Small Estates “Portability” Election Deadline is December 31, 2014

Portability Election Deadline – December 31, 2014

On Jan. 27, 2014, the IRS issued Revenue Procedure 2014-18, which provides an automatic extension for certain taxpayers to elect “Portability” of the “Deceased Spousal Unused Exclusion” (DSUE). Many Executors did not realize that the “Portability Election” had to be made on a timely filed Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The new procedure is available if the decedent was a U.S. citizen or resident who died after Dec. 31, 2010, and before Jan. 1, 2014, and the value of the estate did not require filing Form 706 – $5 Million for 2011 deaths; $5.12 Million for 2012 deaths; $5.25 Million for 2013 Deaths. For qualifying estates, the Portability Election can be made by filing Form 706 on or before Dec. 31, 2014.

With Portability, the DSUE may be transferred to a decedent’s surviving spouse and applied with the surviving spouse’s own Applicable Exclusion to transfers during the surviving spouse’s life and at death.

EXAMPLE: Husband and Wife are married United States citizens with all their assets titled as “Joint Tenants With Right Of Survivorship” (JTWROS), and their combined net worth is $10 million. Husband died in 2013, when the Estate Tax Applicable Exclusion was $5,250,000.

  1. Husband’s estate did not need to use any of his $5,250,000 Estate Tax Applicable Exclusion since all of the assets are JTWROS and the Unlimited Marital Deduction applies without incurring any federal estate taxes.
  2. Wife dies in 2014, when the Estate Tax Applicable Exclusion is $5,340,000 and the net worth of her estate remains $10 million. With Portability, Husband’s DSUE of $5,250,000 is added to Wife’s $5,340,000 Applicable Exclusion, giving Wife a $10,590,000 Applicable Exclusion and, thus, no liability for federal estate tax.

Without Portability – if Husband’s estate had not made a proper Portability Election on a timely filed Form 706, Husband’s DSUE would have been lost, and Wife would have a taxable estate of $4,660,000 ($10 million ‒ $5,340,000) and federal estate tax of $1,864,000 at the current 40% rate.

“IC-DISC” – Offers Tax Savings for Exporters

“IC-DISC” Offers Tax Savings for Exporters

If your Company earns significant income from exporting United States domestic-made products—or from engineering or architectural services on foreign construction projects—you may be eligible to form, and you should consider forming, an “Interest Charge – Domestic International Sales Corporation” (IC-DISC).

Due to its status as an IC-DISC, the IC-DISC pays NO Federal Income Taxes and reduces the Exporter’s tax liability by effectively converting a portion of the Exporter’s net export income, which is taxable at ordinary income rates as high as 40.5 percent (39.6& plus 0.9% Medicare Surtax), into qualified dividends generally taxed at 23.8 percent (20% plus 3.8% Tax on Net Investment Income).

An IC-DISC’s tax benefits are not retroactive, but rather prospective only. The tax benefits are available only for export sales made after the IC-DISC is established.

What is an IC-DISC?

A domestic “C” corporation must request and receive IRS approval to be treated as an IC-DISC for federal tax purposes. It also must maintain its own bank account, keep separate accounting records, and file United States tax returns. But it need not have an office, employees, or tangible assets, nor is it required to perform any invoicing or provide services.

Due to its status as an IC-DISC, the IC-DISC pays NO Federal Income Taxes and reduces the Related Exporter’s tax liability by effectively converting a portion of the Related Exporter’s net export income, which is taxable at ordinary income rates as high as 40.5 percent (39.6& plus 0.9% Medicare Surtax), into qualified dividends generally taxed at 23.8 percent (20% plus 3.8% Tax on Net Investment Income).

To qualify as an IC-DISC, a corporation must also:

  • Be incorporated in one of the 50 states or in the District of Columbia,
  • File an election with and receive approval from the IRS to be treated as an IC-DISC for federal tax purposes,
  • Maintain a bank account,
  • Maintain a minimum capitalization of $2,500 of authorized and issued shares,
  • Have only a single class of stock, and
  • Meet an annual qualified export receipts test and a qualified export assets test. This last requirement means that at least 95 percent of an IC-DISC’s gross receipts and assets must be related to the export of property whose value is at least 50 percent attributable to United States domestic-produced content.

How Does an IC-DISC Work?

           Since the “C” corporation qualifies as an IC-DISC, it is presumed to have participated in the export sales activity, and due to that participation, it is entitled to earn a commission. Your Company (the Related Exporter) is then allowed to pay tax-deductible commissions to the IC-DISC, which are equal to the greater of (i) 4 percent of your Company’s gross receipts from Qualified Exports, or (ii) 50 percent of your Company’s net income from Qualified Exports. Your Company’s taxable income is reduced by the amount of the commissions paid to the IC-DISC and such commissions are deductible against ordinary income.

The IC-DISC, as a tax-exempt entity, pays no federal tax on the commission income. When the IC-DISC distributes its income to its shareholders, their dividend income is taxed at the qualified dividend rate of 20 percent (plus 3.8% Tax on Net Investment Income). The qualified dividend rate is available only to individuals; thus, you’ll need to structure the ownership of the IC-DISC so that the IC-DISC dividends are considered to be received by individuals.

If your Company is a pass-through entity—such as a partnership, S corporation, or LLC—you can form an IC-DISC as a subsidiary. Dividends that the IC-DISC distributes to your Company will retain their character and be passed through to individual shareholders and qualify for the 20 percent rate.

            If your Related Exporter company is a “C” corporation, however, you will need to have the corporation’s individual shareholders form the IC-DISC as a brother-sister corporation in order to obtain the lower tax rate on qualified dividends. If you set up the IC-DISC as a subsidiary instead, the dividends will be paid to the Related Exporter “C” corporation and taxed at regular corporate income tax rates – therefore, no tax savings.

An IC-DISC Calculation Example

EXAMPLE: A Related Exporter is an “S” corporation has $10 million in qualifying export sales and $1 million in net export income on those sales. If the Related Exporter has an IC-DISC subsidiary, it can pay commissions to the IC-DISC equal to the greater of 50 percent of its export net income or 4 percent of its export gross receipts. In this case, the maximum commission is 50 percent of net income, or $500,000.

The IC-DISC distributes the entire $500,000 of commission income as a qualified dividend to its sole shareholder, the Related Exporter “S” Corporation. The consequences are as follows:

  • The Related Exporter “S” corporation incurs an ordinary tax deduction of $500,000 for the commission paid to the IC-DISC.
  • The IC-DISC receives $500,000 of nontaxable commission income.
  • The IC-DISC pays a qualified dividend to the Related Exporter “S” corporation of $500,000, which also flows through the Related Exporter “S” corporation to its individual shareholders.
  • The Related Exporter “S” corporation shareholders pay 23.8 percent federal income tax on the IC-DISC qualified dividend income.
  • The IC-DISC net tax savings is $83,500.

Offers In Compromise

An Offer In Compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s tax liabilities for less than the full amount owed. If the liabilities can be fully paid through an Installment Payment Agreement or other means, the taxpayer will in most cases not be eligible for an OIC. In order to be eligible for an OIC, the taxpayer must have filed all tax returns, made all required estimated tax payments for the current year and made all required federal tax deposits for the current quarter if the taxpayer is a business owner with employees.

In most cases, the IRS will not accept an OIC unless the amount offered by the taxpayer is equal to or greater than the Reasonable Collection Potential (the RCP). The RCP is how the IRS measures the taxpayer’s ability to pay. The RCP includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated Future Income, less certain amounts allowed for basic living expenses.

The IRS may accept an OIC based on Three (3) grounds.

  • FIRST, acceptance is permitted if there is Doubt As To Liability (DATL). This ground is only met when there is a genuine dispute as to the existence or amount of the correct tax debt under the law.
  • SECOND, acceptance is permitted if there is doubt that the amount owed is fully collectible. Doubt As To Collectibility (DATC) exists in any case where the taxpayer’s assets and income are less than the full amount of the tax liability.
  • THIRD, acceptance is permitted based on Effective Tax Administration (ETA). An offer may be accepted based on Effective Tax Administration when there is no doubt that the tax is legally owed and that the full amount owed can be collected, but requiring payment in full would either create an Economic Hardship or would be unfair and inequitable because of Exceptional Circumstances.

When submitting an OIC based on Doubt As To Collectibility (DATC) or based on Effective Tax Administration (ETA), taxpayers must use the most current version of Form 656, Offer in Compromise, and also submit Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B (OIC), Collection Information Statement for Businesses. A taxpayer submitting an OIC based on Doubt As To Liability (DATL) must file a Form 656-L, Offer in Compromise (Doubt as to Liability), instead of Form 656 and Form 433-A (OIC) and/or Form 433-B (OIC).

In general, a taxpayer must submit a $186 application fee with the Form 656. Do not combine this fee with any other tax payments. There are, however, two exceptions to this requirement.

  • First, no application fee is required if the OIC is based on Doubt As To Liability (DATL).
  • Second, the fee is not required if the taxpayer is an individual (not a corporation, partnership, or other entity) who qualifies for the low-income exception. This exception applies if the taxpayer’s total monthly income falls at or below 250 percent of the poverty guidelines.

Taxpayers may choose to pay the Offer Amount in a Lump Sum or in Installment Payments. A “Lump Sum Offer” is defined as an offer payable in five (5) or fewer installments within five (5) or fewer months after the Offer is accepted. If a taxpayer submits a Lump Sum Offer, the taxpayer must include with the Form 656 a nonrefundable payment equal to twenty percent (20%) of the Offer Amount. This payment is required in addition to the $186 application fee. The twenty percent (20%) payment is “nonrefundable” meaning it will not be returned to the taxpayer even if the Offer is rejected or returned to the taxpayer without acceptance. Instead, the twenty percent (20%) payment will be applied to the taxpayer’s tax liability. The taxpayer has a right to specify the particular tax liability to which the IRS will apply the twenty percent (20%) payment.

An Offer is called a “Periodic Payment Offer” under the tax law if it is payable in six (6) or more monthly installments and within twenty-four (24) months after the Offer is accepted. When submitting a Periodic Payment Offer, the taxpayer must include the first (1st) proposed installment payment along with the Form 656. This payment is required in addition to the $186 application fee. This amount is nonrefundable, just like the twenty percent (20%) payment required for a Lump Sum Offer. Also, while the IRS is evaluating a Periodic Payment Offer, the taxpayer must continue to make the installment payments provided for under the terms of the Offer. These amounts are also nonrefundable. These amounts are applied to the tax liabilities and the taxpayer has a right to specify the particular tax liabilities to which the periodic payments will be applied.

Ordinarily, the statutory time within which the IRS may engage in collection activities is suspended during the period that the OIC is under consideration and is further suspended if the OIC is rejected by the IRS and where the taxpayer appeals the rejection to the IRS Office of Appeals within thirty (30) days from the date of the Notice of Rejection.

If the IRS accepts the taxpayer’s offer, the IRS expects that the taxpayer will have no further delinquencies and will fully comply with the tax laws. If the taxpayer does not abide by all the terms and conditions of the OIC, the IRS may determine that the OIC is in default. For Doubt As To Collectibility (DATC) and Effective Tax Administration (ETA) OICs, the terms and conditions include a requirement that the taxpayer timely file all tax returns and timely pay all taxes for five (5) years from the date of acceptance of the OIC. When an OIC is declared to be in default, the agreement is no longer in effect and the IRS may then collect the amounts originally owed (less payments made), plus interest and penalties. Additionally, any refunds due within the calendar year in which the Offer is accepted will be applied to the tax debt.

If the IRS rejects an OIC, the taxpayer will be notified by mail. The letter will explain the reason that the IRS rejected the Offer and will provide detailed instructions on how the taxpayer may appeal the decision to the IRS Office of Appeals The appeal must be made within thirty (30) days from the date of the letter. In some cases, an OIC is returned to the taxpayer, rather than rejected, because the taxpayer has not submitted necessary information, has filed for bankruptcy, has failed to include a required application fee or nonrefundable payment with the Offer, or has failed to file tax returns or pay current tax liabilities while the Offer is under consideration. A Return is different from a Rejection because there is no Right to Appeal the IRS’s decision to Return the Offer.

The IRS Collection Process

If you do not pay in full when you file your tax return, you will receive written Notice of the amount you owe, a Bill from the IRS. This Bill starts the IRS Collection Process, which continues until your account is satisfied or until the IRS may no longer legally collect the tax; for example, when the time period for collection has expired.

The First Notice you receive from the IRS will be a Letter that explains the balance due and demands payment in full. It will include the amount of the tax, plus any penalties and interest added to your unpaid balance from the date the tax was due.

If you are unable to immediately pay your balance in full, the IRS, upon request, may be able to offer you a monthly Installment Payment Agreement. If you cannot full pay under an Installment Payment Agreement, you may propose an Offer in Compromise (OIC). An OIC is an agreement between a taxpayer and the IRS that resolves the taxpayer’s tax liability by payment of an agreed upon reduced amount.

If you are unable to pay anything because of a current financial hardship, the IRS may temporarily suspend certain collection actions, such as issuing a levy, until your financial condition improves. The IRS may, however, file a Notice of Federal Tax Lien while your account is suspended. Interest and late payment penalties will continue to accrue while collection is suspended. If you are a member of the Armed Forces, you may be able to defer payment.

It is important to contact the IRS and make arrangements to pay the tax due voluntarily. If you do not contact the IRS, the IRS may take action to collect the liability. Some of the actions the IRS may take to collect taxes include:

  1. Filing a Notice of Federal Tax Lien
  2. Serving a Notice of Levy, or
  3. Offsetting a Refund to which you are entitled

The Federal Tax Lien is a legal claim to your property, including property that you acquire after the Lien arises. The Federal Tax Lien arises automatically when you fail to pay in full the taxes you owe within ten (10) days after the IRS sends its First Notice of taxes owed and demand for payment, and the IRS makes an Assessment of the tax. The IRS also may file a Notice of Federal Tax Lien in the public records. The Notice of Federal Tax Lien publicly notifies your creditors that the IRS has a claim against all your property, including property acquired by you after the Notice of Federal Tax Lien is filed. The filing of a Notice of Federal Tax Lien may appear on your credit report and may harm your credit rating. Once a Lien arises, the IRS generally cannot release the Lien until the taxes, penalties, interest, and recording fees are paid in full or until the IRS may no longer legally collect the tax.

The IRS will withdraw a Notice of Federal Tax Lien if the Notice was filed while a bankruptcy automatic stay was in effect. The IRS may withdraw a Notice of Federal Tax Lien if the IRS determines that (1) the Notice was filed too soon or not according to IRS procedures; (2) you enter into an Installment Payment Agreement to satisfy the liability unless the Installment Payment Agreement provides otherwise; (3) withdrawal will allow you to pay your taxes more quickly; or (4) withdrawal is in your best interest, as determined by the National Taxpayer Advocate, and the best interest of the IRS.

The IRS also may use a Levy to collect taxes. The IRS may Levy assets such as wages, bank accounts, Social Security benefits, and retirement income. The IRS also may seize your property for the purpose of selling the property to satisfy a tax debt including your car, boat, or real estate. In addition, any future federal tax refunds or state income tax refunds that you are owed, may be applied to your federal tax liability.

IRS Provides Options For Taxpayers Who Pay Late

Do you or someone you know owe taxes but can’t pay in full? The IRS has options for you. However, it is important to file your tax return on time and request an extension for payment. Pay as much as you can since your balance due is subject to interest and a monthly late payment penalty.

Here are some options to consider, even if you can’t pay the full amount right now:

Borrow the money.

If your funds are insufficient to pay all your taxes now, then you may want to get a loan from a bank or other source. The interest rate may be lower than the interest and penalties the IRS charges on late taxes. You also may be able to borrow against your assets or sell them to raise cash. The IRS allows 120 days for additional time to pay without a fee.

Set Up an “Installment Payment Agreement”.

If you are unable to pay in full, Installment Payment Agreements are available. If you owe $50,000 or less and can pay in 72 months or less, you can set up your agreement online. Make your payment(s) as high as possible to keep penalties and interest to a minimum. If you make your payments by direct debit, there is a lower set up fee, no checks to write and mail, and no late or missed payments. If you don’t have access to the internet, you can apply by filing an Installment Agreement Request. You may qualify for an Installment Payment Agreement even if you owe more than $50,000 or need more than 72 months to pay.

Use an “Offer in Compromise” (OIC) as a last resort.

An Offer in Compromise (OIC) is an agreement that allows you to settle your tax debt for less than the full amount. Generally, the IRS will accept an offer if it represents the most the IRS can expect to collect within a reasonable time. The IRS looks at several factors to make a decision on your offer. An “Offer in Compromise Pre-Qualifier” tool is available to see if you may be eligible for an OIC.