Tuesday, October 28, 2008

Retirement? What retirement?

Eavesdrop on any number of conversations, and you'd think that this country's biggest focus is Friday night. After all, back in the 80's, the band Loverboy sang about how 'everybody's working for the weekend,' and The Kings sang about how 'nothing matters but the weekend...from a Tuesday point of view." But, if you ask most people what they'd do if they won the lottery, they'd respond "retire." For most people, work is a means to an end - with the end being, in a perfect world, retirement at 35. Ok, maybe 40. There's a few things to get done first.

But as this new article in the University of Illinois press points out, retirement itself may become a mere myth for many people. Like the farmer of yesteryear who worked to feed his family right up until the day he died, the modern worker may be faced with a very unhappy choice - no retirement at all.

As Professor Kaplan points out, the original intent was for the 401(k) and similar plans to be one of several retirement funds. With the IRA - and later, the Roth IRA - the government added an additional prong. A person contributing the then-maximum $3,000.00 to an IRA over a 40-year career added at least an additional $120,000.00 to their retirement fund. Combine that with the earnings growth, a company pension, Social Security and a 401(k) plan, and retirement should be an enjoyable respite from a long, productive career.

Not so much anymore. With the market tanking, 401(k) plans and IRAs will be taking hits of up to 40%, possibly more. This should serve as a wake-up call for those of you who have given short shrift to your retirement planning process. If your retirement planning consisted of randomly picking three mutual funds offered by your employer's plan administrator, you may be in for a rude awakening. Social Security can't be relied upon for anything more than a small portion of your retirement, and if you haven't saved anything else, you may find yourself working until 70 or later to fund your retirement. In a worst-case scenario, you may not even have a retirement.

Of course, things can and will change. But this is a good primer on why its important to pay attention to what you're picking - and how it's currently doing, including making changes if needed - and don't just pick a stock or fund because a 'friend' 'recommends' it. That's a terrible idea, but one that happens all too often.

Wednesday, October 22, 2008

When Section 1031 exchanges go bad...

The IRS recently announced proposed changes to the Qualified Intermediary (QI) program to address what happens when a QI goes under.

Among rental property owners, a Section 1031 exchange offers the major tax benefit of deferring capital gain recognition. For the unfamiliar, this type of exchange permits a property owner to use like-kind exchange rules to sell a property they no longer want. It allows a property owner 45 days to identify a replacement property, and 180 days to close on that property.

Obviously, unless the properties are close by (and in these types of cases, that's often not the case), it's difficult to close both transactions on the same day. And, as anyone who's tried to sell a home can attest, you are more likely to find the replacement property than sell your property - especially in this market.

Originally, the IRS had unclear rules regarding like-kind exchanges of property, but that all changed with sStarker v. United States, 35 AFTR 2d 75-1550, 75-1 U.S.T.C. ¶9443 (1975). In that case, the Starkers agreed to sell their entire interest in timberland to a company, in return for the promise of future land within 5 years. The IRS challenged on a number of grounds, but lost - the court found that the deferral was permitted.

In 1984, Section 1031 was amended to allow such exchanges, subject to time limits, and to hopefully cut down on abuses which arose after Starker (it was further amended in 1986 to change the identification period from 44 to 45 days).

Section 1031 exchanges have thus existed for over 30 years, but it was only recently, as the real estate market took off, that they've entered the common lexicon. In recent years, the problem of far-flung properties has been overcome by the use of qualified intermediaries. These parties facilitate 1031 exchanges by taking title to the sale property or presenting replacement properties (there is such a thing as a 'Reverse 1031,' but that's for another day).

The real problem arises when the QI has taken title to the sale property or cash, and subsequently goes out of business. There have been several recent cases where taxpayers have sought relief in the form of extensions on the 180 day requirement. However, the time deadlines are absolute, and neither the IRS nor the courts have been willing to give on this issue, and Congress has failed to act. Obviously this is a big problem (because the dollar amounts are rarely small; in one recent case, the taxpayer lost over $2 million), and a solution is needed.

This weeks announcement attempts to address that issue, by requiring foreign financial institutions who are QIs to notify taxpayers when internal controls have failed. However, the announcement says nothing about independant QIs, nor US financial institutions, so it remains to be seen if this is just a first step in addressing the issue, or just a tease.

Sunday, October 12, 2008

When volunteering can cause tax liability

As a lawyer, I am often reminded by the bar associations I belong to how important it is to pro bono work. "Equal access to the law" is the catchphrase, and in Illinois (though not yet in California) you have to report the number of hours you spend doing such work (or, in lieu of pro bono work, how much money you donated to legal aid groups). Although the information collected is not shared with the general public (Illinois does publish whether or not you have malpractice insurance, for example), it's clear that the state is making a concerted effort to convince lawyers to take on non-paying or low-paying work to benefit society as a whole.

Altruistic as that is, it's not always as simple as it seems. And sometimes, volunteer work can be downright expensive, especially if you're the 'take charge' type. Take the case of Jefferson v. U.S., a recent Seventh Circuit case.

In Jefferson, a taxpayer worked on a volunteer basis for a day care center that received at least some funding from the United Way. The day care center hit a rough patch, and failed to pay payroll taxes. Long story short (you can read the details if you're so inclined by following the above link), Jefferson did a number of significant things that worked against him in the long run: he helped the organization secure a loan, he hired an accountant to help manage finances, he had check-writing authority (he claimed to have written only two checks out of over 900, but both were to the IRS), he directed policy and he sat on the board.

The 7th Circuit decided that Jefferson's involvement was enough to make him a 'responsible person' under Section 6672 (Specifically 26 U.S.C. Section 6672(a)). Jefferson argued that he was 'an honorary and voluntary board member' exempt from personal liability under Section 6672(e). That section was quoted by the Court, and reads as follows:

No penalty shall be imposed by subsection (a) on any unpaid, volunteer member of any board of trustees or directors of an organization exempt from tax under Subtitle A if such member—
(1) is solely serving in an honorary capacity,
(2) does not participate in the day-to-day or financial operations of the organizations, and
(3) does not have actual knowledge of the failure on which such penalty is imposed.

Of course, Jefferson's biggest problem was paragraphs (b) and (c). He did, by virtue of getting the loans, hiring the accountant, and so on, participate in both the day-to-day and financial operations. Moreover, the court found that he was aware of the charity's failure to pay payroll taxes. In shooting down Jefferson's argument, the court cited to Bowlen v. United States, 956 F.2d 723, 728 (7th Cir. 1992) and found that, in order to be exempt under 6672(e), one could not, by definition, be a 'responsible person'. As the Court noted, "[t]he term “honorary” suggests a lack of power, a lack of responsibility, and a corresponding lack of ability to do harm—factors that do not apply to the instant case."

In the end, Jefferson was tagged with over $40,000.00 in payroll taxes. The message here is clear: if you are asked, or for professional reasons decide, to join the board of a non-profit group, be sure to check your 'can do' attitude at the door lest you, too, find yourself in a pickle. The more involved you get in the day-to-day, or financial, operations of the non-profit, the more likely you are to expose yourself to tax liability should that organization fail to pay their taxes when due.