Taxability of Lawsuit Settlement Awards

December 18, 2012 by

Blue man carrying the words tax on his back
Personal Injury and Medical Malpractice Lawyers who negotiate settlements need to consider the tax issues affecting their client when drafting both the complaint and the final settlement agreement.

Payments received as compensation for physical injuries are free of federal income tax and Pennsylvania Income tax. Such is the case even if the monies received are from a court-ordered award or an out-of-court settlement. It also matters not if the payment is in a single, lump sum or paid in installments. However, you cannot deduct attorney fees incurred to collect a tax-free award or settlement for physical injury.

Some additional tax rules to consider in determining if the award is taxable:

  • Compensation for emotional distress arising out of a physical injury is tax-free because the distress is considered part of the physical injury or illness.
  • Amounts received under a disability policy where you paid the premiums are not taxable as long as you did not deduct the premiums on your past tax returns. If you did deduct the premiums then the amounts received are taxable as ordinary income.
  • Amounts received for medical expenses will be tax-free unless the individual claimed a medical expense deduction for such expenses that are later reimbursed from the settlement. Even when there is no specific allocation, the settlement is deemed to include a reimbursement for such expenses up to the amount of those expenses and includible in income.
  • Claims for taxable lost wages or lost profits will generally be reported as ordinary income while claims for injury to a capital asset will be taxable as a recovery of basis and capital gain.
  • Front pay or back pay will be characterized as “wages” for purposes of payroll tax withholdings and subject to federal income and payroll tax.
  • Interest received on the award or settlement will be taxable.
  • Awards to effectively punish the wrongdoer such as punitive damages are generally taxable even when paid as a result of a physical injury.
  • Payments for non-physical injuries (i.e. discrimination, wrongful termination, emotional distress not caused by physical injury, invasion of privacy, libel, harassment, etc.) will be taxable. Such amounts for emotional distress are not treated as a physical injury or physical sickness, except to the extent those damages attributable to the emotional distress were used to pay for medical care.
  • If part of your award is tax-free (i.e. physical injury) and the balance is taxable (i.e. interest, punitive damages, non-physical injury, etc.) the recipient is required to report the entire gross amount of the taxable portion of the award as taxable income. No reduction is made for the related legal fees. The proportionate attorney fees applicable to the taxable portion may be deducted as a miscellaneous itemized deduction (i.e. multiplying the total fees by a numerator of the taxable portion over the denominator of the total amount of the award or settlement). Unfortunately, such “miscellaneous itemized deductions” are only deductible in excess of 2% of Adjusted Gross Income (AGI) and they are completely disallowed for AMT (Alternative Minimum Tax) purposes. Thus, the injured person’s actual deduction for the attorney fees related to taxable awards may actually yield little or no tax benefit if their adjusted gross income exceeds approximately $180,000.
  • There are two noteworthy exceptions to this when part of your award is taxable and part is tax free. One is that legal fees will be deductible “above the line” as a Schedule C deduction when the lawsuit arises entirely from the taxpayer’s business. The second will occur for legal fees incurred in certain types of unlawful discrimination cases (i.e. whistleblower rights, civil rights, labor/employment rights, etc.). These can also be deducted “above the line” and not as a “miscellaneous itemized deduction” on schedule A.
  • Structured settlements for physical injury awards are where payments are received over a specified period of time rather than in a lump sum can escape taxation. If done properly, a structured settlement may convert “earnings” (imbedded accumulated interest) which otherwise might have been taxable to tax-free.

If you or your lawyer has any questions about the taxability of your lawsuit settlement call Gregory Spadea of Spadea & Associates, LLC in Ridley Park at 610-521-0604.

Filed Under: Tax Law Tagged With: , , , , , , ,

What Every Residential Landlord Should Know In Pennsylvania

November 12, 2012 by

Due Diligence in Screening Prospective Tenants
You should have the prospective tenants fill out a rental application and sign consents so you can request their credit report. Ensure the prospective tenants have stable employment and check their references by calling their current landlord. If the tenant does not have good credit, find out why. If the tenant has a reasonable explanation for not having good credit such as a divorce, get the tenant to have a cosigner who has good credit to sign the lease with them.

Have a Good Residential Lease
The lease is very important and should outline what each party can expect from the other party during the lease term. It should contain rules that the you expect the tenant to follow. The lease should explain what charges are paid by each party such as utilities, landscaping snow removal, etc.

The lease should address late charges and eviction procedures including how long you are required to store the tenant’s belongings that are left behind. The lease should include a clause regarding Act 215 so you can recover back rent through wage garnishment. It should also have the tenant waive the written notice to quit. The lease should require the tenant to pay landlord’s attorney fees if he is evicted. It should address the notice period each party must give to terminate the lease after the first year. The lease should require the tenant to provide pay stubs annually so you can verify their employment.

Security Deposit
I recommend you take pictures of the property before you rent it. Then walk the tenant through the rental property so the tenant can see there is no property damage. Then when the tenants move out if there is damage you can take a picture of the damage and provide the tenant with before and after photos so you can explain why you are taking their security deposit. You should always give your tenants a receipt if they pay the rent or security deposit in cash indicating the date and amount received.

Limiting your Liability
You should deposit the rent in a separate bank account and should have the rental property owned by a Limited Liability Company (LLC). If you do not want to pay the 2% transfer tax to transfer the property in the LLC’s name you should have a $1,000,000 umbrella policy in addition to a $300,000 liability policy on the rental property itself. You should require your tenants to have content coverage insurance so their contents can be replaced if there is a fire or other damage. You should require the tenant to provide you with the insurance policy declarations page on an annual basis.

If you have any questions or need a good lease feel free to call Gregory J. Spadea of Spadea & Associates, LLC in Ridley Park at 610-521-0604.

Filed Under: Real Estate, Uncategorized Tagged With: , , , , , , ,

Why I Should Form a Family Limited Partnership

November 12, 2012 by

Basic Strategy
The estate planning strategy employed by business owners is to gift limited partnership interests to family members at a discount based on their future business succession plan. This works well for succession planning because a business owner that has a successful LLC can gift the nonvoting LLC units to his children and out of his estate over time. The business owner acts as a general partner and his children are limited partners. In addition all the assets transferred to the Family Limited Partnership are protected from business creditors.

Gifting to the Limited Partnership
The general partner (business owner) can gift the limited partnership interests up to the annual exclusion of $13,000 in 2012 without filing a form 709 federal gift tax return. If the business owner wants to gift more than $13,000 per person he has to file a Form 709 return and may use part of his $5.12 million exemption in 2012. However, the value of the limited partnership shares or nonvoting LLC units may be discounted up to 30% due to their lack of marketability since there is no ready or available market to sell those shares on.

Tips on Surviving an IRS Challenge
In order for the Family Limited Partnership to survive a challenge by the Internal Revenue Service the general partner (business owner) must resist the temptation to maintain too much control over the partnership assets. The general partner should not pay personal expenses from the partnership bank account or comingle his personal funds with the partnership funds. The partnership should be operated as a separate entity and hold annual meetings to discuss management issues.

The partnership agreement should be drafted to

  1. avoid potential abuses by the general partner;
  2. address when distributions from the partnership bank account should be made;
  3. state at least three nontax reasons indicating why the partnership was formed such as:
    • To make a profit.
    • To increase the family’s wealth
    • To provide a means whereby family members can become more knowledgeable about the management and preservation of the family’s assets.*

If you have any questions about Family limited partnerships please call Gregory J. Spadea of Spadea & Associates, LLC in Ridley Park, PA at 610-521-0604.

*Estate of Turner, TC Memo 2011-209

Filed Under: Estate Planning, Uncategorized Tagged With: , , , ,

Exclusion Of Gain On The Sale of Your Small Business Stock

November 8, 2012 by

Checking stock data
If you are the founder or an employee of a technology, manufacturing, wholesale or retail company you may be able to exclude all or part the gain on sale of your company’s stock if you hold the stock for more than 5 years. The amount of the gain to be excluded depends on when the stock was issued.

Exclusion % If Stock was issued
50% After August 10, 1993 and before February 18, 2009.
75% After February 17, 2009 and before September 28, 2010.
100% After September 27, 2010 and before January 1, 2012.

For a stock to be considered qualified small business stock it must meet all of the following five conditions:

  1. The actual stock must be issued after August 10, 1993. Note that options to buy the stock are not considered stock for purposes of Section 1202.
  2. The stock must be acquired by purchase from the corporation or for the performance of services which means it cannot be acquired by gift or inheritance.
  3. The corporation must be an active business.
  4. The corporation cannot be involved in certain activities such as;
    • One involving services performed in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services;
    • One whose principal asset is the reputation or skill of one or more employees;
    • Any banking, insurance, financing, leasing, investing, or similar business;
    • Any farming business including the raising or harvesting of trees;
    • Any business involving the production of products for which percentage depletion can be claimed; or
    • Any business of operating a hotel, motel, restaurant, or similar business.
  5. The corporation’s gross assets before and after the issuance of stock cannot exceed $50 million.

Feel free to contact Gregory J. Spadea of Spadea & Associates, LLC in Ridley Park, PA at 610-521-0604 if you would like additional information on how to make the Section 1202 election.

Filed Under: Tax Law Tagged With: , , ,

What Should I Do If I Get Into An Auto Accident?

November 8, 2012 by

A rear-end car collision
If you are involved in an auto accident try to stay calm and take the following steps:

1. Turn off your vehicle’s engine and leave it where it is as long as it is in a safe place. If you feel threatened or are in danger of being hit by another car, drive your car to a well- lit area .
2. If you or anyone are hurt call 911 for an ambulance and wait in the car for help to arrive. Try to remain calm. You can provide medical aid to others only if you are trained to do so.
3. Evaluate the damage to your vehicle.
4. Call the Police to report the accident by dialing 911.
5. Do not say the accident was your fault even if you think it was and refrain from making any statements to the police. However you will need to provide your driver’s license, registration and insurance card to the police.
6. Ensure the police officer gets the license, registration and insurance card from the other driver if you have not already done so.
7. Write down the other driver’s license plate number.
8. Write the name, address and phone numbers of any witnesses that saw what happened.
9. Call your insurance company to report the accident but do not give a recorded statement unless your lawyer is present.
10. Call an auto repair shop approved by your insurance company and see if they will tow your car to their lot.
11. Do not sign any waivers that your insurance company will send you without having them reviewed by a lawyer.
12. If you were hurt in the accident contact Gregory Spadea at 610-521-0604, to file a personal injury claim within two years of the accident.

Feel free to use the Accident Report Form on my website and keep it in your glove compartment.

Filed Under: Personal Injury Tagged With: , , , ,

When Am I Subject to Gift Tax?

November 7, 2012 by

What is a Gift?

The IRS considers anything a gift that you give away forever and the recipient does not give you anything of value in return.  An example would be something you sell for less than fair market value.  Remember that only the donor is subject to the gift tax.  The recipient never pays gift or income tax on gifts received.

The gift tax was created so that taxpayers wouldn’t give away all of their wealth while they were alive as a way to avoid estate taxes after their death.

Four Exceptions to the Gift Tax

  1. You can give unlimited gifts to your spouse without being subjected to gift tax.
  2. You can give unlimited gifts to charitable organizations recognized by the IRS under code section 501(c).
  3. You can pay someone else’s medical bills as a gift, as long as the payments are made directly to a health care provider.
  4. You can also pay student’s tuition, as long as those payments are made directly to the educational institution.

Annual Gift Tax Exclusion and Gift Splitting

In 2013 you can give $14,000 per year to anyone without triggering gift tax. If you or your spouse makes a gift to anyone, the gift can be considered as made one-half by you and one-half by your spouse. This is known as gift splitting. Currently, gift splitting allows married couples to give up to $28,000 to a person without making a taxable gift. The annual exclusion was just increased to $14,000 in 2013, and is adjusted for inflation annually. The annual exclusion was 13,000 for tax years 2009 through 2012.

If you gift more than the annual exclusion in 2013 you have to file form 709 by April 15, 2014 and either use part of your $5.25 million gift and estate tax exemption amount or pay gift tax rates between 18% and 40% in 2013. Currently the highest federal estate tax rate is 40%.

Congress Made Portability of Your Spouses Unused Basic Exclusion Amount Permanent

If your spouse dies in 2013 without using up their $5.25 million basic exclusion amount you can transfer it to your estate by filing form 706. Note that you must file form 706 to transfer your spouse’s unused exemption even if your spouse owes no federal estate tax.

There are many reasons for gifting including reducing your federal taxable estate. If you have questions about gifting or federal estate tax, feel free to call Gregory J. Spadea at Spadea & Associates, LLC in Ridley Park, PA at 610-521-0604.

Filed Under: Tax Law Tagged With: , , , , , , ,

What Is Income In Respect To Decedent (IRD) Estate Tax Deduction?

November 5, 2012 by

Income In Respect To Decedent (IRD) Defined

Income in respect of a decedent (IRD) is income earned by the decedent (deceased person) prior to his death but was payable or paid after his death. Income in Respect to Decedent includes the taxable portions of annuities, traditional IRAs and tax deferred retirement plans, Series EE U.S. Savings Bonds, installment agreements, partnership income, rent, wages, bonuses and vacation time paid after death. It also includes interest and dividends earned on stocks, bonds or mutual funds in the decedent’s name while he was alive, but paid after his death.

How is IRD Reported

Often you will have to add the item to the final 1040 federal tax return of the decedent because the social security number on the tax document such as a W-2, 1099 or K-1 will be the decedent’s. Once the estate is probated the executor can retitle the retirement plans, EE U.S. Savings Bonds or other asset to the estate or beneficiaries name and tax identification number so it can be included on the return of the person or entity receiving the income.

If no beneficiary is named such as the surviving spouse, it passes to the estate, and passes by will. If the decedent did not have a will it passes by intestate law.

How Is IRD Taxed

IRD retains the same tax nature after death as it would have had if the decedent had received the item of income while alive. There is no step-up in basis for IRD items because the income was never taxed during the decedent’s life.

The IRD Estate Tax Deduction

One of the most missed deductions available to recipients of IRD is the federal estate tax deduction attributable to the IRD items. Since the amount was earned while the decedent was alive and owed to the decedent at the date of death, it is an asset of the estate. If the estate owes federal estate tax, some of it is attributable to the IRD items. When the ultimate recipient receives the items of IRD, the recipient must include these in income and pay income tax on their respective federal 1040 tax return in the year received. Thus items of IRD are potentially taxed twice, once on the federal 706 Estate Tax return and again on the recipient’s federal 1040 tax return.

The IRD estate tax deduction is calculated by re-computing the 706 without any of the items of IRD, then subtracting this number from the true federal estate transfer tax bill which includes the IRD items. This difference is the estate tax due to the IRD items. A proportionate amount of this may be deducted on the recipient’s 1040 federal tax return, by the recipient as they realize the income from the IRD item. For example, someone collecting from a deceased person’s 401(k) or traditional IRA would have a deduction of the federal estate tax on that portion of the decedent’s assets, recovered over time in the year the income was received.

If you have any questions about IRD feel free to call Gregory J. Spadea at Spadea & Associates, LLC in Ridley Park, Pennsylvania at 610-521-0604.

Filed Under: Uncategorized Tagged With: , , , ,

What Are The Duties Of A Trustee?

November 5, 2012 by

Financial Advisor Talking To Senior Couple
A trustee is a person or entity who administers a trust for the benefit of a beneficiary according to the instructions established by the trust maker in the trust document. A trustee should be patient, organized, detail oriented, honest and have the ability to make unbiased decisions with regard to the trust beneficiaries.

Every trustee has the following duties:

1. Duty to Administer the Trust based on the Trust Documents – the trust is your road map and you must follow its directions, whether about when and how to distribute income and principal or what reports you need to make to beneficiaries.

2. Duty of Loyalty to all the Trust Beneficiaries – you have a fiduciary duty to the trust beneficiaries including the current beneficiaries as well as any future or contingent beneficiaries to safeguard and preserve trust property and keep the beneficiaries informed.

3. Duty to Keep and Render Accounts – to keep track of all income to, distributions from, and expenditures by the trust. Generally, you must give an account of this information to the beneficiaries on an annual basis. In strict trust accounting, you must keep track of and report on principal and income separately.

4. Duty to Exercise Reasonable Care especially regarding investment standards – your investments must be prudent, meaning that you cannot place money in speculative or risky investments. In addition, your investments must take into account the interests of both current and future beneficiaries.

5. Duty to Enforce Claims of the Trust and Defend Actions Against the Trust – you would be responsible for hiring legal counsel.

6. Duty to Keep Trust Property Separate from your own Assets – you should have a separate trust bank account using the trust Employer identification Number (EIN) since the trust is a separate entity from the trustee and beneficiaries.

7. Duty Not to Delegate your Responsibility as a Trustee – however if you feel you can no longer serve as trustee you should resign after an alternate trustee is appointed.

As you can see from all the duties listed above being a trustee is an awesome responsibility. The trustee has full legal responsibility and legal liability for trust administration, filing the trust annual federal and state income tax returns, and making distributions in compliance with the trust documents. Therefore it is very important to select a professional trustee that has the experience and resources to handle all the details and duties listed above. Feel free to contact Gregory J. Spadea at Spadea & Associates, LLC in Ridley Park, PA at 610-521-0604 to see how he can help you fulfill your responsibilities as Trustee or act as a co-trustee with you.

Filed Under: Estate Planning Tagged With: , , , ,

What Should an LLC Member or Manager Do at Quarterly Meetings?

November 5, 2012 by

Businesspeople in conference room

Unlike a corporation, the observance of “corporate formalities” is not an important part of maintaining the shield from liability and other protections and advantages offered by the LLC form of doing business. The term “corporate formalities” normally means holding annual meetings of the members, providing written notice in advance of such meetings, preparing detailed minutes of matters decided upon at such meetings, and so forth. The Pennsylvania Act indicates that failure to observe such corporate formalities shall not be considered a factor tending to establish that the members have personal liability for any debt, obligation, or liability of the LLC where the Certificate of Organization or Operating Agreement of the LLC do not specifically require such formalities to be observed. However, this does not mean that LLC members are completely free to ignore the separate legal identity of the LLC. For example, members must always keep in mind that the LLC assets and funds are owned by the LLC, not by the LLC’s members. Separation of LLC assets from members personal assets is very important. It is also important for the members not to pay personal expenses from the LLC funds or bank accounts.

A. Member Votes. Certain fundamental changes in the life of an LLC, such as a merger or liquidation, require a vote by the members. These fundamental changes include amendment of the Certificate of Organization, amendment of the Operating Agreement, merger or consolidation of the LLC, and winding up and dissolution of the LLC.

B. Manager Action. Matters of general operating policy should be considered and authorized by the general manager or managers of the LLC. Although there is no statutory requirement with respect to how frequently the managers should act, it is advisable that they meet at least quarterly. In addition, a specially convened meeting of the managers may be called if action is required before the next regular meeting. Action by the managers may also be taken by unanimous written consent. The managers can vote without a formal meeting but if a significant matter is being voted on it may prove useful to schedule regular managers’ meetings to address it on a quarterly or at least annual basis.

Matters appropriate for manager action that can be immediately approved by written consent or voted on at a meeting, include the following:

1. Appointment of officers, setting of salaries, and declaration of bonuses (at least annually, typically at a meeting of the managers immediately following the annual meeting of members).
2. Opening or closing of LLC bank accounts and the designation and change of LLC managers and officers authorized as signatories. The signing member should secure a copy of the signature card from the bank and place it in the LLC binder.
3. LLC borrowing or loan agreements and delivery of collateral in connection with such agreements.
4. Consummation of material contracts for the purchase or lease of significant assets or services such as the hiring of a payroll service or the purchase of health insurance.
5. The adoption of 401K or SIMPLE IRA pension plans, profit-sharing plans, bonus, and other employee benefit plans.
6. Amendment of LLC bylaws (if any).
7. Review of financial statements and tax returns of the LLC.
8. Appointment of auditors, if any.
9. Any action that requires a member vote listed in the Operating Agreement.
10. The issuance and sale by the LLC of additional interests in the LLC or the repurchase of LLC units by the LLC or members.

In the case of any such actions listed above, the Managing Member of the LLC should prepare minutes of the meeting and indicate what actions were approved or prepare the form of written consent evidencing any such manager or member actions.

If you have any questions about your LLC feel free to call Gregory J. Spadea of Spadea & Associates, LLC in Ridley Park at 610-521-0604.

Filed Under: Business Law Tagged With: , , , , ,

When Can I Deduct Alimony on my Federal Tax Return?

November 5, 2012 by

Tax return paper
When divorce occurs, one ex-spouse is often obligated to make continuing payments to the other spouse. However for the payments to be deducted by the payer, they must meet the tax-law definition of alimony.

For any particular payment to qualify as deductible alimony for federal income tax purposes and meet the tax law definition of alimony, all the following requirements must be met:

1. The payment must be made pursuant to a written divorce decree or separation instrument such as a temporary support order.
Note that payments made in advance of signing a written divorce or separation instrument or before the effective date of a court order or decree cannot be deductible alimony. Such payments are considered voluntary and are therefore nondeductible. The same is true for payment of amounts in excess of what is required under a written divorce decree or separation instrument.

2. The payment must be to or on behalf of a spouse or ex-spouse. Therefore, payments to third parties, such as attorneys and mortgage companies, are okay if made on behalf of a spouse or ex-spouse and pursuant to a divorce decree or separation instrument.

3. The divorce decree or separation instrument must state the payments are alimony.

4. After divorce or legal separation (meaning the couple is considered divorced for federal income tax purposes), the ex-spouses cannot live in the same household or file a joint return for the year they separated or thereafter.

5. The payment must be made in cash or cash equivalent such as check or money order.

6. The payment cannot be fixed or deemed child support in the divorce decree.
Fixed child support simply refers to amounts designated as such in the divorce or separation instrument, so it’s easy to identify. Payments are considered to be deemed child support if they are terminated or reduced by any of the following so-called contingencies relating to a child:

a. Attaining the age 18, or the local age of majority.
b. Death.
c. Marriage.
d. Completion of schooling.
e. Leaving the ex-spouse’s household.
f. Attaining a specified income level.

7. The payer’s return is required to include the recipient’s social security number.

8. The obligation to make payments (other than payment of delinquent amounts) must cease if the recipient party dies. If the divorce decree is unclear about whether or not payments must continue, state law controls. If under state law, the payer must continue to make payments after the recipient’s death, the payments cannot be alimony. Therefore, to avoid problems, the divorce decree should always explicitly stipulate whether a payment obligation continues to exist after the death of the recipient party. Failing this test is probably the most common cause for lost alimony deductions.

What happens when payments to an ex-spouse fail to meet the tax-law definition of alimony? They are generally treated as either child support payments or as payments to divide the marital property (equitable distribution). Both types of payments are nondeductible personal expenses for the payer and tax-free income for the recipient.

Since payments to ex-spouses are often substantial, the issue of whether the payer can deduct them is often substantial too. Therefore, it is very important to consult a tax attorney like Gregory J. Spadea before signing the divorce decree. You can reach him at Spadea & Associates, LLC in Ridley Park at 610-521-0604.

Filed Under: Family Law Tagged With: , , , , ,

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