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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.

* Fiduciaries must have significant understanding of capital-market behavior, including the effects of taxes and inflation. *


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.

Basic Data Required

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.

The Next Level

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.

What Is "Marital Property"

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 ..."

Transfer of Assets Incidental to a Divorce

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

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.

Qualified Domestic Relations Order

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. *


Milton Miller, CPA


Contributing Editors:

Andrew Blackman, CFP, CPA\PFS

Shapiro & Lobel LLP

William Bregman, CPA


The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

©2009 The New York State Society of CPAs. Legal Notices

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