Brady Martz CEO Todd Van Dusen Recognized as Prairie Business Leaders & Legacies Recipient

Top 100 nationally ranked accounting and advisory services firm Brady Martz & Associates today announced that Chief Executive Officer (CEO) Todd Van Dusen has been recognized as a Leaders & Legacies award recipient by Prairie Business magazine. This award recognizes high-ranking executives in the Dakotas and western Minnesota for the exceptional accomplishments they have made in business whether in recent years (Leaders) or over a lifetime (Legacies).

“In his more than 30-year career with Brady Martz, Todd has been an outstanding service provider and has made an incredible impact within the Firm and on our team members while serving in various leadership roles,” Chief Operating Officer (COO) Stacy DuToit said. “Todd leads with a stewardship mindset and sets the same expectation for his peers. With that mindset, he has recognized the need to drive significant changes within Brady Martz and has taken steadfast action to execute that change. Under Todd’s leadership, the Firm has undergone governance changes, operational changes, made investments in advisory service offerings, and added multiple markets to our footprint.”

Van Dusen joined Brady Martz in January 1989 as an intern and then spent the next 20 years of his career in client service before moving into the Firm’s first full-time CEO role. During his tenure, he’s had the opportunity to work in various areas of the accounting industry such as audit, tax, and business valuation. Additionally, he’s served in several leadership roles including market segment lead for the Minot office and board member. Under Van Dusen’s leadership, Brady Martz has grown to over 400 team members, including more than 50 shareholders, and serves communities in North Dakota, Minnesota, and South Dakota. He is a member of the North Dakota CPA Society (NDCPAS), American Institute of Certified Public Accountants (AICPA), and Minot State University Alumni Association.

Earlier this year, Van Dusen announced his plan to step down as CEO effective October 1, 2024, at which time DuToit will assume the role.

Van Dusen shared his gratitude, saying, “I am deeply honored to be named a Leaders & Legacies award winner by Prairie Business magazine. This recognition is a testament to the hard work and dedication of the entire team at Brady Martz. Our commitment to excellence and our clients has always been our driving force. I am grateful for this acknowledgement and look forward to seeing our mission of making an impact on what matters most to our team members, clients, and communities continued.”

Founded in 1927, Brady Martz has been providing exceptional client service for nearly a century. Headquartered in Grand Forks, the firm has nine offices throughout North Dakota, Minnesota, and South Dakota. Brady Martz is proud to offer advisory, audit & assurance, and tax services to clients in a wide variety of industries.

Headlights Newsletter – Summer 2024

The latest issue of Headlights, a publication of the AutoCPA Group, is now available.

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Estate Planning Q&A: Grantor Retained Annuity Trusts explained

ARTICLE | May 22, 2024

Authored by RSM US LLP

Do you have assets you expect to grow significantly? Leaving such assets in your estate to appreciate during your lifetime may increase your estate tax bill. However, if you have already utilized your current available lifetime gift tax exemption, making an outright transfer and triggering gift tax might not be the most desired option. A Grantor Retained Annuity Trust (GRAT) can be a valuable tool to address this. It allows you to transfer wealth to future generations while freezing the current value of the assets for tax purposes and using minimal lifetime gift tax exemption.

What is a GRAT?

A GRAT is an irrevocable trust that exists only for a specified period of time. You initially transfer assets to the GRAT and then receive annuity payments back for the term of the GRAT. For example, you transfer an asset worth $1 million to the GRAT. Over the term, the GRAT pays you $999,999 of annuity payments. This results in a $1 ‘taxable gift.’ If the assets appreciate more than the annuity payment back to you, the excess appreciation escapes your estate transfer tax free. If the $1 million of GRAT assets grows to $1.5 million during the term, that $500,000 of growth will pass to your beneficiaries free of estate and gift tax. At the end of the specified term, the GRAT terminates, and the remaining assets are transferred to the GRAT beneficiaries (typically a younger generation), either outright or in trust.

What are the requirements for establishing a GRAT?

  • The annuity payments must be:
    • Either a fixed dollar amount or a set percentage of the initial value of the transferred assets.
    • Paid to the grantor at least annually.
    • Payable for a fixed term (e.g., 2, 5, 10 years).
    • Made only to the grantor or grantor’s estate.
  • The annuity payments cannot:
    • Be prepaid by the GRAT.
    • Be paid via loans.
    • Increase more than 20% from the prior year’s payment.
  • After the initial GRAT funding, no additional contributions can be made.

What are the benefits of setting up a GRAT?

  • If the assets grow at a rate greater than the annuity rate specified by the IRS (the “hurdle rate” or “7520 rate”), that excess growth accrues to the beneficiaries transfer tax-free.
  • During the term of the GRAT, you are treated as the owner of the assets for income tax purposes. Thus, you are responsible for paying income tax on the GRAT income.  Paying income taxes on behalf of the GRAT is not considered an additional gift to the GRAT. The GRAT is able to grow without being reduced by the payment of income taxes, leaving more to pass to your beneficiaries.
  • Generally, GRATs can even hold shares in S corporations.

What are the potential downsides to setting up a GRAT?

  • If you die during the GRAT term, the assets go back to your estate, negating the transfer tax benefits.
  • If your assets don’t grow as much as expected (or even lose value), little or no assets may remain for the beneficiaries at the end of the GRAT term.
  • GRATs are generally not effective for transfers to grandchildren because the generation-skipping transfer (GST) tax rules may require you to use an excessive amount of GST exemption. Thus, GRAT assets are usually left to only children.
  • When your beneficiaries inherit the assets, they inherit the original tax basis you had. This might not be ideal for assets with low basis, meaning the beneficiaries could owe more capital gains tax when they eventually sell.

Is a GRAT right for you?

GRATs can be a strategic way to transfer wealth to beneficiaries. However, the length of the GRAT term, the specific assets to be contributed to the GRAT, the beneficiaries of the GRAT and the IRS hurdle rate at the time the of the initial gift should all be carefully considered. The benefits and risks of a GRAT can vary greatly based on these factors and should always be adjusted for a grantor’s individual circumstances. By understanding the requirements, advantages, and potential downsides, you can make an informed decision about whether a GRAT is right for your estate planning needs. As always, consult with your RSM US tax advisor to tailor a strategy that best suits your situation and goals.


This article was written by Scott Filmore, Amber Waldman and originally appeared on 2024-05-22.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2024/grantor-retained-annuity-trusts-explained.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Tax Effects of Cancellation of Debt Across Different Entities

ARTICLE | May 20, 2024

Authored by RSM US LLP

Executive summary: Introduction to CODI

Cancellation of Debt Income (“CODI”) can have significant tax implications for various entities, depending on their classification for federal income tax purposes, as well as their solvency and bankruptcy status. Understanding the tax treatment of CODI for partnerships, S corporations, and C corporations is vital for taxpayers to make well-informed decisions and optimize their tax positions. With analysis and illustrative examples, this article provides an introductory guide for navigating CODI in different entity structures.

General cancellation of debt provisions

CODI is a fundamental concept in federal tax law, wherein debtors recognize income when they settle their outstanding debt obligations for an amount less than the adjusted issue price (“AIP”). This principle was formally established in the landmark case Kirby Lumberand later codified in section 61(a)(11)by including CODI as a part of a taxpayer’s gross income. For instance, if a debtor owes $100 of debt but settles it for $60, the debtor generally recognizes $40 of CODI as taxable income.

Certain exclusions are provided, which allow CODI to be excluded from taxable income to the extent a debtor is insolvent.The amount excluded by reason of the insolvency exception cannot exceed the amount by which the taxpayer is insolvent immediately prior to the discharge.4

Example:

Debtor Corp. (D) has assets of $100 and liabilities of $150 (thus insolvent to $50). Creditor (C) cancels the indebtedness in exchange for D’s stock worth $100. D satisfied $100 of its debt with stock and had $50 forgiven. D has no taxable CODI because the amount forgiven ($50) does not exceed the amount by which D was insolvent ($50).

Another prominent exclusion is the bankruptcy exclusion, in which CODI is excluded if the discharge occurs in a “title 11 case.”The term “title 11 case” means a case under the Bankruptcy Code[1] if the taxpayer is under the jurisdiction of the court; and the discharge of indebtedness is granted by the court or pursuant to a plan approved by the court.Where a debt cancellation occurs during the bankruptcy process, but not pursuant to a plan approved/granted by the court, the bankruptcy exclusion does not apply.If the debt discharge occurs pursuant to a plan approved by the court, the level of insolvency of the debtor is irrelevant to the amount of the exclusion. In other words, the burden of proof is on the taxpayer to establish the amount of insolvency outside of a title 11 bankruptcy case.One benefit of a title 11 bankruptcy filing is the absence of the requirement for the taxpayer to establish the amount of insolvency.

Generally, where an exclusion (i.e., bankruptcy or insolvency) applies, tax attribute reduction is required under section 108(b), which provides mechanical ordering rules.10

Additionally, as a way to prevent debtors from avoiding CODI by transferring their indebtedness to related parties, the Code treats the acquisition of outstanding debt by a related person as if the debtor had acquired the debt.11 This means that if a party related to the debtor acquires the debtor’s debt at a discount, the debtor is deemed to have realized CODI.

Example:

X borrows $1,000 from a bank. If an entity related to X [as defined in section 108(e)(4)] acquires the debt from the bank for $900, X is treated as the purchaser of the debt and consequently, must recognize $100 of CODI.12

Partnerships

When a partnership’s debt is forgiven, the consequences are shaped by the interplay of general discharge of indebtedness principles and the rules governing allocation of partnership income and liabilities. For federal income tax purposes, partnerships pass through items of income, gain, deduction, loss, and credit to individual partners. Consequently, when income arises from the discharge of partnership indebtedness, such income is determined at the partnership level, and each partner is responsible for reporting their distributive share of the income on their own income tax returns. Such income is allocated in accordance with the partnership agreement and reflected on Schedules K-1 issued by the partnership to its partners.

The insolvency and bankruptcy exclusions are applied at the partner level and each partner’s individual situation determines eligibility to exclude CODI.13 As such, even in situations where the partnership itself is insolvent, the insolvency exclusion is unavailable to a partner to the extent that the partner is solvent. Likewise, a partner will generally only qualify for the bankruptcy exclusion if they are a party to the bankruptcy (or join in a bankruptcy filing with the partnership).14

Example:

A, B, and C are equal partners in XYZ LLP, a partnership for US federal tax purposes. XYZ LLP’s creditors forgave $300,000 of indebtedness creating CODI. A is insolvent by $150,000, B is insolvent by $100,000, and C is insolvent by $50,000. A and B can each exclude their $100,000 allocable amounts from income, while C can only exclude $50,000 and must include the remaining $50,000 in income.

This allocation of CODI impacts each partner’s basis in the partnership interest, effectively increasing it by the amount of their share of income.15 However, this increase in basis is generally, accompanied by an offsetting reduction due to the partnership tax rules treating a decrease in a partner’s share of partnership liabilities as a distribution of money.16 As a result, partners must include in their income their pro rata share of the discharged debt without enjoying a net basis increase that usually accompanies other types of partnership income.

Example:

A and B are equal partners in a partnership. $100,000 of the partnership’s outstanding debt is forgiven by their creditor without consideration in return. A and B separately report $50,000 as their distributive share of the CODI on their returns. Each partner adjusts their basis in the partnership interest by increasing it by $50,000 (i.e. the decrease in partners’ share of partnership liabilities). However, the reduction in each partner’s share of the liabilities is treated as a distribution of money. Consequently, both A and B must reduce their basis in the partnership by $50,000, resulting in no net basis increase despite the inclusion of the CODI in their taxable income.

As mentioned above, to the extent there is CODI excluded there are attribute reduction ordering rules that apply. In the case of partnerships, attribute reduction applies at the partner level based on the amount of excluded CODI and based on the partner’s tax attributes.

Example:

A and B are equal partners in a partnership. $100,000 of the partnership’s outstanding debt is forgiven by their creditor without consideration in return. A and B separately report $50,000 as their distributive share of the CODI on their returns. Each partner adjusts their basis in the partnership interest by increasing it by $50,000 (i.e. the decrease in partners’ share of partnership liabilities). However, the reduction in each partner’s share of the liabilities is treated as a distribution of money. Consequently, both A and B must reduce their basis in the partnership by $50,000, resulting in no net basis increase despite the inclusion of the CODI in their taxable income.

As mentioned above, to the extent there is CODI excluded there are attribute reduction ordering rules that apply. In the case of partnerships, attribute reduction applies at the partner level based on the amount of excluded CODI and based on the partner’s tax attributes.

S corporations

While S corporations are similar to partnerships in their flow-through nature, for purposes of CODI, the insolvency and bankruptcy exclusions are applied at the corporate level as opposed to the shareholder level. 17 Just as a partner in a partnership is entitled to deduct their share of the partnership’s losses, so too is the shareholder of an S corporation entitled to deduct their share of the corporate losses.18 In the S corporation context, losses are taken into account by the shareholder, but are generally limited to the shareholder’s basis in the stock or debt of the corporation. As such, a shareholder may have losses allocated in excess of basis which are suspended.19

Shareholders must carry forward their suspended losses, and since there is no carryover at the S corporation level, a special rule treats these suspended losses of the shareholder as deemed NOLs of the corporation for that tax year.20 As a result, the suspended losses are subject to reduction when CODI is excluded from income under the insolvency or bankruptcy exclusions.21

CODI that is taxable to the S corporation, increases the shareholders tax basis 22, and also increases the S corporation’s accumulated adjustments account (“AAA”)23. However, to the extent that CODI is excluded from the S corporation’s income because of its bankruptcy status or insolvency, the shareholders do not increase their basis for the excluded CODI.24

Example:

XYZ, an S corporation, has two shareholders, A and B, who each own 50%. XYZ incurred CODI of $600,000 and was fully solvent at the time of discharge but had no other income in the year of discharge. Both A and B have $100,000 of suspended losses from the prior tax year. Each A and B are allocated $300,000 of the CODI which increases their basis in the XYZ stock, thereby freeing up each of their $100,000 suspended losses. As such, after taking into account their suspended losses, A and B each have CODI of $200,000 includable in their gross income ($300,000 of CODI less $100,000 of suspended losses).

C corporations

C corporations recognize CODI at the corporate level, and is included in gross income, subject to specific exceptions. As mentioned above, Section 108(a) outlines circumstances under which CODI is excluded from a C corporation’s gross income and generally include discharge in a Title 11 bankruptcy and discharge when the corporation is insolvent.25 Again, while Section 108 allows for the exclusion of CODI, it generally comes at a cost by way of tax attribute reduction.26

The ordering rules generally provide reduction in the following order:

  1. Net Operating Losses (“NOL”)
  2. General Business Credits
  3. Minimum Tax Credits
  4. Capital Loss Carryovers
  5. Basis Reduction
  6. Passive Activity Loss and Credit Carryovers
  7. Foreign Tax Credit Carryovers

To the extent that any CODI remains after the attribute reduction is applied, it is essentially erased, something that practitioners have come to refer as “Black-hole Cancellation of Debt (COD) ”. By reducing tax attributes, to the extent they exist, the debtor is provided with a fresh start, but also facilitates an equitable tax deferral, rather than a permanent tax difference.

Example:

Debtor Corp. is insolvent by $75 and realizes $100 of CODI. $25 is taxable income and the remaining $75 is excluded from income according to section 108(a)(1)(B). If Debtor Corp. has $25 of NOL carryforwards into the year of discharge, and $25 tax basis in its assets and has no other attributes, it will reduce both the NOLs and tax basis to $0 and the remaining $25 is Black-hole COD.

Additionally, the attribute reduction, described above, occurs after determination of the debtor’s tax liability for the year of the debt discharge.27 This ordering rule can significantly impact a debtor corporation’s tax liability, particularly in instances of liquidating bankruptcies. When it is clear that a corporation will not become profitable even after its outstanding debt is reduced, the purpose of the bankruptcy process is then to ensure the orderly liquidation and distribution of the debtor’s assets to its creditors.28 A liquidating bankruptcy process often involve taxable sales of debtor assets under section 363 of the Bankruptcy Code, and also potential CODI.

Example:

Debtor Corp. is undergoing a liquidation in bankruptcy. At the time of liquidation, Debtor Corp. had assets, with a total fair market value of $10x and tax basis of $0x. Debtor Corp. also had $10x of NOL carryforwards from prior years. Debtor Corp. sells its assets to a Buyer in year 2 and distributes the proceeds to Creditor in partial repayment of its $100x loan. Debtor Corp. had no other items of income or loss. Debtor Corp. then legally liquidates.

Here Debtor Corp. will recognize a $10x gain on the sale of the assets, and likely recognizes $90x of CODI. The CODI would likely be excluded under section 108(a) and will reduce the $10x NOLs after the determination of the tax for the year of the discharge.29 As such the ordering rule will allow Debtor Corp. to use its NOLs to offset the gain on the sale, prior to the attribute reduction. Thus, when the attribute reduction is made, there are no attributes left to reduce and the entire $90x of CODI is Black-hole COD.

Consolidated Group Setting30

If a debtor corporation, that is a member of a consolidated group, recognizes CODI and excludes it from income under section 108(a), there are special rules regarding attribute reduction.31 The consolidated group’s tax attributes are generally subject to reduction, after reduction of the debtor’s own tax attributes, following a mechanical ordering rule. Additionally, in the consolidated context, there is a “tier-down” attribute reduction mechanism that applies to reduce the tax attributes of a lower-tier member in certain circumstances.32

For U.S. federal tax purposes, the exclusion of CODI under section 108(a) (i.e., bankruptcy, insolvency, etc.) does not apply to cancellation transactions between members of a consolidated group involving intercompany debt.33

The ultimate impact of debt workouts for a consolidated group are complex, and often can have odd results depending upon which a consolidated group member is the true debtor. Careful consultation and modeling from knowledgeable tax advisors is always recommended in these contexts.

Conclusion

The tax consequences of CODI are highly dependent on the entity’s classification, solvency, and bankruptcy status. Successfully navigating the complexities of CODI requires a thorough understanding of the tax implications specific to each entity type and the equity owners. Consulting with experienced tax advisors and legal professionals is critical in handling CODI and related tax matters effectively.


[1] Kirby Lumber v. United States, 284 U.S. 1 (1931).

[2] All section references are to the Internal Revenue Code of 1986 (the “Code”), as amended, or to underlying regulations.

[3] Section 108(a)(1)(B).

[4] Section 108(a)(3).

[5] Section 108(a)(1)(A).

[6] Title 11 U.S.C.

[7] Section 108(d)(2).

[8] For example, if during the bankruptcy proceedings, the debtor and creditor independently agree to a modification of the debt, or the debtor buys back its debt for stock at a discount, all without the court’s approval.

[9] Note that a Chapter 7 (liquidating) or Chapter 11 (reorganizing bankruptcy) are two examples of title 11 bankruptcies.

[10] The mechanics of the attribute reduction resulting from excluded CODI is beyond the scope of this article.

[11] Section 108(e)(4);. Reg. section 1.108-2.

[12] Timing of the acquisition of the debt when compared to the timing of becoming related is also relevant, for example:  Reg. section 1.108-2(c)(3) “a holder of indebtedness is treated as having acquired the indebtedness in anticipation of becoming related to the debtor if the holder acquired the indebtedness less than 6 months before the date the holder becomes related to the debtor.”

[13] Section 108(d)(6).

[14] Reg. section. 1.108-9(b); Note: There are Tax Court cases wherein a partner was permitted to exclude CODI, where the partnership was in bankruptcy, but the partner was not in their individual capacity, however the IRS has come out against these decisions in nonacquiescence in A.O.D. 2015-001. See e.g., Estate of Martinez v. Commissioner, T.C. Memo. 2004-150; Gracia v. Commissioner, T.C. Memo. 2004-147; Mirarchi v. Commissioner, T.C. Memo. 2004-148; and Price v. Commissioner, T.C. Memo. 2004-149 (essentially identical opinions for three partners in the partnership).

[15] Section 705.

[16] See Sections 752(b) and 733. Note however, that depending on the nature of the debt discharged, the basis decrease may differ from the increase pursuant to Section 705.

[17] Section 108(d)(7)(A).

[18] Section 1366(a)(1).

[19] Section 1366(d)(1); (d)(2).

[20] Section 108(d)(7)(B).

[21] Reg. section 1.108-7(d).

[22] Section 1367(a)(1)(A).

[23] Section 1368(e).

[24] Section 108(d)(7)(A).

[25] Note: also includes discharge of qualified farm indebtedness

[26] Section 108(b).

[27] Section 108(b)(4)(A).

[28] This process has various tax consequences, but for purposes of this article the discussion is limited to CODI.

[29] Section 108(b)(4)(A).

[30] A detailed discussion of the consolidated return rules regarding CODI is beyond the scope of this limited discussion.

[31] Reg. section. 1.1502-28.

[32] Reg. section. 1.1502-28(b).

[33] Reg. section. 1.1502-13(g)(4)(i)(C).


This article was written by Patrick Phillips, Nate Meyers and originally appeared on 2024-05-20.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2024/tax-effects-of-cancellation-of-debt-across-different-entities.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Modified Intercompany Debt: Is it Still Recognized as Debt?

TAX ALERT | May 16, 2024

Authored by RSM US LLP

Executive summary: Navigating section 385: the impact on intercompany debt and equity reclassification

In the context of multinational companies using intercompany debt instruments to fund domestic subsidiaries, the economic crisis has created insolvency issues and liquidity concerns that has prompted companies to consider modifying these instruments. These modifications, however, raise the potential application of section 385 and the regulations thereunder issued in 2016, which can potentially reclassify debt as equity for U.S. tax purposes, and carries significant tax implications.

Below we will shed light on the risks of modifying intercompany debt instruments and the potential application of section 385. The case study presented reflects how debt restructuring and cross-border intercompany funding can lead to the reclassification of debt as equity for U.S. tax purposes. This highlights the need for careful compliance and risk management in such scenarios.


Background

Section 3851, provides broad authority to Treasury to issue regulations to determine whether an interest in a corporation is treated as stock or indebtedness. In April of 2016, Treasury ultimately used this authority to issue regulations2 that govern how certain debt instruments are treated for tax purposes when they are issued by a U.S. corporation to a related party. While the regulations were originally intended to prevent excessive borrowing by related parties in cross-border transactions, they also broadly apply to debt issued by U.S. corporations to related parties, regardless of whether the related party is domestic or foreign.3 These regulations apply when “covered debt instruments”, generally defined as certain4 debt instruments issued after April 4th, 2016, by certain5 “covered members”, are issued to a member of the “expanded group.”6

The general rule7 (“General Rule”) reclassifies a covered debt instrument as stock, in the following three transactions:

  • If the note is distributed, generally from a U.S. issuer to a foreign related party;
  • If the note is issued in exchange for “expanded group stock” (such as a section 304 cross-chain sale), other than in an “exempt exchange”; or
  • If the note is issued in an exchange for property in an asset reorganization, to the extent that, an expanded group shareholder receives the debt instrument with respect to its stock in the transferor corporation.

The regulations also apply to debt instruments issued in exchange for property that is treated as “funding” any of the three transactions described above, regardless of when issued (the “Funding Rule”). Another rule further expands application to covered debt instruments issued by a “funded member”8 during the period (“Per Se Period”) beginning 36 months before and ending 36 months after, the date of certain distributions or acquisitions (“Per Se Funding Rule”).9 Said differently, if a debt instrument is issued by a U.S. corporation to a related party, and then that related party makes a distribution within the Per Se Period, the debt instrument is subject to recharacterization.

For purposes of section 385, when a covered debt instrument is deemed exchanged for a modified covered debt instrument10, the modified covered debt instrument is treated as issued on the original issue date of the covered debt instrument. If, however, the modifications include: the substitution of an obligor, the addition or deletion of a co-obligor, or the material deferral of scheduled payments due; then the modified covered debt instrument is treated as issued on the date of the deemed exchange (i.e., the date of the modification).11 Notably, a material deferral of scheduled payments is generally understood to be a deferral of at least one payment outside of a “safe-harbor period.”12

In determining which amounts of a covered debt instrument are subject to recharacterization, there are various exclusions, exceptions and reductions available.13 The aggregate amount of any distributions or acquisitions made by a covered member is reduced by the covered member’s expanded group earnings account (“E&P Reduction”).14 This E&P Reduction does not apply to distributions or acquisitions that were made by a predecessor of the covered member.15 There is also an exception that applies to the first $50M16 of covered debt instruments issued by members of the issuer’s expanded group, meaning thatfirst $50M is not subject to recharacterization (the “Threshold Exception”).17

Case study

The following case study analyzes a series of transactions that illustrate the application of the rules described above.

Facts

Original Structure

Prior to the effective date of the regulations, a foreign parent corporation (Foreign Parent) wholly owned another foreign corporation (Foreign Sub 1) and a U.S. corporation (US Parent). US Parent filed a consolidated return with its wholly owned domestic subsidiary (US Sub). Foreign Sub 1 owned 55% of a foreign corporation (Foreign Sub 2). US Sub owned the remaining 45% of Foreign Sub 2 (all entities collectively are referred to as the “Group”).

Prior to the effective date of the Regulations, debt existed between US Parent, as the issuer, and Foreign Parent, as the holder, and consisted of two tranches of bona fide debt. Whether there is a non-tax business purpose for the lending or distributions is irrelevant for section 385 purposes and is thus not discussed here.

Tranche 1 has a principal amount of $100 million and was issued by US Parent to Foreign Parent on Jan. 1, 2016, for cash, with a maturity date of Jan. 1, 2021. Tranche 2 has a principal amount of $20 million and was issued by US Parent to Foreign Parent for cash on Jan. 1, 2017, with a maturity date of Jan. 1, 2022. US Parent has $100 million of earnings and profits (E&P) and Foreign Sub 2 has $150 million of E&P.

US Parent deducts the associated interest expense in the U.S., and Foreign Parent recognizes interest income in the relevant foreign tax jurisdiction. As Tranche 1 was issued prior to the effective date of the Regulations, it was respected as debt for U.S. federal income tax purposes.

Redemption Transaction

On Jan. 1, 2018, Foreign Sub 2 distributed $150 million to Foreign Sub 1 in complete redemption of its stock. Immediately after, Foreign Sub 2 made a check-the-box election to be treated as disregarded for U.S. federal income tax purposes (collectively, the Redemption Transaction).

Debt Restructuring

On Jan. 1, 2019, US Parent and Foreign Parent restructured the two tranches of debt into a single debt instrument (Restructured Debt) with a principal amount of $120 million and a maturity date of Jan. 1, 2026.

Analysis

Original Structure

As of Dec. 31, 2017, prior to the Redemption Transaction, the Group had $20 million of “covered debt instruments” as Tranche 2 was issued after April 4, 2016. At this point, there is no reclassification of any debt into stock.

Based on the ownership, US Parent is a “covered member” and the Group is an “expanded group” with each entity being a member. Interest payments are made by US Parent to Foreign Parent, which are deductible in the U.S. and included as income in the foreign country.

Redemption Transaction

The wide net of the Per Se Funding Rule likely treats the distribution of $150 million in redemption of Foreign Sub 2’s stock, as having been funded by US Parent with the covered debt instrument.

Mechanically, the Per Se Funding Rule applies because the covered debt instrument was issued within 36 months of the distribution, and Foreign Sub 2 made the distribution within 36 months of US Parent becoming the successor. Therefore, US Parent is treated as having funded the distribution in part, by the $20 million Tranche 2.

The $100 million Tranche 1, even though issued within 36 months, is not a covered debt instrument because it was issued prior to April 4, 2016.

Through the application of the Per Se Funding Rule, Tranche 2 is potentially subject to the application of the recharacterization rules under Reg. Sec. 1.368-3. However, as discussed above, the first $50 million is not subject to recharacterization and as such Tranche 2 will not be treated as stock by way of 385.

Debt Restructuring

Assuming the two tranches were combined, and the term extended via modifications of the original debt instruments, this would likely represent a significant modification for purposes of Reg. Sec. 1.1001-3. The extended term would constitute a “material deferral” in that the term is extended beyond the safe harbor period discussed above.18 Since there was a “material deferral”, Reg. sec. 1.385-3(b)(3)(iii)(E)(2) treats the Restructured Debt as having been reissued on the date of the modification (i.e., Jan. 1, 2019).

Therefore, the Restructured Debt is treated as having been issued within 36 months of the Redemption Transaction and is now subject to reclassification under the Per Se Funding Rule.

The aggregate adjusted issue price of the covered debt instruments held by all the members of the expanded group is $120M. However, under Reg. sec. 1.385-3(c)(4), the first $50 million is excluded from recharacterization. Therefore, as a result of the deemed reissuance, $70 million of the Restructured Debt is treated as stock for U.S. federal tax purposes.

As mentioned above, utilizing the E&P Reduction, the aggregate amount of any distributions or acquisitions made by a covered member is generally reduced by the covered member’s expanded group earnings account. In this instance, US Parent has $100 million in its expanded group earnings account. However, since the distribution was made prior to Foreign Sub 2’s joining of the U.S. consolidated group, that amount is unavailable to offset any amount of the distribution.

Conclusion

As a result of the Redemption Transaction and the Debt Restructuring, $70 million of the outstanding Restructured Debt amount is treated as stock for U.S. federal tax purposes. One result is that interest payments that relate to the reclassified $70 million are no longer deductible as interest expense for U.S. federal tax purposes.

Additionally, since payments made under the reclassified amount are treated as distributions on stock (and potentially dividends) for U.S. federal tax purposes, there may be withholding tax consequences that were not present prior to recharacterization. Moreover, since the recharacterization is solely for U.S. federal tax purposes, Foreign Parent will continue to have interest income in its home country without any offsetting interest expense in the U.S.

In terms of alleviating the disconformity between interest income and interest expense, the simplest solution, from a U.S. federal tax perspective, is likely a capitalization of the reclassified debt obligation into the US Parent. For U.S. federal tax purposes, this capitalization would potentially be a tax-deferred recapitalization transaction. However, for foreign purposes the contribution would be treated as a contribution of the note receivable into the US Parent, thus tying out the interest disconformity.

As demonstrated in the case study, practitioners need to be cautious when restructuring debt, particularly in the international context as a seemingly simple modification of an intercompany debt instrument could have major tax consequences.


1 All section references are to the Internal Revenue Code of 1986, as amended, or to underlying regulations.

2 See generally, Reg. Sec. 1.385-3; there are numerous important defined terms within these regulations and while this article refers to a few of them, readers should be aware that some definitions have been simplified herein for readability.

3 See 81 FR 20912.

4 Debt instruments that are not a qualified dealer debt instrument (as defined in paragraph Reg. Sec. 1.385-3(g)(3)(ii)) or an excluded statutory or regulatory debt instrument (as defined in paragraph (g)(3)(iii)).

5 Domestic members that are not an excepted regulated financial company (as defined in Reg. Sec. 1.385-3(g)(3)(iv)) or a regulated insurance company (as defined in paragraph (g)(3)(v)).

6 Generally, a group of corporations connected by 80% common ownership.

7 Reg. Sec. 1.385-3(b)(2).

8 A covered member that makes a distribution or acquisition under the Funding Rule.

9 Reg. Sec. 1.385-3(b)(3)(iii)(A).

10 See generally, Reg. Sec. 1.1001-3.

11 Reg. Sec. 1.385-3(b)(3)(iii)(E).

12 Reg. Sec. 1.1001-3(e)(3)(ii); The safe harbor period is either: five years for debt instruments with an original term of at least 10 years, or 50% of the term of debt instruments with an original term of less than ten years.

13 Note: for the limited illustrative purposes of this article, only the E&P Reduction and Threshold Exception are discussed.

14 Reg. Sec. 1.385-3(c)(3)(i)(A).

15 Reg. Sec. 1.385-3(c)(3)(iii).

16 That is, the aggregate adjusted issue price of the debts.

17 Reg. Sec. 1.385-3(c)(4).

18 In this case, the original terms of both instruments was five years, and combined the term is extended by at least 4 years. The safe harbor in this case, is 50% of five years so 2.5 years.


This article was written by RSM US LLP and originally appeared on 2024-05-16.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2024/modified-intercompany-debt-is-it-still-recognized-as-debt.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Your Payroll Technology is Only as Good as Your Payroll Strategy

ARTICLE | May 15, 2024

Authored by RSM US LLP

In an ever-evolving world of innovation—including the emergence of artificial intelligence (AI)—payroll technology has reached a new level of embracing efficiency. Between enabling companies to hire the right talent across functions, managing workforces globally for unmatched productivity and keeping compliance in check—payroll technology delivers powerful analytics for a deeper understanding of people and businesses.

Payroll software helps automate payroll processes and significantly reduces time spent on manual efforts. These AI-enabled systems streamline payroll processes from start to finish, irrespective of the size and scale of the business. However, modern technology is only one element of a successful payroll optimization approach.

Data integrity is pivotal

Payroll technology software provides personalized windows that display pay stubs, tax information and benefits options, allowing employees to access and update their personal information and tax details via self-service functions. It is important to note that any inconsistencies or inaccuracies in these figures can negatively influence paycheck results, thereby reducing employee confidence in the business and, as a result, lowering employee satisfaction.

The key to improving the employee experience is making the technical advancements that allow for enhanced functionality and ensure the processes the technology relies on are sound. Both contribute to delivering an accurate, secure and easily accessible payroll experience for your employees.

“You could be on any payroll software system, but unfortunately, you will not meet your desired outcomes if your processes are broken,” says Lorry Twisdale, RSM US principal. “You must ensure departments like HR and benefits have strong processes in place to ensure that their data, which filters down to payroll, is accurate.”

Ultimately, as advanced as payroll technology has become, it can only perform as well as the processes behind it. Working with a qualified payroll advisor can optimize your entire payroll approach in several ways, including:

  • Managing administration of the payroll system
  • Evaluating and analyzing data to address challenges related to scalability, new locations, size and functions
  • Automating and utilizing systems better
  • Increasing payroll accuracies, thereby minimizing payroll disputes or audits
  • Assessing tax, overtime and pay and expense policies
  • Analyzing employee payroll trends and benefits
  • Mitigating risk
  • Keeping global compliance and regulations in check

“Your payroll technology is only as good as your payroll strategy. You must take a truly holistic approach when assessing your processes. The world is entering the AI space, but for now, I do not believe that technology can replace service.”

Ana Woods-Hill, manager, RSM US LLP

“The world is entering the AI space, but for now, I do not believe that technology can replace service.” says Ana Woods-Hill, RSM manager of payroll outsourcing services.

Woods-Hill advises that help may be necessary to optimize your payroll approach. “Sometimes, it takes time to fully explore any product’s capabilities, which may not happen within the first three or more months of its use,” she says. “Therefore, that is an excellent opportunity for companies to work with a team focused on payroll strategy to help them discern the nuances of their unique business processes.”

People-related challenges

The dynamics of people, staffing and outsourcing have remarkably changed in recent years. Despite technological advancements, the demand for skilled payroll professionals remains significant. There is a constant need, and even a growing trend of leveraging resources with extensive knowledge, experience and valuable networks.

Workforce dynamics are evolving, and human insight is essential now more than ever. Technology is not diminishing the need for professionals; instead, it is reshaping job roles to allow employees to focus on different, more value-added areas.

“Businesses are realizing that hiring someone with deep experience in a network is always smarter versus bringing someone strictly in-house,” says Woods-Hill. “Additionally, since the COVID-19 pandemic, organizations are facing increased turnover issues and the economic lag of compliance changes.”

Maintaining data integrity amidst self-service strategies

Data integrity is always crucial. It is a mistake to assume that data will somehow be accurately processed if entered into the payroll system incorrectly; therefore, conducting audits is paramount to ensuring data accuracy. Interestingly, payroll-related data entered in real-time via self-service functions often goes unchecked and can have long-term implications, potentially affecting payroll timelines, constructive receipt time stamps and even compliance efforts.

“The garbage in, garbage out rule is of supreme importance now more than ever due to employees’ self-service functions,” concludes Woods-Hill. “Companies have relinquished control due to this practice, and human intervention is, therefore, still needed. Some companies may argue they don’t need as many HR professionals due to self-service functions. But they also may create $1 million worth of audits and compliance risk by letting their users control the inputs. Therefore, payroll success today is all about great people, a great system and a great payroll strategy advisor.”


This article was written by Lorry Twisdale, Ana Woods-Hill and originally appeared on 2024-05-15.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-strategy-operations/your-payroll-technology-is-only-as-good-as-your-payroll-strategy.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Top Eight Estate Planning Factors for Real Estate

TAX ALERT | May 02, 2024

Authored by RSM US LLP

Estate planning for real estate requires a strategic and comprehensive approach. From tax implications to the intricacies of property management, this item is designed to help advisers understand how to craft resilient estate plans for clients with large real estate holdings. The discussion highlights eight important estate-planning factors in the real estate context.

1. Retained interest and estate inclusion challenges

Real estate investors typically value retaining some level of control over or the use of the assets they worked hard to grow, which can add complexity to transfer tax planning. Under Sec. 2036, property is sometimes unexpectedly included in a taxpayer’s gross estate if the taxpayer retains the right to enjoy or control it. This extends to what may be seen as indirect control, such as the taxpayer’s managing a family investment entity. For example, if a taxpayer has the sole ability to amend the operating agreement, dissolve the partnership, or make distribution decisions, they could be considered as having retained “strings” to the interest because they potentially control its beneficial enjoyment.

Planning tip: Retaining a life estate under Sec. 2036 in real estate or creating an appearance of continued control will inadvertently trigger issues involving ongoing use or the ability to shift beneficial enjoyment. Such scenarios should be reviewed carefully to minimize the potential for estate inclusion.

2. Valuation discounts

Valuation discounts can play a pivotal role in transfer tax planning for real estate. These discounts consider factors that contribute to lack of marketability and lack of control, including limitations relating to multiple owners, type of assets, and owner agreements that create restrictions that reduce an interest’s value. Discounting is an important consideration for lifetime gifting and interests an estate owns.

Transferring a portion of assets subject to discounting is an effective strategy for transferring assets out of a taxpayer’s estate while retaining some asset management. However, it is crucial to be aware of certain considerations that might not immediately come to mind:

  • The transfer will incur upfront costs that vary based on the complexity of the type of assets or entity structure and the state of residence. Qualified business valuations and gift tax returns will also need to be done in the years in which interests are transferred. Additionally, annual administrative costs and other ongoing expenses, such as those for tax filings, are a further financial consideration.
  • Operating the business formally will help ensure that the IRS upholds the structure and provides more protection from creditors.
  • Upon death, assets previously gifted to an irrevocable trust, including certain real estate assets, will not result in a step-up in basis; thus, the estate and beneficiaries will be unable to step up their basis and depreciate certain real estate assets.

Planning tip: Discounting the value of applicable assets may present a strategic advantage for the taxpayer to mitigate potential gift or estate tax liabilities if formalities are followed.

3. Estate liquidity challenges

Generally, real estate investors reinvest their cash, leaving a potential liquidity issue at death. Sec. 6151 requires that estate tax be paid within nine months after the date of death. If a significant portion of a taxpayer’s assets are illiquid, alternative options are worth exploring, which include an election under Sec. 6161 or Sec. 6166 and Graegin loans, named after Estate of Graegin, T.C. Memo. 1988-477.

Sec. 6161 allows an estate’s executor to extend the time for paying estate tax for up to 10 years when reasonable cause exists. What constitutes reasonable cause may be a high bar. For example, it may take proving that liquidating assets would cause economic harm to the estate. Sec. 6166 provides relief where an estate’s value is composed at least 35% of closely held interests in an active trade or business, but only the tax related to the closely held interests qualifies for deferral. Sec. 6166 relief requires annual interest payments for the first four years and principal and interest payments for the subsequent 10 years. While offering advantages such as early repayment flexibility and using estate income for interest payments, drawbacks include variable interest rates, IRS loan terms, and potential acceleration related to business disposition or state estate tax complications.

Alternatively, Graegin loans offer an additional method for obtaining liquidity to pay the estate tax. They are typically obtained through a financial institution, family business, or irrevocable life insurance trust. If structured correctly, these loans can prevent financial loss from forced asset sales plus allow the estate to deduct the interest on the estate tax return. The deductibility of interest is subject to certain conditions such as the estate’s insufficient liquid assets, certainty of interest without the option for prepayment, and reasonable loan terms. Conditions imposed under Prop. Regs. Sec. 20.2053-3(d)(2) may make it even more difficult to deduct the interest on a Graegin loan.

Estate tax is not the only issue that requires liquidity after death. Marital trust planning is crucial to ensure a sufficient cash flow for the surviving spouse to maintain their accustomed lifestyle. The distributions from a marital trust to the surviving spouse may be unexpectedly reduced by depreciation expense; however, the impact varies based on state law. These types of issues may affect the operational aspects of real estate after the date of death.

Planning tip: When addressing estate liquidity concerns, consider the available options and choose the most suitable method, based on the estate’s unique circumstances and goals.

4. Basis and capital account planning

Generally, real estate that is held for a long time or is the product of multiple previous Sec. 1031 like-kind exchange transactions tends to have a low basis. Retaining these assets until death presents a unique advantage: a step-up in basis. In the case of assets held within a partnership, a step-up occurs not only for the partnership interests but also potentially in the underlying assets by the partnership’s making a Sec. 754 election.

Negative tax basis capital accounts in partnership interests owned by an irrevocable grantor trust can lead to a taxable event upon the trust’s becoming nongrantor during the grantor’s lifetime, triggering a tax liability corresponding to the negative capital accounts.

Additionally, assets owned by an irrevocable grantor trust are generally not included in the decedent’s estate and therefore do not receive a basis step-up (or step-down) at the grantor’s death. However, many irrevocable grantor trusts allow the grantor to swap assets of equal value with the trust. This is particularly valuable if the grantor has high-basis assets in their estate and the trust has substantially appreciated assets with a low basis. If the grantor swaps assets during their life, the low-basis assets held at death will receive a step-up in basis.

Planning tip: Strategically considering asset basis and tax basis capital accounts may provide opportunities for income tax savings.

5. Passive loss rules and selecting the trustee/executor with care

Many real estate investors actively participate in the activities or are considered real estate professionals for income tax purposes, resulting in preferential income tax treatment for purposes of the passive loss rules and the net investment income tax. Determining whether certain activities are active or passive becomes more complex at an individual’s death. There is no authoritative IRS guidance for how activities of a trust or estate are tested for material-participation purposes. Instead, practitioners rely heavily on two cases, Mattie K. Carter Trust, 256 F. Supp. 2d 536 (N.D. Tex. 2003), and Frank Aragona Trust, 142 T.C. 165 (2014). According to these cases, a trust or estate’s material participation depends on the fiduciaries or their agents engaging in those activities. The IRS may introduce regulations in this area, potentially altering the criteria for income tax testing.

Planning tip: If possible, appoint an executor or trustee who may qualify for material participation with respect to real estate owned in a trust or estate.

6. Multigenerational planning and GSTT

Ultra-high-net-worth families, especially those with extensive real estate holdings, should create estate plans that strategically pass down assets across multiple generations. Multigenerational planning requires incorporating the complex application of the generation-skipping transfer tax (GSTT). While many taxpayers are aware of their available $13.61 million gift and estate exemption in 2024 (indexed for inflation), each taxpayer also has the same amount of generation-skipping tax (GST) exemption. The GSTT is in addition to gift tax and estate tax. GSTT has a flat tax rate equal to the maximum estate and gift tax rate, which is 40% in 2024. Protecting legacy assets, including real estate, in trust with GST exemption allocated to it will prevent additional estate, gift, and GST taxes from being imposed on those assets for future generations.

However, the estate/gift and GST exemptions are set to be cut in half beginning Jan. 1, 2026, due to the sunsetting of a provision in the 2017 law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. The IRS has clarified that exemptions used in a year with a higher exemption than effective at the grantor’s death generally remain outside the taxable estate. The temporarily increased exemptions offer planning opportunities for clients that require prompt review, given the complexity and time involved in most ultra-high-net-worth planning, which often involves multiple estate planning professionals.

Planning tip: Now is the time to engage in estate planning conversations with clients so that they can take advantage of the increased gift/estate and GST exemptions before they sunset on Jan. 1, 2026. Real estate investors should thoughtfully contemplate the succession of their legacy for multiple generations, especially when the family is not a viable option or might not be willing to take on this responsibility.

7. Carried interest gifting valuation issues

Carried interests are commonly held assets for some real estate investors. Since they could greatly appreciate, transferring these assets outside the estate may be a highly effective strategy. Generally, real estate investors believe these assets are nominal in value, but this may not be true under the Sec. 2701 special valuation rules.

If the taxpayer owns other types of interests in the entity, Sec. 2701 may apply and essentially create a deemed gift of an equal portion of each interest even if the grantor retains other interests. Various methods such as making a gift of an equal portion of each interest (referred to as a “vertical slice”) could be used to mitigate the special valuation rules.

Planning tip: Carried interest transfer strategies are complex. Ensure your clients are working with advisers who are well versed in the valuation of these types of assets and that the appraisal is sound and adequately disclosed on a gift tax return to mitigate the risk of IRS scrutiny.

8. Periodic estate plan review

Estate plans should not be static documents created once and put away and forgotten. Regularly reviewing estate plans is vital to ensure they remain true reflections of your client’s life circumstances and evolving wishes.

Periodic estate planning review is critical for the following reasons:

  • Life-changing circumstances: Life is dynamic, and events can affect estate plans, including marriage, divorce, the birth of children or grandchildren, the death of a family member, and changes in financial status. When these life-changing events happen, reviewing the estate plan will allow you to make sure it is aligned with your client’s wishes.
  • Change in assets: If the value of assets increases or decreases significantly, taxpayers may need to adjust their estate plans to optimize tax savings, asset protection, or charitable giving. Also, when acquiring or selling a business or investment, taxpayers may need to update their estate plans to reflect their desired succession planning.
  • Change in tax laws: Ever since the TCJA was enacted, individuals and their advisers have been busy using the temporarily doubled estate, gift, and GST exemptions that will sunset to about $7 million, indexed for inflation. The temporarily increased exemptions are a “use it or lose it” opportunity. Updating an estate plan is crucial, especially with tax laws that have changed or are expected to change.

Planning tip: An estate plan should be reviewed and updated at various times. Clients currently can take advantage of the increased gift/estate and GST exemptions with the guidance of their advisers.

Collaboration is key

Estate planning is a multifaceted endeavor that demands a comprehensive and collaborative approach, particularly when planning for real estate and its distinctive tax-related intricacies. In navigating the complexities of wealth transfer, it is paramount to involve not only the client but also a collaborative team consisting of attorneys, accountants, and financial advisers.

This collective effort ensures that every facet of the client’s financial landscape is meticulously considered, leading to the formulation of the most effective and tailored estate plan to achieve the client’s goals.


This article was written by Carol Warley, Scott Filmore, Amber Waldman, Shannon Ulrich and originally appeared on 2024-05-02.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2024/top-8-estate-planning-factors-for-real-estate.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

New Retirement Plan Distribution Options Introduced by SECURE 2.0

ARTICLE | April 30, 2024

Authored by RSM US LLP

Executive summary: Distribution options

Employers establish retirement plans to provide a vehicle to set aside monies, whether funded by the employee or the employer, to be preserved for a retirement benefit. The rules related to when an employee can take a distribution from their retirement plan account are restrictive considering the goal of preserving the retirement funds. SECURE 2.0, enacted on Dec. 29, 2022, included provisions that loosen some of the restrictions on withdrawals from a retirement plan. The additional options available give plan sponsors flexibility in choosing what to offer their employees.


In general

There are a few general concepts to keep in mind as we dive deeper into some of the provisions added by SECURE 2.0.

  1. A plan sponsor has discretion as to whether and how these optional plan provisions will be incorporated into the plan.
  2. All the distribution provisions discussed are exempt from the 10% tax on early withdrawals (i.e., before age 59½) from a retirement plan. However, the amount withdrawn is still subject to income tax.
  3. While income tax applies, there is the ability for an individual to recoup taxes, and restore their retirement savings, by re-contributing to the plan some or all the amounts withdrawn within three years of distribution.
  4. The provisions can be made available to any plan participant, not just a current employee.

Domestic abuse

A survivor of domestic abuse often needs access to additional funds to assist in escaping or recovering from an unsafe situation. “Domestic abuse” for this purpose is defined in SECURE 2.0 as: “physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including by means of abuse of the victim’s child or another family member living in the household.” The survivor must certify that they experienced domestic abuse within the last year to receive a distribution that is no more than the lesser of $10,000 (for 2024, as indexed) or 50% of the survivor’s vested plan balance.

This distributable event became available, after Dec. 31, 2023, for implementation by an IRC section 401(a) defined contribution plan (including 401(k), but not money purchase pension plans), 403(a) annuity plan, 403(b) plan and a governmental 457(b) plan, as well as individual retirement accounts (IRAs).

Emergency personal expense

Unforeseen emergency situations that require immediate financial resolution are a common occurrence. This distributable event allows up to $1,000 of the participant’s plan account to be withdrawn. To receive the distribution, the participant must certify that they have an expense for themselves or a family member that is an immediate financial need. Only one such distribution can be issued in a calendar year. Another personal expense distribution cannot be issued in the three calendar years following the year of distribution unless the withdrawn amount is repaid to the plan or contributions made by the participant to the plan after the distribution are at least equal to the amount distributed.

Many plans already provide hardship distribution options for employees. However, the circumstances under which a hardship distribution can be issued are limited. For example, an employee’s car may require a $750 repair, which would not fall under one of the safe harbor reasons for hardship distribution. However, the employee could use the emergency personal expense provision to take a distribution to cover the $750 repair.

This distributable event became available, after Dec. 31, 2023, for implementation by an IRC section 401(a) defined contribution plan (including 401(k), but not money purchase pension plans), 403(a) annuity plan, 403(b) plan and a governmental 457(b) plan, as well as IRAs.

Federally declared disasters

Repeatedly, Congress has enacted legislation after disasters (e.g., hurricanes, floods, wildfires) providing individuals the opportunity to take a penalty-free distribution or loan from their retirement plan accounts to assist them as they rebuild their lives. In lieu of the disaster-by-disaster approach, Congress enacted permanent rules for distributions and loans related to federally declared disaster areas.

Key features of the new distribution provision are:

  • A participant can request a distribution of up to $22,000 up to 180 days after the date of the disaster.
  • The individual must have sustained an economic loss in relation to the disaster and must have a principal place of residence located in the disaster area.
  • The tax effect of the amount withdrawn can be spread over three years rather than the entire amount being taxable in the year withdrawn.

Key features of the new loan provision are:

  • The maximum dollar amount that can be made available is the lesser of 50% of the individual’s vested plan balance or $100,000 (increased from $50,000 under the normal loan rules).
  • Loan repayments, whether on an existing loan or one taken because of the disaster, owed between the date of the disaster and up to 180 days after the disaster can be delayed for one year.

These provisions became available for disasters after Jan. 26, 2021, and can be implemented by an IRC section 401(a) defined contribution plan (including 401(k) plans), 403(a) annuity plan, 403(b) plan, and a governmental 457(b) plan, as well as IRAs.

Terminal illness

This provision was not added as a distributable event, but rather just as an exception to the early withdrawal penalty. Therefore, it only applies when a distribution is issued under another plan provision. The intention was to have this be an optional plan distributable event. There has been a technical corrections bill drafted that would address this, as well as some other SECURE 2.0 provisions, but it has not yet been finalized.

IRS Notice 2024-2 provides guidance on terminal illness distributions in the form of Q&As. The guidance confirmed the following:

  • A terminally ill individual is one who has an illness or physical condition that a physician has certified is expected to result in death in 84 months or less. The 84 months is measured from the date of certification.
  • Certification must be obtained prior to the distribution and contain specific information (e.g., the name and contact information of the physician, a narrative description to support the conclusion that the individual is terminally ill, the date the physician examined the individual, etc.) as outlined in Notice 2024-2.
  • Only the physician’s certification must be provided to a plan administrator to support the distribution. However, the individual should retain appropriate underlying documents to support their distribution and as part of maintaining complete tax records.
  • Generally, there is no limit to the amount that can be treated as a terminal illness distribution. However, distributions cannot be made solely because of a terminal illness. Therefore, the participant must qualify for a distribution based on another plan provision, and any limits applicable to the distributable event being utilized to issue the distribution would have to be considered. For example, a plan may allow in-service distributions, but it might cap such distributions to $10,000.

The provision became available after Dec. 29, 2022, for distributions from IRC section 401(a) defined benefit and defined contribution plans (including 401(k) plans), 403(a) annuity plans, and 403(b) plans, as well as IRAs.

Takeaway

Legislators see that employees have unexpected financial needs arise for which they need a source of funds. The only source, for some employees, with an amount sufficient to assist with the need is retirement plan savings. Relaxation of the distribution rules to provide an employee with a current source of funds may negatively impact the individual’s financial position in retirement overall but may also help encourage participants to contribute to their retirement plans by alleviating fears that their funds are not accessible when needed under extenuating circumstances. The opportunity is available for an employee to restore their retirement account by re-contributing the distribution taken, but how many individuals will avail themselves of this opportunity? Employees contemplating one of these distributions should consider 1) other sources of income that may be available to assist with the financial need, 2) the current tax ramifications of the withdrawal, and 3) how the reduction to their account balance will affect them in retirement.


This article was written by Christy Fillingame, Lauren Sanchez and originally appeared on 2024-04-30.
2022 RSM US LLP. All rights reserved.
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Brady Martz Named Among Accounting Today’s 2024 Regional Leaders

Top 100 nationally ranked accounting and advisory services firm Brady Martz & Associates today announced that the Firm was recently named among Accounting Today’s Regional Leaders for the Midwest. Each year, Accounting Today releases an annual ranking of the leading national and regional firms, as well as their chief executives’ take on the major issues facing their firms, and their strategies for success for 2024 and beyond.

“Earning a position among Accounting Today’s regional leaders underscores the relentless effort and commitment of every individual on our team,” CEO Todd Van Dusen said. “Our experienced professionals work tirelessly to anticipate our clients’ needs, offering proactive advice that empowers them to navigate decisions with assurance. As the accounting landscape continues to transform, our dedication to remaining ahead of the curve is steadfast.”

To learn more and view the 2024 leading national and local firms, visit accountingtoday.com.

Founded in 1927, Brady Martz has been providing exceptional client service for nearly a century. Headquartered in Grand Forks, the firm has nine offices throughout North Dakota, Minnesota, and South Dakota. Brady Martz is proud to offer advisory, audit & assurance, and tax services to clients in a wide variety of industries.

Brady Martz COO Stacy DuToit Recognized as Prairie Business Top 25 Women in Business

Top 100 nationally ranked accounting and advisory services firm Brady Martz & Associates today announced that Chief Operating Officer (COO) Stacy DuToit has been recognized among the Top 25 Women in Business by Prairie Business magazine. This award is open to female business leaders in North Dakota, western Minnesota, and South Dakota whose achievements make them stand out in their companies and communities.

“I have had the opportunity to work with Stacy from the time she joined the Firm as an associate through to her progression to a shareholder. In addition to earning ownership in Brady Martz, she has held several leadership roles including serving as a member on our board of directors, a market segment lead, and now our first ever Chief Operating Officer,” CEO Todd Van Dusen said. “At each stage of her career, Stacy has led by example through both her words and actions. She exemplifies what it means to be a real professional and a great leader. Stacy truly makes a positive difference where it matters most to our team members, clients, and communities.”

DuToit is a Certified Public Accountant (CPA) experienced in auditing, accounting, tax, and business consulting services for privately owned businesses. She is a member of the American Institute of Certified Public Accountants (AICPA) and the North Dakota Society of Certified Public Accountants (NDSCPA). DuToit currently serves on the Bismarck-Mandan Chamber Foundation board. She is a former Trustee of the North Dakota Certified Public Accountants Society Foundation. Additionally, DuToit is a past member of the public relations committee of the NDSCPA as well as a past board member of the Bismarck Downtowners Association and past volunteer with the North Dakota Jump$tart Coalition.

DuToit shared her gratitude, saying, “I am deeply honored to be included among such an esteemed group of leaders. This recognition is not only a testament to my personal commitment to excellence in our profession but also reflects the hard work and dedication of our entire team at Brady Martz. I am grateful for the support of my colleagues, our clients, and the community, which has been integral to our success. Together, we continue to drive positive change and innovation in our industry, and I am excited about what the future holds for all of us at Brady Martz. Thank you to Prairie Business for this incredible honor and for highlighting the achievements of women in business across our region.”

Brady Martz shareholders recently voted for DuToit to become the Firm’s next CEO upon Van Dusen’s retirement effective October 1, 2024.

Founded in 1927, Brady Martz has been providing exceptional client service for nearly a century. Headquartered in Grand Forks, the firm has nine offices throughout North Dakota, Minnesota, and South Dakota. Brady Martz is proud to offer advisory, audit & assurance, and tax services to clients in a wide variety of industries.