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Blessings,
Kenneth R. Roney, J.D.
President
PERSONAL PLANNER
Loans and Sales to Children
Parents are frequently approached by children who desire loans for various purposes. Parents may make a loan to a child for the down payment on a home, to start a new business, to cover costs for a personal emergency or for education.
One of the considerations for parents who make a loan is whether they are treating all children fairly. Most parents hope to treat their children equally. But the need for a loan will probably exist with one child and not with the others.
As a result, parents may consider making the loan to a child and then planning to forgive that loan in the estate plan. If this is the case, a parent frequently will create a similar benefit for other children in the estate plan. By forgiving the loan to one child and passing a similar benefit through the estate to the other children, everyone is treated fairly.
Family Loan Guidelines
An "oral agreement" family loan may cause serious conflict. Parents or children may forget the loan amount, the loan duration and the interest rate. Therefore, the loan document should be written.
It frequently is either a "demand" note or a term note. A term note is for a fixed number of years, in a manner similar to most notes for the mortgage on a home. A demand note allows the parent to request full payment at any time. Many family loans are made on demand notes and there may not be an expectation that the principal will be repaid.
Will There Be Taxes?
If the demand note does not require any interest or specifies an interest rate that is below the market rate, then there is assumed income to the parent. In effect, the child is treated as if he or she is making payments of the interest to the parent at the appropriate rate. Even though no interest may be paid, the parent will be required to report income in that amount. If the loan interest is deductible by the child, he or she may take that deduction.
With a no-interest demand note, the parent also is making a gift. However, the annual exclusion ($14,000 in 2014) is frequently sufficient to cover the gift of the parent in forgiving interest payments by the child. If there are two parents, the gift exclusion amount is doubled.
In many cases the note will be written at the applicable federal rate for the month it is created. The IRS publishes a revenue ruling each month with applicable rates for loans of various duration. So long as the note bears an interest rate at that rate, there will not be a gift.
It is beneficial if the child actually makes payments to the parent at the applicable interest rate each year. Even if the parent has used annual gift exclusions to provide funds to the child, a written note with payments by the child shows that the parents and child are treating the note in an appropriate businesslike manner. This makes it much more difficult for the IRS to claim that the principal value of the note was an immediate gift to the child.
Family Loan Exceptions
There are two general family loan exceptions. First, a loan of $10,000 or less is not covered by the "market interest rate" rules. A parent may make an interest-free loan of that amount without any impact.
Second, if the loan is from a parent to a child and is $100,000 or less, there may be another exception that reduces the amount of the assumed income interest reported by the parent. For these loans, the parent may report income that is the lower of the applicable federal rate or the child's actual net investment income for the year. This may reduce the income reported by the parent.
Mother Carol Helps Daughter Susan Purchase a Home
Mother Carol wanted to help daughter Susan purchase a home. Mother Carol lent Susan $100,000 on a written demand note. The applicable federal interest rate that month was 3.2%. Susan does not pay interest on the note and therefore Carol has assumed income. Her income each year is 3.2% or $3,200. In addition, Carol is making a gift of $3,200 to Susan each year. Fortunately, there is no gift tax because it is less than the annual gift exclusion amount.
If Susan records the $100,000 loan as a second mortgage against the home that she purchases, she will be able to deduct the $3,200 of income that Carol reports. However, because Susan is likely to be in a lower tax bracket, Carol will still pay a substantial tax that is likely to exceed Susan's tax savings.
Bill Helps Son Joe Start a Business
Bill would like to assist his son Joe who is starting a business. Bill lends Joe $50,000 on a demand note. The note requires an annual payment of 2.0%, which is the applicable federal rate on the date the note is created. Under the note terms, at the end of each year, Joe must pay $1,600 of interest to Bill.
Joe starts the business and makes the payment of $1,600 each year to Bill. Joe's CPA deducts the payment on Joe's tax return as an ordinary and necessary expense of the business.
Family Sales
There are a number of circumstances in which a parent may wish to sell real estate or stock in a family business to a child.
Many parents also choose to make gifts of land or stock to children. However, a parent may have already used the annual exclusion and his or her gift exemption. Alternatively, the parent may desire the economic security of payments on the property. Some parents prefer to sell assets to children and then have the payments available for retirement income.
Finally, a parent may give part of the land or stock to a child and then sell the balance. This transfer enables the child to own the investment or business. However, the child benefits from the self worth that results from the process of making payments on the note. While the child has been given part of the property or business, he or she has the self confidence that comes with making the business productive and paying on the note.
Installment Sale
Because children who purchase assets are frequently in the initial years of their careers, they usually lack the funds to purchase the entire property or stock in the business. As a result, it is quite common to use an installment sale.
From the perspective of a parent, the installment sale also has the benefit of spreading out the capital gain. He or she probably has a high level of appreciation in the land or stock. Using an installment sale will allow that gain to be recognized over a term of many years. Because the tax on the gain is not due until each portion is recognized, the total cost of the capital gains tax may be significantly reduced.
The parents also may be thinking of the impact on their estate plan. It may be quite desirable to "freeze" the value of a particular asset through an installment note. If the parents owned a parcel of land until they pass away, that property could greatly increase in value by the time of their death. However, if they freeze the value by selling it at a fair price on an installment note, then the growth in value of the land will benefit the children's estates.
Installment Sale Taxation
The primary benefit of an installment sale to the parent is that the capital gain is prorated. The CPA for the parent will develop a schedule showing the amount of the interest (which is ordinary income to the parent) and the amount of the capital gain each year. The payments by the children will be in part ordinary income on the interest portion and capital gain on that portion for the parent each year. If the parent has a tax basis in the property, a portion of each payment will be returned with no tax.
There is an important limitation on the installment sale to the child. If the parent transfers the property to the child, the child should not sell within two years. If the child were to sell the property prior to the two year limit, then in most cases the gain will immediately be taxed to the parent. Therefore, if a parent sells assets to a child on an installment note, the child should plan to hold the property for a minimum of two years.
Joe and Mary Sell to Daughter Linda
Joe and Mary have a commercial building and lot that is valued at $200,000. They have taken straight-line depreciation and the adjusted basis is now down to $20,000. They would like to sell this building to their daughter Linda. She will make payments to Joe and Mary and will immediately lease the building to a tenant who is waiting in the wings.
Because the applicable federal rate is 3%, Joe and Mary set up a 20 year installment sale to Linda using the 3% interest rate.
Each year, Linda will make a payment of the interest plus principal as set forth in the note that has been developed by the family's CPA. Joe and Mary will report the interest as ordinary income and a portion of the capital gain. Their prorated part of the $20,000 of basis is tax-free. Because Linda plans to hold the building and will not sell within two years, there will be no acceleration of the capital gain for Joe and Mary.
Joe and Mary also considered other options with their CPA. One possibility is for there to be a provision in the 20 year note that would eliminate the debt if both Mary and Joe pass away prior to the end of 20 years. This provision to cancel the debt if the parents die early is called a "self-canceling installment note."
Another option is to use an alternative to the installment note called a private annuity. With the private annuity, Joe and Mary would receive payments from Linda for their lifetimes, rather than the fixed term of the installment note.
After discussing these two other concepts with their CPA, Joe and Mary decided to use the 20-year installment note. This will freeze the value and gives Linda a clear picture of the payment amounts and schedule.
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SAVVY LIVING
How to Find Good Nursing Home Care
Can you give me some tips on finding a good nursing home for my 86-year-old mother? She had a stroke a few months ago and has been receiving care at home but it has become too much.
Finding a well-run nursing home that provides quality care is an important decision that requires some homework. Here's what you should know.
Finding Good Care
The decision to move a loved one into a nursing home can be a difficult one. In most cases, the decision is forced by a sudden decline in health or mental ability or by a gradual realization that they can no longer receive the care they need at home. Whatever the circumstance, here are some steps that can help you find a good nursing home and avoid a bad one:
Make a List: Contact your Area Agency on Aging for a list of local nursing home facilities. Ideally, the facilities should be close to family members and friends who can visit often. Residents with frequent visitors usually get better care. The national Eldercare Locator (800-677-1116 or www.eldercare.gov) can direct you to your local aging agency.
Online Help: The Internet is a great resource to help you find and research nursing homes. Medicare offers a Nursing Home Compare resource at www.medicare.gov/nhcompare/home.asp that lists every nursing home that accepts Medicare and Medicaid by state, city and zip code. Also see the Consumer Reports nursing home article at http://www.consumerreports.org/cro/news/2009/08/do-not-for-profit-nursing-homes-provide-better-care/index.htm. This free resource helps identify nursing homes that are likely to provide better-quality care and those you need to avoid. You can also purchase detailed nursing home reports through companies like www.healthgrades.com and www.carescout.com.
Ombudsman Help: This is a government official who investigates nursing home complaints and advocates for residents and their families. Be sure you call them. They can tell you about the nursing homes in your area as well as which ones have had complaints or other problems. To find your local ombudsman, call your area aging agency or see www.ltcombudsman.org.
Check the Ownership: According to a recent study by Consumer Reports, independent not-for-profit homes generally provide better care than for-profits owned by chains. Call the nursing homes you're interested in and ask if they have recently or are about to change owners. A nursing home that's for sale might have problems, just as one with a new owner might be getting better.
Facility Visits: Once you've narrowed your search, visit each facility so you can evaluate them first-hand. Be sure to find out if they're capable of providing the kind of care your loved one needs, what they charge and if they accept Medicaid. While you're there, talk with the staff, residents and their family members, if available. Taste the food, check the cleanliness of the facility and notice if the staff is responsive and kind to its residents. Ask the nurse's aides how many residents they each care for (the smaller the number, the better). It's also a smart idea to include an unannounced visit in the evening or on the weekend when staffing problems are most prominent.
Staff Turnover: Ask the nursing home administrator about top level turnover. If the administrator and the director of nursing have worked at a facility for several years, that's usually a positive sign. Frequent changes in those positions indicate instability, which could translate into poor care.
Inspect the Inspection: Read the nursing home's state inspection survey, known as Form 2567. It should be readily accessible. If it's not and you have difficulty obtaining it, consider that a warning that the facility may be hiding problems or violations.
Compare Facilities: Medicare has a checklist at www.medicare.gov/nursing/checklist.asp that can help you evaluate and compare the nursing homes you're considering.
Savvy Tip: If you find yourself in a situation where your elderly loved one has been hospitalized because of a medical condition or injury and the hospital wants to discharge them before you've had time to investigate any nursing homes, you can appeal to Medicare to extend the hospital stay for two days. That will buy you some time to locate a good facility.
Savvy Living is written by Jim Miller, a regular contributor to the NBC Today Show and author of "The Savvy Senior" book. The articles are offered as a helpful and informative service to our friends and may not always reflect this organization's official position on some topics. Jim invites you to send your senior questions to: Savvy Senior, P.O. Box 5443, Norman, OK 73070.
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YOUR PLAN
The Retirement Unitrust
Mary grew up on a farm. When her parents passed away, she inherited the farm.
When Mary was growing up, the farm was out in the country. Now that the city has grown, the farm is within the city limits. Several developers would like to build homes on the farmland.
Mary: We have received modest payments from the farm over the years. I allowed a neighboring farmer to graze his cows on the farm until recently. Since I inherited the farm from my parents several years ago, the value of the farm has greatly increased.
Bill: We checked with our tax advisor and the farm could be sold, but there would be a very large tax to pay. Since it is a good time to sell the land, we would like to sell. And then it would be good to let the sale proceeds grow for about 10 years until we plan to retire. In fact, we are hopeful that we can sell tax free and then allow the proceeds to grow tax free.
Mary: I was excited to learn from our tax advisor that there is a plan that does provide for our retirement. She explained that we could transfer the land into a special trust. Once inside this trust, the farm could be sold tax free and the cash invested for growth. The proceeds would grow tax free inside the trust until we retire. At that time, the payouts would be taxable, but we could have as much as $900,000 in the trust.
Bill: We will enjoy a very nice retirement. We already have an IRA and are planning to use that for retirement. With the extra income from this retirement trust, we will be able to travel and really enjoy our golden years.
*Please note: The name and image above is representative of a typical donor and may or may not be an actual donor to our organization. Since your unitrust benefits may be different, you may want to click here to view a color example of your benefits.
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WASHINGTON NEWS
House and Senate Tax Extenders Hearings
Both House Ways and Means Chairman Dave Camp (R-MI) and Senate Finance Committee Chairman Ron Wyden (D-OR) have pledged to hold April hearings on the IRA charitable rollover and other tax extenders.
Chairman Wyden stated that he hopes to publish the Senate list of tax extenders on March 31. He and Ranking Member Orrin Hatch (R-UT) are developing the approved list of tax extenders.
Wyden noted that he thinks a bipartisan effort is important. Referring to Hatch, he stated, "We have been working very well together, and I'm going to let you wait until we have an official statement."
Wyden plans to hold the hearing and markup of the tax extenders bill within the next month. It appears that Senate Finance Committee members will be able to offer amendments, but they will also have to include tax increases or offsets for those amendments.
Chairman Camp sent a memo to the Ways and Means Committee members on March 24. He indicated that there will be April hearings on tax extenders. Part of the goal of the hearings will be to determine which extenders should be made permanent.
Camp noted in his memo, "I have long believed that many expiring tax policies have broad bipartisan support and, sooner or later (usually later) get extended." He suggested that these short extensions were not "the way to legislate" and confused the revenue debate.
Camp plans to discuss the future of each extender. In his 979 page comprehensive tax reform discussion bill submitted in February, extenders fell into three categories: extenders Camp proposes to make permanent, extenders that will be allowed to sunset or would be repealed and extenders that may or may not be extended.
First, the Camp draft repealed 37 former tax extenders. These included many energy incentives, the schools supplies deductions for teachers and gifts of food inventory.
Second, nine extenders made the approved list. These include the research and development credit, the basis adjustment for charitable gifts of appreciated property from a Subchapter S corporation and the charitable conservation easements.
Third, there were 11 extenders that were not addressed. It is possible that some of these extenders could be added to the approved list if revenue offsets were available.
Editor's Note: If there are hearings in both the House and Senate during April, it is possible that there could be a tax extenders bill by mid-year. However, if the process becomes delayed past mid-year, then it is quite possible that the tax extenders bill will be passed in November after the election. The Senate bill is anticipated to cover all of years 2014 and 2015. The duration of the House bill is not known at the date of this publication.
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FINANCES
Stocks - Carnival's Quarterly Results Sink
Carnival Corporation (CCL), a leading operator of cruise ships, reported its first quarter results on Tuesday, March 25. Although the company's revenue and income beat expectations, its second quarter financial guidance did not.
Carnival reported first quarter revenue of $3.59 billion. Even though this figure was essentially unchanged from the same period last year, it did beat Wall Street estimates calling for revenue of $3.56 billion.
For the quarter Carnival recorded a net loss of $15 million, or $0.02 per share. This was a drop from the $37 million profit the company reported during the comparable period last year. Still, the $0.02 per share loss was better than Wall Street estimates calling for a loss of $0.08 per share.
Arnold Donald, Carnival Corporation President and CEO, had this to say about the results, "We see progress with our continental European brands and continue to be pleased with Carnival Cruise Lines' pace of improvement. Exciting product innovations and strategic marketing initiatives at Carnival Cruise Lines have driven strong close-in demand resulting in sequential improvement in year-over-year quarterly ticket prices for the brand."
Carnival has faced a difficult time the past couple years. The company is still dealing with lawsuits stemming from a February 2013 mishap when the engine of one of its ships was disabled following a fire. In addition, in 2012 one of its ships hit a reef, resulting in the deaths of 32 people. The company has been using discounts to lure customers back onto its ships. However, Carnival announced that during this recent quarter it lost bets on fuel prices, which were $10 per metric ton higher than previously forecast.
Carnival Corporation (CCL) shares ended the week at $37.23.
Sonic Drives In Second Quarter Success
Sonic Corp. (SONC), the nation's largest drive-in restaurant, announced its second quarter results on Monday, March 24. The company's profit beat expectations and helped drive the stock price to new heights.
Sonic reported revenue of $109.7 million for the quarter, a 1.3% decrease from the same period last year. However, the company did report that company-wide same-store sales increased 1.4%.
Net income for the quarter was $4.1 million, or $0.07 per share, which beat Wall Street expectations. This was a 15% increase over the $3.6 million, or $0.06 per share, reported during the same period last year.
"We are very pleased with our second quarter results, especially in light of the difficult weather that impacted many of our markets," said Cliff Hudson, Sonic CEO and President. "Our solid sales and financial performance resulted from multiple system-wide initiatives such as increased media efficiency, innovative products and layered day-part promotions. These initiatives complement our focus on service, products and pricing."
Many analysts were pleasantly surprised by Sonic's positive same-store sales growth of 1.4%, especially considering challenging weather the company faced during the quarter. Ever since the recession in 2009 the company has made efforts to improve its offerings and attract customers. As part of that process, the company now makes its milkshakes with real ice cream, offers more ice cream cone sizes and uses ciabatta rolls for its chicken sandwich. Evidently some of these changes are having a positive impact on the company's bottom line. Following the earnings announcement on March 24, the company's stock surged 11% to a new high above $22 per share.
Sonic Corp. (SONC) shares ended the week at $22.56.
GameStop Facing Stiff Competition
GameStop Corp. (GME), the number one retailer of videogames, announced its fourth quarter results on Thursday, March 27. Despite new videogame console releases during the quarter, the results missed expectations.
GameStop reported fourth quarter revenue of $3.68 billion, a 3.4% increase over the $3.56 billion reported during the same period last year. Expectations were for revenue to be slightly higher at $3.78 billion.
Net income for the quarter was $220.5 million, a drop from the $261.1 million reported during the comparable period last year. The drop was larger than expected, especially considering the fact Sony and Microsoft released new game consoles during the quarter.
"The launch of new consoles in 2013 marked the return of innovation to the video game category and GameStop's market share increased to an all-time high," said Paul Raines, GameStop CEO. "Our emerging digital and mobile businesses, which did not exist three years ago, surpassed $1 billion of revenue. As we push forward into 2014, both the re-energized video game category and our new Technology Brands business unit provide us with solid growth opportunities in the consumer electronics and wireless markets."
GameStop's fourth quarter earnings release disappointed investors in a number of ways. First, the company's revenue and net income for the quarter missed expectations even as Microsoft and Sony released new game consoles during the quarter. Second, GameStop's financial guidance for the year came in lower than expected. Because GameStop's used-game business is its most profitable, investors are concerned about increased competition from Wal-Mart and Sony, who both plan to begin trading and selling used games. Following the earnings announcement, GameStop's stock price fell 9.3%.
GameStop Corp. (GME) shares ended the week at $40.62.
The Dow started the week of 3/24 at 16,303 and closed at 16,323 on 3/28. The S&P 500 started the week at 1,868 and closed at 1,858. The NASDAQ started the week at 4,289 and closed at 4,156.
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Bonds - Treasuries Set For First 2014 Monthly Loss
Treasury prices fell Friday, March 28, as consumer spending data for March rose for the first time in nearly three months. In addition, bond traders are preparing themselves for further changes in Federal Reserve policy after comments from some of its members in the past week.
Consumer spending rose 0.3% in February, which was the quickest pace recorded since November of 2013. February's spending increase encouraged economists after January's increase was revised downward to 0.2%. Personal incomes for February were also revealed to have increased 0.3%.
The positive consumer spending data reaffirmed opinions that the Federal Reserve will stay committed to its plan to reduce monthly bond purchases. "Unless there is a sharp slowdown in the U.S. economy, which is unlikely at this point, the Fed will continue with this pace of tapering," said Axel Botte, a strategist at Natixis Asset Management.
On news of the rise in consumer spending, the 10-year Treasury note yield, which moves inversely to prices, rose four basis points to 2.726% during early Friday trading. February's final 10-year Treasury note yield was 2.649%, so with two trading days left in March it appears the 10-year note is headed for its first monthly loss of 2014.
Despite the positive consumer spending data, the final University of Michigan and Thomson Reuters gauge of consumer sentiment for the month of March fell to 80 from an 81.6 reading in February. The gauge missed expectations that called for a reading of 80.5 and was the lowest reading since November.
Treasuries have been responding lately not only to economic data but also statements from Federal Reserve members. Last week Federal Reserve Chair Janet Yellen said bond purchases may completely end this fall and that borrowing costs may be raised six months later. In addition, Federal Reserve Bank of Chicago President Charles Evans indicated interest rates will probably rise in the second half of next year.
The 10-year Treasury note yield finished the week of 3/24 at 2.71% while the 30-year Treasury note yield finished the week at 3.54%.
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CDs and Mortgages - Interest Rates Rise
Freddie Mac released the results of its latest Primary Mortgage Market Survey (PMMS) on Thursday, March 27. The results show mortgage rates rising this week following comments from new Federal Reserve Chair Janet Yellen late last week that a possible interest rate increase was in order in early 2015.
The 30-year fixed rate mortgage averaged 4.40% this week. This represents an increase from last week when the 30-year fixed rate mortgage averaged 4.32%.
This week, the 15-year fixed rate mortgage averaged 3.42%. This was an increase from last week when the 15-year fixed rate mortgage averaged 3.32%.
"Mortgage rates rose following the uptick on the 10-year Treasury note after comments by the Federal Reserve Board Chair Janet Yellen indicated a possible increase in interest rates as soon as early 2015," said Frank Nothaft, Vice President and Chief Economist at Freddie Mac. "Also, the S&P/Case-Shiller 20-city composite house price index rose 13.2% over the 12-months ending in January 2014."
The money market fund finished the week of 3/24 at 0.4%. The 1-year CD finished at 0.6%.
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