Contra Costa
Lawyer Volume 33 Number 5 | September 2020
ic
m Econo
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s u l u m ti
The TAX
Issue
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Contra Costa 2020 BOARD of DIRECTORS Oliver Greenwood President Nicole Mills President-Elect Mika Domingo Secretary Dorian Peters Treasurer James Wu Past President David Erb Mark LeHocky David Marchiano Ericka McKenna Cary McReynolds Craig Nevin
David Pearson Michael Pierson David Ratner Summer Selleck Marta Vanegas Qiana Washington
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Lawyer Volume 33, Number 5 |September 2020
The official publication of the
features The Tax Implications of PPP Loans and Forgiveness, by Ericka L. McKenna and Ryan W. Lockhart . . . . . . . . . . . . . . 7 Divorcing Joint Tax Liability: A Primer on Innocent Spouse Relief, by Sandeep Singh . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 I fought the Law and I Won - 1031 “Drop and Swap,” by Christina Weed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 The SECURE Act, by Travis Neal . . . . . . . . . . . . . . . . . . . . . . 17 Retirement Funds: Accessing the Nest Egg in a Coronavirus Era, by J. Virginia Peiser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
925.482.8950 916.718.8938
Q&A on the Recent California Supreme Court Bar Exam Decisions, by Mitchel Winick . . . . . . . . . . . . . . . . . . . . . . . . . 24
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The Contra Costa Lawyer (ISSN 1063-4444) is published 11 times in 2020 – five times onlineonly – by the Contra Costa County Bar Association (CCCBA), 2300 Clayton Road, Suite 520, Concord, CA 94520. Annual subscription of $25 is included in the membership dues. Periodical postage paid at Concord, CA. POSTMASTER: send address change to the Contra Costa Lawyer, 2300 Clayton Road, Suite 520, Concord, CA 94520. The Lawyer welcomes and encourages articles and letters from readers. Please send them to contracostalawyer@ cccba.org. The CCCBA reserves the right to edit articles and letters sent in for publication. All editorial material, including editorial comment, appearing herein represents the views of the respective authors and does not necessarily carry the endorsement of the CCCBA or the Board of Directors. Likewise, the publication of any advertisement is not to be construed as an endorsement of the product or service offered unless it is specifically stated in the ad that there is such approval or endorsement.
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INSIDE: Guest Editor Rita Holder
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2020 SUSTAINING LAW FIRMS
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2020 Education Series: Your Law Practice Roadmap
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The Tax Law Issue Thank you to Guest Editor Rita Holder for putting together a very timely issue on tax law. In this issue Ericka L. McKenna and Ryan W. Lockhart wrote an informative article on the Tax Implications of PPP Loans and Forgiveness; Sandeep Singh penned an article on innocent spouse relief; and Christina Weed brings us an article on her important case with the Office of Tax Appeals on “Drop and Swap” 1031 Exchanges. Travis Neal took a look at the pros and cons of the SECURE Act and J. Virginia Peiser delves into the ways one can access retirement funds in the coronavirus era. Mitchel Winick, President and Dean of Monterey College of Law provides an inside look at the California Supreme Court’s recent decisions on the bar exam. Rita has been a member of the CCCBA and the Lawyer Referral and Information Service since 2011. She specializes in three practice areas: Wills, Trusts, and Probate; Family Law and Tax Law. Her firm, Rita Holder Law, is located in Concord. Rita earned a Bachelor of Science degree in Environmental Science from U.C. Berkeley. Her J.D. and LLM in Taxation are from Golden Gate University Law School. She is a frequent author and an active member of the Contra Costa legal community.
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The Tax Implications of PPP Loans and Forgiveness By Ericka L. McKenna and Ryan W. Lockhart
By now, “PPP” has become a common term for most attorneys and business owners. In response to the potential devastating economic impact of the COVID-19 pandemic, the CARES Act was adopted on March 27, 2020 to provide nearly $350 billion of Paycheck Protection Program (“PPP”) loans for businesses. This amount was later increased by an additional $320 billion. The goal of the PPP was to keep employees on payroll. The program was touted as being simple: Use the funds for allowable expenses, and then the loan will be forgiven! But in the months since its adoption, businesses began to see that the program was anything but simple. And now that businesses have begun to apply for this “forgiveness,” the true tax effects of the PPP are being realized.
But first, what is the PPP? The PPP is a “loan” designed to provide a direct incentive for businesses to keep their employees on the payroll. PPP loans are an extension of the U.S. Small Business Administrations ‘SBA Loans’ and allow businesses adversely impacted by the COVID-19 pandemic to obtain funds needed to continue their business. We put the word “loan” in quotations because, as part of the program, the funds received are eligible to be fully forgiven if certain requirements are met. The loan will be fully forgiven if at least 60% of the funds are used for payroll costs, and the rest is used for interest on mortgages, rent, and utilities.
The loan bears an interest rate of 1%, and all payments are deferred for the first six months. Since its implementation, the rules of the PPP have evolved. For example, when the PPP first came out, the loans had a maturity of two years. That was later changed, such that all loans issued after June 5th have a maturity of five years.
Tax Implications of PPP Loans As of July 6th, the SBA reports that 4,880,943 PPP loans have been approved. As these almost five million businesses continue to utilize the funds received and begin to apply for forgiveness, the tax implications must be considered.
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Tax Implications of PPP Loans and Forgiveness Continued from page 7
Recipients of a PPP loan should be aware of specific tax implications associated with the forgiveness of the loan. These tax implications include disallowance of deductions for expenses if paid by a PPP loan that is forgiven, no cancellation of indebtedness income and impact on payroll taxes.
PPP Loan Proceeds Forgiven Are Not Taxable Income for Federal Taxes Section 1106(i) of the CARES Act provides that any amounts of income forgiven under the Act are excluded from gross income at the federal level. The amounts forgiven will not be considered
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cancellation of indebtedness, which normally results in taxable income to the taxpayer, absent applicable exclusions.1 California has not yet conformed to the CARES Act with respect to the tax-free treatment of PPP loan forgiveness. California is currently analyzing the CARES Act and will issue further guidance when ready. Therefore, the possibility of PPP loan forgiveness being treated as taxable income for California tax purposes remains a possibility.
No Double-Dip of Deductions for Business Expenses After enacting the provisions of the CARES Act, a question remained whether deductible expenses paid with forgiven PPP loan proceeds would remain deductible. The Internal Revenue Service (“IRS”) answered this question of deductibility of expenses. On April 30,
2020, the IRS issued Notice 2020-32 that addresses the deductibility of loan proceeds received under the PPP. The IRS took the position that no tax deduction will be allowed for expenses paid with PPP loan proceeds to the extent such amounts are forgiven under the terms of the CARES Act. Section 1106(i) of the CARES Act provides that “the amount of a covered loan forgiven under section 1106(b) of the CARES Act, the application of section 1106(i) results in a “class of exempt income” under §1.265-1(b)(1) of the Regulations.” Therefore, any payment of an eligible expense,2 is disallowed as an allowable deduction under any provision of the Internal Revenue Code (“IRC”) because such payment is allocable to tax-exempt income. The IRS believes this is consistent with the purpose of IRC Section 265(a)(1) to prevent a double tax benefit.3
Impact on Payroll Taxes Prior to Notice 2020-32, the expectation was businesses would continue to be able to deduct payroll and rent expenses. Payroll taxes are paid by two sources, the employer and employee. The employer is usually charged with the withholding from the employee’s paycheck for the employee’s portion of payroll taxes. Under the CARES Act, PPP funds are not allowed to be used towards the employee’s and employer’s share of FICA (Federal Insurance Contributions Act) for the covered period of February 15, 2020 through June 30, 2020. However, as of June 5, 2020, Section 2302 was amended to permit employers to defer the deposit and payment of the employer’s share of Social Security tax. Employers need to keep track, carefully, of PPP funds used with specific regard to FICA and deferred Social Security taxes. Misuse of PPP funds may result in denial of forgiveness and obligate the employer to repay such funds pursuant to the loan terms.
What Will Change? Certain lawmakers have already expressed their discontent with the IRS’s position in Notice 2020-32 regarding the disallowance of expenses paid with PPP funds. They argue the original intent of the CARES Act was to allow for such deductions. Also, given Congress’s statements that further modifications to the CARES Act are a possibility, the final version of the CARES Act is probably yet to be solidified for the 2020 tax year. Furthermore, California has not decided whether to conform to the tax-exempt status of forgiven PPP loans. With the evolving nature of the CARES Act and the Paycheck
Protection Program, taxpayers are encouraged to continue to monitor future changes with respect to the tax implications of the PPP program through the remainder of 2020. Ericka L. McKenna and Ryan W. Lockhart are both partners at McKenna Brink Signorotti LLP, a boutique law firm in Walnut Creek focused on tax, estate planning, business, and real estate. Ericka’s practice focuses on business and real estate. She serves as outside general counsel to small and midsize businesses, helping them with everything from entity formations and restructurings to lease negotiations and business succession planning. Ryan’s practice focuses on estate planning, multi-generational wealth transfer planning, business succession, estate and gift tax planning, tax controversy, trust administration, probate and tax-free corporate reorganizations.
1
IRC Section 61(a)(11).
2
CARES Act Section 1106.
See also Rev. Rul. 83-3; Burnett v. Commissioner, 356 F.2d 755, 759-60 (5th Cir. 1966); Wolfers v. Commissioner, 69 T.C. 975 (1978); Charles Baloian Co. v. Commissioner, 68 T.C. 620 (1977); Rev. Rul. 80-348, 1980-2 C.B. 31; and Rev. Rul. 80-173, 1980-2 C.B. 60 for prior guidance on nondeductibility of expenses paid by tax exempt income.
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Divorcing
Joint Tax Liability: A Primer on Innocent Spouse Relief By Sandeep Singh You negotiated property division, finalized the divorce, moved out, maybe even got a pet to help you get readjusted into single life, and thought you were finally ready to move on. Not so fast! says the IRS. Despite formally severing all relationships with your ex, you remain liable for all tax liabilities (belonging to both spouses) for years in which you filed joint tax returns. If you’re like most married taxpayers, you file joint income tax returns to qualify for lower tax rates than those available for separate returns. The price you pay for the lower rate is assuming “joint and several” tax liability – meaning both spouses are liable for each other’s tax liability and any resulting penalties and interest. Usually, this is not a problem – particularly in “community property” states – since the money comes out of the same pot. However, things can get complicated for separating or separated couples. For instance, you may have separated from your spouse, or are in the process of separation, and the IRS commences an audit of tax returns filed jointly for past year(s). Upon reviewing the audit results, you notice that the resulting deficiency and penalties are not from your tax items but belong to your ex. For a joint filed tax return, you’re liable all the same. Luckily, the IRS provides relief to the “innocent spouse” from joint tax liability in limited circumstances. As a threshold matter, innocent spouse relief is available only 10
SEPTEMBER 2020
if the tax return for which relief is sought was filed jointly and relief is being sought within two years of IRS’ commencement of collection action. If these requirements are met, you must next determine which section of the Internal Revenue Code entitles you to relief. Relief is available under §6015(b) if you’re not legally separated or divorced, upon showing the following: the understatement in tax is attributable to the erroneous tax item(s) of the other spouse; you did not know, and had no reason to know, of the understatement when you filed the joint return; and it is inequitable to hold you responsible for the understatement. In most cases, the knowledge element is difficult to overcome. In order to obtain relief, taxpayer must show by a preponderance of the evidence that he or she did not know, and had no reason to know, of the understatement. Obviously, this involves proving a negative: that not only you did not have actual knowledge about the understatement, but that you also did not have constructive knowledge.
In order to overcome this difficult burden of proof, the following non-exclusive list of factors must indicate your lack of actual or constructive knowledge: (1) the nature of the erroneous tax item;
(2) couple’s financial position; (3) requesting spouse’s financial and educational background; (4) requesting spouse’s participation in the activity which gave rise to understatement; (5) requesting spouse’s reasonable inquiries into the erroneous tax item; (6) and how the erroneous item was handled in past years’ tax returns. If considering all the factors, it appears by a preponderance of the evidence that the requesting spouse had no reason to know of the understatement, he or she is entitled to relief from joint and several liability so long as the other conditions are also met. If you’re legally separated, divorced, or living apart for at least twelve months, relief is available under §6015(c). Under this subsection, the requesting spouse’s liability for any tax deficiency assessed on the joint return will not exceed the portion of the deficiency properly allocable to him or her. In other words, the deficiency and penalties are pro-rated for each spouse based on tax items allocable to each spouse. However, the burden of proof remains with the requesting spouse to establish the portion of the deficiency allocable to him or her. One important distinction under this subsection is that if the IRS demonstrates that the requesting spouse had actual knowledge of other spouse’s tax items giving rise to the deficiency, then relief is not available under this subsection. Compared to §6015(b), this subsection does not bar relief under a nebulous “reason to know” standard. But the IRS can still deny relief if it senses that the couple have colluded to frustrate the IRS’ ability to collect the tax due. This typically happens when the IRS can demonstrate that the couple have transferred assets between each other to protect them from the IRS.
Finally, for former or separated spouses who cannot seek relief under §6015(b) or §6015(c), for example if they have not been legally separated and have not lived separate and apart for at least twelve months, equitable relief is available under §6015(f). Under this subsec-
Relief is available under §6015(b) if you’re not legally separated or divorced, upon showing the following: the understatement in tax is attributable to the erroneous tax item(s) of the other spouse; you did not know, and had no reason to know, of the understatement when you filed the joint return; and it is inequitable to hold you responsible for the understatement.
tion, relief is available if considering all the facts and circumstances, it is inequitable to hold the requesting spouse responsible for the deficiency in tax, or the underpayment of tax. Notably, subsection 6015(f) provides relief for the underpayment of tax, as well for any underreporting of tax, whereas subsections (b) and (c) provide relief only for the latter tax – that is, a deficiency resulting from adjustments made to tax items as reported on the couple’s filed return. Request for innocent spouse relief can be made by filing Form 8857 with the IRS, which requests basic information about the claim. The IRS will review the information and render an administrative determination. If the IRS issues an unfavorable determination, it can be challenged by seeking review of the Office of Appeals, or by filing a Petition in Tax Court. If a Notice of Deficiency
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Divorcing Joint Tax Liability Continued from page 11
has been issued for a jointly filed return, one or both spouses can petition the Tax Court for review and raise innocent spouse relief as an affirmative defense to the IRS’ determination. In the author’s experience, the IRS carefully scrutinizes innocent spouse relief requests. Oftentimes, the IRS will want to interview the spouses and/or third parties and may request court records to substantiate the claims made by the requesting spouse. Since the determination depends on a facts and circumstances analysis, the facts of the case should be thoroughly developed before seeking relief. Fortunately
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for the taxpayer, the administrative process is relatively informal and straight forward – and often the last hurdle before complete separation – and frequently, freedom. Sandeep Singh is a tax attorney and principal of StoneBridge Counsel, a tax litigation law firm. A former IRS attorney, Sandeep focuses his practice on civil tax representation and criminal tax defense. Sandeep also teaches federal tax procedure at Golden Gate University.
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I Fought the Law,
and I Won
– 1031 “Drop and Swap” by Christina Weed
A like-kind exchange pursuant to Internal Revenue Code (IRC) §1031 permits a taxpayer to exchange likekind property and defer the recognition of gain on the transfer of said property. This allows a taxpayer to continue their investment until such time as their investment is eventually cashed out, i.e., sold. There are strict requirements under the Code and Regulations with respect to properly completing a like-kind exchange. Things become more complicated when, prior to exchanging real property, the property is first transferred out of a partnership or other business entity and exchanged – the property is dropped, then swapped. The state of California has historically pursued these types of transactions aggressively to prevent the deferral of gain when property is exchanged. The Franchise Tax Board (FTB) has been able to successfully challenge these drop and swap exchanges by alleging that the taxpayer did not “hold the property for investment.” The FTB has applied a one year holding period in a blanket fashion to
nearly all drop and swap 1031 exchange cases without any statute or case law as support. Remarkably, the taxpayer in the following case held the property in issue as a tenant in common for approximately ten days. In the Appeal of Sharon Mitchell,1 Sharon was a partner of Con-Med, a general partnership, since 1991. Sharon’s mother, Caroline Mitchell, was a partner of Con-Med long before Sharon became a partner. Con-Med owned a single piece of commercial property in Walnut Creek, California. As early as 1990, the tenant of the property indicated interest in potentially purchasing the property. Early on in the negotiations, several partners expressed an interest in doing a 1031 exchange of their interest in the underlying property. Con-Med ultimately decided it wanted to sell the property, but it also wanted to allow some of its partners to do 1031 exchanges of their interests in the underlying property if possible. In December of 2006, the tenant offered to buy the property from Con-Med. Con-Med made a counteroffer, and the parties entered into a purchase agreement. All throughout this process, Con-Med continued to assure the partners who wanted to do a 1031 exchange that it wanted to permit them to be
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CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
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I Fought the Law
Continued from page 13 able to do so if possible. After the purchase agreement was entered into, the sale did not close for eight months. Ten days prior to closing, Con-Med redeemed the partnership interests of the partners who wanted to do the 1031 exchange, and each of these partners received an undivided interest as a tenant in common. One week later, Sharon entered into a 1031 exchange agreement with a qualified intermediary. In the next four days, the tenancy in common deeds (from the partnership to the partner) were recorded, the sale closed, and the proceeds from Sharon’s 10% tenancy in common interest went to the qualified intermediary. I am familiar with IRC §1031, and the regulations promulgated thereunder, as well as the case law surrounding this statute, because I have argued, and fought, many like-kind exchange cases in the past. Consequently, I am also very familiar with the FTB’s historical treatment, and arbitrary disallowance, of like-kind exchanges that the FTB deems to have been held for less than one year. However, I have always argued that the Congressional intent behind the enactment of IRC §1031 is to alleviate taxpayers from the unfair burden of paying taxes on theoretical gains that have not yet been liquidated.2 To require a taxpayer to pay tax on an investment that had not yet been cashed out would create a substantial burden on taxpayers. The case law at the 9th Circuit level is very clear that a taxpayer’s intent when participating in a 1031 exchange is substantially relevant, if not controlling.3 Despite my opinion that the law is on the taxpayer’s side in these drop and swap transactions, not very
many taxpayers want to, or are able to, take on the FTB and see these cases through. In fact, this case did not go to hearing before the Office of Tax Appeals (OTA) until April of 2018, even though the tax year in issue was 2007, so the taxpayer fought this matter for many years. Throughout briefing, and at the hearing, the FTB proposed to deny the taxpayer like-kind exchange treatment. The FTB asserted that the partnership was the true seller, not the taxpayer Sharon Mitchell. The FTB also asserted that the step transaction doctrine applied to bar the taxpayer from being able to complete a 1031 exchange because of the last-minute nature in which the redemption of her interest and the exchange occurred. Finally, my long-held convictions regarding like-kind exchanges paid off, and the taxpayer ultimately prevailed. The opinion was issued by a panel of three administrative law judges in a 2-1 split decision. The opinion included a strong dissent. The opinion went final on or around January 28, 2020.4 The OTA made 23 separate findings of fact in its opinion. The OTA completely rejected the FTB’s position and held that the taxpayer completed a 1031 exchange of her interest in the underlying property following the partnership’s redemption of her interest. While this is great news for taxpayers everywhere, taxpayers should still be cautious. There is a strong dissent in this case, and there is a conflicting opinion5 that came out around the same time as the Mitchell case.
occurs fairly soon after the property was redeemed by the partnership or other business entity. Or, at least, this would be one important factor in the taxpayer’s favor. This case was labeled as non-precedential, similar to a memorandum opinion in U.S. Tax Court versus a reviewed opinion. However, this case finally got the law correct. This was a huge win for taxpayers all over California, and our hope would be that other taxpayers would be able to benefit from it. We ask that you consider writing to the OTA and requesting that this case be labeled “precedential.” You can submit these requests to the OTA here: precedential@ota.ca.gov. Christina Weed, JD, LLM (Taxation) is a Partner at Mendes Weed, LLP in Walnut Creek and a Co-Founder of Weed Law, PC. mwlawca.com; weedlawpc.com; (925) 390-3222. California Certified Specialist in Taxation Law. 1 OTA Case No. 18011715. 2 Jordan Marsh Co. v. Commissioner, 269 F.2d 453, 456 (2d Cir. 1959); 61 Cong. Rec 5201 (1921); H.R. Rep. No. 67-350 at 10 (1921), reprinted in 1939-1 (part 2) CB 168, 175-76, see also S. Rep. No. 67-275, at 11 (1921). 3 Bolker v. Commissioner, 81 T.C. 782, aff’d 760 F.2d 1039 (9th Cir. 1985); Magneson v. Commissioner, 81 T.C. 767 (1983), aff’d 753 F.2d 1490 (9th Cir. 1985). 4 The opinion was initially issued on August 2, 2018, but the FTB petitioned for rehearing. The OTA issued an opinion denying the rehearing on January 28, 2020. 5 See Appeal of Peter & Susanne Pau, SBE Case 959931, OTA Case 18011375. In this case, the OTA ultimately denied the taxpayers like-kind exchange treatment where in the first like-kind exchange (the second failed for other reasons) the taxpayer’s interests in the LLC was redeemed approximately two days before recording deeds to the individual. Thereafter a new LLC was established to acquire replacement property. The OTA ultimately disallowed the exchange on a substance over form principle.
The takeaway from Mitchell seems to be, at least in part, that if intent to exchange is evidenced early and often, a taxpayer may be able to successfully complete a like-kind exchange even if the exchange CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
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SEPTEMBER 2020
The SECURE Act by Travis Neal
On December 20, 2019, as incorporated into Congress’s 2020 fiscal year appropriations bill, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became law. For many individuals and small businesses, the SECURE Act will be a net positive. For those with significant savings in qualified retirement plans such as IRAs and 401(k)s (referred to hereafter as IRAs for simplicity), their beneficiaries may see a significant tax hit. This article highlights the positive and negative changes that affect estate planners and their clients. Let’s begin with the SECURE Act’s positive changes for individuals. The required beginning date (RBD)—the age at which an IRA owner must begin taking required minimum distributions (RMD)— has increased from 70 ½ to 72. This allows investments in the IRA to grow tax deferred for longer. Additionally, if an IRA owner continues to work after their RBD, they may continue to contribute to their IRA. If an IRA owner has a birth or adoption in their family, they may now withdraw $5000 within one year of the birth or adoption. On the employer or plan level, several changes should expand the pool of employees with access to IRAs. The SECURE Act creates “open multiple employer plans,” or “open MEPs.” MEPs existed before the Act, but only for businesses with a relationship such as a common owner. The SECURE Act removes
that restriction. The ability of small businesses to band together should reduce cost and complexity for employers, which should then translate into increased access to retirement plans for full- and part-time employees. The SECURE Act allows qualified automatic contribution arrangement (QACA) safe harbor plans to increase the cap on automatically raising payroll contributions from 10 percent to 15 percent of an employee’s paycheck, with the ability to opt out. The SECURE Act requires that plan participants receive an illustration of how much monthly income their retirement savings will provide. Now for the SECURE Act’s negative changes. The most significant one affects beneficiaries who inherit an IRA after Jan. 1, 2020. If that beneficiary doesn’t qualify as an eligible designated beneficiary, they must withdraw all IRA funds within 10 years after the IRA owner dies. Previously, an IRA’s designated beneficiary could stretch out the RMDs over the beneficiary’s life expectancy. This change can best be understood by outlining the three categories of beneficiaries that now exist (the first two of which existed prior to the SECURE Act’s passage).
Non-designated Beneficiary (NB) Prior to January 1, 2020, when an IRA did not have a beneficiary listed, the beneficiary predeceased the IRA owner, or the listed beneficiary did
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The SECURE Act
Continued from page 17 not qualify as a designated beneficiary, there existed two payout scenarios. If the deceased participant died prior to their RBD, the NB had to withdraw the IRA’s assets by the end of the year that contained the fifth anniversary of the participant’s death. If the deceased participant
For many individuals and small businesses, the SECURE Act will be a net positive. For those with significant savings in qualified retirement plans such as IRAs and 401(k)s their beneficiaries may see a significant tax hit. died after their RBD, the NB had to withdraw the IRA’s assets over the participant’s life expectancy. These two payout scenarios still exist, but some practitioners have noted that the SECURE Act creates an absurd result if a participant dies with a greater than 10-year life expectancy. Under actuarial tables going into effect in 2021, this situation would exist if the participant dies between the ages of 73 and 80. In this situation, a NB would have a longer withdrawal period than a designated beneficiary. To date, the IRS has not adopted a regulation addressing this issue.
Designated Beneficiary (DB) The SECURE Act does not change the definition of a DB. However, post-SECURE Act, if a beneficiary is merely a “designated beneficiary,” as opposed to an “eligible designated beneficiary,” that beneficiary must withdraw all inherited IRA assets by the end of the year that 18
SEPTEMBER 2020
contains the tenth anniversary of the participant’s death. The new 10-year rule does not require that distributions be equal. A DB could benefit from unequal distributions if they expect their other income to be lower during the 10-year period. Certain trusts can still qualify as DBs. A conduit trust is the most common qualifying trust. Under such a trust, all distributions from the IRA to the trust are passed to the trust beneficiary more or less immediately. The IRS treats the conduit trust beneficiary as the participant’s DB, and the 10-year rule applies to the beneficiary. Another common trust in retirement benefits planning, an accumulation trust, allows the trustee to accumulate IRA distributions. In order to qualify as a DB, all beneficiaries who may be entitled to receive the accumulated funds must be identifiable individuals. The important takeaway for practitioners is that the SECURE Act did not change how a trust qualifies as a DB.
Eligible Designated Beneficiary (EDB) This is a new category of beneficiaries created by the SECURE Act. An EDB is the surviving spouse, minor child, disabled or chronically ill beneficiary, or a beneficiary who is not more than 10 years younger than the IRA owner. The EDB can stretch distributions out based on their life expectancy. This rule has two important caveats. For all EDBs, the 10-year rule will kick in when the EDB dies and their beneficiary inherits the IRA. For minor children, the exemption from the 10-year rule ends when the child reaches majority. The SECURE Act provides little definition of “majority,” and the IRS has yet to adopt regulations. In California, unless the child is in the process of “complet[ing] a specified course
of education and is under the age of 26,” the 10-year clock will start when the child turns 18. Conduit trusts may qualify as an EDB if the trust beneficiary is an EDB. Without additional regulations, accumulation trusts are not likely to qualify as EDBs unless they have a sole designated beneficiary and that beneficiary is an EDB. This harsh outcome may not come to pass if new IRS regulations allow for both life and remainder beneficiaries to qualify as EDBs. What does this mean for estate planning attorneys and their clients? While some attorneys have begun reviewing estate plans for clients who sought to take advantage of the life expectancy rule, others note that beneficiaries often deplete an inherited IRA prior to the 10-year anniversary of the participant’s death. Regardless of approach, attorneys should keep an eye on regulations addressing some of the SECURE Act’s unresolved issues (e.g., definition of “majority” or accumulation trusts as EDBs). Travis Neal is an associate in the estate planning, probate, and trust administration group of Hartog, Baer & Hand, APC in Orinda. He has focused on trusts and estates law for over a decade, working with several Bay Area firms serving a diverse group of clients. He has counseled fiduciaries administering complex trusts and estates, and has helped clients craft estate plans tailored to their needs. Travis obtained his J.D., magna cum laude, in 2006 from the University of California, Hastings College of Law, where he was Order of the Coif and a member of the Thurston Honor Society.
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MORRILL LAW Trust and Estate Litigation
Retirement Funds:
Accessing the Nest Egg in a Coronavirus Era by J. Virginia Peiser It was easy – setting up that retirement account. Just complete some identifying information, check a few boxes and provide a check. Or perhaps withholdings simply began from salary. Either way, a process started to provide a nest egg for retirement. Now, with the economy in shambles, many folks are looking to their nest eggs for assistance with their current needs. There are various types of retirement plans, such as accounts opened by an individual, including an Individual Retirement Arrangement (IRA), a SIMPLE IRA or a SEP, and plans established by an employer, including a 401(k) plan, a 403(b) plan or a 457 plan. Contributions to these retirement plans are deductible from income for tax purposes, but each type of plan has different contribution rules.
Distributions from Retirement Plans All plan types have restrictions on withdrawals designed to maintain assets in the nest egg over the long term – at least until a person reaches retirement age. When distributions are withdrawn from most retirement plans, the distributions are included as taxable income in the year of the withdrawal.1 Traditionally, distributions from any of these plans before the plan owner attains age 59½ have been penalized with:
1. An excise tax of 10%2 (25% for certain distributions from SIMPLE IRAs3) of the amount distributed, paid together with the income tax on the distribution; and 2. Tax withholding by certain plans of 20% of any amount distributed.4 Each type of plan however, permits distributions prior to age 59 ½ for various hardship circumstances without penalty, although the distributions will still be subject to income tax. The current coronavirus epidemic presents hardships for taxpayers who may want to access funds in their retirement nest egg, but many of them will not qualify under the current limited hardship distribution rules. The 2020 Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), signed into law on March 27, 20205, and amplified by recent IRS Notices 2020-50 and 2020-516, recognized the need of many taxpayers to access their nest eggs due to the current economic environment. Qualified individuals can receive favorable tax treatment for distributions from their retirement plans during 20207 that are coronavirusrelated distributions (CRD). Most important, a CRD avoids the 10% (or 25%) excise tax and income tax withholding.8 In addition, the CRD can be included in the individual’s income ratably over a three-year period, beginning with the year of the CRD, instead of entirely in the
Continued on page 22 CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
21
Retirement Funds
Continued from page 21
year of the distribution, although the participant may elect to pay tax on the full CRD in the year of distribution.9 If an individual taking a CRD recontributes part or all of the distribution to the same retirement plan or another retirement plan in the three-year period following the distribution, the distribution will not be subject to income tax.10
Qualified Individuals An individual qualified to take a CRD is a person who, or whose spouse, dependent or member of the household: 1. Is diagnosed with coronavirus.11 2. Experiences adverse financial consequences due to corona-
Elder Law is
virus with: (i) quarantine, furlough or lay off, or a reduction in work hours; (ii) inability to work due to lack of childcare; or (iii) closure or reduced hours of a business owned or operated by that person. 3. Has a reduction in pay or selfemployment income or had a job offer rescinded or start date for a job delayed due to coronavirus.12 A CRD is not limited to amounts withdrawn from a retirement plan solely to meet a need arising from coronavirus, and the amount of the CRD does not have to correspond to the extent of the adverse financial consequences experienced by the individual.13 A plan sponsor may rely on a participant’s self-certification of qualification to take a CRD, unless the plan sponsor has actual knowledge to the contrary.14
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Limitation on Withdrawals and Reporting The maximum CRD that can be withdrawn from all retirement plans is $100,000.15 If more than $100,000 is withdrawn, the first $100,000 can be a CRD taxed over three years, while the amount in excess of $100,000 is subject to the 10% (or 25%) excise tax and fully taxed in the year of distribution, unless another exception from tax applies.16 A CRD is reported to the participant on Form 1099-R, Distributions from Pensions, IRAs, etc., using early distribution codes to report exceptions.17 The participant reports the CRD on (yet-to-be created) Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments, filed with the 2020 income tax return and for the following two years.18
Recontribution of CRDs Once a CRD is taken, it can be recontributed to the retirement plan or another retirement plan of the individual at any time within the threeyear period following the distribution, and the taxable amount of the CRD will be reduced by the amount of the recontribution.19 New form 8915-E will also be used to report a recontribution. If the CRD is repaid in a year after the year in which it was included in taxable income, an amended return may be filed to claim a refund for the tax year in which tax on the CRD was paid.20
Retirement Plan Loans Certain retirement plans, such as profit-sharing plans, permit participants to take loans from their retirement plans. Loans have been limited to 50% of the vested plan balance with a maximum of $50,00021, and must generally be repaid within 5 years.22 The CARES Act has increased the permitted plan loan amount for qualified individuals made on or after March 27, 2020,
and prior to September 23, 2020, to the lesser of $100,000 or 100% of the participant’s vested account balance.23 In addition, payments for plan loans outstanding on March 27, 2020, to qualified individuals have been suspended for 2020. Payments due between March 27, 2020, and December 31, 2020, are delayed for a period of up to one year, when the loan will be adjusted to reflect the delay and the accrued interest during that period.24
Required Minimum Distributions Beginning in the year a taxpayer turns 72 (formerly age 70½), required minimum distributions (RMDs) must be taken each year based upon an IRS table derived from life expectancies.25 Under the CARES Act, all RMDs have been suspended for 2020.26 Any RMD taken in 2020 under earlier rules, including RMDs for 2019 that were deferred to 2020, may be recontributed to the retirement plan without penalty. All repayments of RMDs taken earlier in 2020 must be made by August 31, 2020, even if that date is more than 60 days after the distribution.27 A person is not required to be qualified for a CRD to defer RMDs during 2020.
Conclusion Although retirement plans have permitted limited hardship distributions in the past, the limitations do not address the challenges faced by many in this coronavirus era. The recent CARES Act provides direct assistance to taxpayers adversely affected by coronavirus in accessing their nest eggs.
J. Virginia Peiser practices with Doyle Quane Family Trusts and Estates, based in Danville. She represents investors and owners of closely held businesses in creating specialized strategies for their tax, business and estate planning matters. She also provides counsel in post-death trust and estate administration. Virginia is a Certified Specialist in Taxation Law, as well as in Estate Planning, Trust and Probate Law, by the State Bar of California Board of Legal Specialization. She has been a member of the Board of Directors of the CCCBA Taxation Section since 1988 and has served four separate terms as Chair of the Taxation Section. 1 Distributions from Roth IRAs are not taxed upon withdrawal. 2 Internal Revenue Code (hereinafter “IRC”) §72(t). 3 IRC §72(t)(6). 4 IRC §3405(c)(1). 5 Coronavirus Aid, Relief, and Economic Security Act, Pub. L. 116-136, 134 Stat. 281 (2020) (hereinafter “CARES Act”), §2202. 6 IRS Treasury Notice 2020-50 (hereinafter “Notice 2020-50”); IRS Treasury Notice 2020-51 (hereinafter “Notice 2020-51”). 7 CARES Act §2202(a)(4)(A)(i); Notice 2020-50 §1.C. 8 CARES Act §2202(a)(1). 9 CARES Act §2202(a)(5)(A); Notice 2020-50 §4.A. 10 CARES Act §2202(a)(3); Notice 2020-50 §4.B. 11 The term “coronavirus” includes the virus SARS-CoV-2 and coronavirus disease 2019 (i.e., COVID-19) as diagnosed by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the federal Food, Drug, and Cosmetic Act). 12 CARES Act §2202(a)(4)(A)(ii); Notice 2020-50 §1.B. 13 Notice 2020-50 §1.C. 14 CARES Act §2202(a)(4)(B); Notice 2020-50 §2.E. 15 CARES Act, §2202(a)(2); Notice 2020-50 §1.C. 16 Notice 2020-50 §4.A.
17 Notice 2020-50 §3.A. 18 Notice 2020-50 §4. 19 CARES Act §2202(a)(3)(A); Notice 2020-50 §4.C. 20 Notice 2020-50 §4.D. 21 IRC §72(p)(2)(A). 22 IRC §72(p)(2)(B). 23 CARES Act §2202(b)(1); Notice 2020-50 §5.A. 24 CARES Act §2202(b)(2); Notice 2020-50 §5.B. 25 IRC §401(a)(9); Notice 2020-51 §II. 26 CARES Act §2203(a); Notice 2020-51 §II. 27 CARES Act §2203; Notice 2020-51 §III.C.
Pro Bono Honor Roll – Entries Due September 30 Any CCCBA member who has volunteered 50 or more hours in a legal or non-legal capacity over the period September 1, 2019 – August 31, 2020 is eligible for recognition. Many CCCBA members are already involved in many great organizations and causes. By recognizing these individuals, the CCCBA hopes to show how much we appreciate their service and encourage all members to hit (or exceed) the 50-hour annual target. As attorneys, we have the knowledge, training and skill set to improve the lives of others and make a difference. The Pro Bono Committee would like all members to consider the goal of contributing their many talents by touching the life of at least one person in need. Visit the Pro Bono Recognition page on the CCCBA websie and download the Excel form to track your hours. Submit completed entries to Jennifer Comages at jcomages@cccba.org by September 30.
CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
23
Q&A on the
Recent California Supreme Court
Bar Exam Decisions
with Dean Mitchel Winick of Monterey College of Law
The California Supreme Court announced several farreaching changes to the California Bar Exam on July 16, 2020. Prior to issuing its decisions, four members of the Court participated in a July 2, 2020 Zoom videoconference call with deans representing all categories of law schools in California. The following is a Q&A with Mitchel L. Winick, President and Dean of Monterey College of Law who participated in the discussion with the Justices and who drafted the correspondence to the Court outlining the recommendations of the California Accredited Law Schools (CALS).
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SEPTEMBER 2020
What were the primary concerns that the law school deans voiced to the Court? The deans shared concerns about the serious impact that the delay of the July 2020 bar examination is having on graduates’ careers and personal lives. These impacts include significant economic burdens, loss of employment opportunities, and financial stresses that many graduating law students are now facing because their opportunity for licensure as a California attorney is delayed and uncertain. Many graduates also are reporting significant psychological and emotional impacts, particularly for those of limited economic means, resulting from disruptions in living circum-
stances, family care responsibilities, parenting conditions, and conditions such as depression and anxiety disorders. A growing number of law firms and public agencies have delayed employment offers and job starting dates for recent graduates until after the first of the year. The delays are attributed to a combination of the direct impact that the COVID-19 virus has had on the practice of law and the delay in licensing due to the rescheduling of the July 2020 bar exam. There is little that the Court can do to address the disruption of the legal industry by the coronavirus, but it has direct control over decisions that can lessen the potentially devastating impact of denying or delaying licensure to recent law school graduates.
California is unique in having ABA-approved, State Bar Accredited, and Registered Unaccredited Law Schools. Did the different type of law schools agree on how to address the cancellation of the July 2020 bar exam? Yes, there was fundamental agreement across the board on the menu of choices the law school deans presented to the Court. The key requests included cancelling the in-person September exam due to health and safety concerns, offering an online October exam to provide a safe alternative in the Fall, adjusting
the minimum passing score (“cut score”) from the artificially high 1440 to a number closer to the national mean (1350), and authorization of a supervised practice license (with or without an eventual bar exam) to address the delay and disruption caused by cancelling the July 2020 bar exam. The only significant difference was that the ABA law school deans also advocated for authorization of a “Diploma Privilege” that would grant recent law school graduates a permanent license after a period of supervised practice without requiring a bar exam. The CALS deans were concerned that this recommendation was too difficult to administer given the fact that California has graduates from 40+ in-state and 70+ out-of-state law schools who traditionally sit for the bar exam. The Court’s decision to authorize a two-year supervised practice license within which time the bar exam must be taken and passed followed the CALS’ recommendation. A Diploma Privilege without a bar exam was not approved.
Were you surprised that the Court cancelled the September in-person bar exam? Not at all. Although several other states continue to ignore the potential COVID-19 health and safety consequences of placing hundreds, and in some cases thousands, of unrelated individuals in a closed environment for 18-20 hours to take an in-person exam, cancelling the in-person exam in the midst of California’s escalating pandemic was clearly the only sensible and safe call.
Continued on page 26
CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
25
Recent California Supreme Court Bar Exam Decisions
Continued from page 25
It sounds like the law school deans were in favor of the proposed October 5-6, 2020 online bar exam. However, this has never been attempted before. Any concerns? Certainly, there are concerns anytime that something this important is implemented for the first time. However, administering computer-based, high-stakes professional exams is not new. Elements of the licensing exams for Architects, CPAs, Optometrists, Psychologists, Dentists, Veterinarians, and Realtors, just to name a few, are already administered as computer-based exams. However, the decision to move the October bar exam online is not without consequences. The National Conference of Bar Examiners (NCBE) refuses to provide a validated set of Multistate Bar Exam (MBE) questions for the second day of the proposed October exam. This means that October examinees will not be able to use the October California MBE exam results for applications to any other jurisdiction. There are also legitimate concerns about the security and stability of an online exam, fair access to reliable internet connections, distractions of at-home testing environments, and provision of appropriate testing accommodations. However, balancing public health and safety with these surmountable challenges, the Court made the right call to authorize an online exam alternative.
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SEPTEMBER 2020
What is the long-term impact of changing the minimum passing score (“cut score�) from 1440 to 1390? California has been out-of-step with the national cut-score standards for decades. The result has been that thousands of qualified law school graduates have been denied licensure in California despite consistently achieving some of the highest bar exam scores in the country. Furthermore, a recent report released by the State Bar analyzing ten years of bar exam results clearly indicated that use of the artificially high 1440 cut score has had a significant and profound disparate impact on the basis of race/ethnicity. By bringing California in line with the national bar exam standards and creating a more fair and equitable scoring system, it is very likely that the Court has taken the most significant step forward for improving diversity of the California bench and bar since the Civil Right Act of 1964.
You have previously advocated for adjustment of the cut score to 1330-1350 to be more directly in line with other major jurisdictions. Are you disappointed that the Court only adjusted the cut score to 1390? Not at all. The Court specifically said that it will consider further changes to the cut score and the content and format of the bar exam as part of its soon-to-be convened Blue-Ribbon Commission for the Future of the Bar Exam. The national mean is the equivalent of 1350 . . . New York is at 1330, Illinois is at 1340, and Texas
is at 1350 . . . I believe that the Court will take these factors into consideration when it receives the Commission’s findings and has the opportunity (hopefully, when we are no longer in the midst of a pandemic) to consider alternatives for licensing attorneys in the future.
Will a Supervised Practice License adequately protect the public? Yes, a Supervised Practice License actually enables the discovery and measurement of competency and merit beyond the limited scope of the bar exam. Many law school graduates who have not yet passed the California Bar Exam exhibit valued professional characteristics such as character, compassion, organization, service, and selflessness that the current bar exam is incapable of detecting, much less measuring. While the current bar exam tests grit, a degree of academic competency, and high-stakes test-taking skills, these are not necessarily the most important qualities and values our profession demands of its competent and valued practitioners. Academic competencies alone do not make good lawyers and citizens. They must be tempered with human qualities, not measured by the current bar exam content or format . . . qualities that identify a person as a selfless servant of others, an advocate, and a compassionate guardian of the rule of law. Alternative pathways for establishing minimum competency, such as a period of supervised practice, open up the possibility for identifying a broader range of competent, compassionate, qualified legal professionals who might otherwise be excluded by the narrow focus of the current bar exam. With the cooperation and active participation by the practicing
bench and bar, the proposed supervised practice license may go a long way to provide successful graduates with a pathway to practice. The longer-term impact is that the success of supervised licensed practitioners over the next two years may provide proof that a permanent alternative to the traditional bar exam should be considered.
Overall, given all of these challenges, did the Court make the right call? The Court not only made the right call, but demonstrated their unique ability to strike a careful balance between public protection, oversight of the legal profession, fairness to recent law school graduates, and commitment to diversity of the bench and bar. The Court’s decisions will fundamentally change who will be practicing law in California in the future . . . changes that are good, fair, and long overdue. Mitchel Winick serves as President and Dean of Monterey C o l l e g e of Law, a private, non-profit, California Accredited Law School system that also includes San Luis Obispo College of Law and Kern County College of Law. Winick is the former chair of the State Bar of California’s Law School Council and the Committee of Bar Examiners Rules Advisory Committee.
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