NEW 3.8% MEDICARE TAX ON NET INVESTMENT INCOME

The 2010 Health Care Reform Act, more formally known as the “Health Care and Education Reconciliation Act of 2010,” includes a new “Medicare Contribution” surtax which will become effective for tax years beginning after December 31, 2012. Individuals (and trusts and estates) will be subject to a 3.8% surtax on “net investment income.”

Net investment income includes income derived from interest, dividends, annuities, royalties, capital gains and rents, less any expenses properly allocable to such income. Investment income does not include income from a trade or business in which the taxpayer is an active participant, nor does it include distributions from IRAs, other qualified plans or any selfemployment income.

For individuals, the surtax is computed at 3.8% of the lesser of: 1. Net investment income, and 2. The excess of “Adjusted Gross Income” (with certain modifications) (“AGI”) over a threshold amount ($200,000 for an individual, $250,000 for a married couple and $125,000 for a married person filing separately). Note that AGI is basically the amount appearing on the last line on page 1 of the Form 1040, before any tax deductions (page 2 of Form 1040).For example, if an unmarried individual’s AGI is $250,000 and he has net investment income of $60,000, he will be taxed 3.8% on $50,000 (the difference between his AGI and the $200,000 income threshold) rather than the $60,000 net investment income.

In addition, a portion of the gain on the sale of a personal residence is included in the definition of net investment income. This does not mean, however, that the new surtax is a blanket “sales” tax applicable to all residential sales. First, the AGI threshold discussed above must be met for the new 3.8% surtax to apply. Second, the surtax would only apply to the portion of the gain that exceeds the present exclusion for gain on home sales ($250,000 for an individual or $500,000 for a married couple). Therefore, if an individual has an AGI of more than $200,000 and realizes a gain of more than $250,000 on the sale of his home, that amount in excess of $250,000 will be subject to the new 3.8% surtax. (It should be noted that the income exclusion is limited to the disposition of one personal residence every two years.)

As stated, the new 3.8% tax on net investment income does not take effect immediately, but rather will become effective in the tax year beginning January 1, 2013. Anyone planning to sell a home within the next few years may want to take into consideration that he or she might be subject to greater tax liability commencing in 2013 (assuming this tax remains in effect).

BRIEF ESTATE PLANNING UPDATE

We have been reviewing wills with clients as a result of the changes in the Federal estate and gift tax laws. One important change is the new Federal exclusion of $5,000,000 for an individual dying in 2011 or 2012. In addition, the executor under the will of a married person can elect to transfer the unused portion of the $5,000,000 exclusion to a surviving spouse. There are other significant elections a fiduciary may make, which is why we have reprinted our partner Ed Schlesinger’s article on selecting an executor or trustee.

Please also remember that New York residents are only entitled to a $1 million exclusion even though the Federal exclusion is $5,000,000. Everyone also has a lifetime Federal gift tax exclusion of $5,000,000 for 2011 and 2012. These are some of the reasons individuals should consider review of their wills and trusts. If you have not done so recently, you may want to schedule a discussion with one of our estates and trusts attorneys.

CHOOSING YOUR EXECUTOR AND TRUSTEE

Serving as an executor or trustee is neither an honor, nor a game for beginners to play. Acting as executor or trustee requires technical skills, experience, and an ability to deal with the family members involved. Nevertheless, clients often choose an executor and trustee without fairly evaluating the needs of the estate or trust against the named fiduciary’s abilities to meet those needs.

An executor’s responsibilities differ from those of a trustee. In all but the most complicated estates, the executor’s duties should be completed within three or four years after death. The trustee’s responsibilities continue as long as the trust lasts – perhaps until the surviving spouse dies and the children reach a pre-determined age. Both executors and trustees need to have skills to invest the assets for which they are responsible, as well as skills in other financial areas. Even with the recent tax law changes, relieving many estates of responsibility for federal estate tax, all but the smallest estates need income tax planning.

Executor’s responsibilities. Theoretically, the executor should know at least as much about the assets as the estate owner does. The executor is responsible for collecting all of those assets, paying all of the obligations, and distributing the assets either outright to the beneficiaries, or to the trustee for further management. This may involve selling a business, liquidating speculative investments, and disposing of other valuable property. Lawsuits pending at death must be continued or terminated. Funds must be made available for the family’s immediate living expenses. Problems involving the estate owner’s federal and state income and gift tax liability must be resolved. The executor must determine whether the total of the value of the estate and the estate owner’s adjusted taxable gifts requires filing federal and state death tax returns. If returns are filed, the executor must make many informed decisions and elections.

Trustee’s responsibilities. The trustee’s responsibilities are no less demanding than the executor’s. The trustee must develop an investment program that will permit the surviving family members to continue living as well as they can within the provisions of the governing will or trust agreement. Except in the most rigid type of trust, which requires distributing the income and prohibits invading principal, discretion must be exercised. The trustee may have to decide such imponderable questions as:

• How much money should the surviving spouse receive to live on?
• How much money should be spent for educating the minor children?
• How much money, if any, should be distributed to the surviving spouse to start a new business?
• How much money should be spent for the surviving spouse’s care in a nursing home?

None of these or any other questions a trustee must resolve has a fixed answer. Each of them depends on the amounts of money available, the personalities involved, the other people for whom assets must be made available, and the estate owner’s wishes.

The decision of who should be named as executor and trustee has no one answer either. Among other things, it depends on the size and complexity of the estate, the terms of the will or trust agreement, and above all, on the desires of the estate owner and family. The surviving spouse may be a fine choice as executor in a modest estate, which is left outright to the surviving spouse. But even this generalization fails if the spouse is 82 years old and bordering on senility. Then, the estate should probably not go outright to the surviving spouse, regardless of its size. Similarly, if a relatively simple estate is being left outright to adult children because there is no surviving spouse, it may be appropriate to name one or more of the children to handle it. It may not be appropriate to do this if the children are inexperienced or are antagonistic to one another. In such cases, it may be necessary to pick someone outside the family to act as executor.

Corporate fiduciaries. As complexities develop in either the estate’s assets or the plan for disposing of them, the need for a more complicated selection of executors and trustees becomes apparent. It may be appropriate to consider naming a bank or trust company as at least one of the executors and trustees – perhaps with one or more family members or other trusted individuals. A corporate fiduciary is in the business of handling its customers’ estates and trusts. A well chosen corporate fiduciary should be able to make a meaningful contribution to the satisfactory administration of an estate of trust. It should be able to justify the fees it will charge by the results it produces.

Estate owners who are not familiar with corporate fiduciaries may be reluctant to involve them in administering their estates or trusts because of a lack of experience with how a corporate fiduciary works. Despite the apparent monolithic structure of a large corporate fiduciary, each of them is staffed with people. These people are employed to handle the affairs of the estates and trusts for which the corporate trustee is acting. As in any other corporation, these people’s actions are constantly monitored by their supervisors. But the fact that these people are engaged in the full time administration of estates and trusts gives some assurance that they are at least as competent as other people who don’t devote their full time and attention to estate and trust administration. Moreover, because they are dealing with these problems on a daily basis, they are usually in a position to make informed judgments on the human problems as well as technical problems.

NYC GREEN BUILDING LAWS CREATE NEW OBLIGATIONS FOR OWNERS AND TENANTS OF COMMERCIAL BUILDINGS

New green building legislation passed by the City of New York in December of 2009 seeks to improve the energy efficiency of existing buildings, reduce greenhouse gas emissions, lower energy costs and create thousands of green jobs. It also establishes a New York City Energy Conservation Code (NYCECC). In practice, the four newly enacted laws known as the “Greener Greater Buildings Plan” impose significant responsibilities and costs on building owners and tenants, who will be required to make extensive changes to comply with new energy efficiency standards. The four new Local Laws include:

1. Energy & Water Efficiency Benchmarking (Local Law 84) – requires the collection and input of building operations data into a free, online tool provided by the Environmental Protection Agency (EPA) called Portfolio Manager to annually assess water and energy use performance. Reporting for private buildings is required by May 1, 2011.

2. NYC Energy Conservation Code (Local Law 85) – This law gives New York City direct control over building energy standards primarily by closing the loophole created by the “50% Rule” in the Energy Conservation Construction Code of New York State, which previously exempted renovations of less than 50% of a building’s subsystem from new energy requirements. As of July 1, 2010, all additions, alterations, renovations and repairs must now comply with NYCECC standards even if work performed covers less than 50% of a building’s subsystem. However, at the present, areas not included in a renovation are not required to be code compliant.

3. Energy Audits and Retro-Commissioning (Local Law 87) – requires energy use audits (ASHRAE Level 2 Energy Audit) and retrocommissioning every 10 years to identify capital improvements that will pay for themselves within a “reasonable period” (as defined in the statute, with some exceptions). An Energy Efficiency Report covering both the energy audit and retro-commissioning must be filed with the Department of Buildings once every 10 years. The first reports are due in 2013, with the file date (year) determined by the last digit of a building’s tax block number.

4. Lighting Upgrades & Sub-Metering (Local Law 88) – requires lighting upgrades to meet the NYCECC standards by January 1, 2025 and requires that all renovations be upgraded to current code standards whenever a renovation is pursued. This law also requires the installation of sub-meters for every commercial tenant with over 10,000 square feet or per floor, whichever is smaller.

Each of the new laws applies only to “Covered Buildings”, defined to include 1) any building that exceeds 50,000 gross square feet, 2) two or more existing buildings on the same tax lot that together exceed 100,000 gross square feet, and 3) two or more buildings held as condominiums that are governed by the same board of managers and that together exceed 100,000 square feet. Certain exceptions in the NYCECC are made for landmarked and historic buildings, as well as for minor construction projects such as storm window installation over existing fenestration, glass-only replacements in an existing sash and frame, and existing ceiling, wall or floor cavities exposed during construction, provided that these cavities are filled with insulation.

First Due Dates to be Aware of
For owners or tenants in commercial and mixed -use buildings not planning on pursuing any renovation projects, the earliest date to be aware of in the new legislation is February 15, 2011. By this date, and every February 15 thereafter, owners of Covered Buildings will be required to obtain, and tenants will be required to report, all tenants’ separately metered energy usage for the previous calendar year. Benchmarking information will be required for each energy source (electricity, gas, fuel oil, steam), as well as for water use per gross square feet, provided that the EPA has equipped automatic meter reading equipment which has been in operation for the whole previous year. Owners will be required to input their building’s energy usage directly into the online benchmarking tool by May 1, 2011 and every May 1 thereafter. Exempt from this requirement, at least for the time being, are certain types of dwelling units, and any buildings with data centers, television studios, or trading floors exceeding 10% of gross square footage. It should be noted that the City is working with utility providers to enable them to upload the benchmarking information directly, which would relieve owners of this obligation. However, for the time being, owners and tenants should be prepared to report their own benchmarking information.

Lighting Upgrades
As mentioned above, the passage of the New York City Energy Conservation Code (NYCECC) closed the loophole that previously applied to alterations of existing buildings leading to the replacement of less than 50% of a building’s system or subsystem under the state code (Energy Conservation Construction Code of New York State or ECCCNYS 2007). Thus, owners or tenants of Covered Buildings should be aware that any addition, alteration, renovation or repair for which applications for construction document approvals are submitted to the Department of Buildings on or after July 1, 2010 must now comply with the most stringent standard governing energy use. While the NYCECC provides specific energy standards, it notes that if any provision of (or amendment to) the State Construction Code (ECCCNYS 2007) is more stringent than the NYCECC standard, the more stringent requirement shall govern.

If a tenant or owner of a Covered Building is planning on replacing any portion of the lighting system on a floor, the tenant or owner will have to submit a professional statement, energy analysis and supporting documentation to the Department of Buildings (excepting the minor construction projects mentioned above). Without getting into the technical specifications of the new requirements, tenants and owners should know that the NYCECC governs the following five categories of electrical power and lighting systems: 1. Lighting Controls (interior and exterior, including standards for light reduction, and auto lighting shutoff), 2. Tandem Wiring, 3. Exit Signs, 4. Interior Lighting Power Requirements, and 5. Exterior Lighting Power Requirements. For example, if a tenant in a Covered Building replaces the lighting for an entire floor of enclosed office space, the lighting power density of the new system must be less than the pre-calculated table load delineated by the NYCECC, in this case a maximum of 1.1 watts per square foot. Different types of spaces will have different lighting power density requirements, depending on the business and the use of the specific space. The law includes various exceptions for certain types of spaces and several specific requirements which should be discussed with a professional.

Who Pays for the Upgrade?
It may not be clear whether the owner or tenant of a space in a Covered Building will be required to pay for the costs of an upgrade to a lighting system. Attention should be paid to the lease governing the tenancy to answer this question. While new leases should have provisions for whether the owner or tenant bears the costs of government-mandated alterations to leased spaces, existing leases may not contain applicable provisions. It seems likely that owners will bear the costs of major alterations, but such issues will often be negotiated with tenants, depending on the specific situation. Leases should be examined closely with the help of your counsel; consult your HGG partner contact with any questions.

Planning for Future Upgrades
Even if no upgrade is currently planned for lighting systems, keep in mind that all Covered Buildings will be required to comply with the new code by January 1, 2025. Owners of Covered Buildings will be required to file a report by a registered design professional or licensed master or special electrician certifying compliance with the law prior to that date. There may be reasons to get started on upgrades in the near future. For instance, the New York State Energy Research and Development Authority (NYSERDA) has a Technical Assistance Program which may, in some cases, reimburse a building owner up to 50% of soft-cost engineering fees. This program may not be available in future years.

For more information on energy Audits, we recommend contacting an engineering professional, or one of the partners at HGG who can suggest specific engineering firms. The Department of Buildings requires that Energy Audits and Energy Efficiency Reports be performed and certified by Certified Professionals