Assignment

1. Qualified tuition programs under § 529 enjoy significant tax advantages. Describe these advantages with regard to the:

• Federal Income Tax
• Federal Gift Tax
• Federal Estate Tax

In your analysis, provide an example of the income, estate or gift tax savings associated with a Qualified tuition programs under § 529 that estimates the savings for utilizing this tax planning technique. Note that you may need to make certain assumptions regarding your client's income level and/or tax rate.

2. A local bank has asked you to speak at its Building Personal Wealth Conference on the topic of: "What Should Your Trust Do for you?" Develop a summary of one function that a trust might be able to accomplish for an individual who has more than a modest level of financial resources. Your summary should include any benefits associated with a trust performing such a function.

WEEKLY LECTURE FOR QUESTIONS 1 AND 2

Estate Tax Planning

Did you know that the tax law changed in 2012 to enable each person to transfer approximately $5 million in assets ("Unified Credit Equivalent") to another person during his lifetime without the imposition of estate tax? This amount is indexed for inflation, so it should increase with each passing year. In addition, the tax law maintained the provision that allows tax free transfer of assets between spouses ("marital exemption") upon the death of the first spouse. Estate tax planning generally involves transferring ownership of assets in such a way that takes advantage of the $5 million Unified Credit Equivalent and the marital exemption. A common technique is the use of an AB trust.

This planning technique involves assets getting transferred to two separate trusts upon the death of the first spouse. A typical setup for an AB Trust would be to divide the assets into the "Survivor's Trust" and the "Credit Shelter Trust". The Credit Shelter Trust receives asset values up to the Unified Credit Equivalent. The rest of the assets owned by the former couple go into the Survivor's Trust. The surviving spouse has 100 percent control over the property in the Survivor Trust and can change the ultimate beneficiaries of that trust at any time.

The income and principal from the assets in the Credit Shelter Trust may be distributed to the surviving spouse. The big difference is that the surviving spouse cannot make any changes to the ultimate beneficiaries of the Credit Shelter Trust. In addition, the surviving spouse can never revoke the Credit Shelter Trust. Setting up these trusts helps to serve one of the two main goals for the creation of an AB Trust. That goal it to ensure that upon the death of both spouses, the maximum amount of their assets and property can pass tax free to their heirs.

Let's look at an example of these savings. Assume a married couple creates an AB Trust. The wife dies in 2012, at which time the total value of the estate is $10 million (and Unified Credit Equivalent is $5 million). Upon the wife's death, the surviving husband creates the Survivor's Trust with his $6 million interest in the estate and the Credit Shelter Trust with the deceased wife's $5 million interest in the estate. The husband dies in 2014. If we assume, for the purposes of this example, that the Unified Credit Equivalent is $5 million in both 2012 and 2014, the couple's entire estate of $10 million can pass estate tax free to their children. If however, the couple did not create an AB trust, only $5 million of the total estate could have passed to the couple's children without any estate tax. The other $5 million would be subject to Federal Estate Tax.

The second goal in the creation of an AB trust is the protection of future beneficiaries. Note that the beneficiaries of the Credit Shelter Trust are set up while the couple is still alive. Once one of them dies, the terms and beneficiaries of the Credit Shelter Trust are etched in stone. So imagine there is an elderly wealthy couple with two grown children (Avery and Babs) and the wealthy couple sets up an AB trust. The husband dies and the wife remarries her 25-year-old tennis pro who has 5 kids of his own. The wife could not add the tennis pro's kids to the Credit Shelter trust or disinherit Avery and Babs.

Note that tax laws are always subject to change and estate tax is no exception. The Unified Credit Equivalent and tax rates have changed dramatically over the past decade. An effective tax advisor should understand these laws in conjunction with the finances of his clients in order to maximize tax savings for his clients.

3. Abe is an entrepreneur who likes to be actively involved in his business ventures. He is going to invest $500,000 in a business that he projects will produce a tax loss of approximately $100,000 per year in the short run. However, once consumers become aware of the new product being sold by the business and the quality of the service it provides, he is confident the business will generate a profit of at least $125,000 per year. Abe has substantial other income (from both business ventures and investment activities) each year. Advise Abe on the business form he should select for the short run. He will be the sole owner.

4. Give the Circular 230 position for three of the following situations that are sometimes encountered in the tax profession:

• Taking an aggressive pro-taxpayer position on a tax return.
• Not having a quality review process for a return completed by a partner of the tax firm.
• Purposely delaying compliance with a document request received from the IRS.
• Not keeping up with changes in the tax law.
• Charging $1,500 to complete a Form 1040-EZ.
• When representing a taxpayer in a Federal income tax audit, charging a fee equal to one-third of the reduction of the tax proposed by the IRS agent.
• Representing both the husband and wife as to tax matters when negotiating their divorce.
• Advertising on the Web for new tax clients and including Se habla español in the text of the ads.

WEEKLY LECTURE FOR QUESTIONS 3 AND 4

Penalties

The Internal revenue Service has a variety of inducements to motivate taxpayers to pay their income taxes. These never seem to involve offering taxpayers a discount or a free microwave oven if they pay their taxes early! No, these inducements are more like "this is what we are going to do to you if you fail to pay your income taxes". Then they show a picture of a guy with his pockets turned inside out being hauled into court. In this lecture, we will review some of the penalties that the IRS can use in their administration of our federal tax laws as outlined in Chapter 17 of your text.

Did you know that an S Corporation can incur tax penalties even if it does not owe any tax? If an S Corporation files its income tax return late it faces a $195 penalty per day for each shareholder that owns the S Corporation. Thus, if an S Corporation had 50 shareholders it would be fined $9,750 per day for each day late it was in filing its tax return. If there happen to be taxes due on the return that is filed late it gets even worse. You add a half a percent penalty on the amount of the unpaid tax for each month that the return is filed late up to a maximum of 25 percent.

C Corporations do not get off any easier. If a C Corporation files its tax return late with an unpaid balance remaining on the return, the IRS imposes a 5 percent penalty on the unpaid tax each month until the tax return is filed. For example, if a C-corporation files its tax return two months late and owes $100,000 in taxes, the late-filing penalty by multiplying $100,000 by 5 percent times 2 months is $10,000.

Most limited liability companies are classified as partnerships for federal income tax purposes. If this is the case, the limited liability company would be required to file an annual partnership return. The late-filing penalty is $195 each month the return remains unfiled multiplied by the number of members of the LLC. It is basically the same penalty as the S Corporation; however, this penalty is only calculated for a maximum of twelve months.

Payroll tax penalties are some of the heaviest of all of the levies imposed by the Internal Revenue Service. Company's payroll departments take out many different taxes from an employees pay. These include FICA, Medicare and federal and state income taxes. The employer is then supposed to turn around within a very short period of time and deposit these funds to our government. In some cases, the deposit is expected to be made to the government by the next business day. The penalty for late deposit of payroll taxes is 2 percent if it is 1-5 days late, 5 percent if it is 6-15 days late and 10 percent if it is greater than 15 days late.

Another type of penalty that can be imposed on a corporation is related to an understatement of tax. This occurs when the amount of tax shown on the corporate return is less than the correct amount. The IRS can impose an additional 20 percent penalty for a understatement of tax. This is where the difference between the tax shown on the corporate return and the correct tax amount exceeds 10 percent of the correct tax amount or $10,000,000, whichever is smaller.

The best way to avoid these fines and penalties is to know the filing and deposit deadlines and keep an accurate and up-to-date tax calendar for all of your tax filings.