| Cell: 415 308-0678 Fax: 415 704-3238 Lee@RileyAccounting.net 1001 Bridgeway, #229 Sausalito, CA 94965 Conference room locations; San Francisco Directions Map Sausalito Directions Map San Mateo Directions Map Larkspur Directions Map Walnut Creek Directions Map |
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| Robert Lee Riley CPA, MBA-tax |
| Riley Accounting |
| Unmarried Partners, LGBT, Registered Domestic Partners Lee has been serving the LGBT community for over twenty five years, and has an understanding not only of the opportunities, but also the challenges, particularly in structuring tax, business, real estate, and estate planning for our gay and lesbian clients. Registered Domestic Partners are now required to file tax returns jointly in California, and will generally file separately for the IRS. This requires a good accounting, and document management system. You also face tax issues with joint bank accounts, implied gifts, and allocations of tax deductions such as mortgage interest. There is a special emphasis on taking the time to educate our clients. My approach is to have each partner maintain a separate accounting system, preferably QuickBooks. Then I can help structure the tax issues, especially when real estate is involved. I use a team-work approach for; life insurance, wills, powers of attorney, home-owners insurance, joint property ownership, etc. Basic Accounting Issues ...it is especially important for unmarried couples to have a good accounting system. I recommend using my super-simple pre-configured QuickBooks template file for this. The issues become especially apparent, when real estate ownership is involved, and, deductions are taken on separate tax returns. Tax Issues ...in California, Registered Domestic Partners are generally required to file jointly for California, and separately for the IRS. As a general rule, filing "Married" Separately, in California, often results in increased tax liabilities. CA Registered Domestic Partners (RDPs) Google: California 737 to see the State of California Tax Publication on Registered Domestic Partners There are 2 choices for filing status . Married filing jointly / married filing seperately . Methods to file RDP No - RDP adjustments (4 returns) Yes - RDP adjustments (2 returns) Must file Declaration of Domestic Partnership with CA Sectretary of State . Must be - same sex, or over 62 . Must have common residence . Must not be otherwise related. Financial Planning Issues For gay and lesbian baby boomer couples, in a committed relationship, the two most important aspects of financial planning involve securing a will and a power of attorney. A power of attorney allows a partner to make decisions and act in the event the other partner becomes mentally incapacitated. A will ensures that the deceased partner's wishes are carried out. Beyond these two important components of financial planning, gay and lesbian couples need to carefully think about a number of other issues, such as beneficiary designations, joint property ownership, tax planning, and record keeping. Many couples have difficulty talking about money. That's where a financial planner can come in handy. A financial planner can serve as a neutral moderator, who can help both partners come to an agreement on financial issues that are too difficult to discuss at home. A couple should set specific goals (home ownership, vacation property, college education, retirement, etc.), review how they're using various financial tools, and decide jointly how they'll merge their finances and make future financial decisions. Maintain separate records. Because gay and lesbian couples must file separate federal individual tax returns, and joint state tax returns, it's essential that each partner maintain accurate records year-round. For example, if, as a couple, you actively make contributions to a charitable cause, think ahead about who will use that contribution to lower their overall tax bill. Get life insurance. If you and your partner are relying heavily on a defined benefit retirement plan through your current employer and/or Social Security, know that not all organizations allow a gay partner to be treated as a surviving spouse under the current law. The Social Security Administration only extends a deceased person's Social Security benefits to a married spouse. This could leave the surviving partner without sufficient resources. Life insurance (where your partner is the beneficiary) may be the way to plan for this contingency. In addition, if one partner owns a home and the other partner lives there (without paying rent), either the home-owning partner should extend their property and liability insurance to cover their partner, or the non-home owning partner should obtain insurance to cover their own property and liability. When a mate in a heterosexual relationship becomes ill, faces a medical crisis or dies, decisions are made by the legal spouse and closest kin, such as an adult child or parent. But for gay or lesbian people in a committed relationship, the law does not assume the same. A partner may find him or herself barred from making life decisions on behalf of a partner in favor of a parent or sibling. To avoid this, it's important that gay and lesbian couples obtain a number of documents -- while they're healthy. These documents include a durable power of attorney for health care decisions, a durable power of attorney for financial decisions, a living will, and a last will and testament. For help obtaining these documents, see an attorney. Because of beneficiary issues related to life insurance and Social Security, it's critical for baby boomer couples to contribute the maximum amount to traditional retirement vehicles, such as 401 (k)s, 403 (b)s, and IRAs. As you near the time to begin withdrawing funds from these vehicles, develop a disciplined withdrawal schedule that protects both partners in the event that one or the other dies prematurely. Develop a support network. Many heterosexual couples rely on children and family members to assist them as they become older. Gay and lesbian couples may lack that family-like structure as they become older and need help. Therefore, it's important for gay and lesbian couples to factor in to their retirement plan the additional expense that may be incurred to hire help -- even for traditional day-to-day household chores. Make it joint. To ensure that your partner has enough money, a home and a car, in the event of an untimely death, gay and lesbian couples in committed relationships should consider changing ownership of property from sole to joint ownership, with the right of survivorship going to your partner. Start saving for college. Increasingly, gay and lesbian relationships are blossoming into full-fledged families. In some cases children come from previous heterosexual relationships in which a partner was involved. In other cases, gay and lesbian couples are successfully adopting children. Regardless, gay and lesbian parents should begin saving as early as possible to accumulate funds for college education needs. Life Insurance Issues One option is to place the life insurance in an irrevocable life insurance trust where the trust is the owner and beneficiary of the policy and the non-grantor partner is the trustee. The grantor can pay premiums on the policy with present-value gifts to the trust. This strategy removes the death benefit from the taxable estate of the decedent but must be handled with care, as placing the life insurance in an irrevocable trust is irrevocable and may become problematic in the event of a breakup. A potentially more flexible and simple alternative is to structure cross-ownership of policies whereby each partner is the owner and beneficiary of a life insurance policy on the other. This allows the death benefit of the policy to avoid inclusion in the decedent’s gross estate for estate tax calculation purposes. If a breakup occurs in this scenario, ownership can be transferred back to the insured partner with little difficulty. This transfer-of-ownership stipulation should be outlined in an agreement (drafted by an attorney) to avoid any conflicts and provide an easy transition of property in the event of a split. Be knowledgeable of transfer for value rules, the Goodman rule,11 and that there are no divorce protections in most states. Assuming a life insurance option is desirable, the next challenge is to actually obtain a policy. This often requires additional work for gay and lesbian couples in comparison with married couples. Because gay and lesbian couples are considered “strangers” in the eyes of the law, insurable interest is not automatically granted or inherent, as it is for married couples. As a result, to issue a life insurance policy insurance companies often require additional documentation to illustrate an insurable interest. Depending on the insurance company, a letter from the advisor explaining the nature of the relationship may suffice. Other companies may require greater proof such as bills or a mortgage statement showing mutual insurable interest. Asset Ownership and Titling When it comes to the distribution of a same-sex couple’s joint estate, proper titling, ownership, and organization of assets is very valuable. Depending on applicable state law, same-sex partners can avoid probate by setting up joint banking or brokerage accounts. This strategy has its pitfalls, however, as it may create the potential for unintended gifts or inadvertently inflate the estate of the first owner to die, possibly resulting in an increase in taxation on assets left to a survivor. With jointly owned accounts, gifts occur not when money is deposited into an account, but rather when assets are withdrawn from the joint account. Often with gay and lesbian couples, there is one party that earns more than the other. If contributions to the accounts are not equal, tax could be levied on the excess of contributions that are beyond the annual gift exclusion for the year in which withdrawals are made ($12,000 in 2008). If either partner’s withdrawal exceeds this amount, a gift tax return may need to be filed. As a failsafe, the lifetime gift exemption is available; however, use of the lifetime exemption often makes more sense with partners where there is a large disproportion in accumulated assets or where there are highly appreciating assets in one partner’s estate. One example of an ideal application of the lifetime gift exemption entails making a present-value gift of highly appreciated or other income-producing assets to a common-law grantor retained income trust (GRIT). This is one strategy same-sex couples can take advantage of in a way that married or related parties cannot. In 1989, Congress prohibited the use of common-law GRITs for the transfer of assets to members of a family. A GRIT is an irrevocable trust, whereby the grantor places assets such as a residence, business, or other income-producing asset in a trust for a period of years. The grantor retains the rights to the income produced from the trust. Upon expiration of the trust, the assets are distributed to the beneficiary of the trust. The benefit of the GRIT is that assets placed in a GRIT are valued at a discount for federal estate tax purposes.13 A gift-tax return must be filed acknowledging use of the lifetime gift exemption in order to avoid tax on the present value of the gift. For more details of how GRITs work in this type of arrangement, see the August 2004 article in this journal by Jon Gallo titled “Unique Estate Planning Opportunities for Gay and Lesbian Couples.” With real property titled as joint tenants with right of survivorship (JWROS), a gift can occur at inception of the purchase if the parties contribute disproportionate amounts for a down payment and the contribution difference between the parties exceeds the annual gift exclusion assuming the lifetime gift exclusion is not used. A gift also can be triggered upon paying down the mortgage note on the property if one party contributes an amount above his or her pro rata obligation that exceeds the annual gift exclusion assuming the lifetime gift exclusion is not used Cumbersome Entanglements To make a cumbersome entanglement of assets even more complex, when assets (including real property) are titled JWROS, the Internal Revenue Service will assume that the entire underlying asset values are included in the gross estate of the first to die, unless contributions can be proved. This estate inflation may trigger a major federal or state estate tax liability for the survivor if the taxable estate exceeds the respective exclusion amounts. With jointly held accounts, proving contributions may be cumbersome or difficult as accurate records over time may not be maintained or are lost. Another issue with jointly titled accounts is that the person listed first on the account is usually considered the primary account holder by most financial institutions. As a result, the primary’s Social Security number is likely to be used for income tax reporting purposes. The primary owner will receive the 1099 tax form for the interest and dividends received on the joint account. Since contributions to an account may be equal and because same-sex couples are not permitted to file joint federal tax returns, a primary account holder may need to make a nominee distribution and issue a 1099 to the other account holder in order to apportion the interest and dividends equitably. This becomes an even greater issue if one of the account owners is a high-income earner, as the issuance of a 1099 to correct the taxation of the portion of distribution belonging to a partner may raise an IRS-audit red flag. Finally, titling accounts jointly leaves those assets vulnerable to be attached in a lawsuit (tenancy by the entirety, which avoids creditor attachment, is only allowed for married couples) and potential misuse of joint funds by a partner. As a result of the issues outlined above, it often may make sense to separate jointly held assets by placing them in separate revocable trust accounts (which also controls distribution of the assets held in trust), or more easily through a Totten trust, also known as transfer or payable-on-death accounts (TOD or POD). The beneficiary of these trusts can be easily changed at any point if there is a change in the relationship. Moving assets from jointly held accounts to individual/trust accounts (pro rata based on ownership) ought not to create a taxable event, as no sale of the underlying assets is necessary. In the case of real property, the deed on a residence can be re-titled to tenants in common with the two partners’ respective revocable trusts as owners to reflect disproportionate contributions or note payments. It is important, however, to research whether transfer taxes will be owed with re-titling The partners may want to speak to an attorney about a domestic partnership or cohabitation agreement because of their inability to marry. A partnership or cohabitation agreement spells out how to handle a variety of issues in a relationship. For example, it could outline who owned what piece of property before entering the relationship, how expenses are to be handled, how income earned while in the relationship will be handled, and how finances and purchasing decisions will be made. In addition, the document could define the terms of a potential breakup and how all the assets, such as life insurance, would be partitioned. It also should make provisions for a determination of how real estate would be valued, which is often the largest single asset a couple may own. Once again, it is important to note that not all states may recognize the validity of a partnership agreement. Even worse, most states have no laws relating to same-sex couple divorce, so there are no protections available. Employee Retirement Plans Employee retirement plans are also an issue of concern. The plan documents outlining the policies and procedures for employer-provided retirement plans like 401(k)s typically require nonspousal beneficiaries to take the distribution in a lump sum upon the death of a plan participant.21 This has the potential to push the surviving partner into a higher tax bracket and result in a much smaller remainder of the inherited asset. The passage of the Pension Protection Act of 2006 directly addressed this tax issue. Specifically, the act allows beneficiaries to open an IRA after the death of the participant (they have until the last day of the calendar year following the year of death) and stretch the income (and resulting taxation) over their lifetimes. But in January of 2007 the IRS issued notice 2007-7, giving employers the option of deciding whether to amend their retirement plan documents. At the time of this writing, by leaving assets in an old retirement plan, participants still retain a very real risk of having their partner (as beneficiary) receive a lump-sum distribution and incur a much larger tax bill than is otherwise necessary. Unless you are certain that a plan document has been modified to reflect the new changes, assets should be consolidated and rolled over to an individual retirement account upon departure from an employer. These assets, when moved to an IRA following separation from employment, may be “stretched” according to IRS rules over the life expectancy of the designated IRA beneficiary. Some companies, as outlined in their retirement plan documents, may offer the ability to transfer 401(k)-type assets to an IRA while an individual is still employed, also known as an in-service 401(k)-to-IRA rollover. An advisor will want to determine if this is available. This option may provide greater flexibility in the event of an unexpected death and eliminate uncertainty as to whether provisions from the Pension Protect Act have been adopted. It is critical to review the rules of the rollover to ensure that it is performed correctly and in accordance with IRS regulations. |