With the worldwide spread of coronavirus, this is an unprecedented and unsettling time.  Our health care systems are overwhelmed.  Markets have been upended.  Social distancing and self-quarantine are terms and practices we are adjusting to.

We are wishing others well and trying to help.  Also, for those who are thinking about their personal and closely-held business planning, there are a few points worth considering:

  1. Are your estate planning documents current?  The world is unpredictable (what an understatement!).  For most people, estate planning documents are a form of insurance – you do not think they will be needed in the short term, but you have them anyway.  Do your estate planning documents reflect your current wishes?  Have there been changes in your life and finances that require an update?  Are your fiduciary choices (including guardians for minor children) the people you want?  If not, this should be addressed.
  2. For those with taxable estates, the current economic climate presents an opportunity to gift assets (including securities and real estate) out of your taxable estate at relatively lower values.  If this applies to you, seize the opportunity.
  3. Interest rates are also approaching the lowest levels in years.  As a result, advanced planning techniques that are affected by interest rates, such as the use of GRATs and sales to intentionally defective grantor trusts, produce even more attractive results to reduce potential estate tax exposure and provide financial security to lower generations.
  4. Many, if not most, employers are considering significant employment law and insurance issues, including business interruption insurance claims, force majeure clauses in contracts, layoffs or reduced work schedules for staff, determinations as to whether their business is an “essential business” that can continue to operate, and more.
  5. In New Jersey, property tax appeal deadlines have been extended (currently until May 1).
  6. New York City Small Business Services is offering grants to businesses with fewer than five employees to cover a portion of payroll costs for two months.  New York City businesses with fewer than 100 employees and sales decreases of 25% or more are eligible for no interest loans of up to $75,000.
  7. Interestingly, “qualified disaster relief payments” made by an employer to employees are generally deductible by the employer but do not count as taxable income to the employees.  The coronavirus pandemic has been designated as a disaster by the federal government.  As a result, employers can make certain reimbursements and payments to employees.  This does not include wages, but could include amounts paid to an employee for reasonable and necessary personal, family, living or funeral expenses incurred as a result of coronavirus.  Such payments could include medical expenses, child care expenses as a result of school closures, or increased expenses in the home, such as increased utilities.

Today, the Treasury announced that it will also be pushing back the April 15th deadline to file 2019 income tax returns.  As a result, taxpayers will not need to pay income taxes owed for 2019 and will not need to file 2019 income tax returns until July 15, 2020.  Neither New Jersey nor New York has provided for such extensions and the deadlines to file gift tax returns and estate tax returns for 2019 remain the same (as of March 20, 2020).

Due to the Coronavirus Pandemic, the Treasury announced Tuesday that it will be pushing back the April 15th deadline to pay income taxes owed for 2019 by 90 days. In other words, until July 15, 2020, no taxpayer will be charged interest or penalties on income taxes owed to the federal government for 2019.

The extension announced by the Treasury will give millions of individuals and businesses additional time to pay off 2019 income tax liability owed to the government. Specifically, individuals and small businesses, including passthrough entities such as partnerships and LLCs, may defer the payment of income tax up to $1 million, and corporations may defer the payment of income tax up to $10 million.

The new deadline only applies to federal income taxes owed for 2019 and does not apply to state income taxes owed for 2019. Some states like California, however, have followed in the government’s footsteps and have extended not only the payment of state income tax liability for 2019, but also the filing of state income taxes for 2019. New Jersey and New York have not yet provided for such extensions.

It is important to note that taxpayers must still file their 2019 income tax returns by the April 15th deadline or seek an extension. Similarly, as of now, the deadline to file gift tax returns and estate tax returns for 2019 remains the same.

New Jersey has enacted legislation that gives business owners of pass-through entities a way to bypass the $10,000 limit on state and local tax deductions.

The $10,000 state and local tax limitation was implemented under federal law in the Tax Cuts and Jobs Act.[1] The law has been controversial because of its disproportionate effect on high-tax jurisdictions like New York and New Jersey.

The Pass-Through Business Alternative Income Tax Act allows pass-through entities in New Jersey, which are S corporations and partnerships (including limited liability companies that are treated as partnerships for income tax purposes), to elect to pay state income taxes at the entity level (where deductions for such taxes are not limited) instead of at the personal income tax level. The individual taxpayer (who receives the flow-through income from the business) can then claim a gross income tax credit on his or her personal New Jersey income tax return.

In effect, this allows taxpayers who qualify to reduce their federal income by the full amount of state and local taxes paid by the pass-through entity since such amount is deducted from the taxpayers’ taxable distributive share from the pass-through entity. This provides the same result as what was previously a full deduction against federal income tax for state and local taxes paid.

The legislation is effective for pass-through entities with taxable years beginning on or after Jan. 1. The law works by imposing an alternative income tax at graduated rates depending on the amount of the distributive proceeds of the pass-through entity to its owners. For instance, for 2020, if the distributive proceeds are greater than or equal to $5 million, the tax is $427,887.50 plus 10.9% of the excess over $5 million. The owner would receive a dollar for dollar credit on his or her gross income tax return.

For most, the effect of paying at a higher rate at the entity level will not make a material difference because of the offsetting credit. Nonetheless, this is something that should be considered. A second concern under the new law is that the liability for tax would now rest on the pass-through entity itself.

Under normal circumstances, one partner or shareholder would not be liable for the gross income tax liability of another partner or shareholder. Here, though, once elected, the tax liability needs to be paid by the entity (but the law also provides explicit relief to the entity for taxes of any nonconsenting owners).

It is also not uncommon for the amount of taxable distributive proceeds to exceed actual cash distributed by the entity. When the entity invests its profits back into its operations, the members or shareholders will be taxed on the phantom income. Without the election, the gross income tax liability was not a concern for the entity and the entity would not have to consider how it would be paid. With the election, the entity needs to pay the alternative income tax, which would be a new item to budget. If the entity doesn’t pay the tax, the partner or shareholder is not entitled to his or her pro rata credit.

It is estimated that the new law will save New Jersey business owners $200 to $400 million annually on their federal tax bills. Sen. Troy Singleton, D-Delran, one of the sponsors of the bill, said in a statement, “This law will help to defray the out-of-pocket income tax hit for small business owners here in New Jersey and help alleviate the inequities created by the federal tax law.”

The New Jersey Society of Certified Public Accountants assisted with the legislation. The executive director of the NJCPA, Ralph Albert Thomas, said in a statement:
We are grateful to the Governor, the Legislature and all those who supported the bill. Their dedication to assisting small businesses in New Jersey does not go unrecognized.

The new tax bill is not the first attempt to work around the $10,000 SALT deduction limit. An earlier approach in New York created a state-run charitable fund to which a taxpayer could contribute as a way of paying his or her taxes and receive tax credits in return. In New Jersey, Gov. Phil Murphy signed legislation in 2018 aimed at allowing taxpayers to convert local property tax payments into charitable contributions that could be deductible on federal tax returns.

However, the Internal Revenue Service issued regulations last year that prevent state-run charitable funds from being used in this way. At the present, there has been no federal response to the New Jersey legislation though it would not be surprising to see the U.S. Department of the Treasury issue temporary or proposed regulations to counter the new law as the law’s purpose is to allow taxpayers a workaround to avoid the SALT limitation.

In addition, New Jersey, New York and Connecticut filed a lawsuit in the U.S. District Court for the Southern District of New York to challenge the IRS regulations, which is ongoing. These three states and Maryland also filed suit in the Southern District of New York to challenge the deduction cap itself. That case was dismissed by the U.S. District Judge J. Paul Oetken but is on appeal.

The new legislation may give New Jersey business owners a reason to structure a business as a pass-through entity. For example, an entrepreneur choosing between forming a startup business as a single-member LLC, which would be disregarded for federal and state income tax purposes (and not qualify as a pass-through entity), and an S corporation which could take advantage of the new law, would have an incentive to choose the S corporation structure. Owners of other businesses that are typically organized as pass-through entities, such as law firms, accounting firms and medical practices, would also stand to gain.

Wage earners with state income and property taxes in excess of $10,000, though, have nothing to gain from the new legislation and would justifiably be frustrated by the uneven concern that the legislature has extended to some but not all heavily taxed New Jersey residents.

 

Originally published on Law360.com on January 23, 2020.

In an overwhelming 417-3 vote, the US House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”), which has now been incorporated into a spending bill that was signed by President Trump on December 20, 2019.  While the SECURE Act includes numerous changes to certain qualified retirement plans, there is one notable change that will affect some potential beneficiaries of individual retirement accounts (“IRAs”).

Currently, when an individual reaches age 70 1/2, he or she must start taking a required minimum distribution (“RMD”) based upon his or her remaining life expectancy.  If such individual dies and leaves his or her IRA to an individual beneficiary (other than a spouse, a disabled or chronically ill person, an individual who is no more than 10 years younger than the decedent, or the minor child of the decedent), and that individual beneficiary then rolls the decedent’s IRA over to his or her own IRA (i.e. an “inherited IRA”), the RMD will be calculated on that individual beneficiary’s life expectancy resulting in a “stretch IRA.”  The stretch IRA allows for income tax-deferral and avoids a large income tax bill.

Effective January 1, 2020, under the SECURE Act, the age at which an individual must start taking RMDs is increased to age 72.  However, absent a few exceptions, while a non-spouse individual beneficiary would still be able to roll over the decedent’s IRA to his or her own inherited IRA, instead of calculating the RMD on that individual beneficiary’s life expectancy, the IRA must be distributed within 10 years of the decedent’s death.  This change could force non-spouse individual beneficiaries into higher tax brackets, resulting in higher income taxes on both such beneficiary’s ordinary income, as well as the distributions from such inherited IRA.

As an example, assume a 75 year old decedent left his or her IRA to his or her 40 year old child with a 43 year life expectancy and that the IRA is worth $1,000,000 at the time of his or her death.  Under the current law, the IRA would remain in pay-out status, but would be recalculated to be paid out over such child’s life expectancy.  Using the example, the child would receive approximately $23,256 in the first year from the inherited IRA and gradual increases over the next 42 years.  Under the SECURE Act, the child would not be required to receive any minimum distributions from the inherited IRA, but would be required to receive the entire $1,000,000 within 10 years.  Depending on the child’s income tax bracket and the investments within the IRA, the benefits that the child would have received under current law could have been considerable.

While the SECURE Act will not affect the treatment of spousal inheritance of IRAs, it is still important for all individuals to consider how these changes could impact their estate planning.  We recommend that individuals consult with their tax professionals.