Tax Deadlines June 2014

Client Bulletin
June 2014

What’s Inside

Offshore Practice Group:

Civil Tax Matters & Tax Planning:

Criminal Corner:

Tax Calendar


Offshore Practice Group:

China, Hong Kong, and South Korea

China & Hong Kong:
Both China and Hong Kong have taken steps to cooperate with the US Foreign Account Tax Compliance Act (FATCA). While neither have signed on as of May 2014, the reality is that due to agreements already in place, U.S. Citizens and green card holders with bank accounts, assets, and investments located offshore (i.e., in Hong Kong or China) will be reported to the Internal Revenue Service.

These two important agreements are ratified in the following:

What this means:
Individuals and investment advisors should brace themselves for a heightened level of global transparency in tax matters. Those not complying, whether they knew about the law or not, with U.S. tax filing compliance will face severe criminal and civil penalties for their failure to comply with U.S. laws. While many in the Chinese community have already been identified or are taking measures to ensure compliance with all laws and maintaining their wealth, many are not. As a result of our vast experience in the San Francisco community and our large number of Chinese clients, we understand the cultural differences that Chinese-Americans face; however, cultural differences will not provide a defense for individuals who are not complying with all tax laws. Please visit our website for more information regarding the Offshore Bank Account Initiative.

South Korea
South Korea is currently in talks with the U.S. to accept the Foreign Account Tax Compliance Act (FATCA), under which the U.S. can ask other countries to share information on financial accounts of its individuals and entities.

If Korea accepts the act, it would also get financial information on its nationals from the U.S. The agreement would virtually cover all financial information, since any bank account which paid an annual interest of $10 or more is subject to the act. As such, while much of the conversation on FATCA has been geared towards the U.S. reaping the tax rewards, we now see how other countries will be enforcing their tax policies as well.


Civil Tax Matters – Tax/Business Planning:

How Inherited Assets Differ From Gifts

When someone gives you cash or other valuable assets, do you owe income tax? No; so long as it was a bona fide gift.* Note different reporting laws apply for foreign transfer gifts. The same is true if you receive an inheritance. The giver may owe gift tax and the decedent’s estate may owe estate tax but you, as the recipient, won’t owe income tax.The situation will change, however, if you receive a noncash asset as a gift or inheritance and subsequently sell that asset. By selling the noncash asset you may incur tax consequences, which are dependent on your “basis” in the asset. In this context, your basis can be considered your cost for tax purposes.

Carryover Basis
When you receive an appreciated asset as a gift from a living person, you also receive the giver’s basis in that gift. In other words, the former owner’s basis “carries over” to you.

Example 1: Mike Owens invested $10,000 in ABC Corp. stock many years ago. Mike always receives the dividends from ABC rather than reinvesting them. When the shares are worth $19,000, Mike gives those shares to his niece Pam. In this scenario, Pam retains Mike’s $10,000 basis in the shares. If she sells the shares for $22,000, Pam will owe capital gains tax on a $12,000 gain because of the carryover basis, rather than owing tax on the $3,000 gain since the gift.

For gifts of appreciated assets, the donor’s holding period also carries over. Here, Pam will have a favorably taxed long-term capital gain because Mike held the shares for many years. In another situation, where Pam’s sale takes place one year or less since Mike’s purchase, her $12,000 gain would be taxed at higher ordinary income rates. (The carryover basis rules on gifts of depreciated property are more complex. If you have received such a gift, our office can explain the tax consequences of a future sale.)

Stepped-up Basis
Different rules apply to inherited assets. Here, the heir’s basis typically is the asset’s value on the date of death, with exceptions.

Example 2: Rebecca Smith dies and leaves $200,000 worth of XYZ Corp. shares to her nephew Tom. Even if Rebecca’s basis in the shares was only $90,000, Tom’s basis in the shares would be $200,000; their value when Rebecca died. Tom would have no taxable gain on a subsequent sale for $200,000. Similarly, he would have a $10,000 gain on a sale for $210,000, or a $5,000 capital loss on a sale for $195,000. Likewise, depreciated assets are stepped down. If Rebecca had bought the shares for $200,000, but they were worth $90,000 when she died; Tom’s basis would be $90,000.
After an inheritance, sales generally are taxed as a long-term gain or loss, regardless of the heir’s or decedent’s holding period.

In some cases, special rules apply to the basis of inherited assets. One example is property held jointly with right of survivorship (JTWROS). In this case, the survivor generally gets a basis step-up for half of the asset value.

Example 3: Victor and Wendy Young hold shares of DEF Corp. in a brokerage account. The account is titled as JTWROS so the surviving co-owner will be the sole owner. Victor dies first. At this time, the couple’s basis in the shares is $60,000 and the current value is $88,000.

Going forward, Wendy owns all the DEF shares. Her basis is stepped-up to $74,000: $30,000 for her half of the previous $60,000 basis plus $44,000 for Victor’s half of the current $88,000 value, which stepped-up upon his death. If Wendy sold the DEF shares a week later for $89,000, she would have a $15,000 long-term capital gain, taking into consideration the basis increase to $74,000 at the time of Victor’s death. (Different rules may apply to property held by married couples living in community property states.)

Basis Backup
As you can see, documenting your basis in gifted or inherited assets is vital. When you get a gift, find out the giver’s basis in that asset; after an inheritance, document the date of death value. Putting a value on listed securities or other assets held in an investment account may be relatively easy. Such information should be available online or from the financial firm holding the assets. If you receive a gift of stock from Uncle Joe, who dimly recalls buying the shares “in the 1980s,” make every effort to find a number that can be justified by hard evidence. Illiquid assets present a bigger challenge. Again, try to get a supported valuation on the basis of the assets you receive as a gift. For inherited assets, hire a reputable professional as soon as possible to appraise assets such as real estate, collectibles, and shares of a closely held company. Our office can help you accumulate the necessary documentation for gifts and inherited property.

Trusted Advice: Second Look

  • The basis of inherited assets may be affected by the so-called “alternative valuation date.”
  • An estate’s executor can choose to have all the estate assets valued as of six months after death, rather than the date of death, if that will reduce estate tax or the generation-skipping transfer tax.
  • In that case, the valuation six months after death will be the basis for all inherited assets and on future sales by the heirs.

Prime Points for Your Buy-Sell

Businesses with more than one substantial co-owner should have a buy-sell agreement. This agreement can help all parties when the inevitable happens, and one of the owners no longer can or will participate in the company as they had been. For the best result, your buy-sell should include a plan for what will happen when the following so-called “trigger events” occur.

Owner’s Death
Assume a company is owned equally by Lynn Jones and Greg Harris. They both work full time, contributing to the company’s growth, until Greg dies unexpectedly.A buy-sell can set the stage for Lynn to buy the company shares that Greg’s wife will inherit. A predetermined formula can set the buyout price, which Lynn will pay, and some life insurance can provide the funds she’ll need. Alternatively, the company might receive the insurance proceeds and buy in Greg’s shares, leaving Lynn as the sole owner.

Dealing with Disability
In another scenario, Lynn suffers a serious illness and cannot work. The buy-sell can spell out how disability will be determined, whether Lynn will receive a salary, how long such a salary will continue, and how an ultimate buyout will be structured. Disability insurance may help to provide the necessary funds.

Defending against Divorce
Considering the U.S. divorce rate and the demands of running a small business, it’s not surprising when a company co-owner has marital problems. However, if Greg is in a divorce negotiation, his wife may want a share of the company as part of the settlement-and Lynn might not welcome this additional partner.

Such a situation can be avoided if share transfers are restricted in some manner by the buy-sell agreement; the divorcing co-owner, the non-divorcing owners, or the company might be given the right of first refusal, so the divorcing spouse receives cash instead of shares. (Careful drafting is needed to avoid tax traps.) The buy-sell agreement should cover valuation, and the owners should have a plan to generate enough cash.

Ready for Retirement
In yet another scenario, Lynn decides that she wants to retire while she is still young and healthy enough to enjoy her favorite pastimes. Greg intends to stay active in the business. A buy-sell can set up a plan in which Lynn steps down and is compensated for her interest in the company, perhaps over an extended time period. Some life insurance policies can be arranged to fund such a contingency.

Changing Directions
What if Lynn wants to leave the company at, say, age 55 in order to try another career? A buy-sell agreement may distinguish between retirement and “withdrawal” or “departure,” perhaps based on age. A buy-sell could discount the purchase price if an owner leaves after relatively few years and could delay the payout until a certain time, if that’s what the co-owners agree upon.

Personal Bankruptcy
Suppose that Greg incurs a tremendous amount of debt, either from extravagant living or from poor financial decisions not directly related to the company. He might file for personal bankruptcy to get relief. Again, the buy-sell can set a procedure for Lynn or the company to buy Greg’s shares so that his creditors get cash instead of interests in the business.

Time and Money
Business owners commonly work long hours and need ample cash flow for company growth. Avoiding a buy-sell agreement should be weighed against the outcome if one or more of the previously mentioned trigger events should arise without a buy-sell in place. A deceased partner’s heirs may inherit shares without a procedure in place for an equitable buyout; an owner’s divorce negotiations might spill over and affect company operations.

Our office can help you develop a buy-sell agreement that will protect you, your co-owners and your company from getting hurt when these types of events occur.

Criminal Tax Corner:

The IRS & Identity Theft Enforcement

The theft of social security numbers and the resulting bogus tax return filings that have claimed millions of taxpayer refunds has grown so rampant that Congress passed the Identity Theft and Tax Fraud Prevention Act in 2013. As such, the Internal Revenue Service has employed more than 3,000 agents in an effort to crackdown on identity theft and tax crimes.

Prosecutions for identity theft have sky rocketed. Interestingly enough, we are now seeing identity theft being charged (or threatened) in traditional tax crime cases as well. This has given the prosecutor another arrow in his quiver and it’s a rather unyielding weapon, as well. Identity theft is not only a felony in and of itself, but as opposed to many other tax crimes, the elements of identity theft crime are far broader in scope. The elements include knowingly using the identification of another person in relation to a violation of use of public money (such as taxpayer money). The penalty for includes a mandatory sentencing of 2 consecutive years. Interestingly, this allows for a wider net to be cast around the accused and requires an additional layer of nuance during any plea negotiations.

Alert to Tax Scam in Northern California

Please be aware that we have received a number of calls from frantic individuals who have fallen victim to a telephone tax scam. The scammer(s) call the individual on the telephone claiming to be IRS agents. They then threaten to arrest the individual if the victim does not immediately withdraw funds or purchase cash cards, and provide the numbers to the scammers. If you are the recipient of such a call, please call the police and do not provide any personal information.