Month: April 2016

Can a third party pay a client’s fees?

In certain situations, attorneys may be asked to allow a third party to pay

There are various situations that may arise where an attorney may be asked to allow a third party to pay a client’s attorney’s fees.  Examples include a parent paying for a criminal defense attorney or a divorce attorney for a child.  When a third party is paying the bills it is particularly important to comply with the applicable rules and not to confuse the client with the person paying the bills or to include the third party in confidential client communications.

Rule 3-310(F) provides that an attorney may not accept payment for representing a client from anybody other than the client unless the attorney complies with certain requirements.

No interference is allowed

First, there must be no interference with the attorney’s independent professional judgment or with the attorney-client relationship.  This means that just because a person is paying the bills she doesn’t get to direct the representation.

Confidentiality must be maintained

Second, you must strictly maintain the client’s confidential information as required under Business and Professions Code section 6068, subdivision (e).  Often a person paying the bill, particularly a parent or other close relative who is genuinely interested in helping the client, will want to be informed about what is going on in the case and offer input on the attorney’s strategy.  Also, they may want details about what services they are paying for.

However, just like in any other matter, unless the client specifically authorizes the attorney to discuss confidential or privileged information, the attorney cannot disclose anything to the third party.  An attorney should also be careful to make sure the client doesn’t feel obligated to share confidential information with the third party simply because that person is paying the bills.

Written consent is required

Third, the attorney must obtain the written consent of the client before the attorney may accept payment from a third party.  A good practice is to discuss payment terms directly in the engagement agreement and confirm that though a third party will be paying the bills, she shall have no authority to direct the representation or have access to confidential client information or privileged communications.

The attorney will also want to have the third party sign an agreement to confirm responsibility to pay the client’s bills.  The attorney should consider whether to have the third party sign the same engagement agreement as the client or to enter into a separate agreement with the third party.  In order to preserve any privilege as to the client’s engagement agreement, the attorney should do a separate agreement with the third party.  The agreement should also confirm that the payor is not the client, shall have no authority to direct the representation or have access to confidential client information and privileged communications.

A related issue is who is entitled to a refund of any funds remaining at the conclusion of representation, the client or the person who paid?  COPRAC Formal Opinion 2013-187 addressed this question and concluded that the attorney must return the balance to the third-party payor rather than the client, unless the engagement agreement with the client provides otherwise.  Accordingly, the attorney should also clarify return of funds in the client engagement agreement.

Home Protection

What to Do With a Residence Upon Death

Dear Sophos

 I am acting as Trustee for my dear dead Aunt Betsy.  One of the Trust assets is her California residence.  What are some of my fiduciary duties and what should I be doing with the house?

 Little Johnny

 

Dear Little Johnny:

First, as Trustee, you have a general duty to secure the residence and to preserve its value.

Assuming that the house is not passing to a specific beneficiary, after the initial 120 Notice period, you should consider liquidating, selling, the house.

During the initial 120-day period of administration, I suggest that, at a minimum, you do the following:

  • Make a detailed inventory of the house content, by photos or video, remove and secure any personal property of substantial value and empty the refrigerator;
  • Have a Locksmith change all of the locks and give you the keys;
  • Have all mail forwarded to your address and stop any newspaper delivery
  • Install an inexpensive security system that will automatically contact the security company if there is a break-in;
  • Have the yard regularly maintained, as though someone was living in the residence;
  • Talk to the neighbors and leave your telephone number with them in the event of an emergency;
  • Install a timer on several lamps, set to go on and off at different times;
  • Find the homeowner’s insurance policy and contact the insurance agent to be certain that the coverage is adequate;
  • If appropriate, have a plumber “winterize” the house;
  • Timely pay the monthly utility bills and loan payment as well as any homeowner’s association fees or at least contact the vendors to explain the circumstance.
  • Obtain legal advice from an attorney experienced in the area of trust administration.

I hope that you find this advice helpful and good luck in your capacity as Trustee.

The Sophos

Elderly Hands Holding Wedding Ring

Is a retirement plan loan considered community property?

QDRO NewWhen a participant takes a “loan” from their retirement plan, the plan liquidates investment assets in order to pay the participant cash from the plan. This means that when an account statement for a 401(k) plan states: asset balance $15,000, loan balance $5,000, there is actually still $15,000 worth of community property investments in the plan. It is worth noting that different banks report plan loans differently on statements, so the treatment of the loan should be double checked with the bank prior to arriving at a firm conclusion.

Arguably, a loan should not be thought of as a debt at all. Instead, it is way of cashing out pre-tax dollars from a retirement plan. The reason that a loan is not a debt is the subsequent loan payments made by the participant to repay the loan increase the participant’s plan balance. In other words, the participant is simply transferring funds from their checking account to their retirement plan. They are repaying themselves.

Despite the conclusion that a retirement plan loan is not truly a “debt,” there are special tax and transferability considerations to be taken into account. A participant loan is accompanied by a tax disadvantage for the participant who retains the plan because a participant repays the loan with after-tax dollars and then the participant is ultimately taxed on the benefits when they are withdrawn at retirement. Furthermore, a QDRO cannot assign a participant loan from the participant to an ex-spouse. Parties in mediation or preparing for trial may benefit from a brief analysis on how to equitably treat a retirement plan loan which can depend on the specific facts and circumstances.

The bottom line is that a retirement plan loan is unique and not generally treated as a community property debt obligation.

Retirement Benefits Feature

QDROs can be used for collecting spousal support and child support

The use of a Qualified Domestic Relations Order (“QDRO”) is an often overlooked tool for assisting family law attorneys and divorcing spouses with the collection of child support or spousal support.

A QDRO can be used against a defined benefit plan (which pays monthly benefits over a participant’s lifeme) to collect ongoing monthly child support or spousal support. The participant must be in pay status in order for the defined benefit plan to be able to pay the monthly amount.

In other words, if the participant is not yet rered, the benefits will likely not be payable from the Plan under a child support or spousal support QDRO. Certain exceptions apply.

A QDRO can be used for a defined contribution plan (which has a current account balance) for the collection of spousal support or child support in a lump sum, such as arrears.

The authority for this collection activity resides in ERISA which provides that a QDRO can alienate benefits of the participant if it relates to the provision of child support, alimony  payments, or marital property rights to a spouse, former spouse, child, or other dependent and is made pursuant to a state domestic relations law. (29 U.S.C. § 1056(d)(3) (B)(ii)(I) and (II)).

Finally, it is important to note that child support QDROs and spousal support QDROs are somewhat specialized with regard to the tax consequences. Child support payments from a retirement plan are taxed to the participant, not the alternate payee.

Dividing IRAs in Divorce: Why a QDRO is not necessary to assign IRA benefits to an ex‐spouse

Contrary to popular belief, a Qualified Domestic Relations Order (“QDRO”) is not necessary to divide every type of retirement benefit. The prime example is an Individual Retirement Account (“IRA”). An IRA is not a qualified retirement plan under the Internal Revenue Code and an IRA is not regulated by the Employee Retirement Income Security Act (“ERISA”). Therefore, ERISA regulations and Internal Revenue Code section 72(t) which otherwise govern QDROs do not pertain to IRAs.

If a financial institution representative informs you that a “court order” or “QDRO” is required to divide an IRA, then your client should provide the financial institution with a copy of the Judgment and MSA which will suffice as the court order. A letter of instruction or other forms will sll be necessary, but as far as providing a court order, the Judgment and MSA will satisfy the requirement of a court order.

The good news for family law attorneys is that the process for dividing an IRA is more simplified than having a QDRO prepared. However, there are two aspects unique to IRAs that should be kept in mind:

  1. Early withdrawal penalties apply.

Unlike the transfer of plan benefits with a QDRO, there is no exception in the Internal Revenue Code that permits a spouse to avoid the early withdrawal penalty of 10% (federal) and 2.5% (California) when receiving a distribution of IRA benefits prior to reaching age 59½. In other words, if an IRA holder desires to cash out their benefits prior to reaching age 59 ½, there will be a 12.5% penalty and the distribution amount will be taxed at ordinary income tax rates. For clarity, it should be noted that if the IRA benefits are merely being “rolled over” using a “trustee-to-trustee transfer” from one spouse’s IRA to the other spouse’s IRA, then there is no tax consequence on that transfer and the benefits are held in the receiving spouse’s IRA as pre-tax benefits.

In contrast, the Internal Revenue Code provides under secon 79(t)(2)(C) that a QDRO qualifies for an exception to the early withdrawal penalty. Therefore, if the parties are planning to take any distributions of retirement benefits prior to age 59½, it may be preferable to do an  equalizing assignment with a QDRO rather than equalizing benefits with an IRA.

  1. A tax statement is recommended.

A signed “letter of instruction” with tax language is still recommended when an IRA is divided. Although a QDRO is not necessary, it is sll important to document the IRA transfer in the event that the IRS or Franchise Tax Board conducts and audit of the IRA transfer.

The typical tax statement will contain something similar to the following:

IRA Holder is the former spouse of Recipient. Both IRA Holder and Recipient acknowledge that this assignment is incident to divorce within the meaning of Internal Revenue Code secon 1041. This assignment is related to the cessation of the marriage because this assignment is required by the Marital Settlement Agreement entered into between the IRA Holder and the Recipient. After the transfer, the Recipient shall be solely responsible for all income taxes or

other tax consequences, if any, associated with the subsequent distribution of the assets to Recipient.

For reference, the above language is intended to comply with the Internal Revenue Code secon that provides for the tax free transfer of IRAs between spouses pursuant to divorce which is secon 408(d)(6). The meat of Internal Revenue Code secon 408(d)(6) is as follows:

(6) Transfer of account incident to divorce The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of secon 71(b)(2) is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.

What is the end result? The division of an IRA does not require a QDRO; however, a tax statement should accompany the IRA transfer documentation to document compliance with IRC secon 408(d)(6) if the IRS or Franchise Tax Board conducts an audit.

Audit Featured Image

What to Expect from an IRS Audit

What every taxpayer should know regarding types of IRS audits and common issues that can trigger audit.

An audit is an investigation into a tax return of an individual, business, estate or trust.  The IRS uses this process to determine if the information provided in the tax return is correct. This article discusses three types of audits and several common audit triggers.

Types of IRS Audits

Correspondence Audit

This is the most common type of audit and also the easiest in terms of what is required and the length of time involved.  Usually the IRS will send a request for supporting documentation to prove deductions, exemptions, proof of dependents, proof of charitable donations or other documentation to corroborate a specific part of the return.  This is the least stressful form of audit for the taxpayer and usually sending in the requested paperwork is enough to satisfy the IRS.   It is strongly advised that you seek the help of an experienced tax attorney to prepare your reply to the IRS correspondence audit and to ensure the documentation you send is exactly what is needed.  As long as a response is made within the timeframe and the documentation enclosed satisfies the proof needed by the IRS, the audit is complete.  This type of audit is most commonly utilized for individual tax returns, where there are perhaps one or two simple issues the IRS wants you to substantiate.

 Office Audit

An invitation to appear at an IRS office to conduct an office audit is a serious matter.  It is important you do not attend the office audit without your tax attorney.  Being asked to an office audit means the IRS is counting on the possibility that you owe additional taxes.  It is essential that you seek the advice of an experienced tax attorney to accompany you to the IRS office audit to protect your rights and to use their knowledge and experience to assist you in finding ways to reduce or eliminate any additional taxes.

Field Audit

A field audit is the most serious form of audit and involves an IRS Auditor coming to your place of business to thoroughly audit your records.  If the IRS finds that your business has inaccurately reported income and evaded paying the correct tax, the consequences could result in heavy penalties, additional taxes and possible prison time.  It is of utmost importance to engage the services of an experienced tax attorney to be present while the IRS auditor is at your place of business.

Below is a summary of common audit triggers

Large amount of charitable donations

The IRS looks closely at the receipts and proof of your charitable donations.  If your charitable donations are more than 3% of your income, the IRS will scrutinize your documentation.  Make sure you have receipts, cancelled checks, and appraisals for all donations to substantiate your claim for deductions.

Failing to report part of your income

The IRS already knows what is on your W-2 and 1099s in terms of income.  If you do not report your income accurately on your tax return, this will likely trigger an audit.  You will receive a W-2 from your full-time job, but may also receive 1099s for freelance work you do on the side, as well as other forms of miscellaneous income, in all cases you must report all of your income from all sources.

Large losses on Schedule C, or many years of losses on Schedule C

If you are self-employed, and report your income on a Schedule C, you will report either a profit or a loss.  If your return shows a very large business loss on a Schedule C, or if you have a history of several years of losses on your Schedule C, this will likely attract IRS attention.

The reason behind this is that the IRS likes to see a profit at least two out of five years to consider a business legitimate.  If there are five years of losses reported on a Schedule C, the IRS will likely audit to see if ‘hobby’ would be a better description.  This is important because taxpayers are required to report any income earned from a hobby, but tax payers generally cannot deduct losses.

For example, a Professional Photographer with his own business, clients, advertisements, portfolio etc., can claim as a business expense the purchase of a camera.  Whereas, a doctor who enjoys taking photographs during his weekend hikes cannot claim a new camera as a business expense.

Claiming too many business expenses

In addition to the business/hobby issue just discussed, reporting too many losses can also cause the IRS to question how your business is staying solvent.  If you report many personal expenses through your business without it being a true necessary business expense (in order for your net profit to decrease and therefore your tax liability to decrease) the IRS will scrutinize your records during an audit.

Random Selection

Unfortunately, even if you do everything right, there is always a small (less than 1%) chance that your return will be randomly selected for an audit.

In Conclusion

If you do receive an audit notice from the IRS, it does not need to be the start of a stressful and difficult time for you and your family, or your business.  You will likely benefit from an experienced tax attorney’s advice and direction with the protection of the attorney client privilege.