Avoiding State Income Tax on Retirement Plan Distributions

by | Jul 21, 2015 | Uncategorized

When a retiree begins taking distributions from a traditional IRA, 401(k), or pension plan, those distributions are taxable to the retiree under federal income tax and any applicable state income tax rules. While federal taxation cannot be avoided, state taxation may be avoided depending on your state of residency. In general, there are some states that have zero income tax and therefore don’t tax retirement plan distributions, some states that have special exemptions for retirement plan distributions, and other states that do in fact tax retirement plan distributions. This article breaks down the basics and discusses some of the states where income taxes can be avoided.

The No State Income Tax States

First, the easiest way to avoid state income tax on retirement plan distributions is to establish residency in a state that has no state income tax. It isn’t just the fun and sun of Florida that helps attract all of those retirees. It’s the tax free state income treatment that you’ll get from all of that money stocked away in your retirement account. The other states with no income tax and therefore no tax on retirement plan distributions are Alaska, Nevada, South Dakota, Texas, Washington, and Wyoming.

States with Retirement Income Exclusions

Second, there are some states that have a state income tax but who exempt retirement plan distributions for retirees from state income taxes. There are 36 states in this category that have some sort of exemption for retirement plan distributions. As each of these states are very different, so too are their exemptions. The type of retirement account, however, does tend to govern the exemptions available. Here’s a quick summary of the common exemptions found in the states.

  1. For Public Pensions and Retirement Plans. Distributions from federal or state employer plans are exempt from taxation in many states. This is the most common exemption amongst states that have an income tax but who exempt some types of retirement plan distributions from income. Most of the 36 states that have an exemption for retirement plan income provide an exemption for public employee pensions and retirement plans.
  2. For Private Pensions and Retirement Plans. About 10 states offer a full exclusion for private pensions and retirement plans. Some of them differ between pension and contributory plans (e.g. 401(k)) and some of them make no distinction. Pennsylvania, for example, excludes all income distributions. Hawaii excludes certain distributions from state income tax for private retirement plans and for portions from company plans rolled over to a rollover IRA and then distributed from the rollover IRA.
  3. For IRAs. There are some states that do no tax any retirement pan distributions, including IRA distributions to retirees. Illinois for example does not tax distributions from retirement plans at all (pensions, IRAs, 401(k) s). Tennessee and New Hampshire are states that do not tax wage income and therefore they do not tax retirement plan distributions of any kind (IRA, 401(k), etc.). There are also numerous states that exclude a certain limit of retirement plan income from taxation. For example, Main exempts the first $10,000 of income from any retirement plan, including IRAs.

In sum, the state tax rules for retirement plan distributions are complicated and vary significantly. Each state can be understood rather quickly though and everyone planning for retirement should understand how state income taxes may eat into their planned retirement plan distributions. I, for example, looked into Arizona and found that there is no exemption for 401(k) or IRA income in the state of Arizona. While we do have a low state income tax rate, Arizona state income tax includes income from private retirement plans (pensions and 401(k) s) and IRAs and has a modest deduction for distributions from public retirement plans. Each state is unique to the type of plan, and the amounts being distributed but don’t just think you need to be in a state with zero income tax to avoid taxes on retirement plan distributions. For example, you could be in Illinois, Tennessee, or New Hampshire and could realize state income tax-free distributions of your IRA or 401(k).  The National Conference of State Legislators has an updated 2015 chart that is very useful and can be used to look up your state’s tax treatment of retirement plan distributions for retirees.

UMBRELLA INSURANCE POLICY OR LLC

by | Jul 12, 2015 | Uncategorized

Many real estate investors and landlords often ask whether they should use an umbrella insurance policy or an LLC to protect them from liabilities that may arise on their rental property. An LLC protects the owner of the LLC from liabilities that arise on any property in the LLC and prevents a plaintiff from being able to go after the LLC owner personally. As a result, we often say that an LLC protects a business owner’s personal assets from the risks and liabilities of the LLC business. An umbrella policy is coverage above and beyond the typical property insurance but it only adds additional coverage to insurance the property owner already has in place.

There are many issues and factors to consider in making this decision and there is no one-sized fits all recommendation. In many instances we recommend that you have both an LLC and an umbrella policy and in other instances we may recommend just an LLC or just an umbrella policy. The first factor to consider is the cost. The cost of an LLC in our office is $800 and on average you can expect about $200 in fees a year to keep that LLC active with the State (about $900 annually in California, each state is different). As a result, the major cost of an LLC is in the first year but you can plan on having about $200 in fees each year to keep your LLC active. If you have a partnership LLC then you also have the cost of a LLC partnership tax return but the LLC also provides a significant amount of partnership advantages and protections and we would almost always recommend an LLC for property owned between two or more parties.

An umbrella policy on the other hand is typically paid for monthly and there isn’t an un-front cost. Let’s say you are able to get a $1M umbrella policy at a cost of $50 a month. That would run you about $600 a year. Insurance policies have benefits which include attorneys whom the insurance company will appoint and pay to defend you (and protect themselves from having to pay) but also contain certain exclusions to coverage that may leave you with no coverage for the liability you incur.

One very common misunderstanding about umbrella policies is that they ONLY provide additional insurance coverage on top of insurance coverage you already have. So, for example, let’s say you have a property insurance policy with landlord liability protection of $100,000 and an accident occurs on the property that is covered by the policy. If that liability is covered by existing insurance and once that insurance has been exceeded, then the umbrella insurance provides coverage. Umbrella insurance does not, however, provide coverage in areas where you don’t already have coverage. This is a major limitation to and misunderstanding about umbrella insurance. I’ve talked to a few clients over the years who’ve needed to make claims on their umbrella insurance policy and who were surprised to find out and learn that the umbrella insurance didn’t cover any new liabilities or gaps in their existing insurance. As a result, just make sure you understand what the umbrella insurance actually covers.

An additional factor to consider is the type of property you own. If you own a multi-unit property or commercial property we would recommend having both an LLC and an umbrella policy because you have more liability exposure when you have more tenants. On the other hand, if you have a single family rental in an otherwise good neighborhood where you feel less likely to be sued then we may only recommend an LLC or an umbrella policy on its own. Bottom line, consider both an LLC and an umbrella policy in your analysis and get quotes and advice upon which to make an informed decision so that you are protecting your assets in the most efficient and effective way as possible.

And finally, consider the equity that is in the property and your overall net worth. The more equity you have in the property and the more personal assets you have in general then the more reason to have both an LLC and an umbrella policy.

DUE DILIGENCE TOP TEN LIST

by | Jul 7, 2015 | Uncategorized

Before you invest your hard earned savings or your self-directed IRA into a “alternative” business or real estate investment of another you need to ask some hard questions to the person or business receiving your money. Here are some tips to keep you out of legal trouble and to help you avoid bad investments or structures.

  1. If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
  2. If you aren’t given adequate documents outlining what has been explained to you verbally or what has been put into a presentation then don’t invest.
  3. If you’re told that you can get a commission for bringing others to invest into the same company and if you don’t have a license to receive such commissions then don’t invest. If the investment sponsor is willing to violate the law to pay an un-licensed person to raise money from others then what’s stopping them from misappropriating your money you invested? It is only the law preventing them, which they’ve proved they will disregard.
  4. If you are loaning money for a real estate venture, then demand a deed of trust or mortgage on title to the property protecting your investment. Also, make sure that you get a copy of the title report or commitment showing what position your loan is being placed into when the deed of trust or mortgage is recorded. Many savvy investors (and what all banks do) create lending instructions to the title company closing the real estate transaction and tell the title company to only use the funds being loaned when the borrower signs the note/loan documents, when the title company verifies the priority of the deed of trust you are getting (1st position, 2nd, etc.), and when all other defects to title have been cleared (and if not cleared, disclosure of what they are).
  5. If you’re investing into a PPM or offering you should receive lots of documents outlining the investment, the use of funds, the background of those managing the company, and also documents regarding your rights as an investor (e.g. offering memorandum, an LLC operating agreement or LP limited partnership agreement). Also, check to see if the PPM or offering was properly filed with the SEC by going to SEC.gov and checking the company name in the SEC database (click here to search). If no filing record exists for the PPM or offering with the SEC then the person raising the funds has possibly disregarded the law. As stated earlier, if someone is willing to disregard the law to get your money what is stopping them from disregarding the law to not pay you back (it’s just the law)?
  6. Investigate the background of the person you are entrusting your money with. When you are investing with others you need to think like the bank and do what the bank does. What is this person’s credit worthiness? What is their employment or prior business experience? What is their business or investment plan? What are the terms of the investment? Is there a realistic rate of return that fairly recognizes the risk being taken? It is up to you to conduct and drive this investment.
  7. If you are pressured that this opportunity will pass if you don’t invest now, then let the opportunity pass. Most scams use this technique and most legitimate investments never have this funding crisis.
  8. Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents already it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting you. Sometimes, unfortunately, the devil is in the details and many investments have clauses that can significantly impact your ability to get your money back out or that give the company raising the money the ability to pay whatever compensation to themselves they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
  9. Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else they can help you find issues to consider and questions you should be asking.
  10. Be comfortable saying no and only invest what you are willing to lose. Non-traditional investments have made many millionaires over the years but they have also caused lots of financial ruin. Just keep the risk in perspective and don’t “bet the farm” in one deal.

Don’t be scared about investing into non-traditional investments. Just remember though that you may need to get out of your comfort zone by asking lots of questions, by demanding additional documentation, or by simply saying no. Remember, you are the best person to protect yourself.  So do it.

Court Rules in Favor of Self-Directed IRA Real Estate Investor in Prohibited Transaction Case

by | Jun 29, 2015 | Real Estate & Alternative Asset Investing , Uncategorized

A recent Bankruptcy Court decision dealt with prohibited transaction claims against a self directed IRA owner who was using their IRA to flip real estate for profit. The claims were brought by a bankruptcy trustee who argued that the protected IRA was no longer an IRA because it engaged in a number of prohibited transactions. If the trustee is successful in disqualifying the retirement account because of a prohibited transaction, then the funds and assets held in such retirement account are no longer protected from creditors and may be used to pay debtors involved in the bankruptcy. While most prohibited transaction cases arise in Tax Court, I’m seeing more cases on prohibited transactions in Bankruptcy Court as trustees are becoming more aggressive and as self directed IRAs are becoming more popular.

The case in question is known as In re Cherwenka, Case 13-57592-MGD (Bankr. N. D. GA 2014). The case included two important prohibited transaction analysis that are helpful to IRA owners.

Court Rules No Prohibited Transaction When Managing IRA Investment Properties Without Compensation

The first significant ruling from the Court was that there was no prohibited transaction when the IRA owner completed the following tasks related to the IRA owned property.

  • Research and identified properties to buy
  • Appointed and approved work on the properties
  • Oversaw payments on the property for work from the self-directed IRA.

The Court reasoned that these actions do no constitute a “transaction” as defined in IRC § 4975 and as a result they cannot constitute a prohibited transaction. The Court further stated that, “…self-directed IRAs as qualified IRAs, necessarily implies that a disqualified person (the owner as fiduciary) will make investment decisions regarding the plan. The Court distinguished this case from In re Williams, 2011 WL 10653865 (Bankr E.D. Cal 2011) a similar case in which the self-directed IRA owner was managing properties owned by the IRA because in Williams the IRA was paying the self-directed IRA owner for the services. The court stated that it was the payment from the IRA to the IRA owner in Williams that caused the prohibited transaction and not the mere provision of managing the IRAs investment owned by the IRA.

Court Ruled That No Prohibited Transaction Occurred When IRA and Owner Invested Into Property Together

The second significant ruling from the Court was that there was no prohibited transaction when the IRA owner and the IRA co-invested into a property together. The property in question was owned 45% by the IRA and 55% by the IRA owner. The Court rejected the bankruptcy Trustee’s argument that such co-investment purchase resulted in a prohibited transaction and stated that the interests appeared to have been treated distinctly and that the HUD documents from the sale of the property show that the IRA and the IRA owner’s proceeds from the sale were treated separately and that they were apportioned properly. As a result, the Court concluded that no prohibited transaction occurred since there was no evidence of un-fair benefit between the IRA owner and his IRA. In its reasoning, the Court referenced DOL Opinion 2000-10A which addressed an IRA and the IRA owner co-investing into a partnership. In the Opinion the DOL states that, “a violation of section 4975 (c)(1)(D) or (E) will not occur merely because the fiduciary [IRA owner] drives some incidental benefit from the transaction involving IRA assets.” The Court referenced this opinion and stated that unless there is evidence of some un-fair benefit that no prohibited transaction occurred merely because of co-investment into the same property.

There are two key take-away’s for self-directed IRA investors from this case.

First, never take compensation or payment from the IRA for services rendered. It is clear that the Courts will find a prohibited transaction if you do and that you will no longer have an IRA.

Second, if you are buying property or others assets (e.g. LLC interests) between your IRA and yourself personally (or another disqualified person) those interests must be carefully calculated and treated such that there is no benefit going unfairly between the IRA and the disqualified person (e.g. IRA owner). In sum, get advice and plan carefully as there are many land-mines you could encounter when investing IRA funds with your own personal funds. Bottom line, it can be done but it can easily be done incorrectly.

Using the Law to Protect Your Reputation Online

by | Jun 23, 2015 | Uncategorized

Have you given a negative review of company? Have you ever posted something unflattering about someone you didn’t like?  Do you own a business with a Facebook, Yelp, Google+, or Linkedin page? Well, there’s no shortages of lawsuits about posts people make about businesses. And I get it. If you order a Pepsi and you get a Coke, well that’s one start down on Yelp. If you wait on hold for more than 10 minutes, that calls for a Facebook post about your “crappy” mortgage loan company. While these are trivial things we may have been critical about when posting reviews or comments on-line, there have been hundreds of cases over on-line reviews or comments about businesses that have resulted in legal action.

Consider the case of Jane Perez who wrote scathing reviews of her contractor on Yelp where she accused him on botching her home renovation and stealing jewelry during construction. Well, the allegations of Ms. Perez weren’t truthful and her contractor sued her for defamation and alleged $750,000 in damages from lost business as a result of the un-truthful review. Ms. Perez counter-sued alleging that her contractor’s responses weren’t true either and she too was defamed. The case went to a jury who eventually found that both parties were untruthful in there on-line comments and postings and as a result didn’t award damages to either. However, as reported by Mandi Woodruff on Yahoo Finance, not everyone case ends like this. In a recent case, a disgruntled patient of 2 Arizona surgeons created an entire website alleging that they botched her plastic surgery. Well, the Arizona surgeons found her website un-truthful and took her to court and won damages of $12 million dollars. And lastly, Southwest Airlines sued a passenger for defamation, slander, and libel when the passenger posted numerous complaints about the airline and its agent on her personal Facebook and Twitter accounts. The complaints alleged that the airline refused to allow the passenger to sit next to her children.

There are a few important legal lessons to be learned from these companies.

1. Truth is the Legal Standard. Every case that seeks to silence negative reviews or social media comments must allege that the comments posted are not truthful. The first amendment protects all of us when giving negative reviews or comments but only when those reviews are truthful. Consequently, any case brought to remove or silence a negative comment or review must allege that the comment is not truthful. If the comment or review was the truth, then there is nothing legally that you can do to force the other person to remove or correct the comment. You should certainly attempt to make it right though by contacting the customer to see what can be done to fix whatever the situation is that caused the negative statements.

2. Defamation and Libel. If the information posted about you or your business on-line is untruthful, then the legal action you may bring is called defamation. There are two types of defamation. The first type is libel and this has to do with defamation that is written. This would include on-line writings. The second type is slander and this has to do with defamation that is spoken. In order to win a defamation suit you must show the following; a) that a statement was made, b) that it was published for others to see, c) that the statement caused you injury,  and d) that the statement was false.

Awards in a defamation suit generally consist of removal of the false statement(s) and damages for the amount of lost profits or injury that was caused. Keep in mind that while lawsuits can be powerful and can remedy harm caused to you or your business, they are also costly and they don’t resolve your case in an expedient manner.

Before heading off to court though, heed the advice of digital marketing expert Chris Bennett. Chris is the CEO of 97th Floor and was a guest on our recent radio show. Chris suggested that if your business is subjected to negative comments or reviews on-line, that it is best to attempt to remedy those issues off-line. Don’t write a spirited rebuttal on-line. If you are dealing with a disgruntled person, you are not going to win them over by telling them they are wrong. And, you typically add more fuel to the fire when a comment thread or review thread grows from back-and-forth comments between a business and a customer. This is sage advice and reminds me of a review I read on VRBO.com about a vacation rental I was looking to rent. I was distracted by a 1 star review that was given on a property I was interested in. I read the back and forth between the renter and the property owner and without knowing who was right or wrong (how could a third party), I was only left with a feeling that the property owner was hard to work with because they kept arguing in the comments instead of leaving them as is or saying thanks for your feedback. Instead of arguing on-line in responses to comments, Chris advises to businesses to reach out to the disgruntled customer through phone or e-mail and find a way to make them a happy customer.

If you’re unable to resolve the negative comment or review through personal communication and if that comment or review is false AND is causing you or your business injury, you can bring a lawsuit against the person who caused you harm and can resolve it in the Courts. You could also engage a lawyer to write a letter warning of a lawsuit if the false comment or review is not corrected. Keep in mind, a lawsuit can be a long and costly process so you only want to engage in this effort if you truly are being damaged. If only your feelings were hurt, or if the statements were mostly true, then don’t waste your time with a lawsuit as it wont be worth the legal fees.

 

Pet Law Basics

by | Jun 16, 2015 | Uncategorized

While I’m no “pet lawyer,” I do own a 9-year-old Chihuahua and, along with other pet owners, have often looked up the laws affecting pets. For example, what happens in divorce to the family dog or cat? What if I want to return my pet to the seller? What happens to my pet upon my passing? Well, I’ve wondered this stuff too and decided to write about it. I know it’s off of my typical path, but we all encounter these everyday legal issues:

1. Buying a Pet: According to the American Veterinary Medicine Association, 21 states have so-called “pet lemon laws” that allow a buyer of a pet to return the pet to the seller for a full refund in the event that the pet has an illness or disease. These laws are time-sensitive and the buyer of a pet with an illness or disease must act quickly. For example, in Arizona, a buyer of a pet has 15 days to return the pet to the seller in the event that the pet has an illness or disease. The buyer has 60 days to return the pet in the event of congenital or hereditary disease (California’s time frame is one year). Upon returning the pet, under these laws the buyer is typically entitled to their purchase price plus any veterinary expenses.

2. Owning a Pet: There are a number of laws that govern the care you should extend to your pet. Again, these laws are at the state level and vary from state to state. One common law relating to pet ownership is that pets cannot be left in extreme weather conditions without food and shelter. Another common law found in many states restricts a pet owner from leaving their pet – typically dog – in a car unattended. These laws are designed to protect the pet, and failure to abide by them can be a crime.

3. Divorce and Death: I know, the D words. One is common and the other is certain, and if you own a pet, the law may determine your pet’s new owner in these situations.

Let’s address divorce first. By law, pets are personal property, like your furniture, guns or jewelry. Although there is typically much more meaningful attachment to our pets than to personal effects, the law treats them the same. As a result, in the event of divorce where the ownership of a pet is in dispute, the court will analyze certain factors to determine who should receive the pet. These factors are different from the factors a court will consider when determining custody of children, which generally is determined by considering the best interests of the child. In determining ownership of a pet following divorce, the court would look to who owned the pet. Was this pet owned by one person before the marriage? In this case, the person who owned the pet prior to marriage would get ownership of the pet upon divorce. What if the pet was bought by both parties during the marriage, or even before marriage. Then, the court will look at whose money supported the pet, who took care of the pet (e.g. who walked, cleaned, took to vet, etc.), and who spends the most time with the pet to determine the appropriate owner of the pet. If the pet is a family pet and if children are involved, it is likely that the “family pet” would go to the person who receives custody of the children.

The second situation where ownership of your pet may come into question is upon your death. We all want our pet to be loved and cared for after our passing. As a result, if you have a pet, consider listing in your will or trust a provision that states who shall receive the pet upon your passing and also consider gifting this person a lump sum of, let’s say, $5K to compensate them for caring for the pet. While you may create “pet trusts” and other extensive legal structures to outline the care of your pet, like the billionaire Leona Helmsley who left a $12 million dollar trust fund for her dog, such trusts and structures are not necessary to ensure the proper care and ownership of your pet upon your passing. Consequently, a simple statement in your will or trust as to who you want to receive your pet and a grant of a certain lump sum of money to be given to them from your estate to care for the pet is the proper solution for most of us.