TAX TALK
By Timothy E. Kelly and Kevin W. Rego
No worries on minimum retirement age in California: For our California based readers, should you hear any rumors to the effect the IRS is doing away with the ability to retire at 50, rest easy. A certain amount of concern has set in based upon an issue concerning the Nevada retirement system.
The fact is, a retirement plan in which the majority of members are public safety officers is covered under a Treasury Regulation “safe harbor” which specifically allows a retirement age of 50.
The issue with Nevada’s system, which is not an issue in California (except for a couple of narrow exceptions), is that retirement is allowed in some cases based only upon years of service and without regard to age. The IRS has interpreted the Tax Code to require a plan to only offer retirement once a “normal retirement age” has been reached.
Under CalPERS and most 1937 Act retirement systems, 50 is the normal retirement age. Again, there are exceptions in California where, for example, only 20 years of service are required, and these plans are vulnerable. But for the most part in California, 50 is the minimum retirement age, so there is no conflict with the current IRS position.
Beware bad advice on taxation of final paychecks: We have received two more inquiries from readers who have received bad tax advice regarding their leave balance payoffs. The typical situation is that an officer is receiving a disability retirement. This officer has most likely been out on Labor Code section 4850 time, or the equivalent.
Neither the 4850 time, nor the disability portion of their retirement, will be subject to income tax. Yet when they leave their agency at retirement, they are also paid for their accumulated vacation, comp time and other leave in a single lump sum.
Many so-called tax professionals, including some enrolled agents and accountants who should know better, are advising officers that the leave balance payoff is not subject to tax because the officer is on disability status. This is false.
The reason the 4850 time and the disability retirement pay are excluded from taxation is that they are paid under statutes which are specifically limited to injured workers. Contrast this to the accumulated leave balance lump sum payoff, which is paid as regular wages and not paid under a specific statute limited to injured workers.
The application of the law in this regard is also visible in the taxation of retirement allowances, which combine a 50 percent disability allowance with an additional allowance based on years of service. The disability portion is not taxable (it is paid under an injured workers statute), while the balance, based on service credit exceeding 50 percent, is taxable (because it is paid under a statute not limited to injured workers).
Considering the size of some of these final checks, following this bad advice could result in a nasty tax bill down the road.
New housing bill modifies a common option to avoid capital gain on income property: For those of you who have owned investment, rental or vacation homes for many years, even the current housing market has not eliminated the potential of a large capital gain tax bill if the property were to be sold.
A common strategy in these cases has been to move into the property in question and use it as a primary residence for at least two years.
Until now, when the property was sold after the two year period, the Internal Revenue Code section 121 exclusion of capital gain could be used to exclude up to $250,000 of capital gain ($500,000 for a couple filing a joint return). That option has been for the most part eliminated by the recent signed housing bill.
Under the new law, time during which a property was used as other than a primary residence will be deemed to be “non-qualified” for purposes of the 121 exclusion. The amount of exclusion available on sale of the property will be reduced by a ration of the non-qualified time to the time the property is used as a primary residence. Note this is the case in reverse.
If, after using a property as a primary residence it is converted to another use as a rental or vacation property, or even just a second home, the new requirements concerning non-qualified use do not apply.
Thus the property may be otherwise used or rented for three year after use as a primary residence stopped, and the exclusion would still be available.
As always, there are exceptions, and you should consult a tax professional and analyze your particular facts and circumstances.
ABOUT THE AUTHORS: Timothy E. Kelly is an attorney certified as a specialist in taxation law by the Board of Legal Specialization of the State Bar of California, a distinction held by less than 500 of the state’s 200,000 attorneys.
He is a retired police sergeant with 27 years experience and an honors graduate of the McGeorge School of Law.
Kevin W. Rego is an attorney admitted to practice before the IRS and all California courts.
He is an active police officer with 19 years experience and a graduate of the Santa Clara School of Law.
The pair practice in the area of individual tax planning and litigation, appearing on a regular basis before the IRS, the U.S. Tax Court and federal district courts in California and throughout the nation. They may be contacted at tim@timkelly.com
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