By Beverly Brautigam, CPA
By Beverly Brautigam, CPA
EARNED INCOME OF REGISTERED DOMESTIC PARTNERS
RULES OF DISENGAGEMENT, NAVIGATING THE TURBULENT WATERS OF DIVORCE TAXATION
WHO HAS TO FILE A U.S. TAX RETURN
WHAT THE FAMILY LAWYER SHOULD KNOW ABOUT I.R.C. SECTION 529 PLANS
FUTURE FORMER SPOUSES: Tax Opportunities, Tax Traps
SAYING "I DO" TO FIDUCIARY RESPONSIBILITY
WHO KEEPS THE LOW PROPERTY TAX BASE?
Earned income of registered domestic partners (RDPs) is
community income even for federal income tax purposes.
By Beverly Brautigam, CPA
6/7/2010
We finally have conformity with regard to the character of earned income for RDPs in California. Both for California purposes and for federal purposes, the earned income of each RDP is reported ½ by each partner. For California purposes this is only relevant if the parties file married separate returns or head of household returns. This is the case because for California purposes, RDPs qualify to file a joint return so all the income would be reported on the joint return. Unfortunately, RDPs are considered single for federal income tax filing purposes and therefore file separately.
Chief Counsel Advice 201021050 was issued May 28, 2010 and indicates that federal law respects state law property characterizations and, thus, the federal tax treatment of community property should apply to California RDPs. For tax years beginning after December 31, 2006, a California RDP must report ½ of the community income, whether received in the form of compensation for personal services or income from property, on his or her federal income tax return. For tax years beginning before June 1, 2010, RDPs may, but are not required to, amend their returns to report income in accordance with this law change. In many cases this will result in a refund.
Should amended returns be filed, they should be done together and sent in with a cover sheet explaining that they are being filed in accordance with CCA 201021050. Remember to split the withholding and/or estimated payments along with the income. Penalties should not be assessed as the parties will meet the "substantial authority" provisions of the code. However, interest (paid and/or charged) will apply.
This law change helps with property divisions in a dissolution. To the extent that the property is community, it can be divided between the partners without being considered a taxable event. Internal Revenue Code Section 1041 does not apply to RDPs for federal income tax purposes (it does apply for California income tax purposes.) So, to the extent that one partner receives the separate property of the other partner in a dissolution, there is likely a taxable event (gain or loss triggered) for federal income tax purposes. The fact that the federal law now recognizes the community character of earned income allows those funds to purchase assets which will be considered to be community. Thus, this should reduce the tax burden on the dissolution of RDPs.
An order of $20,000 per month until remarriage, death or further order of the court provided that the payments would be characterized as spousal or child support or some combination thereof. The Tax Court ruled that these payments met the definition of alimony and were deductible to the payor and taxable to the recipient. Theurer v. Commissioner, T.C. Memo 2008.61.
The Tax Court held that a taxpayer may not deduct, as alimony, payments to a former spouse before the existence of a written divorce or separation agreement, despite a state court’s retroactive characterization of the payments as family support payments. Ali v. Commissioner, T.C. Memo 2004-284 (12-27-04.) The Tax Court held, in part, that "the retroactive characterization of the payments as support by a state court does not have retroactive effect for federal tax purposes."
The Tax Court ruled against the taxpayer making payments described in the support judgment as "unallocated family support" that "would cease when the child reaches maturity or graduates from high school, whichever occurs last." The taxpayer argued that amounts not specified as child support must be alimony. The court ruled that the connection of payment termination to the child’s age and graduation clearly indicated that the payments were for child support and not alimony. (Przewoznik, T.C. Summary 2008-50.)
The Housing Assistance Tax Act of 2008 added a restriction limiting the extent to which a taxpayer can convert a rental property or vacation home into a principal residence for 2 years and then sell the home and take advantage of IRC §121. The exclusion does not apply to the extent gain from the sale or exchange of a principal residence is allocated to periods of nonqualified use. Generally, nonqualified use is any period (other than the portion of any period before January 1, 2009) during which the property is not used as the principal residence of the taxpayer or spouse. Use of the property after it ceases being the taxpayer’s principal residence is not counted as a period of nonqualified use. In other words, the reduction of the §121 exclusion applies only to the sale of a residence that was used for other purposes prior to its use as a principal residence.
It’s important to note that the exclusion isn’t reduced for nonqualified use; rather, it’s the gain potentially eligible for the exclusion. Thus, if the gain is large enough, the seller may be able to use the full exclusion despite extensive periods of nonqualified use.
Gain allocated to periods of nonqualified use is the total amount of gain multiplied by a fraction: (1) the numerator of which is the aggregate periods of nonqualified use during the period the property was owned by the taxpayer, and (2) the denominator of which is the period the taxpayer owned the property. The nonqualified use will not include any period before January 1, 2009. But, the denominator (i.e., the period that the taxpayer has owned the property) will include periods of ownership before January 1, 2009.
EXAMPLE |
David buys a property on January 1, 2009 for $400,000 and uses it as a rental property for two years claiming $20,000 of depreciation. On January 1, 2011, he converts the property to his principal residence and moves out on January 1, 2013 and sells it for $700,000 on January 1, 2014. He reports the $20,000 of depreciation taken as income. Of the remaining $300,000 of gain, 40% (2 years as a rental property divided by 5 years of ownership), or $120,000, is allocated to nonqualified use and is not eligible for the exclusion. The remaining $180,000 of gain qualified under § 121. |
EXAMPLE |
Mary buys a principal residence on January 1, 2009 for $400,000 and moves out on January 1, 2019 converting it to a vacation home. On December 1, 2021 she sells the property for $600,000. The entire $200,000 qualifies under § 121 because periods after the last qualified use do not constitute nonqualified use. |
California has not conformed to this provision.
The Mortgage Forgiveness Debt Relief Act of 2007 allows an unmarried individual whose spouse is deceased to exclude $500,000 of capital gain as long as he or she sells the home within two years of the spouse’s death. (IRC § 121 (b)(4).) The decedent and the surviving spouse must have owned and lived in the house two of the five years prior to the decedent’s death (IRC § 121 (a); § 121(b)(A)(i) and (ii).) The exclusion amount applies to sales or exchanges after December 31, 2007.
California has not conformed to this change.
There may well be a difference in the amount of taxable gain from the sale of a principal residence reported for federal and California purposes.
EXAMPLE | Don owns a home in the bay area which he bought for $200,000 several years ago. Glen moved in three years ago when they registered as domestic partners. In 2008, Don and Glen move to Los Angeles and sell the house for $800,000. For California purposes they will file a joint return and report $100,000 (after excluding $500,000 of gain.) For federal purposes, Don will report gain of $350,000 after his $250,000 exclusion for a single taxpayer. |
If death occurs during the divorce proceeding, where is the case litigated:
Property characterization rules differ between divorce court and probate court.
All marriages end: some by death, the rest by divorce. To properly represent our clients, we need to be prepared for either ending.
I think everyone should consider this but there’s no right answer across the board.
A regular IRA accumulates tax free and when you withdraw it, it’s taxable income. There are minimum distribution requirements once you reach 70 ½.
A ROTH IRA also accumulates tax free but when you withdraw from a ROTH IRA, it’s not taxable and there are no required distributions. For it to be nontaxable, the money generally needs to be in the ROTH IRA for 5 years (beginning with January 1st of the year of conversion.)
During 2010, anyone can convert an IRA to a ROTH IRA (or any part of one.) When you do so, the amount of the conversion is taxable (that’s the rub.) The tax on the conversion can be reported in 2010 or half in 2011 and half in 2012.
Obviously we are dealing with a lot of unknowns. What will the tax rates be in 2011 and 2012? What will the tax rates be during the years of withdrawal? For how many years will you be withdrawing? (In other words, life expectancy.)
One general rule is that the younger you are the better. There is no question that the 20 and 30 somethings should convert. Of course, the presumption is that they have years of growth that would ultimately be tax free.
That said, I have elderly clients who are converting because they are looking at the next generation. The inherited regular IRA is taxable to the beneficiary and the inherited ROTH IRA is not taxable.
So you can see how complicated this all gets.
Also, if you have made non deductible IRA contributions you have what we call "basis" in the IRA – that amount comes out tax free. But, you cannot just convert that portion. For people who have both non deductible IRAs and regular IRAs, any portion converted is prorated between the two. In other words, it’s not all taxable in this instance.
There is also a provision that people can undo this by the due date of the tax return for the year of conversion. Let me give you an example. Let’s say you converted $100,000 now and at year end the account is only worth $80,000. You would probably recharacterize to avoid reporting $100,000 for something now only worth $80,000. This could be a reason to wait to closer to year end to convert but that all depends on that crystal ball and your opinion regarding what will happen to the market between now and year end.
A general observation is that for people with long life expectancy who believe the market will continue to grow, who feel that their tax rates will be higher in the future, who don’t need the money for 5 years and who have a source to pay the tax that is not part of the IRA -- these are the best candidates.
California offers a way to hold title to property which began July 1, 2001. You may want to consider it for your brokerage accounts and/or real estate.1
Married couples can hold title as follows:
Joint Tenants—At the death of one joint tenant the property automatically passes to the surviving joint tenant. The asset avoids probate. There is a step-up in basis in the decedent’s half.2
Community property—Each spouse’s half interest can be willed to whomever they wish. The entire property gets a step-up in basis.3
Community property with right of survivorship—Allows probate avoidance benefits of joint tenancy and the tax benefits of community property (entire property gets a step-up in basis.
This third type is an inexpensive, practical way to hold title without probate, without a community-property set aside, without a living trust and still achieve a double step-up in basis.
I would think that you should consider changing title to community property with right of survivorship unless you are not leaving your property to your spouse (which could be very appropriate estate planning) or you have assets worth less than you paid for them (and you would, therefore, not want to change the basis on both halves).
Of course, any decisions regarding title should be made in the context of your full estate plan and with input from your estate attorney.
What the Family Lawyer Should Know
About IRC Section 529 Plans
Typically in a divorce where there are children, the parents are concerned with their children’s education. A Section 529 plan is one investment vehicle which may provide many benefits.
July 2002
Technically, the term "short sales" refers to the repurchase of stock within thirty days of selling it at a loss. It is now being used to refer to a loan amount exceeding the value of the property.
The tax result when a bank forecloses on property in such a situation depends on whether the loan is recourse or non-recourse.
If non-recourse (purchase money mortgage - not more than four units), the amount owed becomes the deemed sales price and you have a capital transaction as you would if you’d sold the property for the amount of the debt.
If recourse (which it is if refinanced), there are two required calculations when the property is repossessed.
Here we need to know the fair market value of the property as well as the amount of the debt and the taxpayer’s basis in the property. We calculate:
1) cancellation of debt (COD) income and
2) gain or loss on the disposition of the property.
Illustration #1 is non-recourse debt. Illustrations #2 and #3 are recourse.
#1 #2 #3
Gain on Sale - non-recourse:
Loan Balance
$250,000
Basis
180,000
Gain/Loss on sale
$70,000
Recourse:
COD Income
Loan Balance
$250,000
$250,000
FMV
225,000
225,000
COD Income
$25,000
$25,000
Gain on Sale
FMV
225,000
225,000
Basis
180,000
260,000
Gain/Loss on sale
$45,000
($35,000)
Gain from the sale of a principal residence is capital gain to the extent it exceeds the exclusion amounts available in § 121. Loss on the sale of a principal residence is not deductible. COD income is taxable as ordinary income. This bifurcated approach (when recourse debt) produces strange tax consequences in situations such as #3 above.
by: Beverly Brautigam
As appeared in Family Law Counselor, August 1997
The Taxpayer Relief Act of 1997 affects your clients. This article addresses the change in the tax laws regarding the tax when a principal residence is sold after May 6, 1997 and the changes in the capital gain rates.
THIS ACT REPEALS IRC §1034 (deferral when a principal residence is purchased for more than the prior home sold for within 24 months of selling the prior home).
THIS ACT CHANGES IRC §121 (lifetime exclusion of up to $125,000 for those 55 years or older if used as a residence in 3 of the last 5 years).
The NEW IRC §121 contains no age restriction and is changed as follows:
The law generally provides that $250,000 ($500,000 in the case of a married couple) of gain from the sale of a principal residence is exempt from tax, for sales after May 6, 1997. The exclusion is allowed each time a taxpayer selling or exchanging a principal residence meets the eligibility requirements (has owned and used the home as his/her residence in 2 of the last 5 years), but generally no more frequently than once every two years. However, gain would be reportable to the extent of any depreciation allowable with respect to the rental or business use of a principal residence for periods after May 6, 1997.
The new law specifically indicates that for purposes of the ownership test (2 of the last 5 years), if a person receives property in an IRC §1041 transaction (from a spouse or former spouse), the holding period of the former spouse will be added on. This eliminates concern regarding whether the half of a house received from a former spouse in a divorce would need to be owned an additional 2 years before sale for the entire home to qualify.
Example: H & W owned a home they acquired in 1980. It was awarded to W in their divorce settlement effective September 1, 1997. She sold the home on February 1, 1998. She is deemed to have owned 100% of the home since 1980 and if she lived in the home for 2 of the last 5 years prior to sale, she would exclude $250,000 of gain.
Additionally, the new legislation considers the divorcing couple! We have an answer to the old question, "How long can the out-spouse be out and still be considered as having sold a residence?" The out-spouse is treated as using the property as a residence during any period of ownership while his/her spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in the alimony section, IRC §71 (b)(2).)
These rules could result in more delayed sale of home orders (DUKE). If each spouse continues to own half a house and one is granted the use of the property under a delayed sale of home order, each single person would have $250,000 to exclude at time of sale.
In a divorce context, it would seem that each spouse or former spouse could sell his or her half of the property and each exclude $250,000 without a need for a joint return.
However, here are the requirements to obtain the $500,000 exclusion:
A joint return is filed,
Either spouse has owned the residence in 2 of the last 5 years
Both spouses have used it as a residence in 2 of the last 5 years, and
Neither spouse is ineligible due to having had another sale within the 2-year period.
As only one spouse needs to meet the ownership test of 2 out of 5 years, a joint return should be considered when one spouse doesn’t meet the ownership test. For example, when the residence being sold is the separate property of one spouse (and both have used the property as a residence in 2 out of the last 5 years), $500,000 would be excluded on a joint return, whereas only $250,000 would be excluded on the owner spouse’s separate or single return.
PLANNING
It would appear that we have more certainty regarding the gain from the sale of residences than we have had in the past. An out-spouse can be out for 3 years and still qualify under new IRC §121 and exclude $250,000. If, as mentioned above, the out-spouse is out for longer than 3 years AND the in-spouse has been granted use of the property under a divorce or separation instrument, the ability to exclude the gain continues.
NEW CAPITAL GAIN RATES
There’s more good news. To the extent that there is reportable gain in excess of the amount excludable (and for gain from the sale of other capital assets after May 6, 1997), the maximum capital gains rate is lowered from 28% to 20% (10% for those otherwise taxed at the 15% bracket).
The holding period required to benefit from the reduced rates is 12 months for assets sold after May 6, 1997 and before July 29, 1997 and after December 31, 1997. For assets sold after July 28, 1997 and before January 1, 1998 the holding period was 18 months. The 1998 Act eliminated the 18 month holding period.
Keep in mind, however, that in high income situations, the effective tax rate could be higher due to various phase out provisions of the Internal Revenue Code.
The California law has been changed to conform to these new residence rules.
Tax Opportunities and Tax Traps
by: Beverly Brautigam, CPA
As appeared in TAX HOTLINE, JANUARY 1998
The divorce rate is more than 50% now - even higher for second marriages. So, it only makes sense to plan for a marriage with the possibility of divorce in mind. Your soon-to-be spouse very well may someday become your former spouse.
PRENUPTIAL AGREEMENTS
Once used only by the wealthy, prenuptial agreements are increasingly popular legal
devices for prospective spouses. These agreements determine a couple's property rights
both during the marriage and in the event of death or divorce.
The parties need to decide how property acquired during the marriage will be treated.
Will it be their joint property or the separate property of the spouse who acquired it? This decision will affect the property settlement between the spouses in case of divorce. If no decision is made, then state law will prevail.
In community property states
: There is a presumption that property acquired during the marriage is community property, belonging equally to both spouses regardless of which spouse paid for it.In most other states: Ownership of property generally depends upon who holds title to it. However, in the event of divorce, property is subject to what is known as equitable distribution.
The division of property acquired during the marriage is left up to the court if the couple cannot agree on a settlement. The court will divide the property using such equitable considerations as length of the marriage, who earned the income, who spent most of it, type of assets, etc.
Key asset: Couples that are planning to marry need to address how to deal with the pension plans. Under state law, a spouse can gain an interest in the other party's pension. This interest can be waived by the spouse, allowing pension plan benefits to flow to children or other beneficiaries of the owner/spouse...if that is desired.
Catch: Such a waiver cannot be accomplished with a prenuptial agreement.
Reason: The parties to a prenuptial agreement are engaged, they are not yet spouses, and only a spouse can waive his/her legal rights to pension benefits.
Strategy: Spell out in the prenuptial agreement that the parties will execute a pension waiver after the wedding.
Caution: For a prenuptial agreement to be legally binding, there must be full financial disclosure by both parties. Each spouse should have his/her own lawyer and get independent advice before signing the agreement.
TAX IMPLICATIONS
It's important that both future spouses understand the impact that marriage and possible divorce will have on their income taxes.
Married couples may, depending on their income and expenses, face what is known as the marriage penalty. They will pay a higher combined income tax bill than if they had remained single and filed single returns.
Problem: There is nothing that can be done about this short of not marrying in the first place.
The marriage penalty can, however, be influenced by the timing of a marriage or a divorce.
Marital status for tax purposes is determined as of the last day of the tax year.
Example: If a couple married on December 31, they are treated as having been married for the entire year. And, if a divorce become final on December 31,
Couples bring to the marriage prior tax issues that may be positive or negative....
Home sales. The new, very favorable rules regarding the sale of a residence generally allow single people to exclude $250,000 of gain, and married couples filing joint returns $500,000. In a divorce context, each spouse or former spouse can sell his/her half of the property and each exclude $250,000, assuming both meet eligibility requirements.
New break: A former spouse who remains joint owner, but does not live in the house for three out of five years preceding the date of sale, can still claim a $250,000 exclusion when the house is sold if, under a divorce or separation instrument, the other spouse is granted use of the house for the requisite two out of five years.
Tax Carryovers. Spouses may bring tax carryovers into the marriage that can be used on the tax returns they file as a couple.
Examples: Capitol losses, net operating losses, investment interest deductions, passive activity losses, home office deductions.
Tax Liabilities. Spouses may have potential tax liabilities that follow them into a marriage.
Example: A gain that will be taxes when real estate or a tax shelter holding real estate is sold.
When couples marry, they can file joint returns, which carry with them joint liability for the tax due on those returns.
This means that each spouse remains liable for all the tax on a joint return, even if it is attributable to the income of one spouse.
Strategy:
While a joint return generally saves taxes over filing separate
returns, once marital difficulties arise, it may be advisable to file separate returns.
FAMILY BUSINESS
When a divorcing couple owns a business jointly, great care must be taken in planning the way complete ownership will be shifted to one spouse. Often the business is a significant asset and the spouse who will continue ownership lacks enough other assets to offset the value of the departing spouse's interest. Consider the following methods of transfer....
Payout over time. Treat the shifting of ownership as a nontaxable property settlement. Pay the departing spouse's interest in installments. (The interest payments will be taxable income.)
Redemption of the departing spouse's stock. If a jointly owned business in
incorporated, business funds can be used to redeem the departing spouse's stock, leaving
the other spouse with full ownership. The departing spouse may or may not be hit with an
immediate tax on the transaction. It depends on how the divorce settlement is structured.
STRATEGIES FOR PROTECTION
Couples with prenuptial agreements should follow the terms of the agreements they have signed. They should.....
Keep property brought into the marriage as separate property.
Not put existing funds into joint accounts.
Keep inheritances and gifts from third parties under separate names.
POSTNUPTIAL AGREEMENTS
A couple who did not make a prenuptial agreement can, after marriage, sign an agreement governing ownership of property and tax issues. Postnuptial agreements can address questions that have arisen after the marriage and they can be responsive to changes in tax law.
by: Beverly Brautigam
New the past few years as part of the federal Form 1040 is Schedule H (Household
employment taxes) on which payroll taxes are calculated. This tax is added to your
individual tax and paid with Form 1040….you know the form… it’s the one you
(and I) sign right below the "Under penalties of perjury…" language.
So, the good news is that the form is relatively simple (certainly as compared to filing actual quarterly payroll returns). Here’s when it’s required (when any of the following three conditions apply):
You paid any one household employee cash wages of $1,300 or more.
You withheld federal income tax at the request of any household employee.
You paid total cash wages of $1,000 or more in any calendar quarter to household employees.
A household employee is any person (over age 17) who does household work if you can control what will be done and how it will be done.
So, you’re wondering what this will cost. Presuming you, as the employer, pay what should have been withheld from the pay check and the employer’s share of payroll tax, 15.3% of gross wages will be due for Social Security and .8% for FUTA (Federal Unemployment Tax). This 16.1% of gross wages will be included as tax on your Form 1040 (e.g. $1,500 wages = $241.50 of federal taxes.)
If you are required to file, here’s what we’ll need from you in order to complete Schedule H:
Your federal employer ID# (obtained by completing Form SS-4 and faxing to the IRS at (801) 620-7115 or mailing to Internal Revenue Service; Entity Control; Mail Stop 6271; P.O. Box 9941; Ogden, UT 84201)
Which of the above three filing criteria you meet
Amount you paid household employees
All of the following requirements are payroll reporting (rather than affecting your income tax returns).
In addition to the above, W-2 forms need to be issued to the employees (by January 31) and copies sent to the government. And, of course, the California rules are different. Enclosed is a chart comparing the requirements.
You might choose to use the services of a bookkeeper (and we can recommend several) to handle this for you. Needed are:
Name, address and social security number for each employee (although, if you are unable to obtain a SS# (!), you can send the person Form W-9 and send their W-2 without a SS#);
Amount paid to each employee by quarter;
If you withheld anything, you’ll need the details;
California employer account number (Obtained by preparing Form DE 1 HW and calling (916) 654-7041 or faxing (916) 654-9211.)
We can provide the SS-4 and/or the DE 1 HW.
Don’t panic – we will help you – call us!
The Independent Contractor
Beginning January 1, 2001, California law requires business owners to report individuals who perform services to the state’s Independent Contractor Registry. The rules are somewhat complicated, and there are penalties for failing to comply. You must report independent contractors to the EDD within 20 days of making payments or entering into a contract for $600 or more within any calendar year. (By the way, the law was enacted to assist the state in collection of delinquent child support.)
Information to be reported includes the contractor’s full name, address and social security number. You need only report each contractor once a year. You may use Form DE 542 for this purpose. Report only individuals, and do not report contractors who are corporations, partnerships, etc. This is in addition to the annual requirement to file Form 1099 MISC.
Some examples of independent contractors to be reported by owners of rental property are those who do repairs, landscaping and/or make improvements, etc. It may be most convenient for you to file the DE 542 at the time you make your first payment to a contractor rather than having to track payments until they reach the $600 threshold later on.
AB 1358 (Ch. 00-808) invokes a penalty of $24 for each failure to report within the required timeframe.
The Best of Both Worlds
California will offer a new way to hold title to property beginning July 1, 2001. You may want to consider it for your brokerage accounts and/or real estate. 1
Currently, married couples can hold title as joint tenants or as community property.
To recap these options:
Joint Tenants – At the death of one joint tenant the property automatically passes to the surviving joint tenant. The asset avoids probate. There is a step-up in basis in the decedent’s half.2
Community property – Each spouse’s half interest can be willed to whomever they wish. The entire property gets a step-up in basis.3
Step-up in basis is depicted on the enclosed worksheet.
AB 2913 (Ch. 00-645) creates a new form of title—community property with right of survivorship—and allows spouses the option to take this new title. This new title allows the probate avoidance benefits of joint tenancy and the tax benefits of community property forms of title.
This bill is an important change. It is an inexpensive, practical way to hold title without probate, without a community-property set aside, without a living trust and still achieve a double step-up in basis.
I would think that you should consider changing title to community property with right of survivorship unless you are not leaving your property to your spouse (which could
be very appropriate estate planning) or you have assets worth less than you paid for them (and you would, therefore, not want to change the basis on both halves).
Of course, any decisions regarding title should be made in the context of your full estate plan and with input from your estate attorney.
1. Of course, if your property is separate property, you probably want to keep it in that person’s name and dispose of it by will or trust.2. They can also hold title as tenants in common, but this would be very unusual for married couples.
3. There are other legal distinctions not presented here, including ones regarding bankruptcy law.
Saying "I Do" to Fiduciary Responsibility
by: Beverly Brautigam, CPA, PFS and Hal Bartholomew, CFLS
If you are advising a spouse who is the decision maker – be careful. Generally, a husband and wife owe one another duties of mutual respect, fidelity and support. Failing to advise happily married clients about the fiduciary duty between spouses could result in penalties to one spouse and even future windfalls to the other spouse due to lack of disclosure.
How can your client get in trouble? Suppose your client uses his separate property rather than community property to make an investment that goes up in value. Questions that arise include: Why didn’t he use the community? And why didn’t he allow the community to benefit from the investment?
Or, suppose your client - and the community - own stock in a company. Your client sells his stock, which then goes down in value, but not the community’s. Why did he allow the community to suffer from the decrease in value, but sell his stock?
Any transaction between a husband and wife arises in the context of a confidential relationship imposing a duty of the highest good faith and fair dealing on each spouse, with neither side taking unfair advantage of the other.
The standard of care stems from California’s public policy that marriage is an equal partnership and that spouses owe each other the same highest duties owed by parties to a fiduciary relationship.
FAMILIAL DUTIES
In 2003, the California Legislature redefined the fiduciary relationship between spouses to include all of the duties owed by nonmarital business partners in Family Code Sec 721(b). This confidential fiduciary relationship includes, but is not limited to:
Providing access at all times to any books regarding a transaction for the purpose of inspection and copying;
When a transaction between husband and wife is advantageous to only one spouse, the law presumes the transaction to have been induced by undue influence. The “advantaged” spouse would need to show that the transaction was freely and voluntarily consented to, with full knowledge (of the other spouse) of all the facts and a full understanding of the effect of the transfer.
MANAGEMENT AND CONTROL
A spouse who is primarily managing and controlling a business may act alone in all transactions, but is required to give prior written notice to the other spouse of any sale, lease, exchange, encumbrance or other disposition of all of the personal property used in the business operation, whether or not title to that property is held in the name of only one spouse.
This duty includes the obligation to make full disclosure to the other spouse of all material facts and information regarding the existence, characterization and valuation of all assets in which the community has or may have an interest; debts for which the community is or may be liable; and to provide equal access to all information, records and books that pertain to the value and character of those assets and debts, upon request.
To protect your client from claims of mismanagement of marital property, you should advise your client to keep the other spouse fully informed regarding major transactions and provide written notice and full disclosure.
BREACH OF DUTY REMEDIES
A spouse can file a civil action against the other spouse for abuse of this fiduciary duty. But these problems that arise between a couple usually result in one spouse filing for divorce.
When one spouse fails to act in accordance with the fiduciary duty, the aggrieved spouse has several statutory remedies.
When one spouse’s undivided one-half interest in the community estate is impaired by the actions of the spouse, a court may order an accounting of the property.
Any asset undisclosed or transferred in breach of a spouse’s fiduciary duty could result in a 50 percent or even 100 percent penalty. Remedies may include an award to the other spouse of 50 percent of any asset – plus attorney’s fees and court costs.
Remedies when the breach arises from oppression, fraud or malice could include an award to the other spouse of 100 percent of any undisclosed asset.
Interspousal fiduciary duties is a complex area of law that must be clearly conveyed to clients.
Who Keeps The Low Property Tax Base?
by: Beverly Brautigam, CPA, PFS
The Rule
When a principal residence is sold by someone 55 or older in California and that person purchases another principal residence in the same county within two years of selling the original one, and the second one costs the same or less than the original one sold for, that person can transfer their property tax base.
Actually there is a 5% inflation allowance if the subsequent purchase is less than one year of the sale of the original residence and a 10% inflation allowance if at least one year and one day but fewer than two years.
To qualify, Form BOE-60-AH [Claim of Person(s) At Least 55 Years of Age for Transfer of Base Year Value to Replacement Dwelling] must be filed with the assessor within three years of the date the replacement dwelling is purchased or newly constructed.
The above rule is Proposition 60.
Proposition 90 extends this rule to transfer the tax base rate from one county to another. Only certain counties accept Proposition 90. As of August 6, 2004 (when Kern County repealed their approval) those counties are Alameda, Los Angeles, Modoc, Orange, San Diego, San Mateo, Santa Clara and Ventura.
The Issue
The question becomes whether two co-owners who sell their original residence can share and each still qualify for the claim when each acquires a separate replacement dwelling. Let’s say a married couple sells a home for $1,000,000 and each buys a new home for $500,000 within two years of the sale. They are each over age 55. Do they each qualify?
NO! Only one can receive the benefit and it will be the one who files the above-mentioned form first.
This potentially unfair result will require legislation to correct.
by Beverly Brautigam, CPA, MBA in Taxation and Personal Financial Specialist
There is a shocking level of financial illiteracy among Californians. Its impact is staggering:
The California CPA Society has created a Financial Literacy Committee consisting of statewide members. The committee has developed programs and materials to help Californians improve their financial knowledge. In cooperation with elected officials, the committee has launched a “Dollars & Sense” workshop to provide financial information in town hall-style forums.
The committee also is collaborating with the Caifornia Jump$tart Coalition and Junior Achievement to provide financial literacy programs for school children.
They are hosting the first Summit on Financial Literacy in California on April 26, 2006 at the Sacramento Convention Center and will be the first summit in the nation to bring together legislators, financial professionals and educators for the purpose of providing personal financial education to Californians.
For more information, contact Clar Rosso, CalCPA Director, communications, clar.rosso@calcpa.org.
Beverly is the current President of the CA CPA Education Foundation and serves on the Financial Literacy Committee.