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McNees Insights – Estate Planning Newsletter

July 14, 2017

In This Issue:  Deducting Miscellaneous Itemized Deductions  /  Trust Modifications and Terminations by Agreement  /  Business Succession Planning in an Uncertain Tax Environment

Deducting Miscellaneous Itemized Deductions

by David M. Watts, Jr.

You can elect each year to itemize deductions rather than claim the standard deduction. Itemized deductions are those that you claim on Schedule A of Form 1040, Itemized deductions – specifically, (1) medical and dental expenses, (2) taxes, (3) interest, (4) gifts to charity, (5) casualty and theft losses, (6) job expenses and certain miscellaneous deductions, and (7) other miscellaneous deductions.

Certain miscellaneous itemized deductions for any tax year are allowed only to the extent that, when added together, they exceed 2 percent of your adjusted gross income (AGI). Job-related miscellaneous itemized deductions that are subject to the 2 percent floor include the following to the extent not reimbursed by your employer:

  • Business bad debts;
  • Business gifts, up to a limit of $25 for gifts made to any one individual during the year;
  • Damages paid to a former employer for breach of an employment contract;
  • Depreciation on a computer or cell phone the employer requires you to use on the job;
  • Dues paid to professional organizations (such as bar associations and medical associations) and to chambers of commerce and similar organizations, if membership helps you carry out the duties of your job;
  • Expenses of a home office or part of your home used regularly and exclusively for work;
  • Job search expenses in your present occupation;
  • Legal fees related to doing or keeping your job;
  • Licenses and regulatory fees you pay each year to state or local governments for your trade, business, or profession;
  • Malpractice insurance premiums;
  • Medical examinations required by an employer;
  • Occupation taxes;
  • Passport for a business trip;
  • Subscriptions to professional journals and trade magazines related to your work;
  • Tools and supplies used at work, if they wear out and are thrown away within one year from the date of purchase;
  • Travel, transportation, meals, entertainment, and local lodging related to the your work;
  • Union dues and expenses;
  • Work clothes and uniforms if required and not suitable for everyday use; and
  • Work-related education.

Certain expenses that are not trade or business expenses, but that are paid or incurred for the production of income, are treated as miscellaneous itemized deductions, and are deductible to the extent that the aggregate of these expenses, plus your unreimbursed employee business expenses, exceed 2 percent of your AGI. These production-of-income expenses include amounts spent to (1) produce or collect income that is included in gross income; (2) manage, conserve, or maintain property held for producing such income; or determine, contest, pay, or claim a refund of any tax. Examples of these types of expenses include:

  • Appraisal fees for a casualty loss or charitable contribution;
  • Casualty and theft losses from property used in performing services as an employee;
  • Clerical help and office rent in caring for investments;
  • Convenience fees charged for paying income tax by credit or debit card;
  • Depreciation on home computers used for investments;
  • Excess deductions (including administrative expenses) allowed a beneficiary on termination of an estate or trust;
  • Hobby expenses, but generally not more than hobby income;
  • Indirect miscellaneous deductions of pass-through entities (partnerships, S corporations, and mutual funds that are not publicly offered);
  • Investment fees, custodial fees, trust administration fees, and other expenses paid for managing investments that produce taxable income;
  • Legal fees related to producing or collecting taxable income or getting tax advice;
  • Repayments of income;
  • Repayments of social security benefits;
  • Safe deposit box rental on a box used to store taxable income-producing stocks, bonds, or investment-related papers and documents;
  • Service charges on dividend reinvestment plans;
  • Tax advice and preparation fees; and
  • Trustee’s fees for an IRA, if separately billed and paid.

For an individual whose adjusted gross income exceeds a threshold amount, the amount of the itemized deductions otherwise allowable for the tax year is reduced by the lesser of (1) 3 percent of the excess of adjusted gross income over the threshold amount, or (2) 80 percent of the amount of the itemized deductions otherwise allowable for the tax year. For 2017, the threshold amount is: (1) $313,800 in the case of a joint return or a surviving spouse; (2) $287,650 in the case of a head of household; (3) $261,500 in the case of an individual who is not married and who is not a surviving spouse or head of household; and (4) $156,900 in the case of a married individual filing a separate return.

Please call any member of the Estate Planning Group at McNees Wallace & Nurick LLC at your convenience so that we can discuss the rules regarding miscellaneous itemized deductions as they apply to your particular situation.

Certain other items are deductible as miscellaneous itemized deductions on Schedule A, but are not subject to the 2-percent-of-AGI floor. These items include (1) amortizable premium on taxable bonds; (2) casualty and theft losses from income-producing property; (3) federal estate tax on income in respect of a decedent; (4) gambling losses up to the amount of gambling winnings; (5) loss from other activities from Schedule K-1 (Form 1065-B), box 2; (6) losses from Ponzi-type investment schemes; (7) repayments of more than $3,000 under a claim of right; and (8) unrecovered investment in an annuity.

Trust Modifications and Terminations by Agreement

by Elizabeth P. Mullaugh

In 2008 we wrote about a then relatively new provision of Pennsylvania law allowing modifications and terminations of irrevocable trusts. In the decade since the legislation was enacted, we’ve worked with dozens of clients to modify, and in some cases terminate, irrevocable trusts, in most cases without the need for court involvement. We believe that trust modifications will continue to serve as a valuable tool in refurbishing complex estate plans. This article updates our 2008 comments to focus on the specific statutory authority to modify or terminate trusts by agreement.

Clients create irrevocable trusts to serve a myriad of goals: minimizing taxes, protecting minors, transferring wealth and planning for beneficiaries with special needs, to name a few. Changes in the law, such as substantially increased exemption from federal estate tax, or changes in family circumstances occasioned by divorce, sale of a family business or disability may cause the terms of irrevocable trusts to no longer be appropriate. Prior to 2006, it may have required court proceedings to fix or get rid of a “bad” trust.

In 2006, Pennsylvania’s Uniform Trust Act (“UTA”) was enacted. The UTA made both subtle and radical changes to Pennsylvania’s trust law framework, among them allowing for modifications and terminations of otherwise irrevocable trusts. Court approval for modifications to irrevocable trusts will still be required in certain circumstances; however, the UTA allows for modifications by agreement in two scenarios.

The first scenario for non-judicial modification or termination arises where the settlor (creator) of the trust is living and competent and the settlor and the trust beneficiaries agree to change some aspect of the trust or to terminate it. All of the current and future beneficiaries must agree to the modification or termination and the settlor cannot represent any beneficiary under the virtual representation rules discussed below. This scenario provides broad flexibility to alter or eliminate trusts that no longer serve their initial purpose. Crucially, modification is allowed by agreement among the settlor and the beneficiaries whether or not the change is consistent with the initial purposes of the trust and indeed is most useful where the initial purposes of the trust are no longer valid.

The second scenario allows a narrower range of modification options. Where the settlor is not living (or is incapacitated) the beneficiaries can agree to a modification or termination if the modification or termination is not inconsistent with a material purpose of the trust. Many technical tax modifications fall in this category, as will some substantive changes; however, the material purpose limitation places limits on the sort of modifications that can be made.

Helpfully, the UTA facilitates agreement among the beneficiaries by allowing certain beneficiaries who do not have the legal ability to act on their own behalf to be represented virtually by another person. For instance, a person may represent his minor and unborn descendants as long as there is no conflict of interest between the representative and the represented party. So, in the case of a trust established by a settlor for his minor child, a modification may be agreed to by the settlor, acting for himself, and the other parent of the minor child (assuming no separate conflict of interest).

If you think you might have an old trust that would benefit from a modification or if you have any questions, please contact any member of the McNees Estate Planning Group. 

Business Succession Planning in an Uncertain Tax Environment

by Vance E. Antonacci

Currently, there is a significant amount of uncertainty concerning the status of the federal tax laws, including the federal estate, gift, and generation skipping taxes. Various proposals have been laid out by legislators and these proposals include a (1) repeal of the federal estate tax coupled with the application of a deemed capital gains transaction at death and (2) a repeal of the federal estate tax with no deemed capital gains transaction at death. Of the various proposals, some include a repeal of the gift tax, some retain the gift tax, and others simply do not address it. With respect to the income tax, multiple proposals exist as well with a variety of “winners” and “losers”.

With all this uncertainty, it is easy for a business owner to put off succession planning until the “dust settles” on the tax laws. A business succession plan takes time to develop and to implement. Although a business succession plan is developed with an eye towards minimizing taxes, the development of a plan should not be slowed by tax law uncertainty. The main components of a business succession plan are as follows:

Buy-Sell Agreement
No business owner wants to have an unexpected event (such as death or disability) that results in the transition of a business. Nevertheless, the owners of a business should have an agreement in place to address these events and the agreement should be reviewed regularly irrespective of the status of tax laws. The agreement should be reviewed to ensure that the “mechanics” of the agreement still work and that the determination and payment of the purchase price is fair. The owners need to be sure that the purchase price can be paid (whether through life insurance or cash flow) and that the buyout will not disrupt ongoing operations or liquidity needs.

Life Insurance, Business Debt, Income Needs, and Fringe Benefits  
The starting point for a successful succession plan is understanding the owner’s goals and objectives and addressing contingencies such as an unexpected death or disability. One important issue that must be assessed is the amount and type of life insurance needed. A determination should be made whether the life insurance is adequate to fund the purchase of the owner’s business interests. In addition, the owner should assess whether “key person” insurance is needed to provide the business with working capital. None of these considerations are dependent upon tax laws.

Most businesses carry some debt, and this debt is often personally guaranteed by the business owner. The death of the guarantor normally is a default under the loan documents of the business. Therefore, the business owner needs to consider how personal guarantees of debt will be addressed.

With a planned succession or an unexpected death or disability, the owner needs to determine how to replace lost income and fringe benefits. The owner should consider, for example, how the standard of living enjoyed by the owner’s family will be maintained. Likewise, the owner needs to consider how health insurance coverage will be provided for the owner and his or her family and the potential loss of other fringe benefits, such as a company car or phone. These considerations are somewhat dependent on tax laws. For example, under our current system capital gains and ordinary income are taxed at very different rates. Therefore, a consulting agreement (ordinary income) currently is not as attractive as the payment of a purchase price (capital gain).

Business Related Real Estate     
Many business owners separately own the real estate where the business operates. The transfer of the real estate needs to be considered in any business succession plan. Many owners desire to retain the real estate since the rental income is a way to maintain disposable income in retirement or in the event of an unexpected death or disability. Granted, there is considerable uncertainty revolving around how real estate income will be taxed in the future. However, this uncertainty should not delay planning, particularly if the real estate will be retained when ownership of the operating business is transferred.

Transaction Structure
The purchaser of the business interest may need to rely on compensation and distributions from the business as the source of the purchase price payments. In essence, the seller acts as the “bank” for the purchaser. The business owners should give careful consideration to the terms of any seller financing. Common issues include:

  • How much of a down payment will be required?
  • Will the obligation to pay be secured by any collateral?
  • If there is a redemption, will the remaining owners personally guaranty the payment obligation of the business? If so, will the guarantees be backed by collateral?
  • What events, such as the sale of the business or its assets, will cause payment to be due in full?
  • Will life insurance insuring the lives of the purchasers be collaterally assigned?
  • Will distributions from the business and compensation of the owners be limited?

The structure of the sale transaction may be driven in part by tax considerations. However, those considerations are generally ancillary (or perhaps should be ancillary) to the remaining issues that are outlined above.

Establishing and implementing a succession plan requires dedication and effort on the part of the business owner. A succession plan should address tax planning, but the primary goals should be a successful transition of ownership coupled with financial security of the transitioning business owner.

© 2017 McNees Wallace & Nurick LLC
McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.


Elizabeth P. Mullaugh

Vance E. Antonacci

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