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          Search Software Personal Help
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By John S. Armour If you're acting as the fiduciary of an estate or advising fiduciaries,
you need to take account of a key legislative change enacted in more than
a dozen states, including California, Florida, Illinois, New York, and
Texas. In still more states, the same change is likely coming: to discard
the concept of the "prudent man" in governing the responsibilities
of trust fiduciaries and substitute the concept of the "prudent investor."
The laws are to some extent state-specific, but their guidelines cluster
around these concepts: * "Prudence" is defined in light of the total portfolio, not
any single investment in it. A security that doesn't produce much in the
way of interest or dividends, for instance, may still pass muster for an
income-oriented portfolio if it's likely to spur capital growth and thus
enhance portfolio income over time. Moreover, the new rule recognizes that
total return is the true measure of investment results‹interest and/or
dividends plus change in market value‹and that no one asset, in isolation,
is "good" or "bad." * The test is how well the portfolio's combination of investments meets
the beneficiaries' needs. If, for instance, a trust's objectives include
providing long-term security for young children, a 100%-bond portfolio
would almost certainly be adjudged insufficiently growth-oriented. * It's now incumbent on fiduciaries to understand the dynamics of capital-market
risk and return, including the impact of taxes and inflation, and to define
"risk" on a case-by-case basis in relation to the goals of a
specific portfolio. * Diversification has become a key consideration. While not mandated,
it is regarded as appropriate in most instances. At the least, a fiduciary
who hasn't diversified may be called upon to explain why. * Fiduciaries have considerable power in serving beneficiaries' interests,
often including the ability to define how distributions are divided. For
example, in some circumstances fiduciaries may decide that an "income"
beneficiary is entitled to more than just the simple yield on a portfolio,
depending on how its assets are configured. * In some states, fiduciaries are permitted to delegate responsibilities
to investment professionals‹choosing deliberately, based on their expertise,
style, and performance record. In New York, for example, the standards
for such delegation are spelled out as "care, skill, and caution."
The organization so delegated then shares in the fiduciary responsibility.
In one sense, the revised rules put a heavier burden on fiduciaries
and their professional advisors. But the new standard of responsibility
reflects the true task of any estate fiduciary: to assemble a portfolio
well-suited to the beneficiaries' time horizon and financial objectives.
* John S. Armour is a vice president of Sanford C. Bernstein
& Co. Inc. * Prudence is judged on the basis of the overall trust portfolio, not
any particular security within it. * Diversification is considered appropriate in most cases. * Investment strategies must be designed to match the trust portfolio's
specific objectives. By William Bregman, CPA Price Waterhouse's latest personal financial product is an inexpensive,
easy-to-use interactive software program designed to help an individual
determine, in the event of his premature death, whether his family would
be left financially secure or whether there would be a gap that could be
closed with life insurance. The initial screen requests personal information: age, marital status,
ages of children and other dependents, and smoker vs. nonsmoker status.
Additional screens are provided in order to assess goals, such as funding
children's education, and to determine if resources and economic assumptions
are adequate. The program asks for information regarding annual income
for self and spouse, current value of investment assets, and value of existing
life insurance. With this information, the program can determine if survivor's
income and spending goals can be met for current and later years. If not,
the program will compute the additional life insurance needed to cover
the gap. Additional insurance required is based on an estimate of the cost
of a one-year guaranteed renewable term policy based on age and gender
and whether the person smokes. At this level you can modify data and test varying economic assumptions.
For instance, you can alter the rate of spending, the rate of inflation
or investment return, or the survivor's life expectancy. You can also reestimate
dependent support and income information and enter more detailed information
regarding such things as assets, liabilities insurance, etc. The program
allows you to change variables and see almost instantaneously the recomputed
results. For those who want to be guided through the planning phase, the program
offers a 10-step process that resembles an online tutorial filled with
informative prompts. It also features excellent graphics and summary reports.
The program is available in Windows and DOS versions from Price
Waterhouse. It can be ordered by calling 1 (800) 752-6234. The price is
$45 per copy and a detailed manual and access to a user support hotline
are included. * By Theodore J. Sarenski, CFP, CPA, Glazier, Gerber & Sarenski,
P.C. Financial planners usually work with people in establishing goals and
developing a plan to assist them in achieving those goals. But what happens
when those goals and dreams are shattered by a divorce? Emotional issues
often cloud rational thinking, and both spouses can end up damaged mentally
and financially. The need for professional financial planning and advice
and the expertise of a knowledgeable CPA is never greater. CPAs can offer their services to attorneys and mediators involved as
well as to the divorce principals. A natural offshoot of the service is
to offer financial planning services before, during, and after the divorce.
Predivorce financial planning is essential to assure the best possible
tax consequences after equitable distribution of the marital assets. Planning
before the distribution of the assets also allows the financial planner
opportunity to select the division of assets that best accomplishes each
spouse's goals. Prior to the divorce, the financial planner can help define
new goals and develop realistic budgets. During the divorce, the planner
can assist in determining alimony, child support payments, and the division
of assets. After the divorce, the planner can assess risk management issues,
investment analysis, wills and trust changes, or estate planning issues.
Marital property, as defined in New York State Domestic Relations Law
Section 236(B), is "all property acquired by either spouse during
the marriage and before the execution of a separation agreement or the
commencement of a matrimonial action, regardless of the form in which title
is held, except as otherwise provided in agreement pursuant to subdivision
three of this part. Marital property shall not include separate property
..." IRC Sec. 1041 allows for the nonrecognition of gain on all transfers
of assets between spouses during marriage and within one year after the
date a marriage ceases. Further, IRC Sec. 1041(c) allows a six-year window
of nonrecognition of gain for transfers made between former spouses if
the transfers are related to the cessation of the marriage and are pursuant
to a divorce or separation agreement. IRC Sec. 1041 (c) is important if
all transfers to be made between former spouses cannot be made within one
year after the date the marriage ceases. The parties must specifically
identify the assets to be transferred in the divorce agreement to qualify
for the nonrecognition of gain on the transfer of those assets pursuant
to IRC Sec. 1041(c). A transferor has no gain or loss in a transfer under
IRC Sec. 1041. The transferee's basis in the property is the same basis
the transferor had in the property immediately prior to the transfer. The nonrecognition of gain on transfers between spouses is a significant
tool in the financial planning process. It allows the shifting of appreciated
assets to the spouse who will be in the lower tax bracket after the divorce.
It allows title transfers of individually held assets to the other spouse
without tax consequence. How is it best to divide assets in a divorce?
While each situation is unique, there are some guidelines to abide by.
The principal residence is often an emotional issue to deal with. In
a long-term marriage, it can be the source of many memories. As a planner,
you need to recognize the emotional issues but not let them interfere with
the service you have been hired to perform. A principal residence acquired by a two- wage earner family may need
to be sold because neither spouse can afford to maintain the residence
on his or her own. The residence may be sold because each spouse wants
to start fresh in a new location or in a new house. Whatever the reason
for selling the principal residence, there are some traps to be aware of
and avoid. IRC Sec. 1034(a) allows for the non-recognition of gain on the sale
of property used as a principal residence if, within a two-year period
before or after the sale, the taxpayer purchases a new principal residence
that costs at least as much as the adjusted selling price of the old principal
residence. A key phrase in this section is "used as a principal residence."
Example: Spouse A and Spouse B are not getting along,
and Spouse A moves out of the principal residence. Spouse B remains in
the house. Six months pass and a divorce action is started. Two years after
the action commenced, the divorce is finalized with the sale of the house
being ordered with the proceeds split equally between the spouses. Will
each spouse be able to receive the nonrecognition of gain if they invest
the proper amount in a new residence within two years? Spouse A cannot
claim the house being sold was a principal residence as he or she was not
using the house as a principal residence at the time the divorce action
began. Rev. Rul. 74-250, 1974-1 CB 202 expanded IRC Sec. 1034 to allow the
deferral of gain on the sale of a principal residence individually to a
couple who sell their jointly-owned residence and invest his or her one-half
interest in separate principal residences within the two-year window allowed
by IRC Sec. 1034. While many couples continue to file a joint tax return until their divorce
is finalized, it may not be the prudent filing status in the year of sale
of the principal residence. Example. Spouse A and Spouse B sell their jointly owned
principal residence in year one and file a joint personal income tax return.
Each spouse includes an indemnification clause in the separation or divorce
agreement agreeing to reimburse the other spouse for tax liabilities due
to the failure to reinvest their share of the proceeds pursuant to IRC
Sec. 1034. Spouse A reinvests one half of the proceeds within the two years
and Spouse B does not. Is Spouse A liable for the income tax due on the
amended joint personal income tax return for year one that is filed because
Spouse B did not reinvest the proceeds? IRC Sec. 6013(d)(3) states that
both spouses are jointly and severally liable for any tax due on a jointly
filed personal income tax return. The IRS does not recognize the legal
agreement between the two spouses. Spouse A clearly would have legal recourse
against Spouse B for the tax but that could take years to collect. The
best method to avoid this problem is to file separate income tax returns
in the year of sale of the principal residence. Another large asset that most marriages have is an employer-sponsored
pension plan. Division of this asset can be accomplished using a qualified
domestic relations order (QDRO). A QDRO, as defined by ERISA Sec. 206(d)(3)(B),
is a judgment, decree, or court order that creates or recognizes the existence
of an alternate payee's right to receive all or a portion of a plan participant's
benefits payable under an ERISA-qualified employee benefit plan. The person
to whom the benefits are assigned to is called the alternate payee. The QDRO cannot require a qualified pension plan to alter any of the
payments or amounts in favor of an alternate payee that are not originally
available to the original participant. If the pension plan allows lump-sum
distributions, loans, or early withdrawal, then the alternate payee is
allowed the same rights. If the plan does not allow such items, the alternate
payee cannot be allowed these rights. The alternate payee can elect direct
rollovers of eligible distributions, special averaging and capital gains
treatment, or early withdrawals. All withdrawals from a qualified pension
plan by an alternate payee are subject to personal income tax just as they
would be to a participant. The taxation of plan benefits is the main reason
you may want other assets given to the nonparticipant spouse instead of
an equitable share of pension assets. IRC Sec. 72 (t)(2)(C) specifically exempts distributions from qualified
pension plans pursuant to a QDRO from the 10% early withdrawal penalty
on distributions to participants before the age of 591*2. While income
tax is due on the distribution, this exemption can be a tool used to get
a nonparticipant spouse currently needed living expenses. The division of a qualified pension plan interest is often an emotional
issue. The participant views the pension as a personal asset since it is
a direct result of employment. Domestic relations law, however, looks at
the qualified pension plan as an asset acquired or enhanced during the
marriage if there were any contributions to the plan during the marriage.
A recent Tax Court case illustrates the problems associated with distribution
of pension assets when the parties do not understand the concept of a QDRO.
In Brotman v. Commr., 105 TC No 12, a husband's profit-sharing plan
assets were transferred to his wife as part of the property settlement
in their divorce. The transfer was not made pursuant to a QDRO and the
result was disastrous. The husband had income tax due on the distribution,
as well as early withdrawal and excess distribution penalties. As the transfer
was not made pursuant to a QDRO, the husband was subject to the income
taxes and penalties on the distribution to the former spouse. In addition,
the spouse was subject to the six percent penalty on excess contributions
because she rolled her share into her IRA. The 10% early withdrawal and
15% excess distribution penalties would definitely have been avoided if
the distribution was accomplished through a QDRO. The QDRO would have also
allowed the income taxes to be deferred by the wife if she left the assets
in the plan or would have been payable by her if she removed the assets
from the plan. * By David R. Marcus, JD, CPA, Paneth, Haber & Zimmerman
LLP Looking for a way to protect assets while developing an estate plan?
Consider forming a family limited partnership (FLP) as an investment vehicle.
Depending on what your goals are for your family and your future, an FLP
may be right for you. The FLP has gained immense popularity in the last several years thanks
to many tax-saving features. In general, an FLP is made up of family members
who are partners in a limited partnership. Usually, a parent has the role of general partner and assumes most of
the liability connected to the venture. Any family member, however, can
assume this role as long as they are willing to accept the liability. Most
frequently, the children or members of the extended family are the limited
partners. They assume little or no personal liability and the partnership
is usually maintained for their benefit. An Example. Mom and Dad establish a family limited partnership.
The partnership is funded by transferring certain investment assets (e.g.,
securities, real estate, or a business) into the venture. Over time, limited
partnership interests are gifted to their children. At any time, a partner can make contributions to the partnership or
keep the venture growing. These gifts result in a transfer of property
with the utmost flexibility and can generally be completed tax free. Save Estate Taxes. Suppose your main priority is minimizing
estate taxes, which could total up to 55% of your estate. You have many
options open to you, including making lifetime gifts of cash, making gifts
of family business stock, or putting your money into a trust for future
generations. An FLP, however, may meet your needs even better than these
options. For example, a 10% interest in an FLP with $1,000,000 of assets may
be valued at less than $100,000 because the IRS allows substantial discounts
for lack of control and lack of marketability. If you fund an FLP with personal or business assets, you may be able
to make larger tax-exempt gifts and lower the value of your interest in
the property, ultimately reducing estate taxes. Reduce Income Taxes. An FLP is also a great vehicle to
reduce income taxes. Because partnerships do not pay tax on their income,
any income from assets contributed to the venture flows through to the
partners according to their interests. If children are in a lower tax bracket
than their parents, it makes sense to use an FLP to shift the income to
the lower brackets. Protecting Assets from Creditors. When dealing with asset
protection needs, an FLP works at its best. Because the FLP is a separate
legal entity from all other investments or funds, assets lose individual
ownership identity. Assets are even further protected because they are
combined, making it more difficult for creditors to pinpoint individual
assets within the partnership. For example, suppose a creditor seeks a judgment against one of the
partners in an FLP. The creditor cannot become a partner, can't force the
partnership to dissolve, and cannot claim any of the partnership assets.
What a creditor can obtain, however, is the right to that partner's
distributions when they occur. But, this can backfire against a creditor
as well because only the general partner can decide if and when any distributions
will be made. Because a creditor may have to report its share of the partnership income
on tax returns, the creditor could be reporting the share for a very long
time, paying taxes and receiving nothing but ill will in return. Manage Finances More Effectively. Family finances are
difficult to handle without sound investment strategies. Another fine feature
of the FLP is its long-lasting control capabilities. Children or family
members who are limited partners really have no control over the day-to-day
operations of the venture. The general partner controls all aspects of
the partnership and loses no control by giving away assets. Many family battles can be avoided because of the way the partnership
works: Gifts of real estate do not have to be divided among family members,
and most importantly, death or divorce does not necessarily mean the end
to the partnership. * Editor: Milton Miller, CPA Consultant Contributing Editors: Andrew Blackman, CFP, CPA\PFS Shapiro & Lobel LLP William Bregman, CPA JANUARY 1995 / THE CPA JOURNAL
The
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