Business & Tax Briefs  - Winter 2002

While having employees sign non-competition agreements is often a good idea, many employers make the mistake of using non-competition agreements that are so broad and overreaching that a court might not enforce the agreement. In the employment context, Ohio courts will generally only enforce "reasonable" non-competition agreements, and those that are unreasonable are enforced only to the extent necessary to protect the employer's legitimate business interests.

The Ohio Supreme Court has held that a covenant restraining an employee from competing with his former employer upon termination of employment is reasonable if the restraint is no greater than is required for the protection of the employer, does not impose undue hardship on the employee and is not injurious to the public.  Thus, although possible counterintuitive, it is advisable for enforceability purposes to limit the scope of an employment-based non-competition agreement to only those matters which are truly necessary to protect the employer's interests. As to the assignment of non-competition agreements, an Ohio court of appeals has held that there may be assignments of non-competition agreements (e.g., as part of the purchase of a business) even though the agreement may be silent regarding assignments.  However, if such an assignment is contemplated, it is better to affirmatively state the right of assignment in the agreement. Last, with respect to the basis required to grant injunctive relief for the breach of a non-competition agreement, an Ohio court of appeals has adopted the "inevitable-disclosure rule" which recognizes that an actual threat of harm exists when an employee possesses knowledge of an employer's trade secrets and begins working in a position that causes him or her to compete directly with the former employer or the product line that the employee formerly supported.

On June 7, 2001, President Bush signed into law The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA 2001”).  One of the cornerstones of the new law is the supposed gradual repeal of the estate tax.   Many people are starting to ask themselves whether estate planning is needed any more.  “After all,” they say, “if the estate tax has been repealed, why bother?”   The core reasons for estate planning still apply.

Family wealth creates both possibilities and problems.

Family succession planning – How to leave behind harmony rather than discord.  This often involves planning for “fairly equal” treatment of surviving family members, which may not be as easy where a family business is involved. 

Before you think your estate is “too small,” ask yourself:  “how much money would it take for my heirs to start fighting over it?”

Protecting wealth from family members – What if Junior is a spendthrift?  What if Junior’s wife divorces him?  What if Junior is sued?  Can the money be protected in advance?

Protecting family members from too much wealth.  How much is too much (will the next generation have incentive to be independently productive)?  How young is too young (are you comfortable leaving $500,000 outright to a 19-year old child or grandchild)? 

Do I want some of my wealth dedicated to charity, and if so, do I want to encourage my surviving family members to be involved in the charitable uses?

Who will care for “my people” when I’m gone?

The #1 reason people prepare their first wills is to appoint a legal guardian for their minor children.  Money matters, but people matter more.  Without a will, a guardian is appointed by a court, which might or might not choose someone you would want.

If you want to leave some money in trust for your children, grandchildren or others, someone needs to serve as Trustee to ensure its proper investment and administration.  Who should have “checkbook discretion” over when the beneficiaries should get the money? You (or your surviving spouse) may be surprised by what the new law does to existing documents. For example, many existing wills/trusts use so-called “bypass” planning to maximize the use of both spouses’ unified estate/gift tax credit.   A formula in the will and/or trust determines how much passes to the surviving spouse, and how much passes to the children (or grandchildren, or “family trust”).

Under most existing “bypass” estate plans, the increase of the unified credit will decrease the surviving spouse’s inheritance.  This effect will be particularly pronounced in mid-sized estates (say, between $600,000 and $2.5 million).  

We recommend all clients have their estate plans reviewed, including a projection of how much will pass to the surviving spouse, and how much to the children (or “family trust”), based on your updated financial information.

Income tax planning will also become more important. 

IRAs, 401(k)s, and other retirement accounts will continue to be taxed heavily on distribution.  A review and update of your beneficiary designations are advisable to avoid expensive surprises.  If you have charitable inclinations, always consider using these accounts to fund those bequests, either directly or through a planned giving vehicle.

If repeal becomes effective, the new law provides for a repeal of “stepped-up basis” on death.  Also, the gift tax is not repealed.  These points may factor into decisions on the timing and size of lifetime gifts. Finally, repeal is a 9-year process, and even then is still far from certain.

Amazingly, the new bill “sunsets” after the year 2010, bringing the estate tax back in full in the year 2011.  It unfortunately will be no simple matter for Congress to “keep the estate tax repealed.” 

Even if repeal really happens, it’s not until the year 2010.  Prudence dictates planning for the interim.

The short-term outlook is for fewer estates to be subject to federal estate taxes, and for lower overall taxes on taxable estates. 

However, tax planning will still be required, including on the state level (which for revenue reasons are unlikely to repeal their death taxes).

In 2001, President Bush signed into law the biggest tax cut in two decades, a sweeping 1.35 trillion dollar bill lowering U.S. income tax rates across the board.  The tax reductions gave households a refund of up to $600 for 2001, reduced most income tax rates by three percentage points as of July 1, 2001 and created a new ten percent tax bracket. 

At the center of the new law is a reduction of the marginal tax rates for individuals.  Most taxpayers will pay less taxes under the new rate cuts, which start with the creation of a new ten percent rate bracket.  All other individual income tax rates (except the fifteen percent rate) are also being cut for 2001 (see Rate Reduction Schedule).

In addition to the reduction in tax rates, those taxpayers currently subject to the limitation on itemized deductions and the phase-out for personal exemptions will receive an additional bonus through the gradual elimination of these limitations.  The overall limitation on itemized deductions will be reduced by 1/3 in 2006-2007, by 2/3 in 2008-2009 and completely eliminated starting in 2010.  Similarly, the personal exemption phase-out will be reduced by 1/3 in 2006-2007, by 2/3 in 2008-2009, and completely eliminated starting in 2010.

Despite the new tax rates and the elimination of the itemized deduction and personal exemption limitations, many taxpayers will receive little or no relief under the new law.  Those taxpayers who are subject to the alternative minimum tax (“AMT”) will receive no rate reduction at all.  Rates will remain 26% for the first $175,000 of AMT income after applying a $45,000 exemption.  Additional AMT income in excess of $175,000 will be taxed at 28%.  According to various projections, six times as many taxpayers will be subject to the AMT once all the new provisions under the new law are phased in.

At long last, the much talked about marriage penalty relief may finally become a reality.  Although it will not begin until 2005, the marriage penalty relief will provide joint filers with a standard deduction which is twice the amount of the standard deduction provided to single filers.  This will be phased in over a four year period starting 2005 and ending in 2008.  In addition, the new law provides an expansion of the fifteen percent tax bracket to an amount double that of single taxpayers.  This will be phased in over a three year period beginning in 2006 and ending in 2008.

The new law doubles the current child tax credit to $1,000.  This will be phased in over ten years.  For tax years 2001 through 2004, the child tax credit will be $600.  For tax years 2005 through 2008, the credit will be $700.  The credit will increase to $800 in 2009 and eventually reach $1,000 for tax years 2010 and later. 

Additionally, the new law introduces an above-the-line deduction for qualified higher education expenses.  For 2002 through 2003 taxpayers will be entitled to an above-the-line tuition deduction of $3,000 for each year, subject to certain income limitations.  In 2004 and 2005 the amount of the deduction increased to $4,000, again subject to income limitations.  After 2005, this deduction is scheduled to disappear in order to meet certain budget restrictions. 

Annual contributions to education savings accounts (which were previously limited to $500 per year) have been raised to $2,000.  Also, beginning in 2002, contributions will be allowable not only from individuals, but also from corporations, tax-exempt organizations and other entities.  Also, contributions for each tax year will be permissible until April 15^th of the following year, rather than being cut off on December 31^st. 

The student loan interest deduction is also expanded under new law.  Current rules permit taxpayers to deduct up to $2,500 in student loan interest as an above-the-line deduction each year.  This deduction also has been severely limited by the rule that a taxpayer’s adjusted gross income must fall under a certain threshold (the deduction is phased out for single filers with incomes between $40,000 and $50,000, and joint filers with incomes between $60,000 and $75,000).  In addition, the interest must be attributable to payments made during the first sixty (60) months in which interest payments are required.  Under the new law, the income phase-out thresholds are increased to $55,000 to $65,000 for singles, and to $100,000 to $130,000 for joint filers.  The new law also completely repeals both the annual dollar limitation and the sixty (60) month limit.

Pension reform is also a very large part of the new law.  The contribution limits for both traditional and Roth IRAs will increase from the current $2,000 annual cap to $5,000 ($3,000 for 2002-2004; $4,000 for 2005-2007; and $5,000 for 2008 and thereafter).  Taxpayers who are age 50 and above will be permitted to make “catch up” contributions to their IRAs.  In tax years 2002 through 2005, individuals may contribute an additional $500 to an IRA.  In tax years beginning in 2006 and all years thereafter, such taxpayers may contribute an additional $1,000.

Beginning in 2002, the limit on annual additions to a defined contribution plan are increased to $40,000.  The annual limit on benefits under a defined benefit plan is increased to $160,000.  The limit on salary reduction contributions to 401(k) type plans (including 403(b) annuities and salary reduction SEPs) are increased from $10,500 to $15,000 by 2006 (scheduled to increase to $11,000 in 2002 and increase by an additional $1,000 each year until 2006).

The limit on annual elective deferrals to a SIMPLE plan are increased to $10,000 by 2005 (scheduled to start at $7,000 in 2002 and then increase $1,000 each year until the $10,000 limit is reached in 2005).  The limit on compensation taken into account under a qualified plan is increased to $200,000.

Finally, business taxpayers were not forgotten in the pension reform section on the new law.  Among its many changes, the law increased the limit on an employer’s deduction for contributions to certain types of defined contribution plans to 25% of compensation; provided tax credits for small business start-up costs and matching contributions; and modified the “top-heavy” rules.

As you can see, there are many new and exciting changes taking place in the area of income and retirement planning.  We at Kadish, Hinkel & Weibel look forward to discussing these changes and the planning opportunities which they provide with you in the very near future.

In 1997, the Ohio Supreme Court held that the preparation and filing of a complaint with a board of revision on behalf of a taxpayer constitutes the practice of law and must be performed by an attorney licensed to practice law in the State of Ohio.  Although an individual who owns property in his own name may file on his own behalf, the law in this area is unique and has changed drastically and rapidly over the last five years.  Technicalities as to the form of the complaint, the information to be provided to the board, the timing of the filing, and the evidence to be presented to the Board, to name just a few, are such that individuals and attorneys not familiar with this area of the law should not attempt to file complaints with county boards of revision.  Therefore, it is recommended that an owner retain counsel experienced in this area of the law if the value of the property is going to be challenged.  Business entities such as corporations, limited liability companies, partnerships, and trusts must retain counsel to prepare and file a complaint.  The Cuyahoga County Board of Revision and the Ohio Board of Tax Appeals strictly adhere to the rules and laws in this area and readily dismiss complaints that are filed by corporate officers, members of limited liability partnerships, partners in partnerships, and trustees on behalf of trusts.  A change in valuation carries forward for a three-year period called a triennium.  In Cuyahoga County the latest triennium began with the year 2000.  Although complaints filed this year will be for tax year 2001, any change in valuation will carry forward for the remaining two years of this triennium.  The deadline for filing complaints seeking a change in the auditor's value is March 31, 2002.  If you are interested in contesting the auditor's value of real property that you or your business entity own, please contact Kevin Hinkel.