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Archive for November, 2015

We recently conducted tax training for our firm’s newly hired staff accountants.   At the beginning of the program, I wanted to convey to them the importance of their jobs and so I launched into a discussion of how the federal tax law exists not merely to raise and collect revenue but also to incentivize and encourage specific taxpayer behavior in an attempt to achieve certain economic, social and political goals.  It all sounds pretty good as long as you don’t focus on the incompetence in Washington these days.  Of course, it is also pretty meaningless at this time of year because right now, all taxpayers want is one thing – minimize my tax bite!  And, don’t confuse me with talk of tax equity and other wonky stuff!

All kidding aside, tax planning is really not conceptually difficult because all it involves is reducing, eliminating, or deferring tax or taxable income.  That’s it.  Sure, it may seem daunting because, well, tax law is law and the law is generally daunting.  However, each of us can follow a fairly short and straightforward “to-do” list and take advantage of most of the opportunities available to us.  One caveat – although conceptually simple, the implementation of some of these steps may be more complex than they seem, so please consult your tax and investment advisors before jumping in.

  1. It’s always best to start at the beginning.  You or your accountant should prepare a baseline projection of your 2015 and 2016 income tax liabilities.  This multiyear tax projection is the best tool for testing the effectiveness of the various tax planning strategies listed below.  Don’t make the mistake of shortchanging this process.  You do so at your own peril, as it is truly impossible to plan on the back of an envelope.
  1. Determine if you have the ability to defer or accelerate any ordinary income items such as bonuses, client fees or IRA/Keogh distributions (among others). Go back to step 1 and evaluate the impact of these potential moves.
  1. To avoid possible penalties, make sure you take all required minimum distributions (RMD’s) from your IRA’s and other retirement plans by 12/31. This may not save you any taxes, but it will certainly save you headaches and, as I mentioned, those possible penalties.
  1. Review your portfolio and prune for tax purposes. Try to match capital gains and losses to lower the tax bite as much as you can, but not too far below zero.  For federal purposes, net capital losses can be deducted up to $3,000 per year ($1,500 for married filing separate) with any balance carried over indefinitely.  However, you may be more limited for State purposes.  For example, New Jersey does not allow net capital losses to offset ordinary income, nor does it allow for carryover losses.  So NJ residents who consciously generate net capital losses are throwing away any future tax benefit.
  1. Manage your deductions, keeping in mind that prepayment of most expenses (other than charity) has significant implications for the alternative minimum tax. In other words, consider the deduction and then return to step 1 to evaluate its impact.

The most common deductions that people defer or accelerate are:

  • Charitable contributions
    1. You can’t go wrong with direct contributions of cash or appreciated long term securities, but be sure to get a receipt for any contribution of $250 or more.
    2. Don’t even think of contributing depreciated securities- better to sell them first, take the tax loss and donate the cash.
    3. Consider using a donor advised fund.  It is a really simple way to accelerate outsized contributions to the current year, particularly if you are unsure who the ultimate charitable beneficiary should be.
    4. Be careful when donating old clothing or household goods to charity.  They must be in “good or better” condition for their value to be deductible and the proof of that condition is on you.
  • State and local income taxes
  • Real property taxes
  • Some interest expense
  • Miscellaneous itemized deductions such as investment or tax advisory fees.
  1. Make sure that all retirement plans and IRA’s to which you are entitled are funded to the max.  Make an early New Year’s resolution for 2016 to fund these plans as early in the year as possible, rather than waiting until Thanksgiving.
  1. Fund the appropriate “529 plan” for yourself and/or your beneficiary(ies). 529 plans enable you to accumulate savings free from federal income tax if the eventual proceeds are used to pay for qualified post-secondary education expenses.  In some states, such as New York, contributions to certain plans may be deductible for state tax purposes.  Compare the plans at http://www.savingforcollege.com.
  1. Review your family’s gifting program.  Up to $14,000 in gift-tax-free, present value gifts ($28,000 if married and gift splitting) can be made to as many donees as you would like.  In addition, check out the “gracious grandparent” technique we outlined in a recent blog post where, under the right circumstances, you can invest upwards of $140,000 in a 529 plan free of any gift tax.
  1. Keep current on late breaking tax news at the end of the year.  Certain “extender” provisions have not yet been enacted and reinstatement of these extenders prior to year-end may produce additional tax savings opportunities.

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This week’s guest blogger is Stephen Paul, CPA, a staff accountant at WithumSmith+Brown.

A recent article in Wall Street Journal reminds me of the pitfalls that can sink self-directed IRAs. The article (click here for a free version posted on Yahoo! Finance) explains how investors who held units of a master limited partnership (MLP) in IRA accounts were hit with a painful Unrelated Business Income Tax (UBIT) due to a significant partnership transaction. The specifics of this case are best explained in the WSJ article, so let’s discuss in general what to be wary of with your IRA investments.

Passport-ShotSelf-directed IRAs allow you to hold a wider range of investments beyond the typical marketable securities offerings of most big banks and brokerages. You can open a self-directed IRA with a custodian (often a trust company or boutique brokerage) which agrees to hold nontraditional investments such as MLPs, publicly traded partnerships (PTPs), private equity funds, real estate, private loans, and closely held business entities. Essentially, a self-directed IRA can hold any asset except collectibles and life insurance. Self-directed IRAs are generally funded through a rollover from another IRA with the intention of earning tax-deferral on high income streams or outsized returns through alternative assets.

What’s to worry? Well, IRAs have very strict rules, and breaking them can trigger unintended taxes. A few red flags:

  • Self-dealing is when an investment directly or indirectly provides a personal benefit to the IRA owner or a disqualified person. For example, your IRA can’t own the LLC that pays your salary. You also can’t own the LLC that pays your friends or family in your IRA. Definitely don’t put your vacation home in your IRA! Self-dealing is an IRA killer. Prohibited transactions disqualify the IRA and the entire account is deemed a taxable distribution.
  • Unrelated Business Income Tax (UBIT) is an IRA risk when investing in pass-through entities such as MLPs, PTPs, and private equity funds. UBIT is imposed on tax-exempt entities, including retirement plans, which earn income unrelated to their exempt purpose. The purpose of your IRA is for passive investments to grow for future use, specifically retirement. If your IRA owns a partnership interest, the IRA is considered the partner with the partnership income flowing to the IRA for tax purposes. When there’s partnership income from an active trade or business (versus passive income such as dividends and interest) your IRA has earned unrelated business income which is subject to UBIT and taxed at corporate rates when incurred. This negates the tax-deferral you were taking advantage of in the first place.
  • Liquidity and/or Capital Calls may or may not result in additional tax and penalties, but it’s something to watch. Many alternative assets have significantly reduced liquidity (i.e. it takes longer to convert to cash) or capital contribution commitments, which can cause problems with required minimum distributions (RMDs) or when passing the account to a beneficiary.

We’re just scratching the surface here. The key takeaways are:

  • IRA rules are complex.
  • Your investments can trigger unintended taxes or even disqualify your account.
  • Plan carefully and do your due diligence.

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