‘Three and a Third’ Law Explained
Q: I intend to sell my home and move out of the state. Now I hear that the state will assess me a 3.3% tax on the proceeds. Can this possibly be true? -- J.L .
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A: The so-called “three and a third” law to which you refer is, indeed, a fact. But it’s not as sweeping as you’ve been led to believe.
Beginning in the late 1980s, the state Legislature imposed a withholding tax of 3.3% on the sale of property in California by landowners whose last known address was out of state. The goal was to ensure that the state gets its fair share of any profits generated by the transactions.
The reasoning behind the tax is that once taxpayers have money withheld from their proceeds, they are likely to make the required tax filing with the state Franchise Tax Board. If taxpayers reside out of state, California authorities have only a limited reach. But if money is withheld at escrow, the state can claim its share.
Apparently, the law works; a Franchise Tax Board spokesman reports that tax-filing compliance has soared in the last five years, and tax collections now hover around $500 million annually.
That said, you can see that as a state resident, you will not be hit with the withholding tax.
Out-of-state residents whose California property sale will produce a loss can petition the Franchise Tax Board for a waiver from the withholding. A modified waiver is also available if the 3.3% withholding tax is greater than the amount of tax the property owner would otherwise owe. Any waiver petitions must be filed before the sale becomes final.
Taxing Insurance Proceeds of Deceased
Q: How are insurance proceeds treated when the insured dies? Are they subject to estate taxes? Whose duty is it to report the proceeds and how is it done? What about the situation in which a living trust is the owner of an insurance policy--are the proceeds still taxed? -- E.S.W .
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A: Insurance proceeds are subject to estate taxes if the deceased owned the policy or directed the living trust that owned the policy. (Basically, the ownership test is based on whether you pay the premium and choose the beneficiaries.) The proceeds are reported on Form 706 of the estate tax filing prepared on behalf of the estate. Any estate taxes due on the insurance proceeds are paid by the estate, not the beneficiaries of the policy.
However, you should know that if the insurance policy is owned by an irrevocable life insurance trust, proceeds paid by the policy are not subject to estate taxes.
Making Deductible IRA Contributions
Q: Last February I left a job which had allowed me to participate in a 401(k) program. I am not allowed to join the 401(k) plan at my new employer until I have been on the job for a year. My family income in excess of $50,000 annually. May I make a tax-deductible contribution to an IRA for 1994? -- M.D .
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A: As you know, to make a deductible IRA contribution, taxpayers must either not be covered by a qualified pension plan, such as a 401(k), or their adjusted gross incomes must not exceed $35,000 for individuals or $50,000 for families. You clearly do not meet the income requirement.
Now the issue is whether you were covered by a qualified pension plan during any part of 1994. Yes, that is right; if you were covered by a qualified plan at any time during the year, even if for only two of the 12 months, you are deemed to have been an active participant and stand to lose the right to make a tax-deductible IRA contribution.
In your case, the answer appears to hinge on whether you or your employer made any contributions to your 401(k) plan during 1994. If either of you did, then you’re a plan participant and a tax-deductible IRA is out of the question. Of course, you may still make an IRA contribution with after-tax funds and let that money generate tax-deferred interest until you withdraw it after turning age 59 1/2.
FEMA Grants to Quake Victims Not Taxed
Q: Please clarify whether a grant from the Federal Emergency Management Agency must be counted as income when I file my tax form this year. I received such a grant because of the damage my home suffered in the Northridge earthquake last January. -- M.W.A .
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A: Assuming the taxpayer is in a federally designated disaster area--Los Angeles, Orange and Ventura counties were so designated after the earthquake--FEMA grants are not considered ordinary income and do not have to be declared when you file your taxes.
However, FEMA grants do offset the amount taxpayers may deduct as casualty losses from a disaster. How does this work? Let’s say you suffered $25,000 in uninsured casualty losses and received a $10,000 FEMA grant. The most you could possibly deduct as a casualty loss would be $15,000. (Your casualty losses would also be reduced by the amount of insurance proceeds you receive.)
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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
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More on Earthquake Insurance
* Even as Southern Californians prepare to observe the first anniversary of the devastating Northridge earthquake, questions remain about how earthquake casualty losses, insurance settlements and FEMA grants should be handled on 1994 income tax filings. Because of repeated reader inquiries, Times on Demand has prepared a compilation of the most-asked questions and answers on this subject. To order send $4, plus 50 cents delivery to Times on Demand, P.O. Box 60395, Los Angeles, CA 90060. Please allow two weeks for delivery. You may also order by calling Times on Demand. Dial 808-8463, press *8630 and select option 3. Order Item No. 2823.
