Rabbi Trust

Used to accumulate assets for deferred compensation plans and to provide the employee with some assurance that the employee will actually receive the promised future payments. The term comes from an IRS case which involved a trust established by a religious organization for its rabbi.

Real Estate Environmental Considerations

» Phase-I Audit - An evaluation of property to determine, among other things, what the property has been used for in the past and what other properties in the vicinity are being used for and have been used for in the past. It includes a walk-through of the property and typically aerial photographs of the property and other properties within a certain radius. It also includes a check of public records to determine whether there have been any reported environmental violations of the subject property and other properties in the vicinity, as well as whether there have been any reported releases or spills of contaminants on or near the property. The general purpose of a Phase-I Audit is to determine whether a more detailed environmental investigation, known as a Phase-II Audit, is warranted. A Phase-I Audit is important to determine whether prior uses of the property may pose a risk to present ownership or occupancy. Properties that are or were formerly used as gas stations or dry-cleaning operations are usually environmentally suspect and should be investigated closely prior to purchase or lease.

» Phase-II Audit - Typically involves a number of soil borings at various depths and locations and a laboratory analysis to determine whether the soil and/or groundwater is contaminated. If there is contamination beyond certain acceptable limits, remediation or clean up will usually follow. The remediation or clean-up process is sometimes referred to as a Phase-III Audit.

» Phase-III Audit - The term sometimes used to indicate the remediation or clean-up work performed after contamination has been confirmed. It is done with a certain degree of oversight and approval by the Environmental Protection Agency and/or its state counterparts.

» Resource Conservation and Recovery Act of 1976 as amended by the Hazardous and Solid Waste Amendments of 1984 (usually referred to together as "RCRA") - Designed to regulate the generation, handling, transportation, treatment, storage, and disposal of solid and hazardous wastes from cradle to grave. It can have a significant impact on owners and operators (including lessees) and should be considered before the purchase or lease of any property, particularly commercial property, that may have been used for purposes involving hazardous wastes. In addition to the Environmental Protection Agency and its state counterparts being able to bring enforcement actions, in certain circumstances RCRA also allows any private person to file what is known as a citizen suit against persons who have contributed to and/or who are contributing to an imminent or substantial endangerment to health or the environment. Potentially-liable parties include present owners and operators (including lessees) for prior actions on the property by former owners and operators.

» Comprehensive Environmental Response, Compensation, and Liability Act or Superfund (often referred to as "CERCLA") - Imposes liability on, among others, present owners and operators (including lessees) of property on which hazardous substances are located and on former owners and operators (including lessees) who owned or operated property at the time hazardous substances were disposed of on the property. Before purchasing or leasing any commercial property (and depending upon the circumstances, possibly residential property), minimum environmental due diligence requires that a Phase-I Audit be performed. Nearly all lenders currently require at least a Phase-I Audit as a condition to making a loan secured by commercial property. Under certain circumstances, persons who inherit real estate will not be liable for hazardous substances on the property. Also, there are certain limitations on the liability of those who own or operate real estate in a fiduciary capacity for the benefit of others; this applies to trustees, executors, administrators, and custodians, among others.

» Wetland Permit (also sometimes referred to as a Section 404 Permit or a Dredge and Fill Permit) - Required before dredging or filling any real estate classified as a wetland. The U.S. Army Corps of Engineers issues individual permits, which are required by Section 404 of the Clean Water Act. A wetland includes swamps, marshes, bogs, similar areas, and any area inundated or saturated by surface or ground water sufficient to support vegetation typically able to live in saturated soil conditions. Typically, any activity that changes the bottom elevation of a wetland or converts it to dry land requires a permit.

Real Estate Investments

See Adjusted Basis (Real Estate), Appropriate Ownership of Property and Business Interests, Basis (Real Estate), Building Restrictions and Zoning, Capital Gains, Contracts to Buy or Sell Real Estate, Depreciation, Fair Market Value, Family Leases to Shift Income, Home Equity Loan, Immovable Property, Installment Sale, Intrafamily Leases to Shift Income, Mortgage Loan Monthly Payments, Real Estate Valuation for Investment Purposes, Real Estate Environmental Considerations, Redhibition, Reverse Mortgage, Sale and Purchase of a Business, Sale of Depreciated Property, Sale of Residence, Servitude, Stepped-Up Basis, and >Tax-Free Exchange.

>>> Tip: Real estate should be insured by an owner's title insurance policy even if the mortgage lender has title insurance coverage and even if a competent title examination has been performed because neither the lender's policy nor the title examination protect an owner against certain potential title defects which can surface as "hidden defects" such as for example forgery in the chain of title which could not have been detected by the title examiner. Also the mortgage lender's policy only covers the current mortgage balance and provides no protection to the owner.

Real Estate Valuation For Investment Purposes

Investment real estate property such as multi-family units, office buildings, warehouses, and similar property that generate rental and other income frequently are valued roughly by prospective investor-purchasers by the following income approach analysis:

(1) gross estimated annual rental income (for example, $250,000)

(2) less estimated vacancy and collection losses (for example, less $15,000)

(3) plus income from other sources such as late fees, concession vending machines, and so forth (for example $10,000)

(4) equals effective gross income (for example, $245,000)

(5) less annual operating expenses (exclusive of debt service-mortgage payments); operating expenses would include utilities, insurance, real estate taxes, maintenance and repairs, equipment replacement and decorating, management fees, legal and accounting, and so forth (for example, less $120,000)

(6) equals annual net operating income (for example, $125,000)

(7) divided by the investor's rate of return (that is, desired current capitalization rate or yield) (for example, 10%)

(8) equals value of the property that the prospective investor would offer to buy the property (for example, $1,250,000)

>>> Tip: Similarly, if the prospective investor-purchaser knows the annual net operating income and the seller's asking price for the property, the annual net operating income (for example, $125,000) can be divided by the seller's asking price (for example, $1,500,000) to calculate the estimated current capitalization rate at that price (for example, 8.3%). This calculation can thus serve as a basis for negotiating a lower price.

See Real Estate Investments references.

Redhibition

The avoidance of a sale because of a vice or defect in the thing (such as a building, vehicle, and so forth) which renders the thing absolutely useless or its use so inconvenient that it may be presumed that the buyer would not have purchased the thing had the buyer known of the defect.

See Real Estate Investments references.

Renunciation

The Louisiana functional equivalent of a disclaimer.

Rescission

Annulling or abrogating a contract and placing the parties to the contract in a position as if there had been no contract.

Retirement Plans and Benefits

Employer provided or sponsored retirement benefits for employees are either qualified or non-qualified. A qualified benefit is one that qualifies for preferential tax treatment, including (1) deductions by the employer for contributions; (2) tax deferred for (a) the employee for the employer's contributions, (b) the employee's contributions, and (c) earnings on the contributions, (3) favorable tax treatment in some cases when benefits are paid, and (4) tax exemption for the fund established to provide retirement benefits. These tax benefits to the employers, the employees, and the retirement fund itself are not available unless the retirement plan is qualified by satisfying Internal Revenue Code requirements relating to (1) discrimination in coverage, and (2) benefits for highly compensated employees. See Highly Compensated Employees, Key Employees, Non-Discrimination, Participation, Top Heavy and Vesting.

An employer maintained and funded (by employer contributions to a trust or by the employer's purchase of annuity contracts) but non-qualified retirement or other deferred compensation plan results in the participants' realizing taxable income but the employer may deduct the contributions under certain rules.

The basic types of retirement plans are as follows:

» Pension Plan (Defined Benefit Plan)

A pension plan is more accurately called in tax parlance a defined benefit plan. It is a type of retirement plan that provides a fixed benefit, for example, a percentage of a retired employee's salary for some number of working years. An annual retirement benefit cannot exceed the lesser of $130,000 (indexed annually for inflation) or 100% of the employee's average annual salary for three consecutive years of the highest salary.

Maximum benefits are payable at Social Security retirement age and are reduced on an actuarial basis for any earlier retirement. See Social Security (SS) Benefits and Taxation.

A defined benefit pension plan is frequently used in small businesses where the owners are paid high salaries and they are older than most other employees; contributions to a defined benefit pension plan are not limited in amount. The owners make annual contributions of an amount actuarially determined to fund each employee's fixed retirement benefits. Most of the contributions are credited to the owners.

>>> Tip: Such plans can be disadvantageous because the owners' contribution in actuarially determined amounts must be made each year even if the business does not realize a profit.

» Profit-Sharing Plan (Defined Contribution Plan)

A profit-sharing plan is more accurately called in tax parlance a type of defined contribution plan. The employer's annual contribution is fixed and the employee's benefit is not fixed.

>>> Tip: The employer is not required to make an annual contribution; therefore, in years in which the business does not realize a profit or the profit is low, reduced contributions may be made or contributions may be skipped altogether for that year.

>>> Tip: Defined contribution profit sharing plans are frequently used in businesses where the owners are relatively young and receive a high salary. Thus, they have many years during which they can make contributions and realize investment growth.

» Money-Purchase Plan

A money-purchase plan is a type of defined contribution plan in which the employer's contribution is fixed as a percentage of each participating employee's salary. It combines features of a defined benefit pension plan and a defined contribution profit-sharing plan. The employer is required to make annual contributions as in a defined benefit plan but the participating employee's benefit is not fixed because it depends on the investment result.

The limit on contributions is currently $30,000 or 25% of compensation, whichever is less.

The employer's income tax deduction is 25% of the total compensation and in that respect it differs from a defined contribution profit sharing plan.

It is possible for a business to establish both a 15% profit sharing plan and a 10% money purchase plan with certain limits.

» 401(k) Plan

A 401(k)s cash or deferred plan is one in which the employer's contribution is received by the employee in cash and the employee pays income tax on it, or the employee may defer income taxes on the contribution by having the contribution credited to the employee's 401(k)s plan account.

A salary-reduction plan is one in which employees may decide to reduce their salaries in a certain percentage. This amount is deferred from income taxation and credited to the employee's 401(k) plan account. This amount is currently fixed at $10,500 (indexed for inflation). Once a deferral is made, it is the same as an employer contribution to any other qualified retirement plan; accordingly, any withdrawal of deferred income made before retirement is subject to a tax penalty unless certain hardship conditions are met.

A 401(k)s plan is offered in conjunction with a profit-sharing or stock bonus plan. Certain non-Discrimination rules apply which require certain balances between highly compensated employees and other employees.

Participation in a 401(k)s plan by a highly compensated employee is sometimes encouraged to achieve qualification of the plan for highly paid employees by the employer's matching each employee's deferral, for example, $.50 for each dollar deferred by the employee.

A 401(k) "simple plan" has less stringent non-Discrimination requirements. The annual deferred amount is a maximum of $6,000 (indexed for inflation). Eligible employers are those who employ 100 employees or less, each of whom receives at least $5,000 in compensation and the employer does not sponsor any other retirement plan.

» KEOGH or HR-10 Plans

A retirement plan for the self-employed which may be a pension, profit-sharing, money-purchase, 401(k)s or SEP (Simplified Employee Pension Plan or Super IRA). However, the contribution limit is based on the self-employed's earned income (that is, the net self-employment income less the retirement plan contribution). For example, mathematically, the self-employed individual can only contribute 20% of compensation to a money-purchase plan with a 25% limit and only 13.04% to a plan with a 15% limit.

» Highly Compensated Employees

Highly Compensated Employees are employees who are owners of 5% or more of the business, earn more than $80,000 (indexed for inflation), and are in the top 20% of employees ranked by compensation.

» Key Employees

A key employee is an employee who (1) for five consecutive years is an owner of 5% or more of the business, or (2) is an officer with compensation of more than 150% of the annual maximum contribution for defined contribution plans (that is, currently $45,000 based on a current maximum of $30,000), or (3) is an owner of 1% or more of the business who has compensation of more than $150,000, or (4) is among the ten employees with annual compensation in excess of the $45,000 outlined in number (2) and owns the largest percentage of the business (after applying IRS attribution rules).

If a plan is top-heavy (see below) in any year, adjustments must be made to enhance the benefits for employees who are not Key Employees. The adjustments vary, depending on whether the qualified plan is a defined benefit pension plan or a defined contribution plan.

» Non-Discrimination

The requirements must be met for a retirement plan to be qualified for favorable income tax treatment. The purpose of non-Discrimination rules is to ensure that qualified retirement plans do not discriminate in favor of the highly compensated employees with respect to coverage, contributions, or benefits. Qualified plans may not be top-heavy. At least 70% of all employees who are not highly compensated must be covered by the plan or the percentage of employees who are not highly compensated is at least 70% of the percentage of highly compensated employees who are covered. Also, the plan must cover 50 employees or 40% of all employees, whichever is less.

» Participation

Means that an employee (participant) is eligible to take part in the retirement plan sponsored by the employer. Eligibility includes reaching age 21, working more than 1,000 hours each year, and having one or two years of service. If two years is the eligibility standard, all participants must be given 100% immediate vesting.

» Top-Heavy

Refers to a plan in which more than 60% of the accumulated benefits have accrued for Key Employees.

» Vesting

Is the time when an employee (participant) actually owns the contributions to the plan; 100% vesting (Cliff vesting) occurs after five years of service; graded vesting occurs 20% after three years and 20% for each of the next four years; 100% vesting also occurs if two years of service is the eligibility standard.

If an employee (participant) terminates employment before 100% vesting occurs, the balance is forfeited, and will either reduce future employer contributions or will be used for bonus contributions for the other employees.

» Distributions After Death

Distributions after the death of the participant are included in the gross estate if distributions were payable to the participant or to the participant and a beneficiary, and after the death of the participant, any payment is made to a surviving beneficiary. This rule applies to pension plans, profit-sharing plans, 401(k) plans, IRAs, along with annuities.

If the annuity beneficiary receives a lump sum, then the lump sum is included in the gross estate. If installments are received, the present value of the beneficiary's rights are included in the gross estate.

>>> Tip: Voluntary payments made by an employer to a surviving spouse or other beneficiary are not subject to estate taxes.

See Income In Respect of a Decedent, Estate Tax (Federal), and Generation-Skipping Transfer Tax.

» Lifetime Distributions

A lump sum distribution to a participant (other than a self-employed person) from a qualified retirement plan, IRA, or SEP may be made only because of the participant's (1) death (see Gross Estate), (2) having reached age 59½, or (3) separation from service. Otherwise, a lump sum distribution will cause a 10% penalty for premature distribution (plus income tax).

However, if a lump sum distribution from a qualified plan is not made because of any of these three reasons, the lump sum can be rolled over into an IRA within 60 days, and the income tax remains deferred and no premature distribution penalty is due. The rollover must be from a trustee to a trustee, or else the account is subject to a 20% income tax withholding.

Installment distributions are taxed under IRS annuity rules which prorate the distributions between the contributions made by the employee and the contribution made by the employee, with the employee's contribution being tax-free because it was made with after-tax dollars. Of course, if the employee made no contribution, the entire distribution is taxable.

The option of lump sum versus installment benefits can be complicated because of the minimum distribution requirements. As an example, for a married participant, the minimum distribution based on the life expectancies of both spouses sometimes results in distributions in the first few retirement years that do not diminish the retirement funds which may even increase.

An MRD means a minimum required distribution.

An RBD means a required beginning date.

» Minimum Distributions (Withdrawals)

Distributions from qualified retirement plans and IRAs must begin by April1^st following the calendar year that the participant reaches age 70½.

>>> Tip: Owners of less than 5% of a business which sponsors a qualified retirement plan may defer or delay distributions until actual retirement. Distributions must be made in accordance with IRS tables that give the life expectancies of the participant or of the participant and the participant's designated beneficiary (joint life expectancies may be used). Under-distributions are subject to a 50% penalty unless waived by the IRS. Distributions from IRAs and from the qualified retirement plans of owners of 5% or more of a business may not be deferred until actual retirement.

» Premature Distributions (Withdrawals)

A distribution from a qualified retirement plan, 401(k)s plan, IRA, or SEP before the participant is age 59½ triggers a 10% penalty (and the distribution is subject to income tax), unless the distribution is made because of the participant's (1) death, (2) disability, (3) divorce pursuant to a qualified domestic relations order, (4) early retirement after age 55, (5) early retirement before age 55 if the withdrawals are made in equal payments over the life expectancy of the participant or of the participant and the participant's beneficiary, (6) medical expenses, or (7) because most of the distribution from a qualified retirement plan were rolled over (transferred) into an IRA within 60 days from distribution (but a 20% income tax withholding is required unless the rollover is from trustee to trustee directly).

» Social Security Integration

Social Security may be integrated in a qualified retirement plan provided by the employer. This has the effect of allowing increased employer contributions to highly paid employees (including those who are owners) because Social Security taxable income (wage base) is less than a highly-paid employee's taxable income. Thus, for example, a profit sharing plan could call for a larger percentage contribution on income in excess of the Social Security wage base.

» Retirement Plan Tax Penalties

Apply to premature distributions (withdrawals), failure to make minimum distributions (withdrawals), and excess distributions (withdrawals). See also annuities, Buy/Sell Life Insurance, Disability Buy-Out Insurance, Disability Income Insurance, Income Shifting Among Family Members, and Reverse Mortgage.

See IRA and Roth IRA.

Reverse Mortgage

A mortgage loan not in excess of certain amounts between a lender and homeowners (usually those approaching retirement) with equity in their homes under which the homeowners receive regular payments, often in the form of an annuity. The repayments are deferred until the home is sold or vacated, the death of one or both of the homeowners, or at the end of the term of the loan; the lender has an equity interest depending on the amount disbursed to the homeowners.

>>> Tip: A reverse mortgage may force the sale of the house after the death of the second spouse to pay off the mortgage loan, unless other assets are available. In that case, the home cannot be left to the homeowners' children or grandchildren.

>>> Tip: Payments to the homeowner are not considered income for Medicaid purposes. The payments can be used to pay for nursing home care, a home care attendant, or other expenses.

>>> Tip: For other methods for "cashing out" certain assets, see Accelerated Death Benefits, Home Equity Loan, Life Insurance, Sale and Purchase of a Business, Sale of Residence, and Viatical Settlements.

See Real Estate Investments references.

Reverse QTIP Election

A provision in a will of the first spouse to die that allows the executor or executrix to divide the QTIP trust. The purpose of the division is to get full benefit of the Generation-Skipping Transfer Tax exemption.

To get the full benefit of the GSTT exemption, the first spouse to die must transfer $1,030,000 (indexed for inflation) to the grandchildren net of estate tax. This is $335,000 more than the $675,000 (indexed) sheltered from estate taxes by the $220,550 unified credit in 2000. If not for the reverse QTIP election, the amount in excess of the amount sheltered for estate taxes by the credit would be subject to estate taxes, or the first to die would be subject to estate taxes, or the first to die must reduce the amount transferred to grandchildren to $650,000. See QTIP Election and see Unified Transfer Tax and Credit

One part of the divided QTIP trust for GSTT purposes is treated as if the QTIP election had not been made.

Both parts of the QTIP trust which has been divided by the election of the executor qualify for the marital deduction. Therefore the first spouse to die can get the full benefit of the GSTT exemption while deferring any estate taxes until the surviving spouse's death.

Rollovers

The transfer of distributions from one IRA or retirement plan to another IRA or retirement plan.

Roth IRA

Allows qualified individuals to make nondeductible contributions of up to $2,000 per year. Qualified distributions are tax-free without penalty for early withdrawal; accumulations (growth) are tax-deferred.

>>> Tip: Contributions may be made after age 70½ and both a husband and a wife may each contribute $2,000 annually even if either of them is a participant in a qualified retirement plan, unlike regular IRAs. However, contributions to traditional (non Roth) IRAs and Roth IRAs cannot exceed a total of $2,000, except for qualified rollover contributions.

>>> Tip: Contributions are phased out when the taxpayer's adjusted gross income exceeds certain amounts. For example, with a joint return, the amount is between $150,000 and $160,000.

Roth IRAs are not subject to traditional IRA distribution requirements when the account holder reaches age 70½.

Qualified tax-free distributions must satisfy a five-year holding period. They must also be made either (1) after the age of 59½, (2) or to a beneficiary or the contributor's estate upon the contributor's death, (3) or the contributor is disabled, (4) or distributions are used to pay for a first residence, (5) or distributions are made for medical expenses totaling more than 7.5% of adjusted gross income, (6) or to pay for certain college expenses, (7) or to pay for health insurance premiums while receiving unemployment compensation, (8) or where the distributions are made at least annually in substantially equal payments for the life or joint life expectancies of the taxpayer and a designated beneficiary.

See Education IRA and IRA.