As we wrap up the holiday season and move into the new year of 2015 it is appropriate to review federal and Idaho specific business, estate, and tax planning issues that may affect your business and personal planning this year. This newsletter covers some of the annual housekeeping matters you should address as well as subjects you may find of interest. The topics covered are certainly not exhaustive of every issue you could face.
If you have an entity such as a corporation, limited liability company (LLC), or partnership, the governing documents for the entity (i.e., bylaws, operating agreement, and partnership agreement) likely require you to have an annual meeting. By law, a corporation must have at least an annual meeting of its shareholders and board of directors. Minutes of such meetings should be recorded even if they are simple minutes. January and February are the perfect time to hold an annual meeting to review the past year’s performance, approve action taken by the company and its officers and managers, and to plan for 2015. For entities, having an annual meeting and recording minutes is one way to establish that you are treating your company as a real, operating business that is entitled to all of the personal liability protection afforded to you under state law.
Maintaining your Business Entity
In addition to annual meetings and minutes you should make sure that your entity is in good standing with the Secretary of State’s Office for the state in which it is formed. In Idaho, the State mails an annual postcard asking you to file an online annual report to keep your company in good standing. If you let your company’s status with the State lapse you can lose your personal liability protection and the company may be administratively dissolved.
If you have been operating a business as a sole proprietor or leasing real estate in your own name you are generally personally liable for the debts and liabilities arising from your business or real estate that may exceed any liability insurance you have. To limit and isolate personal liability related to your business and real estate you may consider creating an entity like a limited liability company to own the business or real estate. The formation of an entity is typically straight forward and can be done on a cost-efficient basis. By using an entity your personal assets can usually be protected from business-related claims.
For business owners with partners and additional shareholders, you should make sure that an agreement is in place to address what will happen to your and the other owners’ interests in the business should an owner die, become incapacitated, divorce, want to leave, or file bankruptcy. This type of agreement, commonly called a buy-sell agreement, will provide an exit plan instead of leaving those issues open for disagreement when they will inevitably arise.
Important Court Case
In 2014 the Idaho Supreme Court decided the case of Wandering Trails, LLC v. Big Bite Excavation, Inc., et al., which is a landmark case on the issue of a limited liability company (LLC) owner’s personal liability for claims brought against the LLC. Under Idaho’s LLC statutes, individual LLC owners, like shareholders in corporations, are exempt from being personally liable for claims brought against the LLC. The protection afforded owners by a corporate or LLC structure is referred to in the law as a liability veil. There is, however, a theory in the law, called “piercing the veil”, which has allowed an injured party to recover damages directly against a corporation’s shareholders despite the statutory personal protection they enjoyed. A piercing the veil argument is usually valid if the corporation and its owners have no real legal separation, the corporation has not been treated as a legitimate going concern business with its own records and accounting, and the corporation is simply the owners’ alter ego. Before Wandering Trails, Idaho appellate courts had not addressed a significant piercing the veil claim in the context of an LLC.
In Wandering Trails, an injured party sued an LLC and its owners, under a veil piercing theory, for an alleged contract violation. The Idaho Supreme Court held that the individual owners of the LLC could not be personally liable for the contract claim because they had treated their entity as separate from themselves by having a separate bank account and accounting records for the LLC, they had not paid personal expenses directly from the LLC bank account, they had properly reported taxes consistent with the LLC form, they had not personally guaranteed the contract, and they had kept their entity in good standing with the State by always filing their annual report (see annual report discussion above). Wandering Trails confirms that the best way to enjoy the liability benefits an LLC provides is to consistently treat the LLC as a bona fide business with its own accounts and records and to separate it from your personal activities. The case also serves as a warning to LLC owners that relying upon the Idaho LLC law’s promise of no liability for LLC owners is not enough to prevent personal liability. An injured party can still sue to pierce the veil of an LLC and attack its owners personally unless the owners have treated the LLC as a true operating business and can prove it.
Federal Estate, Gift, and GST Tax Rates; Idaho Estate Taxes
For 2015, the federal estate, lifetime gifting, and generation skipping transfer (GST) tax applicable exclusion amounts are $5,430,000. With respect to the federal estate tax, the exclusion amount generally acts to exclude assets valued at up to $5,430,000 from each person’s taxable estate at death. The top estate tax rate will remain at 40%.
Despite the current taxpayer friendly estate tax exclusion amount of $5,430,000, President Obama’s 2015 fiscal year budget proposals favor lowering the exclusion amount to $3,500,000. Although the estate tax applies to just a very few Americans, it likely will be the subject of continuing political debate in the years to come and an issue to stay focused on.
With the large estate tax exclusion amount many asset portfolios that were at risk of being subject to estate tax can now pass estate tax free to heirs. Older estate plans that pre-date 2012 and contain estate tax planning techniques based on a lower exclusion amount, such as the former $600,000, $1,000,000, or $2,000,000 exclusion amounts, may be reviewed and revised to simplify the planning now that the estate tax risk is diminished.
Idaho does not have an estate or inheritance tax. If you own assets in other states you should consider that the other state may have an estate tax. For example, our sister states Oregon and Washington both have state estate taxes that will apply, in addition to the federal tax, to a person’s assets located in those states at death. The Oregon estate tax exclusion amount is only $1,000,000 and the Washington amount is $2,000,000. Careful and coordinated planning is needed to reduce the effect of another state’s estate tax on your assets at death.
In legislation enacted into law in 2010, a surviving spouse/partner in a legal marriage may elect to tack his or her deceased spouse’s unused federal estate tax exclusion amount (the $5,430,000 figure discussed above) to his or her own estate tax exclusion amount to create a super exclusion amount of $10,860,000. This super exclusion amount can be used at the survivor’s death to shelter assets from estate taxes. The exclusion tacking ability is called “portability.” To make a portability election, the survivor must file an estate tax return for the deceased spouse. The estate tax return is generally due 9 months after the deceased spouse’s death. If the portability election is not timely made, the option to use the deceased spouse’s unused exclusion amount is lost. A portability election would likely provide limited value to a married couple whose total assets are valued well under the surviving spouse’s single, personal estate tax exclusion amount of $5,430,000.
Before portability, the most common estate tax planning technique employed by attorneys for large estates was to create a trust at the first death into which the deceased spouse’s assets, up to his or her then applicable exclusion amount, would pass. By creating such a trust, both spouse’s estate tax exclusion amounts could be used. This trust would commonly be called a bypass, “B”, credit shelter, family, or exemption trust (“B trust”). The B trust would be irrevocable during the surviving spouse’s life, would benefit the survivor, and would be estate tax exempt when the survivor passed away because its assets were exempted from estate tax using the first deceased spouse’s estate tax exclusion amount. One downside to this type of planning is that the income tax basis of the B trust assets is not adjusted (usually upwards to their then current fair market value) when the survivor dies because the B trust assets are not included in the survivor’s taxable estate. Basis is the base value of an asset, typically what you paid for it, by which gain or loss is measured when the asset is sold. The basis of an asset that is included in a person’s estate at death is adjusted to its date of death fair market value. B trust planning can still be effectively used to reduce estate taxes, but due to the lack of income tax basis adjustment to the B trust assets at the second death, it may result in income taxes to your heirs when they later sell potentially low basis B trust assets.
With the onset of portability, many people prefer to simplify their planning documents to omit such B trusts and rely instead on portability to cover estate tax risk for asset portfolios in excess of $5,000,000. This may also make sense from an income tax planning perspective to allow all assets to have their income tax basis adjusted at the surviving spouse’s death. Before moving away from a B trust-based estate plan, especially if your net assets are at or approaching $5,000,000 or when a trust to control assets for the surviving spouse is desirable, it is best to consult an estate tax specialist to weigh out the pros and cons of doing so.
Estates with portfolio values in excess of the combined remaining estate tax exclusion amounts of both spouses will need additional estate tax planning beyond what B trust or portability planning can provide.
Annual Gift Tax Exclusion
For 2015 the total value of gifts you may make each year to a person gift tax free will remain at $14,000. This is called the annual exclusion gift amount. Married persons may combine their annual gifting exclusion amounts to make gifts totaling $28,000 to a person.
Important Court Case to Consider
In the United States Supreme Court case of Clark v. Rameker, the Court ruled that inherited IRAs are not retirement funds under federal law in the hands of the inheriting beneficiary and are therefore not immune from the inheriting beneficiary’s personal creditors in bankruptcy. An inherited IRA is generally a retirement account received by a person upon the account owner’s death. An inherited IRA could apply to the spouse of the deceased account owner if the survivor does not roll over the retirement account to re-characterize it as his or her own IRA. If the beneficiary of an IRA has creditor issues, careful planning may now be needed to avoid passing the account to the beneficiary and then directly on to the beneficiary’s creditors through bankruptcy.
Planning Issues and Reminders
If you are part of the majority of Americans who do not have an estate plan, it is not too late to put together a core estate plan that will take care of you, your loved ones, and your assets. All of us should have at least the following core documents: a Will containing a plan for the disposition of your assets, a durable power of attorney for financial matters to allow someone to make financial decisions for you should you become incapacitated, and a health care directive (called a living will in Idaho) that will allow someone to interface with your doctors and follow your wishes for your health care should you be incapacitated.
You should review your estate plan each year to make sure it is accomplishing your desired planning goals and to update names and addresses and make other needed changes. If your estate plan has not been reviewed within the last five years, significant revisions to the estate tax laws that have occurred in that time frame could impact your plan.
If you have a revocable living trust as part of your estate plan you should review the titling of your assets to make sure that appropriate assets are titled to the trust to take full advantage of the probate avoidance benefits a living trust provides. When titling assets to a living trust, assets that pass by beneficiary designation at death, such as retirement accounts and life insurance, are typically not re-titled to the living trust; instead, the beneficiary designation for such assets may be updated to name the trust as a primary or alternate beneficiary of the asset. Because of income tax considerations related to naming a trust as the beneficiary of a retirement account, you should consult with a tax attorney or accountant before you name a trust as a beneficiary.
As mentioned above, your assets may contain beneficiary designated assets such as retirement accounts and life insurance. It is important to remember that such assets will pass at death to the named beneficiary for the asset and will not automatically pass through your estate plan. Coordinating your beneficiary designations with your estate plan is crucial to avoid unintended consequences when you pass.
If you have an irrevocable life insurance trust, now is a good time to make sure that any withdrawal notices required to be issued when you deposit monies or other assets with the trust have been properly made. These notices are commonly referred to as Crummey letters.
For 2015, federal individual ordinary income tax rates and capital gain tax rates will stay flat and at their 2014 level. Inflation adjustments to the standard deduction amount, exemptions, and credits will boost them all slightly but not significantly. The Idaho income tax rates may be adjusted downward at the end of this current legislative session but we will have to wait and see. Governor Otter is advocating for an income tax rate drop as well as eliminating, or at least further decreasing, the business personal property tax for those larger businesses that are not exempt from personal property taxes.
The Affordable Care Act (ACA) and its IRS-regulated tax component will roll on in 2015. The scope of the ACA is too big to address here but if your business has not yet reviewed the ACA and its impact you are definitely behind the curve. An employer mandate provision of the ACA will apply in 2015 to employers with 100 or more full-time employees. Hawley Troxell has attorneys that can assist you in navigating the ACA regulations and to avoid penalties associated with non-compliance with the law.
Starting in 2015, federal law now allows states to establish tax-exempt Achieving a Better Life Experience (“ABLE”) accounts to be used for the benefit of certain persons with disabilities to pay for qualified disability expenses. The ABLE account is similar to a 529 college saving plan account. The main advantage of an ABLE account is that its assets can grow income tax free and distributions made from the account are tax-free if made for qualified disability expenses. Another advantage to the ABLE account is that its assets are generally not counted for determining financial eligibility for certain Social Security and Medicaid benefits; however, there is a Medicaid pay back element to the account upon the account holder’s death which must be considered. An ABLE account does have contribution rules that limit the total contributions from all contributors to the account for a given tax year to $14,000. Other maximum account funding limits and eligibility requirements apply. As of the date of this newsletter the state of Idaho has not adopted an ABLE account option but the State Treasurer’s Office, which will regulate the accounts, has informed me that the wheels are turning to get the ABLE account approved by the Idaho Legislature hopefully this year.
If you have an account held with a foreign financial institution, money management firm, fund, trust, or other foreign entity, you and the foreign party may have a legal duty to report the account and its balance annually to the IRS. This reporting requirement is found under the Foreign Account Tax Compliance Act (FATCA). If you have a foreign account you are strongly encouraged to speak with your accountant or contact our tax team to assist with properly reporting the account. The IRS has a voluntary compliance program that allows taxpayers who have not reported foreign accounts to get back into the good graces of the IRS with reduced costs. The voluntary compliance program is a valid alternative to ignoring the reporting problem and facing significant penalties if the IRS should conduct a foreign account audit and discover the account on its own.
These are a few of the many planning highlights and issues to be familiar with for 2015.