the rules for you lucky folks have recently been changed. The old rules were a real tax giveaway! They allowed the corporation to deduct the full costs of operating the plane — while the amount the executive had to pick up as income for personal use of that same plane was limited to a minor amount calculated as cents-per-mile, under a special formula with no relation to the actual operating costs — but no more!

Under the Jobs Act of 2004, the employer’s tax deduction is limited to the exact amount included in the executive’s income for all personal use of the plane. Since the executive’s income for personal use of the aircraft is still usually calculated under that favorable cents-per-mile formula, the net result is that the company can no longer deduct most of the operating costs related to all personal use. The IRS auditors will want to verify that the new rules are being followed.

TAXTIP: A lot of companies will simply forgo the tax deduction at the corporate level (a Schedule M adjustment), except for the minor amount the top executives will continue to report as income.

Group Term Life Insurance

Employees qualify for group term insurance of up to $50,000 as a tax-free fringe benefit. However, such insurance paid to insure the life of a spouse or dependent (of any amount), is additional income to the executive-employee. An IRS Audit Guide advises to audit this possibility and then adds this further instruction to the auditor: “Split-Dollar Life Insurance provided for the executive’s spouse should be examined. For further guidance, refer to Audit Techniques Guide titled ‘Split Dollar Life Insurance’.” Better check your own company’s policies in these areas.

New Form 944

Effective January 1, 2006 nearly 950,000 small business owners will be able to file this new payroll tax form once a year instead of filing the quarterly Form 941. The new form will reduce the burden on eligible small employers who file quarterly returns with little or no tax due. Most employers who file the new Form 944 will be able to make a single payment with this new annual return.

Identity Theft and Death (A New Topic)

This story is about the same kind of people who steal the toys of little children at Christmas. Identity thieves have found a new and fertile field in taking the identity of the recently deceased to obtain loans, credit cards — and all the other badges of fraud and theft.

They obtain personal information from obituaries, death certificates and similar. Many obituaries list the exact date of birth of the deceased. They also frequently list the maiden name of the widow (or deceased wife). Those are two major pieces of information used to obtain new credit cards and the like!

Many financial institutions use the mother’s maiden name as a security password. The date of birth is used almost universally as part of credit information — and you unwittingly just supplied both of them for all to see — and steal. Also, the full name and address would further help the thieves.

Recommendations are to never publish date of birth and maiden name in any obituary. Only supply the age of the decedent. Further, it might be smart to omit the actual children’s names. So we are reduced to stating only this: the deceased, Melvie, was 94 years old, survived by a wife named Poopsie (no maiden name), four (unnamed) children and seven (unnamed) grandchildren. (It’s OK to give Melvie’s last name, but that’s about all; and if you give his home address — they sometimes rob the premises during the time stated for the funeral services. Whatta life!)

(Personally, I intend to be cremated — and have my ashes sprinkled over the Neiman Marcus store in Beverly Hills. That way, I can be sure that my widow will continue to visit my remains at least three times a week.)

Further, the best advice is to obtain multiple copies of the death certificate and promptly close bank, brokerage, credit card, and other accounts as needed. Then, reopen them in the survivor(s) name(s). Use your attorney and accountant for help as needed. Also, quickly report the death to the fraud departments of the three major credit bureaus. (Great safety play!)

“It’s important to help prevent identity thieves from assuming the deceased person’s identity before the estate is settled. Otherwise, there may be credit extended to the fraudsters that will need to be resolved before distributions can be made to the heirs.”

If you think I’m overdoing things — this general information (and the preceding quote) was supplied by the U.S. Federal Deposit Insurance Corporation in their FDIC Consumer News. Just remember: “You are paranoid — and they are out to get you!”