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Volume 3, Issue 4, Fall 2002 (pdf)

• 9/11: A Year Later

• PA Tax Changes

• Reports of The Erb Law Firm's demise are greatly exaggerated, but continuing

• More Changes to the 529 Plans in Pennsylvania

• Thanks!

• Estate Planning for Citizens of Countries other than the US

• Corporation Tax Forms no Longer Being Mailed

• The Times, They Are A-Changin'

9/11: A Year Later

by J. Christopher Erb

Well, the year hath wrought quite a few changes in the world of immigration law, not surprisingly, given the events of September 11th.

First off, the bad news. A host of new measures were passed with the avowed intent of ensuring that the bad guys do not slip as easily into the United States as did the terrorists. Much of this has been focused on information gathering, collection, and sharing between government agencies and increased scrutiny during the application process. Students and other trainees have borne the brunt of many of these changes, and visa holders from certain countries are now subject to registration in the United States. Business travellers and transferees are still welcome in the United States, but processing of visa applications has slowed as a result of the new procedures, and all stages of the system are subject to backlogs and delays due primarily to security concerns. In addition, border guards taking a much more careful look at travelers, business or otherwise. As always, plan for delays, and remember that it's best to be polite and deferential no matter how infuriating the delay.

Having entered the US, noncitizens will find that every aspect of starting a new life here in the United States has become more cumbersome. The INS is now enforcing a long-standing but rarely enforced requirement that visa holders who are in the United States for over 30 days report every change of address within 10 days of that change of address.

In addition, everyone from bureaucrats to police officers now consider it their duty to determine the visa status of nonimmigrants, and noncitizens may find themselves handing over passport and other documentation for even the most minor official business, including marriage certificates and driver's licenses. Some of these `requirements' may or may not be required by law, and many of those demanding documentation may not be able to understand the documents they receive. In any case, non-citizens may want to consider carrying their passport and a copy of the approval notice with them to be on the safe side, however inconvenient that may be.

There was some good news on the visa front. The spouses of L and E visa holders may now obtain employment authorization to work in the United States without applying for a separate visa. In addition, transferees coming in under the L-1 blanket visa petition need only have worked for six months for the foreign company, rather than the one year required for regular L visa applicants.

These are not the only changes, there are more than can be covered in this short article. Indeed, there will be additional (probably significant) changes with the complete restructuring of the INS under the Homeland Security Act. It's a safe bet that life won't get easier any time soon for those seeking visas, or even for those who already have one.

PA Tax Changes

by Kelly Phillips Erb

On June 29, 2002, Governor Mark Schweiker signed into law a $20.7 billion budget. Highlights of the tax package include:

Increased Tax on Cigarettes

Effective July 15, the excise tax on a regular pack of cigarettes has been increased from $.31 per pack ($.0155 per cigarette) to $1.00 per pack ($.05 per cigarette), for a total increase of $.69 per pack. Now there's an incentive to stop smoking!

Continued Phase-out of the Capital Stock/Franchise Tax

Despite a budget shortfall, the phase-out of the Capital Stock/Franchise Tax (CSFT) will continue, albeit on a smaller scale. As of January 1, 2002, the CSFT rate is 7.24 mills. The CSFT will continue to be phased-out through a series of rate reductions. The CSFT will expire with regard to taxable years beginning after 12/31/09.

Decoupling From Federal Bonus Depreciation

However, in order to continue to raise revenue, the Commonwealth has decoupled from the federal Job Creation and Worker Assistance Act of 2002, which authorizes taxpayers to deduct a 30 percent "bonus depreciation" on their federal tax returns for certain qualifying assets acquired after September 10, 2001, and before September 11, 2004. The federal Act allows for 30 percent of the adjusted basis of qualified property to be depreciated under normal rules over the life of the asset.

For personal income tax purposes, individuals, business owners, partnerships, limited liability companies, Pennsylvania S Corporations, estates, and trusts cannot take this additional depreciation, but may continue to calculate depreciation on the same basis as they would have calculated it under the Internal Revenue Code of 1986, as amended to January 1, 1997. If you took the bonus depreciation for the 2001 year, you must file an amended personal income tax return.

If you are taking the bonus depreciation for federal purposes, and using your federal income to calculate PA Personal Income Tax, you must also make an adjustment. If file a federal schedule C or federal schedule F, you must reduce the depreciation expense on the PA schedule M that is provided with the PA-20S/65 Information Return. This applies to taxable years beginning after December 31, 2000.

For Corporate Net Income Tax purposes, corporations also cannot take the additional depreciation. You can use the same asset basis as for federal depreciation; however, you are required to use a two-step adjustment to calculate Pennsylvania taxable income. The first step requires that the amount of any federal bonus depreciation be added back to income. In the second step, a fraction of 3/7 is multiplied by the remaining federal depreciation on property to which the bonus provision applied in order to compute the amount of additional depreciation. In effect, 100 percent of the property is systematically depreciated over the life of the asset. This applies to taxable years beginning after September 11, 2000.

Likewise, for purposes of Philadelphia's Business Privilege Tax, you must calculate net income using the same two-step adjustment method described above. This applies to taxable years beginning after September 11, 2000.

Federal Estate Tax Decoupling

In order to prevent the loss of state tax revenue because of the passage of the federal Economic Growth and Tax Relief Reconciliation Act of 2001, the bill also decouples the Pennsylvania Estate Tax from current federal law. The Pennsylvania Estate Tax will continue to be based on federal law as amended to June 1, 2001, which is prior to the effective date of the federal act. Applies to estates of decedents dying after June 30, 2002.

Note: New Jersey has passed similar provisions.

Reports of The Erb Law Firm's demise are greatly exaggerated, but continuing

Troubles with our phone service have made some of you wonder what's going on. For some time, unbeknownst to us, our telephone service provider has answered our lines with a generic voice mail system. Not only didn't we know this was happening, we can't even access the messages now that we do know. If you have called us and not received a call back, please e-mail or call one of our cell phones and we will get back to you immediately.

We are changing providers (not numbers) as of 5 December 2002 and will have a brand new - and functional - voice mail system. If you want to know which phone provider not to use, give us a call.

More Changes to the 529 Plans in Pennsylvania

Pennsylvania has modified its 529 plan in an effort to close a "loophole" that allowed participants to get a financial windfall for withdrawals that are not related to educational expenses.

Prior to September 1, 2002, participants who made withdrawals for reasons other than to pay educational expenses got the full value of the fixed rates of the Guaranteed Savings Plan (GSP) even if the market value was lower. However, under the new rules, an "unqualified withdrawal: from a GSP will result in the participant receiving the market value or the fixed rate, whichever is less. In simple terms, if the participant chooses a 15% fixed rate and the fund is only performing at 10%, when the participant withdraws the money for noneducational purposes, the participant will only receive the 10% early withdrawal penalty and is fully taxable.

The GSP is one of two plans under Section 529. The GSP increases the value of saved credits at the same rate as yearly tuition increases at US schools. Participants can choose fixed rates at one of five tuition levels, such as the Penn State University level, which pays according to a 13.5% tuition increase this year, while the Ivy League level pays 4.6%.

Thanks!

Kelly, Chris and Katie would like to thank everyone who donated money this year to the American Cancer Society Making Strides Against Breast Cancer walk. We walked the five mile loop in honor of Kelly's grandmother, Aline Joye, who died of breast cancer. Thanks to the support of family and friends, we met our goal for this year. Next year, we plan to have our own Erblaw team!

Estate Planning for Citizens of Countries other than the US

by Kelly Phillips Erb

They say love is blind - but clearly Uncle Sam thinks differently. Like it or not, it does matter who you marry - at least when it comes to federal estate taxes!

The Internal Revenue Code ("IRC" or "Code") allows an unlimited marital deduction for federal estate tax purposes as between United States citizen spouses. This means, in simple terms, that there is no federal estate taxes payable at the death of the first spouse. The reason for this tax treatment is that Congress, for reasons of public policy, did not want to create a situation in which a spouse must sell inherited assets in order to pay federal estate taxes. Rather, Congress created a system of tax deferral by taxing those assets at the second death.

This tax structure has not always been in place. Prior to 1988, the federal estate tax laws allowed an unlimited marital deduction, and accordingly the deferral of federal estate taxes, when any spouse passed away leaving assets to a surviving spouse. This unlimited marital transfer rule applied to all taxpayers, whether or not they were U.S. citizens.

However, in 1988, Congress took steps to close what was perceived to be an inequity in the federal estate tax rules as they applied to non-US citizens. What Congress sought to eliminate was tax avoidance that resulted when a non-US citizen spouse inherited assets and returned to his or her native country. Since the non-US citizen would no longer hold the assets in the United States, those assets would no longer be subject to taxation. Congress' solution was to eliminate the unlimited marital deduction for assets passing to a non US citizen spouse. Those assets are currently subject to the personal exemption allowable under the Code. Under the current administration's plan for the years 2002-2003, that exemption is $1,000,000.

As a result, the ability to defer, reduce or eliminate federal estate taxes for assets passing to a non US citizen spouse is limited and requires additional estate planning.

1. Qualified Domestic Trust

A Qualified Domestic Trust ("QDOT") is analogous to a Qualified Terminable Interest Property ("QTIP") Trust. The QDOT allows a non-citizen spouse to receive the same federal estate tax benefits as a citizen spouse with certain restrictions.

To qualify as a QDOT, the trust must be maintained under the laws any state or DC in order to establish nexxus. Further, the Trustee of the QDOT must be a US citizen or domestic corporation. The Trustee must also be willing to be personally liable for any tax that is due as the result of distributions of principal to the noncitizen spouse.

The election to treat a trust as a QDOT must be made on the federal estate tax return of the citizen spouse on or before the due date (including extension). The election, once made is irrevocable. The surviving noncitizen spouse may transfer any property to the QDOT which is includable in the citizen's spouse's gross estate for federal estate taxes.

The noncitizen spouse can take interest income, but not principal, out of the trust without federal estate tax consequences. If any principal is withdrawn from the trust, federal estate taxes become due immediately on that amount. An exception to this rule exists if there is a hardship; a distribution is deemed made on account of hardship if the distribution is made to the noncitizen spouse from the QDOT in response to an immediate and substantial financial need relating to the spouse's health, maintenance, education or support, or the health, education, maintenance or support of any person the surviving spouse is legally obligated to support.

It is worth noting that assets such as closely held business interests, real estate and tangible personality are not considered assets that are reasonably available and as such are not includable for purposes of taxation at distribution. Also excluded are payment for ordinary and necessary expenses of the QDOT; income tax payments; other tax payments; sales or exchanges for full and adequate consideration; and reimbursements.

Tax rates for distributions made to the noncitizen spouse are the rates in effect on the date in the U.S.

2. Change of Citizenship

If the noncitizen spouse becomes a US citizen before the day on which the federal estate tax return is filed, then the unlimited marital deduction would apply.

To qualify as a US citizen, the noncitizen spouse must have been a "permanent resident" for five years (three years if married to a US citizen) and have been "continuously residing" in the US for a period of time, usually five years. A trip out of the US of even six months may break the continuity of residence, and an absence of one year normally does, unless permission is obtained ahead of time. Additionally, the noncitizen spouse must be of "good moral character" and pass a civics and English exam. The INS will also take fingerprints, schedule an interview and run a background check.

The time between approval of an application for citizenship and actual naturalization varies from a low of 60 days (in Cincinnati) to 1170 days (in San Jose). Most offices have a range of 200-400 days, though how that could change following September 11, 2001, is still uncertain. This may or may not allow a noncitizen spouse enough time following the death of the citizen spouse to avoid the payment of federal estate taxes.

3. Gifting

A final estate planning technique would be to make gifts of assets to a noncitizen spouse prior to death. While again there is an unlimited transfer allowable between citizen spouses, there is a reduced amount as between a noncitizen and a citizen. The annual gift tax exclusion to a noncitizen spouse is $100,000. The annual exclusion for gifts made to those other than noncitizen spouses is limited to $10,000. The exclusion does not include IRAs or joint assets. Generally the gifting option is not a practical one.

Corporation Tax Forms no Longer Being Mailed

by Kelly Phillips Erb

Beginning with tax year 2002 returns, the Pennsylvania Department of Revenue will no longer be mailing the CT-1 Corporation Tax Booklet to all corporate taxpayers. Copies of this booklet will be available at the Department's 23 field office across the state. In the recent years, approximately 85 percent of all Corporation Tax reports filed with the Bureau of Corporation Taxes have been prepared using computer software.

The instructions for 2002 will be posted at www.revenue.state.pa.us. Forms and instructions may be ordered by calling 1-800-362-2050.

If you have any quetions regarding your corporate taxes for the taxable year 2002 give us a call at the office.

The Times, They Are A-Changin'

This is a very exciting time for The Erb Law Firm, PC! We're making some changes to serve you better.

As mentioned, we will shortly be changing our voice mail to a new and improved system. We're also making some additions to the website - keep checking for details.

Most importantly, we're significantly expanding our staff beginning in January. Check out the website and future editions of the newsletter for more information.