By Wendy M. Greenberg, Esq., Morrison & Foerster LLP
We have previously discussed in this space the possible tax traps related to clients' gifts and bequests to their employees. This article continues in that vein to provide some practical options specifically for clients who would like to provide retirement benefits to their domestic employees. Keep in mind, of course, that any of the discussed options may result in taxable income to the employee.
Formal employer-sponsored retirement benefit plans under the Employee Retirement Income Security Act (ERISA) generally are not available for employers of domestic employees. This results from that fact that a domestic employee does not work for the purpose of production of income for his or her employer, and thus the employee's wages and any contributions made to a retirement plan on his or her behalf would not be tax deductible to the employer. However, one formal retirement benefit plan that is available for contributions by the employer of a domestic employee is a Simple IRA. The basic features of a Simple IRA are as follows:
• An employer may contribute up to 2% of the employee's salary annually to his or her Simple IRA, or up to 3% if the employee matches the contribution with salary withholding. (Assuming that the employee's salary is $35,000 per year, even if he or she matched the 3% contribution, the total combined contribution would only be $2,100 per year).
• Catch-up contributions of $2,500 annually are allowed for new participants over the age of 50.
• Contributions would not be taxed to the employee until withdrawn (though the contributions will not be deductible to the employer at any point).
• Compliance and reporting are fairly minimal, though administration by a trustee is required.
• It will presumably be difficult to engage a financial institution to invest the IRA funds given the small amounts involved.
Inter Vivos Charitable Remainder Trust
The employer could establish a charitable remainder trust (also known as a CRT) for his or her employee's benefit upon the employee's retirement, the basic features of which are as follows:
• The employer establishes and transfers a lump sum of money to the CRT. The Trustee would make "unitrust" or annuity payments to the employee, for his or her remaining lifetime, in amounts which total either a certain percentage (at least 5%) of the trust's fair market value each year, or a set annuity amount.
• Following the employee's death, all remaining CRT assets will be distributed to the employer's designated charitable organization(s).
• The employer receives a charitable income tax deduction for the present value of the charitable remainder interest upon establishment of the CRT, but the present value of the employee's unitrust or annuity interest upon establishment of the CRT will be subject to gift tax.
• The CRT itself is not subject to income tax, but taxable income of the CRT is carried out in the unitrust or annuity payments, and becomes taxable to the employee beneficiary. If the CRT is established to satisfy an employment obligation, further tax complications may result.
Combined Lifetime and Testamentary Gifting
After the employee retires, the employer could simply continue to pay his or her salary, as a gift.
• The employer and his or her spouse may each give up to $13,000 to the employee annually (a combined $26,000 for a married couple), without needing to file gift tax returns.
• After the death(s) of the employer (and his or her spouse), if the employee is then living, the employer's revocable trust would provide either for a lump sum payment to the employee, or for a separate trust to be established to pay amounts to the employee annually for life. This could be a simple annuity trust, or a testamentary form of a charitable remainder trust.
° A testamentary CRT would work in the same manner as a CRT established upon the employee's retirement, discussed above; provided that the present value of the charitable remainder interest, determined as of the date of death of the employer (or his or her spouse), would be deductible for estate tax purposes rather than for income tax purposes.
The employer could purchase a lifetime annuity for his or her employee from an insurance company. This would be a taxable gift upon purchase. The advantage here is ease of administration (i.e., the insurance company would handle administration, rather than the employer or the trustee), but the purchase price will reflect this, along with a profit margin for the insurance company.
The option the employer chooses will depend on a number of factors (most importantly, the age of the employee and the generosity of the employer), and of course the options may be combined as convenient to suit any particular circumstance.
Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients. If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.
© Copyright 2012 Morrison & Foerster LLP. This article is published with permission of Morrison & Foerster LLP. Further duplication without the permission of Morrison & Foerster LLP is prohibited. All rights reserved. The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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