e- NEWSLETTER

June/July 2006

Jessica M. Kirsch
Editor-in-Chief

Real Estate

REAL ESTATE DEVELOPERS - ALERT!

By Kerry M. Lavelle

     How should your land be categorized? Is your land considered a capital asset whereby the sales of the land would be treated as a capital gain and taxed appropriately? Or is your land “inventory”, and when sold, it would result in income tax to you?

    Being classified as a dealer in real estate, you may owe at least double the tax on the sale of your “inventory”, than an investor. An investor may treat the sale of his or her capital asset as “gain” and save an extraordinary amount of money in contrast to a “dealer” who will pay ordinary income tax, and then to add insult to injury, would also incur self employment taxes on the sale of the land.

    This classification is more of a problem today because of the way real estate progresses from investment to development and its significant changes in recent years. In the “old days” a speculator or farmer would own a large parcel of undeveloped raw land and would hold it for many years until the growth pattern of the community caught up and then he would sell a parcel to a homebuilder who would convert it to usable lots or a subdivision.

    Today homebuilders and shopping center developers use “just in time” inventory control mechanisms (just like their manufacturing brethren) to control their supply of ready-to-build lots. Meanwhile, governments have matured in their regulatory processes so that it is very difficult for the unsophisticated investor to make much out of his parcel of land.

    The legal principals involved in determining whether your land is a capital asset or inventory lie in IRC § 1221 (a)(1) and in Fraley, TC Memo 1993-304 where the Tax Court confirmed the laundry list that needs to be examined to determine the owners intent. This list of attributes was detailed in a series of the Sixth Circuit decisions issued in the late 1970s in which the court upheld the axiom that “whether land is held primarily for the sale to customers in the ordinary course of the taxpayers trade or business is a purely factual determination”. The Fraley factors are:

                    1) the purpose for which the property was acquired;
                    2) the purpose for which the property was held;
                    3) the extent of improvements made to the property;
                    4) the frequency of sales;
                    5) the nature and substantiality of the transaction;
                    6) the nature and extent of the taxpayers dealings with similar properties;
                    7) the extent of advertising to promote sales; and
                    8) whether the property was listed for sale either directly or through brokers.

    Recently, in Phalen, TC Memo 2004-206, the Tax Court went into greater detail on the Fraley attributes as well as IRS private letter rulings 200510029 and 200530029 which analyzed in detail the actions of the seller to determine what his intent was when purchasing, adding value to the property, and ultimately selling the property.

    Lastly, do not forget favorable treatment under IRC § 1237 to articulate the 5-year land subdivision rule. Under this rule, an individual, trust, estate, LLC, or s-corporation will not be treated as holding land primarily for sale to customers merely because the taxpayer subdivided a tract of land into lots or parcels and engaged in the advertising, promotion, selling activities, or the use of sale agents in selling lots if the taxpayer: 1) has not previously held any of the same land primarily for the sale to customers in the ordinary course of business; 2) does not make substantial improvements on the land; and 3) has owned the land for five years or more or acquired it by inheritance or devise.

    In conclusion, the growth of cities and urban areas has brought many long held parcels to their ultimate market i.e., residential and commercial development. The old attributes articulated in Fraley, and cited in many cases thereafter, have been re-examined and confirmed and given new application to recent market trends. Fortunately, there is now quite a bit of guidance, and at least in this area, favorable application for those investors who are willing to carefully structure their activities in bringing their investment property to market.

    If you would like your development reviewed or analyzed in any fashion by the attorneys at Lavelle Legal Services, Ltd., do not hesitate to contact Kerry Lavelle at klavelle@lavellelaw.com

Real Estate

DEATH SHOULD NOT BE A TAXABLE EVENT

By Lauren E. Schaaf

    They say the only two certainties in life are death and taxes, but should one really be taxed upon their death? Is this scheme fair to the taxpayer’s beneficiaries who are forced to share the benefits of their loved one’s lifetime of hard work with the government? Most Americans would agree it is not fair. However, the current law is composed so that only relatively wealthy Americans have any death tax imposed upon their estates.

    Do you know how much will your estate pay in estate taxes? This is a question currently being address by Congress as it enters into its summer session. As of today the law on estate taxes states that each person may distribute up to two million dollars tax free upon his or her death. This is the unified credit amount. In 2009 that amount increases to three million. In 2010 there is no estate tax imposed, and in 2011 the unified credit amount is one million dollars. However, this law may change soon and no one knows exactly what that change could entail. Therefore, a good estate planning attorney will word his or her documents in such a general fashion that no matter what the estate tax law states is the unified credit amount, the taxpayer takes full advantage of the existing credit amount at the time of his or her death.

    Even if your estate is currently under the supposed “final” unified credit amount scheduled for 2011 (one million dollars) you need to consider that fact that your investments may grow, you may inherit money from an unexpected source, or the estate tax law could change such that the unified credit amount is drastically reduced so that your current estate would incur estate tax. The ultimate question then becomes, are you prepared to take advantage of whatever estate tax credit is allowed upon your death? Will your loved ones realize the full benefit of your years of hard work? If there is any doubt in your mind you need to see a good estate planning attorney immediately, because in the end the only certainties in life are death and taxes, and not necessarily in that order. I can answer this question for you as well as other estate planning questions you may have. For the answers contact me any time at lschaaf@lavellelaw.com.

Tax Law

HOW THE TAX INCREASE PREVENTION
AND RECONCILIATION ACT AFFECTS INDIVIDUALS

By Timothy M. Hughes

     As you probably know, Congress recently passed the Tax Increase Prevention and Reconciliation Act, a new law that carries important tax changes for individuals. Some apply this year while others kick in several years down the road, and while most changes (such as those affecting the AMT and capital gains) are tax-savers, others (such as the new "kiddie tax" rules) could have a negative affect on you and your family. Here's an overview of what you need to know right now about this new law.

     AMT relief. In general terms, to find out if you owe alternative minimum tax (AMT), you start with regular taxable income, modify it with various adjustments and preferences (such as addbacks for property and income tax deductions and dependency exemptions), and then subtract an exemption amount (which phases out at higher levels of income). The result is subject to an AMT tax rate of 26% or 28%. You pay the AMT only if it exceeds your regular tax bill. Although it was originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT has wound up ensnaring many middle-income taxpayers. The reason? Many of the tax figures (such as the tax brackets, standard deductions, and personal exemptions) used to arrive at your regular tax bill are adjusted for inflation, but the tax figures used to arrive at the AMT are not. For 2006 only, the new law provides some relief. It increases the maximum AMT exemption amount over its 2005 level by $4,550 for married taxpayers filing joint returns, and by $2,250 for unmarried individuals. However, after 2006, the maximum AMT exemption amount will drop precipitously to where it was in the year 2000 unless Congress provides another fix.

    Another provision in the new law provides AMT relief for those individuals claiming certain "nonrefundable" personal tax credits (such as the credit for dependent care and the Scholarship and Lifetime Learning credits). For 2006, these credits may offset an individual's regular tax and AMT. After 2006, unless Congress acts, these credits will be allowed only to the extent that an individual has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against AMT.

    Investor tax breaks extended. An individual's long-term capital gain generally isn't taxed at a rate higher than 15%. It may be taxed at just 5% (0% for tax years beginning after 2007) if the gain would have been taxed at 10% or 15% if it were ordinary income instead of long-term capital gain. Most dividends from domestic corporations (and certain qualifying foreign corporations) also qualify for the same favorable tax treatment as long-term capital gain. These favorable tax rates were set to expire at the end of 2008, but the new law extends the favorable rates through 2010.

    Income limit on Roth IRA conversions eliminated, beginning in 2010. A person who makes deductible contributions to a regular individual retirement account (IRA) gets a tax break now for the dollars he puts in and his earnings grow tax free. However, he pays ordinary income tax on every dollar he takes out, and withdrawals are subject to significant restrictions, such as the required minimum distribution rules. A person who makes contributions to a Roth IRA can't get a tax deduction for contributions, but his money grows tax free and there's no tax, and few restrictions, on qualifying withdrawals.

    Under current law, only individuals with $100,000 or less in modified adjusted gross income can convert a regular IRA into a Roth IRA. A taxpayer making the conversion generally must pay tax on money he takes out of his regular IRA, but once it's in his Roth IRA, he won't pay tax on the withdrawal of that money or the money it earns (assuming a few relatively simple requirements are met). Generally speaking, Roth conversions appeal to taxpayers who either think their tax rate will go up in retirement, or believe that the value of their account will rise significantly, and thus are willing to make an upfront tax payment when they convert in order to reap large tax savings in later years.
Under the new law, beginning in 2010, taxpayers will be able to convert a regular IRA into a Roth IRA regardless of how high their modified adjusted gross income is. What's more, the new law permits taxpayers who convert in 2010 to spread the income and resulting tax payments on the converted funds over two years-2011 and 2012.

    Kiddie tax age limit raised from under 14 to under 18. At one time, wealthy parents could significantly lower their family's tax bill by transferring investment assets to minor children. This tax technique, called income shifting, worked by taking income out of the parents' higher tax bracket and placing it in the lower tax brackets of their children. To curtail the use of this tax technique, Congress enacted the "kiddie tax" rules, which provided that children under 14 who had more than a small amount of unearned (investment) income had to pay tax at their parents' marginal tax rate (the rate of tax on the last dollar earned). The threshold amount at which the kiddie tax kicks in is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2006, that amount is $850, so the kiddie tax begins to apply when the child has more than $1,700 in unearned income.

    Under the new law, the age limit below which a child's income from investments is taxed at the parents' rates is raised from 14 to 18. The new law specifies, however, that the kiddie tax does not apply to a child who is married and files a joint return for the tax year. It also adds an exception to the kiddie tax for distributions from certain qualified disability trusts. The new provisions apply to tax years beginning after Dec. 31, 2005.

    Capital gain treatment for self-created musical works. Before the new law came along, literary, musical, or artistic compositions, letters or memoranda, or similar property held by a taxpayer whose personal efforts created the property weren't treated as capital assets. As a result, when a taxpayer sold copyrights he owned in songs he created, gain from the sale was treated as high-taxed ordinary income rather than low-taxed capital gain.

    Under the new law, at the election of a taxpayer, the sale or exchange of musical compositions or copyrights in musical works created by the taxpayer's personal efforts is treated as the sale or exchange of a capital asset. This applies to sales in exchanges after the date the Tax Increase Prevention and Reconciliation Act is signed into law by the President, and before 2011.

    Changes to the foreign earned income exclusion and housing allowance for U.S. citizens working abroad. The new law makes three changes to the foreign earned income exclusion and housing allowance. First, the income exclusion is indexed for inflation starting in 2006 (rather than 2008 under current law). Second, the base housing amount used in calculating the foreign housing cost exclusion in a taxable year is modified (the new base amount is 16% of the amount of the foreign earned income exclusion limitation). Reasonable foreign housing expenses in excess of the base housing amount remain excluded from gross income, but the amount of the housing exclusion in excess of the base housing amount is limited to 30% of the taxpayer's foreign earned income exclusion. Third, income excluded as either foreign earned income or as a housing allowance is included for purposes of determining the marginal tax rates applicable to non-excluded income.

    Please keep in mind that the above only describes the highlights of the new law. If you would like more details on any aspect of this legislation, please call me at your earliest convenience at thughes@lavellelaw.com.

Tax Law

COURT FINDS RESTAURANT MANAGER WAS RESPONSIBLE

PERSON FOR PAYROLL TAX LIABILITY

By Timothy M. Hughes

    A federal court found that a Taxpayer employed as a restaurant manager, who had the ability to sign checks on his employer's account, and who assumed partial responsibility for his employer's financial affairs, was a responsible person liable for the restaurant’s failing to withhold payroll taxes. Accordingly, the court upheld the assessment of trust fund penalty taxes against the manager.

    Under Code Section 6672(a), if an employer fails to properly pay over its payroll taxes, the IRS can seek to collect the taxes from a person(s) who is responsible to collect, account for and pay over payroll taxes and who willfully fails to perform his responsibility. A responsible person is subject to the trust fund recovery penalty-a penalty equal to the total amount of tax not collected and paid over to the government.

    In this recent case the Taxpayer, who previously owned and operated his own restaurant, was hired by the President of a catering company (C&M) to help manage its restaurant. As part of his duties, he had and exercised the authority to hire new employees, although usually he did so jointly with the President. While he did not have formal signatory authority on C&M's bank account, the President had him sign checks, and those checks were honored by the bank He did not sign any other federal tax returns while employed by C&M, and for one quarter he signed checks for state withholding tax payments.

    Testimony revealed Taxpayer gradually became aware that C&M was having cash flow problems. He withheld payments to creditors on an average of twelve times a month. On at least one occasion, The President asked him to postpone cashing his own paycheck for a week so that there would be funds to cover the paychecks of other employees. Taxpayer even loaned $6,000 to C&M to cover its current expenses.

    On occasion, Taxpayer met with The President to discuss pricing, strategies to increase revenue and C&M's cash flow problems. He discussed with The President what invoices would not be paid in order to accumulate sufficient funds to pay C&M's rent. Taxpayer said that he was unaware of whether C&M had sufficient funds to cover checks when he wrote them and that he would withhold payments to some vendors to pay others.

    The court concluded that Taxpayer was a responsible person. He had the ability to sign checks on the company's account, and he assumed partial responsibility for the company's financial affairs. While he was not formally designated as a signatory, he clearly had the ability and the permission of the business owner to write checks to pay employee wages and vendor invoices. He signed federal, state and local tax returns for one quarter during the time he was employed by C&M, and he was partially responsible for hiring and discharging employees.

    Were you involved in a business where the IRS is now contacting you regarding a past employer’s liability? If so, please contact me at thughes@lavellelaw.com to discuss.

Home Health Care

SUMMARY OF APPELLATE PROCESS IN

HOME HEALTH CARE MEDICARE CLAIMS
By Theodore M. McGinn
 

    In the operation of your home health care agency, you need not accept a denial of a claim for reimbursement of services. All agencies have rights to seek a review and or appeal of the denial of their claim. However, it is critical that the necessary steps are taken in order to assure that the appeal is heard appropriately.

    The initial way to have review of a denied claim is to seek a redetermination. When seeking a redetermination, the provider must admit your request within 120 days of receipt of the denial. Any request for redetermination should contain the name of the agency, a signature from an authorized party, the name of the beneficiary in question, the Medicare provider number, a list of the services and/or items which are under consideration with the appeal, and the dates of service. In addition, the agency should attach all relevant evidence in support of its request for redetermination. A decision will be provided within 60 days of receipt of the written request for redetermination. If the decision is unfavorable, then the agency has a right to seek an additional appeal.

    If Medicare denies the request for redetermination, the agency has a right to seek reconsideration with a qualified independent contractor. A request for an appeal to such Qualified Independent Contractor must be made within 180 days of receipt of the redetermination decision. Again, the agency will have the opportunity to submit additional evidence to the qualified independent contractor in support of its claim. The Qualified Independent Contractor will render the decision within 60 days of receipt of the request for reconsideration. If the agency receives an unfavorable decision from the Qualified Independent Contractor, they can then choose to appeal to the administrative law judge.

    The final step of the appeal process is submitting your request for redetermination to the administrative law judge. It is critical to understand however, that the administrative law judge will not accept any additional evidence that was not otherwise already submitted. Therefore, it is essential that the agency create an adequate file in the record in order to have a supported case for consideration by the administrative law judge.

    A home health agency should not necessarily accept a denial of a claim. An agency that has provided services to a patient deserves to be paid for any eligible services. However, the requirements for such appeals is set forth by statute and the time frames must be met otherwise the agency will run the risk of losing their appeal rights. Furthermore, it is critical that the evidentiary records are maintained in order for their position to be properly considered.

    If you have any additional questions, regarding this article, please contact Ted McGinn at Lavelle Legal Services, Ltd. via email tmcginn@lavellelaw.com.

For past e-newsletter articles of interest, please visit the Lavelle Legal Services, Ltd. website at:  http://www.lavellelaw.com/newsletters/newsletter.htm.