Tuesday, December 24, 2013

Clearing Up Common Myths about Life Insurance Proceeds

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"The foundation of life insurance is the recognition of the value of a human life & the possibility of indemnification for the loss of that value." In translation, it means someone pays a premium to an insurance company for someone else to receive a a sum of money on his/ her death. The contract can also include a terminal or critical illness. Some life insurance contracts are only for a specified term. 

Many people know that having life insurance is important, however are not so sure about the proceeds that are distributed and the tax consequences of such distribution. This post seeks to clear up some of those common myths. 

The question, "Are life insurance proceeds taxable?", elicits the favorite answer of accountants worldwide, "It depends!". So what's the scoop? For federal income tax purposes, the proceeds are not taxable when received due to death of the insured. In fact, hey, they don't even get a mention on the federal income tax return! That's easy, you say?

How about the interest that has accrued on the policy? 
Like any other interest, this accrued interest is also reported. So if a beneficiary gets a check for $52,500 for the proceeds & the death benefit was $50,000 and $2,500 was interest, you report the $2,500 on Schedule B of your tax return. 

What if I receive death benefits in a lump-sum versus in installments?
That doesn't change the taxability. The benefits are not reported as income or you would not pay tax on any benefits paid due to death of the insured. The only exception to this is if the insurance proceeds are paid to you on death of a spouse, who died before October 23, 1986 and the benefits are received in installments-you can exclude $1,000 of the interest included in installments. 

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Is the right to receive life insurance proceeds a good planning tool?
Yes, it is & is used a lot in estate, trust & business planning. A life insurance policy can also be considered an asset. If the ownership is passed or sold to another party, for cash or any other kind of consideration, the proceeds paid to the beneficiary is considered taxable income to the beneficiary. 

Can this "asset" be useful to the owner of the policy as well?
Many use this as an investment device to pay for college or retirement. Income grows in the policy tax-deferred. Generally, if the policy is cashed in (or surrendered) during the lifetime of the policy holder, the proceeds are subject to tax if they are more than the investment in the policy. 

How is Investment in the policy calculated? 
The Investment = Total Premiums Paid In - Payouts in Cash from the Insurance Company. This is reported by the company to the policy holder on Form 1099-R, & it is reported on lines 16a and 16b of Form 1040. 

If a loan is taken out on a life insurance policy-if allowed under the terms of policy- the amount of the loan is not taxable. The interest paid is not tax deductible as well since the loan is a personal expense. 

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Sometimes benefits are paid out before death & the proceeds are excluded from income. These are called accelerated death benefits. These are fully excluded only if the insured has been certified by a qualified physician  as having an illness or physical condition that is expected to result in death within 24 months from the date of the certification. There are other definitions for chronically ill people who can exclude the proceeds from tax. There are certain restrictions that apply, the details for your policy should be examined. 

What does all this break down to?
Life insurance proceeds are taxable only in certain cases. However since life insurance premium is considered a personal expense, it is not deductible on your federal taxes. There are some costs that can be excluded from employer-provided insurance policies. The type of the policy, the ownership & the method by which the policy was purchased determines if the life insurance is taxable. 

Making this determination and planning for various ways in which your taxes will be affected needs consultation with a tax professional. 

Bibliography: Pub 554: Tax Guide for Seniors; The Life Insurance Buyers Guide from the NAIC. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxsolutionsllc.com.

Wednesday, December 18, 2013

Streamlined Procedure And Foreign Bank Account Regs For Non-Resident US Citizens

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It all started with the announcement of the FATCA going into effect, then the new streamlined compliance procedures were announced in 2012 to go into effect on September 1st, 2012. More on FBAR Filing Requirements in my posts here and here

They were implemented in recognition that some U.S. taxpayers living abroad had failed to timely file U.S. federal income tax returns or FBARs, Form TD F 90-22.1. These delinquent taxpayers may have recently become aware of their filing obligations and now seek to come into compliance with the law. 

The new procedures are for non-residents including but not limited to dual citizens who have not filed U.S. income tax and other related information returns. 

As the Internal Revenue Service (IRS) envisioned it, this procedure is designed for those taxpayers who are considered a "low compliance risk". Having said that, the IRS still is the one to decide the intensity of the review and that will vary according to the level of risk presented by the submission. 

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  • For those presenting a low compliance risk, the review will be expedited and no penalties will be asserted or follow-up actions will be pursued. 
  • For those submissions that present a higher compliance risk, as determined by the IRS, the taxpayers will not be eligible for the streamlined process. Not only so, they will also be subject to a thorough review and sometimes full examination. The examination may then include more than 3 years of tax returns. 

Eligibility:  This procedure is available for: 
  1. Non-resident U.S. taxpayers who have resided outside of the U.S since January 1st, 2009. 
  2. These taxpayers must not have filed a U.S. tax return during this period. 
  3. Amended tax returns submitted through this program will be considered "high risk" except in certain cases where the amended return was filed to submit a Form 8891. 
  4. The taxpayers must have a valid Taxpayer Identification Number (TIN) or a Social Security Number (SSN). Those who do not have a TIN & are eligible for one may apply for it along with the submission made through this program. 
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The Procedure:  The actual process of submission goes like this: 
  • The taxpayers will be required to file delinquent tax returns.
  • With appropriate informational returns like Forms 3520 or Form 5471 for the past 3 years.
  • Or to file delinquent FBARs (TD F 90-22.1) for the past 6 years. 
  • Any applicable tax & interest has to be paid along with the  delinquent returns filed. 
  • The submissions must include any income deferrals elected by the taxpayer where permitted by a relevant treaty.  

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How the IRS determines Compliance Risk:  The level of compliance risk is based on the returns filed & the additional information provided as per the responses to the Questionnaire which is an integral part of a submission. 

  • Those returns which are "simple" and carry very little or no U.S. tax will have low compliance risk. Or if the submitted returns and application show less than $1,500 in tax due in each of the years filed, will be treated as low risk. 
  • The risk level may rise if any of the following are present: refunds claimed on returns filed; tax returns not filed in country of residence; taxpayer is under audit or investigation; FBAR penalties previously assessed against taxpayer etc. (Complete list provided on irs.gov under instructions for the procedure) 

Other Considerations:   Please note that the above information is only to jump start your streamlined process & is not exhaustive. Taxpayers considering going down this route are advised that there is a risk of prosecution if the IRS & the Dept of Justice warrant it. In such cases, taxpayers should consult with their legal advisers and explore other means of disclosure such as the Offshore Voluntary Disclosure Program (OVDP). More about OVDP in my post here.  Readers should also note that those taxpayers who are ineligible to use the OVDP cannot use this streamlined procedure as well. 

Bibliography: irs.gov; Instructions for Streamlined Filing Compliance; IRS Fact Sheet FS-2011-13; IRM 4.26.16; Form TD F 90-22.1; Notice 2011-55

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxsolutionsllc.com.

Thursday, December 12, 2013

Small Business Payroll: Mistakes & How To Avoid Them

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Payroll Compliance is a challenge that many small businesses struggle with. Payroll done by business owners themselves mean that they need to have the know-how to comply with the Internal Revenue Service (IRS)'s strict rules regarding accurate reporting & deposits. Moreover, federal, state & local tax regulations change & many times without notice. Small business owners need to follow such changes keenly as well. 

Having a professional as a trusted guide & advisor helps small business owners (SBO) navigate these dangerous waters. It also saves them time and costly errors. Errors which are due to late filing or deposit of taxes increase the risk of steep penalties & scrutiny from the IRS. 

Mistakes & How to Avoid Them: 

  • Misclassifying Employees: It is very important to correctly classify a worker-either as an independent contractor or as an employee. More on how that determination is made, is on my post here. This is a rampant problem and therefore the Government has enacted an Employee Misclassification Initiative. Misclassified employees are often denied access to critical benefits and protections and it also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers compensation funds.
        To Avoid: The SBO should learn the government definitions & the rules & regulations regarding worker classification. 

  • Late Deposit of Taxes & Forms: There are due dates stipulated for depositing taxes & for filing the required forms by the IRS. Failure to meet these due dates may result in failure-to-deposit penalties upto 10% based on the total payroll amount & a 5% failure-to-file penalty. 
        To Avoid: The SBO should start preparing for payroll taxes early and keep a watchful eye on 
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the timeline. 

  • Incorrect Forms Filed: Correct forms are necessary so that over or underpayment of taxes can be avoided. Correct forms also help with year-end reconciliation so the employees get correct W-2s. The business owners should also that the forms are signed before submission. 
To Avoid: The SBO should first verify the version of the forms being filed & make sure they are the most recent. They should double-check their figures. 

  • Submitting Incorrect Amounts: The business owner will incur a penalty from 2 up to 10 percent if the wrong payroll amount is deposited. The penalties start accruing from the due date of the taxes. They can only be avoided if the failure is due to a reasonable cause and not willful neglect. There can be a one-time abatement sought. 
To Avoid: The SBO should make sure the math on the form is right if being done by hand. The numbers should be placed on the correct line numbers. Everything should be double-checked. 

Personally I urge all small business owners to hire a professional to do this job. Having a copy of the Publication 15 (Circular E)  is a must. 


As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website, www.mntaxsolutionsllc.com

Friday, December 6, 2013

Final Regs On The 3.8% Net Investment Income Tax

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The Accounting community was waiting for this eagerly, to see which of their recommendations had been adopted. On November 26th, 2013, the Department Of the Treasury issued final regulations governing the Net Investment Income Tax (NIIT). 

If you remember, the 3.8% tax took effect from January 1st, 2013. We talked about this in my post here and here.  It applies to individuals, estates & trusts who have Net Investment Income and Modified Adjusted Gross Income above the following threshold amounts:

  • Married Filing Jointly & Qualifying Widower with Dependent Child- $250,000
  • Single & Head of Household with Qualifying Person - $200,000
  • Married Filing Separately- $125,000

Some Salient Points in the Final Regs & What May Affect You?
The final regulations usually follow proposed regulations but with changes adopted in answer to the recommendations provided. Comments which had been made were for the following: 
  1. Calculation of net investment income;
  2. Treatment of several special types of trusts;
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  3. Interaction between various aspects of the Sec. 469 passive activity rules with the calculation of net investment income;
  4. The method of gain calculation regarding a sale of an interest in a partnership or S corporation; and
  5. Multiple areas where the proposed regulations could be simplified.
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  • The general structure of calculating NIIT have been retained as in the proposed regulations. 
  • The Internal Revenue Service (IRS) did not address the income & expenses excludible from NIIT. 
  • The IRS rejected calls for providing special relief for estimated taxes with regard to NIIT even though many investors do not know till the end of the year if their pass-through investment will generate NIIT. 
  • The IRS clarified that the foreign tax credit may not be used to offset NIIT. 
  • The IRC 1411 final regs follow the proposed regs & provide that foreign trusts & estates are not subject to NIIT. However, this rule does not exempt U.S. beneficiaries from the application of NIIT to distributions from foreign income. 
  • The IRS has issued guidance on capital loss carry-forwards against NIIT. 
  • Certain net operating losses will be allowed against NIIT, the propsed regs had expressly disallowed these. 
  • The IRS has deemed real estate professionals to be conducting "trade or business" thus removing their rental income from net investment income if certain requirements are met. 
  • The final regs did not provide further clarification regarding the term "trade or business". 
  • Regrouping of activities under Reg. Section 1.469-4 may not be elected if taxpayers do not have both net investment income & MAGI in excess of the applicable thresholds. However with the final regs, if a taxpayer has to amend his 2013 or 2014 tax return that causes him to exceed this threshold, he may then elect to regroup. 
  • The special treatment of sale of S corp or partnership interests have been completely overhauled. Please read more here in this excellent article on forbes.com. 
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The final regulations are effective Dec. 2, upon their publication in the Federal Register, and generally apply to tax years beginning after Dec. 31, 2013. 

For tax years beginning before Jan. 1, 2014, taxpayers can rely on the proposed regulations or on the final regulations, but if a taxpayer takes a position in a tax year beginning before Jan. 1, 2014, that is inconsistent with the final regulations, and that position affects the treatment of one or more items in a tax year beginning after Dec. 31, 2013, then the taxpayer must make reasonable adjustments to ensure that the taxpayer’s tax liability under Sec. 1411 is not "inappropriately distorted" in tax years beginning after Dec. 31, 2013.

Bibliography: T.D. 9644REG-130843-13; Journal Of Accountancy; Thomson Reuters-Resources; irs.gov

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website, www.mntaxsolutionsllc.com



Monday, November 25, 2013

Year End Tax Planning Tips-2013

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As you go about making your Black Friday shopping list for all the good & naughty little angels in your life, don't forget to look at your finances as well. You might have re-assessed your withholdings & even explored tax-loss harvesting. Going into 2014, there are deductions that will not be extended and there will be steps you need to take to make the best use of them for the 2013 tax year.

Sales Tax Deduction on "Big Ticket Items":  If you are going to elect to claim the sales tax deduction vs the state tax deduction on your Schedule A or if you live in a state that doesn't have taxes, this is the year to accelerate your "big ticket" purchase, this election will not be available after 2013.

Energy Efficient Home Improvements: If you are a homeowner and have not availed the full extent of the energy efficient home improvements deduction, which is $500, it's time to put in any required energy efficient home improvements, such as, insulation/ installing energy-efficient windows/ heater or air conditioner before 2014. 

Tuition & Fees Deduction:  The above-the-line tuition & fees deduction is up for Congressional approval and unless it is extended, consider prepaying eligible tuition
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expenses, if this will increase your deduction. Generally, this deduction is allowed for enrollment at an institution of higher education during 2013/ for an academic period beginning in 2013/ in the first 3 months of 2014. 

Flexible Spending Account:  Increase the amount set aside for next year in your employer's health flexible spending account (FSA) if there was very little set aside for this year. 

Health Savings Account: If you become eligible to make health savings account (HSA) contributions in December of this year, a full year's worth of deductible contributions can be made for 2013. 

Defer Bonus: If getting a bonus at the end of the year will push you into the next tax bracket for 2013, you can arrange with your employer to defer your bonus. 

Purchase of Qualified Small Business Stock (QSBS):  Purchase QSBS before the end of this year. There is no tax on gain from sale of QSBS if, 

  • It was purchased after September 27th, 2010 & before January 1st, 2014, and 
  • Held for more than 5 years.
These sales will not cause AMT preference problems. To qualify for this break, the stock must be issued by a C Corporation with total gross assets of $50 million or less, and a number of other technical requirements are to be met. 

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Required Minimum Distributions:  If turning 70-1/2 in 2013, one is required to take minimum distributions or pay a penalty of 50% of the RMD as excise tax. (See more in my post here) The first RMD can be delayed into 2014 if turning 70-1/2 in 2013. If one is not going to continue to work as well in 2013, this would be a good strategy, as the overall income will be lower or will remain the same in 2014. If not, this will result in a higher taxable income for 2014. 

Gifts Before the End Of the Year:  You can give up to $14,000 to each of unlimited number of individuals and save on gift taxes. Read more on Gifts in my post here

Traditional IRA Conversions to Roth: If you expect to be in a higher income tax bracket well in to your 60's & 70's, converting your assets in a Traditional IRA to a Roth IRA would be a good tax strategy. The conversion will result in a higher income tax bracket for the current year, however, Roth IRAs are not subject to RMD and can be passed on to future generations. 

Mortgage Insurance Premiums: For years 2007 to 2013, taxpayers can treat insurance premiums on mortgage as qualified residence interest. Not so after 2013, so if you are due a re-fi on your mortgage and can get a better rate of interest or can stop paying mortgage insurance premiums, this would be a good time to explore that.

Tax-free Distributions from Individual Retirement Plans for Charity: A qualified charitable distribution (QCD) from a individual's IRA is excluded from his/ her gross income. To qualify for this, certain conditions have to be met and the total QCD for the year cannot be more than $100,000. Taking advantage of a QCD from an IRA has various advantages for higher income seniors who are drawing on Social Security & have income from other sources. This option is not available after 2013. 

Bibliography: Parker Tax Pro Library; Year End Planning Resources From Thomson Reuters; irs.gov. 

Please read my disclaimer here. For more questions regarding this and other matters, I can be contacted at manasa@mntaxsolutionsllc.com.     

Friday, November 22, 2013

Offshore Voluntary Disclosure Program: The Basics (2013)

Let us start with the fact that the 2009 Offshore Voluntary Disclosure Program and the 2011 Offshore Voluntary Disclosure Initiative had deadlines but the new Offshore Voluntary Disclosure Program (OVDP)  does not. This new program will be available until further notice to taxpayers who wish to come forward and disclose their foreign bank assets. 

What Does the OVDP do?  This program seeks to bring taxpayers who had undisclosed foreign bank accounts or undisclosed foreign entities for the purpose of evading or avoiding tax into compliance with the laws of the United States.
This program is a counter-part of the Criminal Investigation's Voluntary Disclosure Practice. It addresses the civil side of the taxpayer's voluntary disclosure of the foreign accounts and assets by defining the number of tax years covered and civil penalties that will apply. 

Penalties that Apply for Non-Compliance with FBAR Requirements:  These penalties are
quite substantial. The FBAR penalty, which is a one-time penalty, is based on the highest aggregate balance in a taxpayer's offshore account over an eight year period. This penalty is 27.5% of the above balance. Some taxpayers may qualify for a reduced 12.5% or 5% rate. Taxpayers might also have to pay a 20%-40% accuracy-based penalty for under-payment for eight years and failure-to-file &/or failure-to-pay. 

There are also criminal charges to be faced if a taxpayer has undisclosed foreign bank accounts & doesn't qualify for the OVDP. A person convicted of such tax evasion can face up to $250,000 in fines and a prison term up to 5 years. And failing to file an FBAR could subject a person up to $500,000 in criminal penalties and a prison term up to 10 years. More details of said criminal charges are on the IRS website. 

What Forms Part of the OVDP?  The FAQ 8 of the Offshore Voluntary Disclosure Program on the Internal Revenue Service's website gives details of how the OVDP works with examples. In a nut-shell, a taxpayer will need to take the following actions: 

  • File both the original and the amended returns for prior eight years that report all income & disclose foreign accounts. 
  • File all missing FBAR reports. 
  • Cooperate fully with the OVDP process. 
  • Sign agreements to extend statute of limitations. 
  • Pay the penalties set. 

Should You Make a Voluntary Disclosure?  Since this could be one of the most important decisions you could make if you have undisclosed foreign accounts or assets, please read the following paragraphs carefully. To be eligible to make a voluntary disclosure,      

  • One must not be under audit or criminal investigation;
  • One must not have received notices from the IRS regarding undisclosed foreign bank accounts;
  • Or the IRS should not have already received your name from a cooperating bank. 

The decision to be part of the OVDP is based on each person considering it. Once entered into, all the participants are measured by the same yardstick. Moreover, the OVDP does not include any chances to offer mitigating evidence in support of a defense for non-filing which include reasonable cause and/ or good-faith reliance on advice of others. 

If the taxpayer has prior failures which are not willful but are caused by inadvertence or negligence, and is able to prove it, he may be able to reduce the amount of penalties under special circumstances. However, there is no guarantee. 

All of this will make any taxpayer apprehensive or indecisive about entering the OVDP. If you are one of those who is "willing to take a chance" and keep your foreign accounts undisclosed, know this: the IRS enforcement initiatives have taken on a very determined nature. 

The US government has entered into tax treaties (as of 11/22/2013) with France, Germany, Italy, Spain, the UK, Denmark, Mexico, Switzerland, Norway & Japan under FATCA, 2010 {Foreign Account Tax Compliance Act}. These tax treaties increase the odds of the IRS becoming aware of undeclared bank accounts of US taxpayers. If this happens, the OVDP is no longer an option. 

The banks are more than likely to comply with the FATCA notwithstanding the reputation of bank secrecy that some of the named countries have. This is because compliance guarantees immunity from prosecution from the US Govt. 

So if you have undisclosed foreign bank accounts or assets, contact a tax professional right away to make an informed decision before it is too late. 

Bibliography: irs.gov FAQs for OVDP; treasury.gov; irs.gov OVDP submission requirements; Various posts on forbes.com by expert Robert Wood

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website, www.mntaxsolutionsllc.com

Friday, November 8, 2013

Don't Look a Gift Horse In the Mouth: All About Gifts & Taxes

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It's the proverbial time of the year when there are a lot of gifts exchanged. Some are store bought, some gift cards & there are those who just get plain ol' cash. 

What constitutes a "gift" in the eyes of the Internal Revenue Service? 

  • You make a gift if you give property, including money, or the use of or income from property, without expecting anything of equal value in return. 
  • You also make a gift if you sell something at less than its full value 
  • There's a gift made if you give an interest-free loan or reduced interest loan

So then, what is gift tax? 

  • The gift tax is a tax on the transfer of property 
  • By one individual to another while receiving nothing, or less than full value, in return. 
  • The tax applies whether the donor intends the transfer to be a gift or not. 

When is no gift tax owed? 

  • Most gifts are not subject to the gift tax.
  • There is usually no tax if you make a gift to your spouse. 
  • There is no tax for gifts made to a charity. 
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  • If you make a gift to someone else, the gift tax usually does not apply until the value of the gifts you give that person exceeds the annual exclusion for the year. 

What is the Annual Exclusion for Gift Tax for 2013 and What Are Not Considered Gifts ?  

  • $14,000 is the annual exclusion for gift tax for the year 2013. 
  • Tuition or medical expenses paid on someone's behalf as long as that is paid directly to the institution by the donor.
  • Gifts to your spouse.
  • Gifts to a political organization for it's use. 

When is a Gift Tax Return Filed & By Whom? 

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A gift tax return (Form 709) is usually filed by the donor who is a US citizen or resident of the United States, in the following situations: 
  1. If you gave gifts to someone in 2013 totalling more than $14,000 (other than to your spouse).
  2. Certain gifts, called future interests, are not subject to the $14,000 annual exclusion and you must file Form 709 even if the gift was under $14,000. 
  3. A husband and wife may NOT file a joint gift tax return. Each individual is responsible for his or her own Form 709
  4. You must file a gift tax return to split gifts with your spouse (regardless                                                 of their amount).
  5. If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $200,000 of community property is considered a gift of $100,000 made by each spouse, and each spouse must file a gift tax return. 
  6. Each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.
Gift tax paid cannot be deducted on your federal tax return. In fact, gift taxes are completely separate from your income tax return. 

Bibliography: irs.gov; Publication 950; Form 709 & Instructions

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website, www.mntaxsolutionsllc.com

Friday, October 25, 2013

Inheriting an IRA? Here's What You Need To Do!

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When writing my post on Required Minimum Distributions, I found that Pub 590 Rules for RMDs from Inherited IRAs were completely different and very extensive thus needing it's very own blog post. 
The person who receives an IRA when the owner dies is known as a beneficiary. Beneficiaries must include any taxable distributions in their gross income. 

Rules To Remember:  

A. Spousal IRA or NOT: If you inherit from a spouse, you can do one of 3 things:

  1. Treat it as your own, by designating yourself as the account owner.
  2. Treat it as your own by rolling it over into your IRA/ qualified employer plan/ qualified employee annuity plan/ tax-deferred annuity plan/ a deferred compensation government plan. 
  3. Treat yourself as the beneficiary. 
You will have chosen to have treated the inherited IRA as your own, if you made contributions into it including rollovers; did not take RMDs from it till the required age; if you are the sole beneficiary of the IRA & you have an unlimited right to withdraw amounts from it. 

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If the inheritance is from someone who is not a spouse, you CANNOT treat the IRA as your own. The only recourse is then NOT TO TOUCH it, but to make a trustee to trustee transfer into an IRA that has been designated as an inherited IRA, for example, "Poppa Blue-eyes, deceased, inherited for the benefit of Sonny Bono, beneficiary". 

You will then not to have pay taxes on the assets in the IRA, until you receive distributions from it. You must take distributions under the rules for distributions applicable to beneficiaries. The method to do so & rules are explained very well by Vanguard hereThe custodian can be asked to split the inherited IRAs into separate accounts if there are more than 2 beneficiaries. 

B. Beneficiary Forms:  The form on file with the custodian of an IRA CONTROLS who inherits the IRA AND its ability to be taken over the life of the beneficiary. If people other than a spouse are named as heirs, they must begin taking distributions from the account by Dec. 31 of the year after inheriting, but these can be drawn out over the expected life spans of the beneficiaries. They too can enjoy years of income-tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA by making proper arrangements with the custodian. 

If your inherited IRA had named both primary and alternate individual beneficiaries (For Example: Spouse as primary and kids as alternates OR kids as primary and grand-kids as alternates), you, the primary beneficiary then have the option of “disclaiming” or turning down the account, enabling it to pass to the younger alternate. The custodians resort to their default policy if there is no beneficiary on file & send the funds directly to the estate. Different brokerage firms have different policies. 

An important point to remember is that a beneficiary form overrides a will. 

C. Estate As Beneficiary:  Some name their estate as their IRA beneficiary, or inadvertently do so by failing to select a beneficiary. This cuts short the IRA's tax deferral. If the IRA is a Roth IRA, all funds must be withdrawn within five years. For a traditional IRA the same rule applies unless the former owner was already 70 1/2–the age at which a traditional IRA owner must begin cashing out. In that case the distribution rate for the heir is based on the age of the person who died.

D. Traps and Pitfalls:  
  • If the late IRA owner was 70 1/2 or older, beneficiaries must make sure the owner’s mandatory distribution for the year of death is withdrawn before doing anything else. 
  • When non-spousal beneficiaries take their own payouts, check if the estate paid estate tax, they may be able to take an itemized deduction to offset some IRA income. (Pub 559)
  • For non-spousal beneficiaries again, the minimum distribution is calculated differently than for your own IRA. You take the balance on Dec. 31 of the previous year and divide it by your life expectancy listed in the IRS’ “single life expectancy” table, rather than the table used by IRA owners. The next year you use the same life expectancy, minus a year. (You use a different table for yourself every year.) 
  • Be mindful of key dates & deadlines outlined here.  

Bibliography: Publication 590; Publication 559; Vanguard.com; Estate Planning Smarts by Deborah L Jacobs. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website, www.mntaxsolutionsllc.com

Monday, October 21, 2013

The ABCs of RMDs: Cracking the Code on Required Minimum Distributions

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As you gear up for your year end planning, let me ask you this-did you or someone you know turn 70 years old this year? If you did or they did, you know it is the year you hear the buzz of the words "Required Minimum Distributions" aka RMDs

What are RMDs? 

The Internal Revenue Service (IRS) defines it as "Required Minimum Distributions generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. However, if the retirement plan account is an IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 70 ½, regardless of whether he or she is retired."

When Do They Have To Be Taken?

You must take your FIRST required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31 of the year.

Let us break that down for you:

For year 2013, if you were born on or before June of the year 1942, you are eligible to take an RMD. You have to take RMDs from:
  • All employer sponsored retirement plans, including profit-sharing plans, 
  • 401(k) plans, 403(b) plans, and 457(b) plans. 
  • Traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
  • Roth 401(k) accounts if the Roth 401(k) is inherited. 

How Do We Calculate RMDs?

An RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor. This factor is published by the IRS in Tables in Publication 590, Individual Retirement Arrangements (IRAs)
You would use the:
  • Joint and Last Survivor Table if your sole beneficiary of the account is your spouse and your spouse is more than 10 years younger than you;
  • Uniform Lifetime Table if your spouse is not your sole beneficiary or your spouse is NOT more than 10 years younger; and
  • Single Life Expectancy Table if you are a beneficiary of an account.
You can also use an online RMD Calculator such as this one from Charles Schwab or talk to your tax professional. 

How to Take an RMD? And "dit and dat": 
Pic Courtesy: Google Images
  • The IRA Custodian or the plan Administrator may calculate the RMD to be taken by you, but you are ultimately responsible for taking the correct RMD based on your total investment in all plans. 
  • You can withdraw more than the RMD. 
  • If you are an IRA or a 403(b) owner: You must calculate the RMD separately for each IRA that you own, but you can withdraw the total amount from one or more of the IRAs.
  • If you are the owner of 401(k) or 457(b) Plans: the RMDs have to be taken separately from each of those plan accounts. 
  • You cannot roll over the RMD into another tax deferred account.
  • You will be taxed on this distribution at your tax rate. To the extent the RMD is a return on basis, it is tax-free.  
  • You cannot apply the excess distribution of one year to the next. 

Penalties and Other IRS Favorites: 

  1. If you fail to withdraw an RMD; fail to withdraw the full amount of the RMD; or fail to withdraw the RMD by the applicable deadline; the amount not withdrawn is taxed at 50%. 
  2. You should then file Form 5329 {Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts}, with your federal tax return for the year in which the full amount of the RMD was not taken.

If the magic number seven-zero is fast approaching, you need to sit down with your tax professional and/ or your financial planner and talk about your options. If you are going to to end up paying a lot of taxes on your RMDs, maybe Roth conversions are an option for you. Planning, planning, planning is the answer to the cracking the code of the RMDs. 

Bibliography: www.irs.gov; Pub 590; schwab.com

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxsolutionsllc.com