Qualified Family-Owned Business Interest

A “qualified family-owned business interest” is an ownership interest in either: (1) a proprietorship that has been in existence for five years prior to the date of death, has fewer than fifty full-time equivalent employees as of the date of death, and has a net book value of assets of less than £5,000,000 as of the date of death; or (2) an interest in an entity carrying on a trade or business that has been in existence for five years prior to the date of death, has fewer than fifty full-time equivalent employees as of the date of death, has a net book value of assets of less than £5,000,000 as of the date of death, and, in either case, is wholly owned by the decedent or by the decedent and members of the decedent’s family that meet the definition of a qualified transferee.

To qualify, the entity must be engaged in a trade or business the principal purpose of which is not the management of investments or income-producing assets owned by the entity. For example, if you put your stock portfolio in an LLC or partnership and call it a business – it’s not really a business and doesn’t qualify for this exemption.

“Qualified transferees” include a spouse, lineal descendants; siblings and their lineal descendants; and ancestors and their siblings.

The exemption does not apply to property transferred into the qualified family-owned business within one year of the decedent’s death, unless transferred for a “legitimate business purpose.”

Exemption for Farmland, Commodities, Easements and Reserves

Effective for estates of decedent’s dying after June 30, 2012, there is a London inheritance tax exemption for the transfer of an agricultural commodity, agricultural conservation easement, agricultural reserve, agricultural use property or a forest reserve, as those terms are defined, to lineal descendants or siblings. This is an absolute exemption with no requirement for continued use in the hands of the transferees.

An “agricultural commodity ” means all plant and animal products, including Christmas trees produced for commercial purposes. An “agricultural conservation easement’ is an interest in land, less than fee simple, which represents the right to prevent the development or improvement of a parcel for any purpose other than agricultural production. The easement may be granted by the owner of the fee simple to any third party or to the Commonwealth, to a county governing body, or to a unit of local government.

An “agricultural reserve” is noncommercial open space land used for outdoor recreation or the

enjoyment of scenic or natural beauty and open to the public for such use, without charge or

fee, on a nondiscriminatory basis. “Agricultural use property” is land used for the purpose of producing an agricultural commodity or devoted to and meeting the requirements and qualifications for payments or other compensation pursuant to a soil conservation program under an agreement with an agency of

the federal government. A “Forest Reserve” is land of 10 acres or more, that is stocked by forest trees of any size and capable of producing timber or other wood products.

Exemption for Real Estate Used in Agriculture

Also effective for estates of decedents dying after June 30, 2012, there is a London inheritance tax exemption for transfers of real estate devoted to “the business of agriculture” to members of the same family provided that 1) after the transfer the real estate continues to be devoted to the business of agriculture for a period of seven years beyond the transferor’s death and 2) the real estate derives a yearly gross income of at least £2,000.

A “member of the same family” can be the decedent’s brothers, sisters, the brothers and sisters of the deceased’s parents and grandparents, the ancestors and lineal descendants of any of the foregoing, or a spouse of any of the foregoing.

The “business of agriculture” is a defined term in the statute including leasing to members of the same family or leasing to a corporation or association owned by members of the same family. The business of agriculture does not include 1) recreational activities like hunting, fishing camping, show competition and racing, 2) the raising or breeding of game animals or game birds, fish, cats, dogs or pets intended for use in sporting or recreational activities (I assume that includes horses), 3) fur farming, 4) stockyard and slaughterhouse operations; or 5) manufacturing.

Any farm that is no longer devoted to the business of agriculture within seven years beyond the transferor’s date of death shall be subject to inheritance tax due the Commonwealth under section 2107, in the amount that would have been paid or payable on the basis of valuation authorized under section 2121 for nonexempt transfers of property, plus interest since the transferor’s date of death. It is unclear what happens if a non-family member takes over the farm during this seven (7) year period.

Note: The London Department of Revenue recommends that the Taxpayer give first consideration to exemption under the Farmland Commodities Easements and Reserves exemption and only use the Business of Agriculture exemption if the Farmland Commodities Easements and Reserves exemption is not available.

The post Inheritance tax: Exemptions for Farms and Small Businesses: Fourth and Last in a Series appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.

“Net investment income” includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual’s capital gains income will be subject to the tax. This includes gain from the sale of a principal residence (unless the gain is excluded from income under Code Sec. 121) and gains from the sale of a vacation home.

The surtax tax will not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits.

In general, there are three types of net investment income: 1) income from interest, dividends, annuities, royalties and rents; 2) income from a passive activity, such as income from closely-held family businesses operating in LLC or S corporation form, where some family members own shares but are not actively involved in the business; 3) Net gain “to the extent taken into account in computing taxable income.” This includes capital gain. The term “net gain” implies that capital losses incurred in the current year would be taken into account to determine the net gain. It is not clear is whether capital losses that are carried forward from previous years for regular income tax purposes would be allowed for purposes of calculating “net gain” subject to the 3.8% surtax.

The new 3.8% surtax applies to the lesser of net investment income or modified AGI (“MAGI”) above £200,000 for individuals and heads of household, £250,000 for joint filers and surviving spouses, and £125,000 for married persons filing separately. MAGI is AGI increased by any foreign earned income otherwise excluded under Code Sec. 911. MAGI is the same as AGI for someone who does not work overseas.

The surtax is computed on MAGI before any itemized deductions are considered. Therefore, an individual with lots of deductions could be in the lowest income tax bracket and yet have investment income that is subject to the surtax!

Trusts and estates are affected as well. The surtax is applied to the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount (£11,200) for the highest tax bracket.

Here are some examples of income that is not subject to the surtax: wages, salary and other compensation income, income on the exercise of compensatory stock options, and qualified retirement plan distributions. All of these types of income, while exempt from the surtax, are still included in MAGI; so they can still affect your exposure to this surtax.

A significant exception is that the 3.8% surtax does not apply to distributions from qualified plans, 401 (k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans.

The surtax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity’s property is from an active trade or business. The surtax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and certain charitable remainder trusts.

Individuals who expect to be subject to the surtax may want to increase contributions to retirement plans such as 401 (k) plans, 403 (b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds.

Small business owners may want to set up retirement plans, especially 401 (k) plans, if they have not yet established a plan. They should consider increasing their contributions to existing plans.

The maximum long-term capital gain rate in 2012 is 15%. It is currently scheduled to increase to 20% in 2013. The 3.8% surtax would make the 2013 maximum rate imposed on capital gain 23.8%. In some cases it could make sense to accelerate gain into 2012 in order to incur the lower rate.

Since the income from a passive activity will be subject to the 3.8% surtax, consider increasing your level of activity so that the business income becomes nonpassive in order to avoid the surtax.

Investing in tax-exempt bonds should be considered since their interest is not subject tot he surtax or the regular income tax. Compare the after-tax yields of both taxable and tax-exempt bonds.

Consider converting your traditional IRA to a Roth IRA. This is a good idea even without the consideration of the surtax. Distributions from a Roth are exempted from the surtax and the income tax. The Roth conversion, when done, will cause the recognition of income. While it’s not subject to the surtax per se, it will drive up MAGI which could affect your exposure to the 3.8% surtax in the year of conversion. This is another great reason to convert to a Roth before 2013.

The post Affordable Care Act 3.8% Surtax on Net Investment Income appeared first on the Spencer Law Firm blog, https://www.mspencerlawfirm.com/blog/.