Discussion:CALPERS pension and insolvency

Also, this is an RDP couple. For federal purposes, the COD will be split in half (jointly owned property with both taxpayers on the mortgage), but should the insolvency calcs include only jointly held assets, with separate property allocated to each? I think so, but want feedback if possible.

If the taxpayer has a vested interest in a retirement plan but has no ability to access any benefits, then there’s nothing to be included in assets for this retirement plan. The taxpayer must be able to access the benefits of that plan on the insolvency calculation date. See Caton v. Commissioner, T.C. Memo. 1995-80; Johns v. Commissioner, T.C. Sum. Op. 2001-67.

For a pension plan like the Civil Service Retirement System where the taxpayer has a vested interest in the plan, assets should include the value of the pension benefits that the taxpayer would be eligible to receive. See Gale v. Commissioner, T.C. Sum. Op. 2006-152.

Regarding your question as to how to allocate assets and liabilities for an RDP couple, in Letter Ruling 8920019. the IRS ruled that each spouse may determine his or her own extent of insolvency separately even if the spouses file a joint return. The IRS reasoned in that ruling that while a joint return allows spouses to combine their income and deductions, each spouse should be able to determine his or her own insolvency based on separate assets and liabilities. As a result, I agree with your procedure to split jointly-held assets and jointly-owed liabilities (taking into consideration California community property rules) and to add separate assets and separate liabilities to the calculation.

One further point regarding the RDP angle. It can be tough to figure out how much the community property rules come into play. If couple were together the entire time pension was earned it is easy - 50/50. But if pension was earned, even in part, before they became RDP's then you have some number crunching to do.

I think that these two cases are sufficient to show that a taxpayer must have a vested interest in the pension plan before it is included as an asset in the insolvency calculation.

Could you place a link to Caton and Johns? For some reason I could not find them in http://www.ustaxcourt.gov

I have looked at pub 4681 and CPE material and never found a good explanation of "Interest in a pension plan." Since it was often discussed in the same breath as IRA, 401K's, etc; I assumed it meant "defined contribution" pension plans where you actually have an account. But, your inclusion of Social Security benefits leads me to believe that "defined benefit" pension plans should also be included in the calculations. Is this correct? If so, how would you go about determining the benefit? A 30 yr old may have a vested pension of $100 month at 65.

Most of the my COD's have been on principal residence ... the few that I have done involving insolvency, the client was to deep in the hole that I thought I needed to do a Chinese return so no concern about pension making them solvent.

Thanks!

"If the taxpayer has a vested interest in a retirement plan but has no ability to access any benefits, then there’s nothing to be included in assets for this retirement plan. The taxpayer must be able to access the benefits of that plan on the insolvency calculation date. See Caton v. Commissioner, T.C. Memo. 1995-80; Johns v. Commissioner, T.C. Sum. Op. 2001-67."

This is from the Johns' case: "Because petitioners were solvent, we need not address

         whether the potential benefits under the FPL pension plan and the           
         Florida Retirement System, which petitioners had no access to in            
         1996, should be included in "assets".  Nor do we need to decide             
         whether the fair market value of the home was greater than the              
         assessed value of the home."

Based upon this statement, how did you come to the conclusion that the taxpayer must be able to access the benefits of that plan on the insolvency date before it had to be included in the asset section of the insolvency worksheet? In the Caton case, they should have included it, and the Gales case indicates that because it was not included, the court could not ascertain whether petitioners were insolvent and ruled petitioners did not prove insolvency.

I have a case where your statement would be a tremendous help, but these cases seem to be antithetical to the position I want to take. Am I just misreading them? Thanks for your help.

This was your later comment. I understand that part, but the "has no ability to access any benefits" is what is confusing me. I'm not seeing that in the court cases.

In the Johns case, the court said this:

"Because petitioners were solvent, we need not address whether the potential benefits under the FPL pension plan and the Florida Retirement System, which petitioners had no access to in 1996, should be included in 'assets'."

In my opinion, the language of the court's decision gave a hint that such items would not be included as assets anyway because they emphasized that the taxpayer had no access to the potential benefits. It seems to me that this is analogous to someone who is currently paying into social security but not yet of age to receive benefits. That person may have accumulated the required quarters of coverage (i.e., is vested), but has no access to benefits.

An entity must control an item’s future economic benefit to be able to consider the item as its asset. To enjoy an asset’s benefits, an entity generally must be in a position to deny or regulate access to that benefit by others, for example, by permitting access only at a price. Thus, an asset of an entity is the future economic benefit that the entity can control and thus can, within limits set by the nature of the benefit or the entity’s right to it, use as it pleases. The entity having an asset is the one that can exchange it, use it to produce goods or services, exact a price for others’ use of it, use it to settle liabilities, hold it, or perhaps distribute it to owners [Concepts Statement 6, paragraph 184].

In part, the taxpayer did not prove the fair market value of two parcels of real estate. In addition, the taxpayer failed to list, as an asset, the value of his interest in the New Jersey Public Employees Retirement System (PERS). In relevant part, the Tax Court stated:

"We find that the portion of Mr. Shepherd’s pension that could have been withdrawn as a loan from PERS is an asset for purposes of insolvency under section 108(d)(3)."

As a result, for those of you who need to determine the value of a client’s interest in a public employees retirement system, this case is helpful guidance.

I just don't follow how, with this "loan" theory, we have a bump up in net worth. If the guy "could have withdrawn" $50k as a loan...and he did...and if we make the insolvency calculation at that very moment...doesn't he have a $50k increase in net worth and also a $50k decrease in net worth (the loan itself), thereby resulting in an unchanged position?

Or is the judge saying that the guy has a $50k bump up, but no liability to offset, under the theory that such loans basically represent a borrowing from one's self...and if it goes unpaid, so what, it never has to be repaid...it simply goes into default (becomes taxable at that time) and reduces the guy's vested benefit prospectively?

I also realize that we may have to run the insolvency calculation at various points during the tax year...

• If he could have withdrawn $50K from the pension fund, but didn't, then his net worth attributable to the pension fund is $50K.
• If he could have withdrawn $50K from the pension fund, but withdrew $15K as a loan, and he used the $15K to pay expenses (not acquire an asset), then his net worth attributable to the pension fund is $35K (the $50K value of the pension minus the $15K loan).
• If he could have, and did, withdraw $50K from the pension fund as a loan, and he used the $50K to pay expenses (not acquire an asset), then his net worth attributable to the pension fund is zero ($50K value of the pension fund minus the $50K loan).
• If he could have, and did, withdraw $50K from the pension fund as a loan, and he used the $50K to acquire gold bars as an investment, then his net worth attributable to the pension fund is $50K ($50K value of pension fund plus $50K value of gold bars minus $50K loan).

So do we value @ $0?

...and to Dave, I'm still a bit confused, which may have to do with pension vs. defined contribution plan, I'm not sure. But if a guy has a $250k vested benefit and takes a $50k loan against it, his vested benefit is unchanged (i.e. the plan replaces the $50k cash the guy took out with a $50k receivable). And on the guy's end, he's got $50k in cash and a $50k loan. That is, the loan itself doesn't change the guy's net worth. There just seems to be a disconnect, in my mind, between the judge's loan theory and the pension valuation for insolvency/net worth purposes. I agree with the "how much can you access" notion, but when the right to access is always coupled with a liability of the same amount, it calls into question this theory.

Or, maybe I'm over-thinking things.

But in the Shepherd case, the taxpayer listed the $15K that he borrowed against the PERS pension fund as a liability in his insolvency calculation without including the value of the pension fund as an asset, and the Tax Court said that that was inconsistent. It appears from the Court's opinion that Mr. Shepherd's reason for not including PERS as an asset because it was exempt from creditors, but the Court held that pursuant to Carlson v. Commissioner, 116 T.C. 87, 105 (2001), even assets that are exempt from creditors are included in the insolvency calculation.

This is unlike a bank loan, which isn't your money already, isn't an advance against anything you already own and non-repayment does have consequences above and beyond the income tax impact.

The recent court's approach is certainly interesting, and perhaps, maybe the most workable approach. It's obviously a tough question, hence so many posts on this board about it.

Prior to retirement I would value a CalPERS retirement as being equal to the employee's balance within his retirement account. This is the employee's money and cannot be forfeited. The employee would have full access to the funds upon termination of CalPERS membership. The employer also contributes to CalPERS on behalf of the employee, but this money is never accessible and will vanish upon termination of membership.

That's very logical, but it is a tough question.

Dave's recent tax court cite seems to says that we don't take this route. Rather, we back up and look at the definition of an "asset," which involves the notions of accessibility and control.

I also do not believe that PERS is subject to raiding by the state. Please correct me if I am wrong.