LBGT and the IRS

Is being gay a choice? The IRS still thinks so. That was one of the reasons that was given in the denial of a medical deduction for in-vitro fertilization and surrogacy expenses for a Florida gay man.

 Joseph F. Morrissey is a constitutional and business law professor at Stetson University. He is suing the federal government in an attempt to overturn a ruling by the IRS for the denial of the aforementioned medical deduction. Mr. Morrissey and his long-term partner have twin sons who were born last year from a surrogate. According to the lawsuit filed in federal court in Florida, the process took “nearly four years, seven IVF procedures (including those scrubbed at the last minute for failed medical exams), three surrogates, three egg donors, two clinics and more than $100,000,”. At the time that Mr. Morrissey started the process, it was illegal in Florida for a homosexual to adopt a child.

On his 2011 income tax return, Mr. Morrissey took a medical deduction of $36,538 for fertility costs on Schedule A of his 1040. This saved him $9,539 in federal income tax.

His return was pulled for audit examination by the IRS. The IRS eventually denied the medical deduction on the grounds that the medical expenses were not related to the taxpayer, his spouse or dependents, nor were they necessary to treat a medical condition. Furthermore, the IRS Revenue Agent who audited his return stated that being gay is a “choice” and that Mr. Morrissey could have children by traditional methods.

The IRS has previously granted the medical deduction for surrogacy costs for straight couples in which one of the spouses was infertile. Section 213 of the Internal Revenue Code states that medical expenses are only deductible to treat a medical condition. In 2008, in Magdalin, TC Memo 2008-293, the US Tax Court ruled that the IRS could deny a medical deduction for surrogacy costs to a single man based on the fact that he had no medical condition preventing him from having kids.

Mr. Morrissey contended that since he is gay and in a monogamous relationship, he is “effectively infertile”. Also, the surrogate would have no parental rights and the baby would be a dependent of Mr. Morrissey, therefore the medical expenses were related to a dependent and thus deductible under section 213.

Mr. Morrissey is now suing the IRS in federal court seeking a judgement for the amount of the tax savings from the medical deduction plus attorney fees. He is also seeking to prevent the IRS from treating him differently from heterosexual couples.

The case is Morrissey v. United States of America, M.D. Fla. 2015 (Case No. 8:2015cv02736).

 

Estate Planning In New Jersey

The primary purpose of estate planning is the get your financial assets in order to make sure your heirs are provided for. This includes planning for your golden years as well as what happens to your assets after you die.

One aspect of estate planning is avoiding the estate tax. The IRS defines the estate tax as a tax “on your right to transfer property at your death”. Basically, it is a tax on the net worth of the deceased individual. The 2016 exemption for the federal estate tax is $5.45 Million. This means that only someone who has assets valued at over $5.45 Million will be subject to tax.  Double that for a married couple.  This amounts to approximately 2 out of every 1,000 people. So the chances that you will be subject to the estate tax are very small.

State estate taxes are a different story. Especially if you live in New Jersey. The exemption for New Jersey’s estate tax is $675,000. This means that if your estate is worth more than $675,000, you will owe NJ estate tax. The estate tax rates in New Jersey can go as high as 16%.  Your gross estate includes any real estate you own, as well as bank accounts, investment accounts, vehicles, funds in retirement accounts, small business interests, and proceeds from insurance policies on your life.

Thus, it does not take much to be subject to the NJ estate tax.  Fortunately, NJ has a marital deduction for the estate tax which means that any amounts left to your spouse are not counted towards the $675,000 mark. But property left to anyone else will be subject to the tax.

As if this wasn’t enough, New Jersey also has an inheritance tax. The inheritance tax is a tax on money or property which is left to someone other than a close relative. New Jersey divides inheritors into three categories:

Class A Beneficiaries are exempt from the inheritance tax. They include parents, grandparents, spouse, child, stepchild and adopted children of the decedent.

Class B was deleted when the NJ Law changed.

Class C beneficiaries include the decedent’s siblings, or the spouse or civil union partner of the deceased person’s child. The tax rate for each of these beneficiaries is as follows:

First $25,000 No tax

Next $1,075,000: 11%

Next $300,000: 13%

Next $300,000: 14%

Over $1,700,000: 16%

Class D beneficiaries are everyone else. The tax rate for each of these beneficiaries is as follows

First $700,000 @ 15%

Over $700,000 @ 16%

Class E beneficiaries are exempt from the NJ Inheritance tax. These beneficiaries include State of New Jersey or any of its political subdivisions for public or charitable purposes, an educational institution, church, hospital, orphan asylum, public library, and some other nonprofit agencies.

The Estate Tax and Inheritance Tax are two reasons why it is essential to do estate planning if you live in NJ. Estate planning can give you many methods on how to lower your potential estate and inheritance Tax Bill.

One way would be to start gifting assets to your children. Federal law allows you to gift up to $14,000 to each child ($28,000 if married couple) without any federal gift tax consequences. Two parents could put this money into the NJ 529 plan for their children. Although NJ does not offer a state tax deduction for contributions to a 529 plan, the money does grow tax free until the time it can be withdrawn for college education purposes.

There are also various kinds of trusts one can use to lower the value of your estate. Consult a good estate planner to find out how you can plan for your future.   

All About Gun Trusts

Benjamin Franklin long ago said that “nothing can be said to be certain, except death and taxes”. But in America, another certainty is the large number of guns all over the country. Even though America leads the world in gun deaths, America’s love of firearms shows no signs of abating. In many parts of the country, even the mildest of gun-regulations is anathema to any politician hoping to get elected or stay in office.

Although there is no sign that robust gun-control legislation will become law, fear of gun confiscation still runs high throughout much of the country. Many people believe that a firearm is the only thing stopping the government from turning into a totalitarian dictatorship. It is because of this environment that many of those interested in protecting their Second Amendment rights have turned their sights to a specific Trust which adds an extra layer of protection to gun rights. It is called the NFA Gun Trust.

The NFA Gun Trust is specifically geared toward weapons listed under Title II of the National Firearms Act. By way of introduction: the National Firearms Act (NFA) was enacted in 1934, amended in 1968 and 1986. Title II of the NFA regulates certain types of guns and weapons which are considered more dangerous than other firearms. These include silencers, short-barreled shotguns, short-barreled rifles, explosive ordinances, and other types of weapons. The NFA has strict requirements with severe penalties for breaking them. Among the requirements is that each weapon must be registered with the ATF (Bureau of Alcohol, Tobacco, and Firearms). The owner is the only individual allowed to possess the weapon. Also, the owner must notify the Bureau of Alcohol, Tobacco and Firearms when crossing state lines with the weapon.

Purchasers of these weapons must also undergo a background check as well as get approval from a local law-enforcement officer (most of the time, the local sheriff). Many times, the local sheriff refuses to approve the purchase.

Transferring these weapons to another person is no easy task. If the owner wishes to sell his firearm, or if he dies and leaves it to his heirs, the recipient of the weapon must pay a $200 transfer tax, file an ATF transfer form, and jump through the same hoops as someone purchasing an NFA firearm for the first time.

The NFA Gun Trust may solve many of these problems and make the process of transferring a weapon less burdensome. Gun Trusts are revocable. There is at least one trustee (who is usually also the settlor or the grantor), at least one beneficiary, and the trust property (the firearms). A gun trust allows the customer to purchase guns in the name of a trust instead of in the purchaser’s name. This allows the purchaser to bypass many of the aforementioned regulations under Title II.

 Usually, for NFA firearms, only the registered owner is allowed to possess the weapon.  By appointing additional trustees, the gun owner can allow others to use the weapon.

For Estate Planning, the owner can appoint additional trustees or beneficiaries to the trust. That way, the gun owner can easily pass the firearms to his heirs without having to bother with the burdensome ATF regulations.

An additional benefit for estate planning purposes is that the gun trust will act as a guide to the executor of the estate who may otherwise not be familiar with the complex NFA Gun laws.

Gun trusts are becoming more and more popular. According to the Bureau of Alcohol, Tobacco, Firearms, & Explosives (ATF), 111,599 trusts were set up in 2014, up from 13,710 in 2009.

Obviously, Gun Trusts are controversial. A gun purchased by or transferred to a Gun Trust used to allow the purchaser or beneficiary to avoid a background check, fingerprinting, or obtaining the approval of a law enforcement officer while simultaneously enjoying the benefits of private-gun ownership. But new regulations signed by Attorney General Loretta Lynch on January 4^th added new hurdles to setting up a legal trust. Starting in July, all the members in a new trust must get a background check as well as submit fingerprints and photos to law enforcement. But the trust still allows the members to skip the approval of local law enforcement. The July deadline has caused a huge surge in the registration of gun trusts.  

It is important to note that Title II weapons are prohibited in New York and in other states. For residents of these states, the main benefit for creating a gun trust will be estate planning and insuring that one’s firearm is passed on to its intended beneficiary. There are many “do it yourself” sites popping up on the web. But nothing can substitute for a qualified estate planning lawyer who is well versed in this area of the law.

Business or Hobby?

The difference between a business and a hobby can be tricky. According to the Internal Revenue Code, a taxpayer is allowed to deduct business losses in excess of income on his personal tax return. Hobby losses can be deducted only to the extent of the hobby income, and only as an itemized deduction on Schedule A of the 1040. A Tax Court memorandum was just filed which distinctly shows the difference between a business and a hobby. The case Michael G. Judah and Sally A. Judah v. Commissioner of Internal Revenue concerns a saddlebred horse activity engaged in by the Judahs. The activity consisted mainly of promoting their daughter as a saddlebred horse rider, buying and selling horses, and various other activities.  The Judah’s reported this activity as a business and over 14 years (1998-2012), they reported nearly $1.5 Million in losses and did not earn a profit in any single year. The Judah’s took these losses against their profitable real estate businesses thus saving them hundreds of thousands of dollars in taxes. The Judah’s claimed that their horse business should be combined with their real estate business because their horse business allows them to network with well-to-do potential clients.

According to the Internal Revenue Code Section 183(d), the IRS defines a business or “activity engaged in for profit” as “the gross income derived from an activity for 3 or more of the taxable years in the period of 5 consecutive taxable years which ends with the taxable year exceeds the deductions attributable to such activity”. The IRC has a special rule for horse activities. If the activity “consists in major part of the breeding, training, showing, or racing of horses”, then the activity only has to be profitable in 2 out of 7 years.  If the activity cannot meet this definition, the taxpayer must establish that the activity has a profit motive.

The IRS decided that the Judah’s horse activity was not a business and disallowed their losses in an audit for the years 2008 to 2010. Consequently, the IRS determined that the Judah’s owed $136,800 in back taxes as well as $27,378 in penalties. The Judah’s went to Tax Court to see if they could get these taxes and penalties eliminated.  The Tax Court decided that the Judah’s Real Estate business was separate from their horse activity based on a number factors, but mainly that the two activities did not share land, management, caretakers, or even the same accountant. Since the Judah’s horse activities had never been profitable, the Tax Court had to determine if there was a profit motive. The factors used by the Tax Court are outlined below.

1)      The Manner in Which the Taxpayer Carries On the Activity

The Tax Court was looking to see if the saddlebred activity was carried out in a business manner. The court outlined five considerations in making this determination.

A)    Whether the Judah’s maintained complete and accurate books and records for the activity.

B)    Whether the taxpayer conducted the activity in a manner substantially similar to comparable activities that were profitable.

C)     Whether the taxpayer changed operating procedures, adopted new techniques, or abandoned unprofitable methods in a manner consistent with an intent to improve profitability.

D)    The preparation of a business plan.

E)     In the case of horse breeding and sales, a consistent and concentrated advertising program.  

The Tax Court ruled that the only factor the Judah’s met of those five was that they did advertise their activity. But that was not enough, the court ruled that the Judah’s did not carry out their activity in a business manner.  

2)      Expertise of the Taxpayer

For this factor to be ruled in the Judah’s favor, the Tax Court must find that the Judah’s consulted experts as to the how to run their business in a profitable manner. The Tax Court found that since the Judah’s did consult with horse trainers on the best ways to sell their horses. This factor was ruled in their favor.

3)      Time and Effort Allocated to Activity

The Tax Court found that the Judah’s did not spend the time or effort to establish that they had the objective of making a profit. The Judah’s spent most of their time on the enjoyable aspects of the saddlebred horse activity and none of the nitty-gritty aspects of running a legitimate saddlebred horse business.

4)      The Expectation That Assets Used in the Activity May Appreciate in Value

Sec. 1.183-2(b)(4) of the Income Tax Regs. states that a profit motive may be indicated if there is an expectation that the assets used in the activity will appreciate in value. However, the Tax Court has previously ruled that a profit objective is inferred when the expected appreciation of the assets is sufficient to recoup the accumulated losses of prior years. From 1998-2012, the Judahs had combined losses of nearly $1.5 Million. The Judah’s conceded that they would never generate enough profit to recoup the $1.5 Million in losses. This factor was ruled in favor of the IRS.

5)      Success of Taxpayer in Carrying on Other Related Businesses

The Tax Court looked to see whether the Judah’s had ever engaged in any similar businesses and turned them from unprofitable to profitable. The Judah’s had never engaged in any similar businesses. Therefore, this factor had no effect on their case.

6)      The Taxpayer’s History of Income or Loss With Respect to the Activity

Although a business in the initial or startup stage can be expected to generate losses, the Judah’s record of 14 years of losses was persuasive evidence that the taxpayer did not have a profit motive.

7)      The Amount of Occasional Profits Earned

Per Sec. 1.183-2(b)(4) of the Income Tax Regs., the amounts of profits in relation to the amount of losses incurred may provide evidence of the taxpayer’s intent. The Judah’s saddlebred activity has never had a profitable year. The fact that the Judah’s engage in this activity despite the fact that they continue to lose money gives the impression that there is an ulterior motive other than profit.

 

8)      The Financial Status of the Taxpayer

The Judah’s had substantial income from their Real Estate businesses. A taxpayer who has substantial income from a source other than the activity could indicate that the taxpayer is not engaged in the activity for profit. The Judah’s were able to offset their substantial income with losses from the saddlebred activity. Because the Judah’s wanted to promote their daughter as a saddlebred rider, it’s likely that the Judah’s would have incurred much of these expenses anyway. This factor was ruled in favor of the IRS.

 

9)      Whether Elements of Personal Pleasure or Recreation are involved

 

Sec. 1.183-2(b)(9) of the Income Tax Regs. states that the presence of personal motives and recreational elements in carrying on an activity may indicate that the activity is not engaged in for profit. The Judahs avoided all the unpleasant aspects of saddlebred activity such as cleaning stalls or feeding the horses. Their work consisted of the pleasurable parts of the activity, mainly watching their daughter ride horses.

 

Conclusion

 

The tax court concluded that the Judahs operated their saddlebred horse activity as a hobby not a business. Therefore the Judah’s owed $136,800 in back taxes for years 2008-2010. The Judah’s did have a minor victory in this decision. The CPA who prepared the returns had advised the Judah’s that the saddlebred horse activity was a business. Because the Judah’s took the business deductions “in good faith” based on their CPA’s opinion, they were not held liable for the $27,378 in accuracy-related penalties that the IRS was seeking.

A taxpayer who does not meet the 3 years out of 5 rule but still believes his activity is a business should take a look at the factors above to determine if their activity is indeed a business. The Judahs learned the hard way about the difference between a business and a hobby and it cost them big.

My Experience With Identity Theft

I got my identity stolen about three years ago. I went to an ATM, tried to use my debit card and got a message stating that the card was no longer working. A phone call to the bank’s customer service was no help and they told me to come in for a face-to-face meeting with a bank representative. At this meeting, I was informed that a rogue employee had sold my personal information to a third party. Not only that, I learned that someone had walked into a branch in California with a phony social security card and tried to drain my savings account. Luckily, he could not get past my security questions. But my account had to be changed and my debit cards destroyed. The bank gave me two years of credit monitoring.

The credit monitoring would come in handy because before long, I was seeing applications for all sorts of loans popping up on my credit report. Too many inquiries to a credit report can bring down a credit score so I became very concerned.

Disputing these items on my report proved to be an adventure in itself. After many calls with the credit agencies and the creditors themselves, I was able to get most of these items taken off my credit report.

I then placed a secure freeze on my credit file with all three credit agencies. Placing a secure freeze on your credit report stops lenders and others from viewing your credit report and it is usually free. With a secure freeze, you will need to take extra steps to apply for credit.

Information about putting a secure freeze on your credit report for the three credit agencies can be found at the following:

Transunion - https://www.transunion.com/credit-freeze/place-credit-freeze

Experian - http://www.experian.com/consumer/security_freeze.html

Equifax - http://www.equifax.com/help/credit-freeze/en_cp

After I placed the security freeze with all three agencies, the inquiries on my credit report stopped.

I learned a lot about identity theft during this process. Here are some things you can do to stop someone from stealing your identity.  

1)      Review your credit report at least once a year. The website https://www.annualcreditreport.com will give you an annual free credit report from each of the three agencies for free. Examine the report for anything looks strange. If you find something on your credit report that you know shouldn’t be there, dispute it with the credit agency.

Information on how to dispute an item on your credit report can be found at the following:

 

Transunion - https://www.transunion.com/credit-disputes/dispute-your-credit

Experian - http://www.experian.com/disputes/how-to-dispute.html

Equifax - https://experian.referral.equifax.com/CreditInvestigation/home.action

2)      Do not carry your social security card in your wallet. If someone steals your wallet with your social security card and driver’s license, they have everything they need to obtain a new credit card or open up a bank account in your name. Also, do not write your SSN on checks. Do not give out your SSN unless it is absolutely necessary.

 

3)      Examine your bank statements and your credit card bills monthly. If you see any unauthorized charges, contact the banking institution immediately.

 

4)      Tear up or shred any junk mail which comes to your residence. Especially if you get one of those pre-approved credit card applications. Dumpster diving is a common method of identity theft. You should also tear up any receipts before you throw them away.   

 

5)      Cancel credit cards which you are not using. This is an unnecessary risk. Cancelling the card means that you have one less account to monitor.

 

6)      Consider subscribing to a credit monitoring service. You will get a notification any time a new credit event pops up on one of your credit reports. If something suspicious appears on your credit report, you will be able to deal with it quickly before it can cause more damage to your credit.  

 

The Federal Trade Commission (FTC) has published a guide about what to do if your identity has been stolen. It can be found at https://www.consumer.ftc.gov/articles/pdf-0009-taking-charge.pdf

For more resources on how to combat identity theft, go to the FTC’s identity theft website http://www.consumer.ftc.gov/features/feature-0014-identity-theft

According to the Bureau of Justice Statics, 17.6 Million people were victims of identity theft in 2014. That is 1 out of every 17 Americans. It is imperative that you take steps to make sure it doesn’t happen to you.

Unclaimed Funds

Odds are, you, or someone you know has some money they have forgotten about. There is approximately $42 Billion of unclaimed funds in state treasury departments around the country and some of it could be yours. Unclaimed funds are accounts which go without activity usually for a year or longer. They can be funds from checking or savings accounts, tax refunds, uncashed dividends, security deposits and more.  There are many celebrities who have unclaimed funds on the NYS database including Al Pacino, Bill and Hillary Clinton, Kofi Annan, Matt Lauer, Marisa Tomei and many more. `

You can find your applicable state database at http://www.unclaimed.org or you can search 35 states at once at http://www.missingmoney.com.

New York State currently has $14 Billion in unclaimed funds in its coffers. Many states borrow against their unclaimed funds so there is little effort to return the money to its rightful owners besides listing their names in a database. Other states shorten the time someone has to claim their funds. If someone doesn’t claim their money in time, the funds escheat to the state.

One point to remember is that every one of these databases is free. You should never pay money to an outside contractor to get your unclaimed funds.

The first time I went to the NYS website, I found that my father had two unclaimed accounts that were over 20 years old. My father claimed the funds and received a check approximately one month after. On the Florida website, I was able to find an unclaimed account for my deceased grandfather. He had unclaimed rebates from the Florida DMV.

There are also other types of funds which go unclaimed. The Pension Benefit Guaranty Corporation (PBGC) keeps a database of unclaimed pensions and TreasuryDirect keeps a database of unclaimed treasury bonds.

Remember, it’s free money and it’s yours. Take 2 minutes out of your day and search these databases. 

Mo Vaughn Strikes Out In Court

Yet another pro athlete has lost millions of dollars because he chose the wrong financial advisor. In this case, it is former Met Mo Vaughn who is the victim.

Following Vaughn’s retirement after the 2003 MLB season, Mo hired financial advisor Ra Shonda Kay Marshall and her company, RKM Business Services Inc., to manage his financial affairs including investing money, paying his taxes and bills, etc. During the four years Marshall was his financial advisor, she embezzled approximately $2.77 Million dollars from Vaughn. It wasn’t until 2008 when Vaughn examined his records personally that he discovered Marshall’s fraud.

Marshall was so corrupt that she did not bother to file a tax return for Vaughn for the 2007 tax year and did not pay the taxes owed on his 2006 return.

Vaughn obviously did not do a lot of research in his choice of financial advisor. A good primer on how to choose a financial advisor can be found on an earlier blog post of mine at  http://www.davidsilversmithcpa.blogspot.com/2015/12/clinton-portis-files-for-bankruptcy-two.html

Vaughn eventually filed his 2007 tax return late and paid his 2006 and 2007 tax liabilities. This drew late payment and late filing penalties of $1,037,158.25 for 2006 and $102,106.76 for 2007.

Vaughn paid the lower amount and went to court to dispute the late payment and late filing penalties on his 2006 return. He argued that his reliance on his financial advisor constituted “reasonable cause” (which would negate the IRS penalties) and not “willful neglect” (which would incur the penalties).

The court sided with the IRS ruling that because Vaughn did not make even a minimal effort to oversee his finances, he did not display “ordinary care or prudence”. This lack of oversight constituted “willful neglect” and Vaughn now has to pay up.

Besides doing research on a prospective financial advisor, the lesson learned from this debacle is that no matter who does your taxes or handles your finances, you still have a duty to oversee your affairs.

The appellate court decision upholding the IRS fines and penalties can be viewed at http://www.ca6.uscourts.gov/opinions.pdf/15a0818n-06.pdf.

IRS requirements for noncash contributions

December is usually the busiest time of year for thrift shops and charities that accept clothing as donations. People are eager to get rid of their old clothes, but more importantly, get the tax deduction that comes with their donation. Valuing your bag of clothes can be challenging. Some charities, like the Salvation Army give a donation guide for noncash contributions. But most people just put down a number that they deem appropriate. Others value their donations at exorbitant levels. If you don’t have the proper paperwork to backup these valuations then you could be in trouble. The IRS is cracking down on overvalued noncash contributions.

The recent US Tax Court case Kunkel v. Commissioner, T.C. Memo 2015-71 is a prime example of what happens when someone makes noncash donations but does not keep adequate records.

In tax year 2011, the Kunkels claimed on their tax return, $37,315 in noncash charitable contributions. These donations consisted of nearly $22,000 in clothing, $8,000 in books and other related items to four different charities. The only substantiation the Kunkels had was doorknob hangers left by two of the charities. The doorknob hangers were undated and did not describe the property contributed.

The IRS disallowed the $37,315 of noncash charitable contributions in its entirety. The US Tax Court upheld the determination made by the IRS. The Kunkels had to repay $12,338 in taxes along with an accuracy related penalty of $2,468.

For those making noncash charitable contributions (e.g. a bag of clothes to the Salvation Army), it is important to know the substantiation requirements that the IRS requires for your donations.

For property valued at less than $250, taxpayers must obtain and keep a receipt from the charitable contribution showing the name of the organization, date and location of the contribution, and a reasonably detailed description of the property.

Property valued from $250 to $499 has additional requirements to those above. If there are two or more contributions worth more than $250, a written acknowledgement is required for each one. The acknowledgement must be in writing, contain a description of the property donated, and state whether the qualified organization gave any goods or services for the contribution. The acknowledgement must also include a description and good-faith estimate of the value of any goods and services given. The taxpayer must receive this acknowledgement before the earlier of (1) the date the taxpayer files the return or (2) the due date, including extensions, for filing the return.

The taxpayer must keep written records for each item of property donated. The record must include the following info:

1)      Name and address of the donee organization.

2)      The date and location of the contribution

3)      A reasonable detailed description of the property donated

4)      The FMV of the property donated at the time of the contribution and the method this FMV was calculated.

5)      The cost or other basis of the property

6)      The amount of the deduction that the taxpayer is claiming

7)      Any terms or conditions which are attached to the property.

For property valued between $500 and $4,999, there are additional written requirements as well as the requirements above. According to the sec. 170 of the IRC, these records must include the approximate date the property was acquired and the manner of its acquisition.

For property valued at greater than $5,000, the taxpayer must also obtain a qualified appraisal of the item.

In conclusion, the doorknob hanger that you received for your contribution of clothes is NOT a proper form of documentation that will be sustained in an IRS audit. Make sure you keep the appropriate records.