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News Notes

WFTRA • Washington’s Attorneys’ Lien Law (Box) • Generating Cashflow in Retirement Plans (Box)

Lesli S. Laffie, J.D., LL.M.

 

As we went to press…

President Bush signed into law the American Jobs Creation Act of 2004 (AJCA), which, among other things, makes numerous business and S corporation changes; repeals the exclusion for extraterritorial income; and provides tax relief for manufacturers and individuals. It also includes an itemized deduction for state and local sales taxes. These changes will be discussed in future issues.

Legislation

WFTRA

On Oct. 4, 2004, President Bush signed into law the Working Families Tax Relief Act of 2004 (WFTRA). Some of the critical non-technical-corrections tax changes include:

  • Under WFTRA Section 101(a), amending Sec. 24(a), for tax years beginning in 2005–2009, the child tax credit increases to $1,000.
  • For tax years beginning in 2005–2008, the basic standard deduction for married filing jointly (MFJ) doubles to that of single filers, under WFTRA Section 101(b), amending Sec. 63(c)(2).
  •  Under WFTRA Section 101(a), amending Sec. 1(f)(8), for tax years beginning in 2005–2007, the 15% MFJ bracket’s endpoint increases to twice that for single filers.
  • For 2005–2010, under WFTRA Section 101(d), amending Sec. 1(i)(1), the 10% bracket will apply to the first (1) $7,000 of taxable income for single filers and those married filing separately (MFS); (2) $14,000 of taxable income for MFJ filers and surviving spouses; and (3) $10,000 of taxable income for heads of households (HOHs). All taxable income levels are indexed from 2003.
  • According to WFTRA Section 103, amending Sec. 55(d)(1), for tax years beginning in 2005, the alternative minimum tax (AMT) exemption for individuals increases to $58,000 for MFJ, $29,000 for MFS and $40,250 for single filers.
  • For tax years beginning in 2004 and 2005, under WFTRA Section 312(a), amending Sec. 26(a)(2), the combined total of nonrefundable personal credits is limited to (1) regular tax liability reduced by the foreign tax credit allowable under Sec. 27(a) plus (2) the AMT.
  • For tax years beginning after 2004, WFTRA Sections 201, 204(a)(1), 205(a), 203(b) and 202(a), amending, respectively, Secs. 152(c), 24(c)(1), 32(c)(3)(A), 21(b)(1)(A) and 2(b)(1)(A)(i),  establish a uniform definition of “qualifying child” for purposes of the dependency exemption, the child credit, the earned income credit, the dependent care credit and HOH filing status. 
  • WFTRA Section 301 extends the Sec. 41 research credit to amounts paid or incurred after June 30, 2004 and before 2006.
  • Under WFTRA Section 303(a), amending Secs. 51(c)(4) and 51A(f), both the work opportunity credit and the welfare-to-work credit extend to wages paid or incurred for individuals beginning work in 2004 and 2005.
  • The credit for a qualified electric vehicle is available for those purchased in 2004 and 2005, under WFTRA Section 318(a), amending Sec. 30(b)(2).
  • The renewable electricity production credit under Sec. 45(c)(3) is extended by WFTRA Section 313 to facilities placed in service in 2004 and 2005.
  • The election to treat qualified environmental remediation expenses as deductible in the year paid or incurred is extended for expenses paid or incurred in 2004 and 2005, under WFTRA Section 308, amending Sec. 198(h).
  • The enhanced deduction under Sec. 170(e)(6)(G) for qualified computer charitable contributions is extended to contributions made in tax years beginning in 2004 and 2005, under WFTRA Section 306.
  • WFTRA Section 314(a) extends the suspension of the 100%-of-taxable income limit for marginal wells, under Sec. 613A(c)(6), to tax years beginning in 2004 and 2005.
  •  WFTRA Section 307(a) extends the Sec. 62(a)(2)(D) $250 above-the-line deduction for educators, to tax years beginning in 2004 or 2005.
  • The deduction for qualified clean fuel property is available in full for 2004 and 2005, under WFTRA Section 319(a), amending Sec. 179A(b)(1)(B). 

Washington’s Attorneys’ Lien Law
by Robert W. Wood, J.D., Robert W. Wood, P.C., San Francisco, CA

In Banaitis, 340 F3d 1074 (9th Cir. 2003), petition for cert. granted, 3/29/04, the Ninth Circuit found that contingent attorneys’ fees paid directly to a taxpayer’s lawyers were not gross income to the taxpayer; see Wood and Daher, “Attorneys’ Fee Saga Continues: Maverick Circuit Says, ‘Oregon Good, California Bad,’” 2003 TNT 189-35 (9/30/03). Relying on Cotnam, 263 F2d 119 (5th Cir. 1959), the court held that the taxpayer could exclude such fees. Given the strength of the Alabama lien, the Cotnam court found that there had been a transfer of part of the taxpayer's claim, so any recovery by the lawyers was simply gross income to them, not their client. In Banaitis, the Ninth Circuit found that Oregon’s attorneys’ lien law mirrored Alabama’s.

Apparently, the Washington Legislature has been following the attorneys’ fee issue fairly closely; on June 10, 2004, a new attorneys’ lien law went into effect; see the Notes to Wash. Rev. Code Ann. 60.40.010, citing 2004 Wash. Laws, chapter 73, 1. The law’s stated purpose is to:

[E]nd double taxation of attorneys’ fees obtained through judgments and settlements, whether paid by the client from the recovery or by the defendant pursuant to a statute or a contract. Through this legislation, Washington law clearly recognizes that attorneys have a property interest in their clients’ cases so that the attorney’s fee portion of an award or settlement may be taxed only once and against the attorney who actually receives the fee. This statute should be liberally construed to effectuate its purpose. This act is curative and remedial, and intended to ensure that Washington residents do not incur double taxation on attorneys’ fees received in litigation and owed to their attorneys.

This lien law was designed to replicate those discussed in Cotnam and Banaitis. Washington’s new law not only mirrors Alabama’s and Oregon’s laws (in that it provides attorneys with generous property interests in settlements and judgments), but actually surpasses them, by providing that attorneys’ liens in Washington are now superior to all other liens (including tax liens); see Wash. Rev. Code Ann. 60.40.010(3). Thus, it appears that Washington’s new law may provide the strongest protection yet under the Cotnam line of reasoning.

Helping Clients Generate Cashflow in Retirement Plans
by James R. Wagner, J.D., President and Chief Executive Officer, Trust Administration Services Corp., Carlsbad, CA

More than ever, investors are looking to generate cashflow in their retirement plans. To tap into this opportunity, CPAs can introduce investors to nontraditional investment options, by following the seven easy steps presented below.

1. CPAs need to focus on one segment of the retirement plan marketplace. IRAs are a good place to begin, as they are the fastest growing segment of that market. The increase in IRAs is due to (1) employees being able to withdraw funds from employer-sponsored retirement plans (while still employed) and roll them into IRAs for greater investment choices and (2) the large number of baby boomers expected to retire in the next few years. An estimated $1.3 trillion will flow from qualified retirement plans into IRAs; thus, the majority of qualified plan participants will be looking for advice at the time of rollover.

2. Tax advisers should determine method of compensation—through either planning or consulting fees. It may also be possible to receive referral fees from investment companies in which clients invest.

3. CPAs should investigate alternative investment options, by contacting local private lenders, mortgage brokers and real estate brokers or researching the Internet. For example, the California Department of Real Estate has an excellent publication, “Trust Deed Investments: What You Should Know” (available at www.dre.ca.gov/trust.htm).

4. Which transactions are prohibited inside an IRA? The Sec. 4975 prohibited transaction rules are intended to (1) ensure that IRA assets are invested to benefit the plan and (2) prevent a self-serving use of such assets. Although the definition of a prohibited transaction is complex, basically, under Sec. 4975(c), an IRA may not, directly or indirectly, sell, exchange or lease any property to an IRA accountholder or a disqualified person (as defined in Sec. 4975(e)(2)) (i.e., the IRA holder and his or her spouse, ancestors, lineal descendants and their spouses; investment advisers and managers; any corporation, partnership, trust or estate in which the IRA holder has at least a 50% interest; and anyone providing services to the IRA, such as the trustee or custodian).

5. Tax advisers should ask clients to sign a disclosure agreement. An attorney can draft it; the language can be as simple as:

In addition to any planning/consulting fees, we may receive other types of compensation directly from the product source. In most situations, these fees will not affect the yield you will receive on your investments.

6. CPAs should offer clients several investment options and allow them to make the final choice. This will help appease clients’ newfound interest in directing their own investments, while at the same time reducing liability exposure.

7. Once the tax adviser has presented the cashflow solutions and the client has made his or her choice(s), the practitioner will need to find a self-directed IRA custodian (SDIRA). Typically, SDIRA custodians are financial services companies (e.g., banks, brokerage firms and mutual fund and trust companies). Under such arrangements, the IRA accountholder, rather than the custodian, decides how to invest the funds.

Most firms today claim to provide self-directed IRAs; however, the majority restrict investments to those publicly traded. CPAs should look for an independent (i.e., non-product-source) IRA custodian, to enable investors to select from a wider range of options. Over a dozen such companies are located in the U.S.

Offering self-directed assets is a natural extension of the services many CPAs provide. By offering clients even more options, CPAs will continue to build value for their services and become indispensable. For more information, see www.trustlynk.com.

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2004 AICPA