Tax-Savvy Planning Strategies for Inherited IRAs

Say an IRA is inherited by multiple individual beneficiaries or by one or more individuals and one or more charities or other beneficiaries that aren’t “natural persons.” How do these scenarios affect the rules for required minimum distributions (RMDs) that apply after the IRA owner dies? And how can you optimize the tax results for individual beneficiaries?

Here, we answer these questions and explain the importance of the fast-approaching deadline on September 30, 2016, that must be met to change beneficiaries for IRAs that were owned by individuals who died in 2015.

Required Distribution Rules and Penalties for Noncompliance

After an IRA owner’s death, the account beneficiary or beneficiaries must take RMDs each year. RMDs from traditional accounts are generally subject to tax (unless the beneficiary is tax-exempt, such as a charity, or the distribution is attributable to nondeductible contributions), and each withdrawal also reduces the amount left in the account that can continue to grow tax-deferred (or tax-free, in the case of a Roth IRA).

If the RMD rules aren’t followed for a tax year in question, the IRS can assess a penalty equal to 50% of the shortfall (the difference between the required amount and the amount that was actually withdrawn during the year, if anything). That’s one of the most expensive tax penalties on the books. So, complying with the RMD rules isn’t something that can be ignored with impunity.

Inherited IRAs with Multiple Individual Beneficiaries

An inherited IRA is said to have multiple individual beneficiaries when more than one individual is designated as a primary co-beneficiary. For RMD purposes, however, the beneficiaries of a deceased IRA owner’s account aren’t finalized until September 30 of the year following the account owner’s death. This rule allows for creative planning options to achieve better tax results for the beneficiaries. Here are some examples.

When the account owner died before the RBD. The latest date for an original traditional account owner’s initial RMD is April 1 of the year after he or she turns age 70½. That April 1 deadline is referred to as the “required beginning date” (RBD). When the original account owner dies before the RBD (say, at age 70 or younger), beneficiaries can usually follow the life expectancy rule to calculate their annual RMDs.

How do you calculate RMDs using the life expectancy rule? When all the IRA beneficiaries are individuals, the general rule is that RMDs for each year are calculated using the single life expectancy figures for the oldest beneficiary. The RMD for each year is calculated by dividing the IRA balance as of December 31 of the previous year by the oldest beneficiary’s remaining life expectancy as set forth in IRS tables. The RMD is then split up between the beneficiaries based on their account ownership percentages.

This rule isn’t optimal for a younger beneficiary who wants to stretch out the inherited IRA’s tax advantages by taking smaller RMDs over his or her longer life expectancy. Thankfully, IRS regulations allow a postmortem planning solution: After the IRA owner dies, the IRA can be divided into separate IRAs for each beneficiary.

This strategy is implemented using tax-free direct transfers from the original IRA into new IRAs set up for each beneficiary. That way, a younger beneficiary can take smaller RMDs based on his or her longer life expectancy figures. In turn, this setup allows the younger beneficiary to keep his or her tax-saving IRA going longer.

However, any direct transfers to split up the account must be completed by September 30 of the year after the year of the IRA owner’s death. So if the owner died in 2015, the deadline to divide up the account for tax-saving results is September 30, 2016.

When the account owner died on or after the RBD. A different set of rules applies if the owner of a traditional IRA dies on or after the RBD (for example, at age 72 or older). The first order of business is calculating and withdrawing the RMD for the year of the account owner’s death. (If the account owner died in 2015, the RMD should have been taken last year.)

For subsequent years, RMDs are usually calculated using the beneficiary’s life expectancy figures as set forth in IRS tables. However, if there are multiple individual beneficiaries, RMDs for subsequent years are calculated using the oldest beneficiary’s life expectancy figures.

Once again, this rule isn’t optimal for a younger beneficiary who wants to stretch out the inherited IRA’s tax advantages by taking smaller RMDs over his or her longer life expectancy. Fortunately, again relief can be found in the IRS regulations allowing a deadline of September 30 of the year after the year of the IRA owner’s death to split the IRA into multiple accounts.

Here’s an example of the postmortem RMD planning permitted under this rule.

Example 1: Inherited IRA with Multiple Individual Beneficiaries

Uncle Henry was 73 years old when he died in 2015. His traditional IRA has two equal beneficiaries: son Iggy (age 53) and niece Jenny (age 38). Under the RMD rules that apply for 2016 and beyond, Jenny can achieve better tax results for her share of the inherited IRA if the account is split up into two accounts: one for her and one for Iggy. That way, Jenny can calculate her annual RMDs using her longer life expectancy figures, which will result in smaller RMD amounts and a longer tax-saving life for the inherited IRA. However, the IRA must be divided into separate accounts by no later than the upcoming deadline of September 30, 2016.

When the account is a Roth IRA. To calculate RMDs from an inherited Roth IRA, follow the rules for account owners who die before the RBD. Those rules apply regardless of how old the Roth IRA owner was when he or she died. Again, if there’s a younger beneficiary who’d like to take advantage of his or her longer life expectancy, the Roth IRA can be split up by the September 30 deadline.

Inherited IRAs with a Nonhuman Beneficiary

If an IRA has one or more nonhuman beneficiaries (other than certain types of trusts), it’s the same as having no beneficiaries for RMD-calculation purposes — even when one or more human individuals are also named as beneficiaries.

In this scenario, when the IRA owner dies before the RBD, the account must be completely liquidated by December 31 of the fifth year following the year of the account owner’s death. Obviously, the five-year rule curtails the tax-saving life of the inherited account for any human beneficiaries.

When the account owner dies on or after the RBD — for example, at age 72 or older — the first order of business is calculating the RMD for the year the account owner died. (Again, if the account owner died in 2015, the RMD should have been taken out last year.) RMDs for subsequent years are calculated using the deceased account owner’s remaining life expectancy as if he or she were still alive.

Unfortunately, this rule also results in less-than-optimal tax results for any human beneficiaries who are younger than the now-deceased account owner. They’ll have to take larger RMDs each year, which will deplete the tax-saving IRA more quickly.

The problem can be resolved by paying out the non-natural beneficiary in a lump sum and then removing that beneficiary by September 30 of the year after the year of the account owner’s death. If the account owner died last year, you’ll have until September 30, 2016, to finalize IRA beneficiaries for purposes of calculating RMDs for 2016 and beyond. If the removal strategy is employed, subsequent RMDs are calculated as if the removed beneficiary had never been in the picture.

Here’s an example of the postmortem RMD planning permitted under this rule.

Example 2: Removal of Charitable Beneficiary of Inherited IRA

Ken, age 32, is a 50% beneficiary of his mother Jan’s traditional IRA. Jan died last year at age 66 (before the RBD). The other 50% beneficiary is a charity. Therefore, Jan’s account is considered to have no beneficiary for RMD calculation purposes. Because Jan died before the RBD, the dreaded five-year rule will apply, which means curtailed tax deferral advantages for Ken. The charity doesn’t care about tax deferral because it’s tax-exempt.

The tax-savvy strategy in this situation is to distribute 50% of the IRA balance by September 30, 2016, to cash out the charity. That way, Ken can calculate RMDs for 2016 and beyond using his relatively long single life expectancy figures. He’s only 32 years old, so the tax deferral advantages of the inherited IRA will last much longer than if the RMDs had been calculated using his deceased mother’s life expectancy figures.

Act Now

The September 30 deadline for finalizing beneficiaries can be an important consideration when trying to maximize the tax advantages of an inherited IRA for individual beneficiaries. That deadline is fast approaching for account owners who died in 2015. Contact your tax advisor to fully understand the impact of making beneficiary changes and make any tax-saving moves before it’s too late.

© Copyright 2016.

Sell (or Buy) a Corporate Business With a Tax-Free Reorganization

There are two basic ways to sell an incorporated business — sell the assets or sell the stock. For two good tax reasons, sellers usually prefer stock sales:

  1. Assuming you’ve owned the shares for more than a year, your profits will generally be taxed at a maximum federal rate of 20 percent.* This applies equally to C and S corporations.
  2. Double taxation is avoided when you sell C corporation stock, because the sale won’t trigger any taxable gain at the corporate level.

However, there may be an even better alternative. If you can find another corporation to acquire your C or S corporation, you may be able to structure the transaction as a tax-free reorganization. How? You swap the stock in the company being sold for stock in the purchasing corporation. There is no current taxable income or gain for you, the target corporation you’re selling or the acquiring corporation.

Here are the basic advantages of this strategy:

  • You exchange your stock in the target C or S corporation for stock in the acquiring corporation. Your new shares will have the same tax basis as your old shares. In addition, you don’t have to report any taxable gain until you actually sell the shares. Result: The tax bill is put off indefinitely.
  • When you do finally sell, the long-term capital gain will be taxed at a maximum federal rate of 20 percent.*

If you die while still owning the shares, the tax basis will be stepped up to fair market value as of the date of death. So your heirs can sell the stock and owe little or no federal capital gains tax. (This assumes the current date-of-death basis step up rule remains in force.)

There is a small glitch for the buyer: With a tax-free reorganization, the corporate buyer cannot step up the tax basis of your corporation’s assets. However, the buyer may be willing to overlook this issue when the acquisition can be made with stock rather than cash.

A tax-free reorganizations can potentially be structured in several different ways, including as a state-law merger, straight stock acquisition, or asset acquisition. The best structure for your corporation may depend more on legal considerations than tax issues.

The optimal scenario for a tax-free reorganization: You receive investment-grade publicly traded shares in exchange for your stock. This would give you great tax benefits but also a high-quality and highly liquid asset. Tax-free reorganizations are complicated so it is important to have an experienced professional handle the transaction. Contact your attorney for more information.

*Note:The 20 percent rate only affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000, heads of households with income above $425,000, and married individuals who file separate returns with income above $225,000. Capital gains on investments held less than a year are short-term capital gains and taxed at ordinary income tax rates of 10, 15, 25, 28, 33, 35, or 39.6 percent.

© Copyright 2016.

Onboarding Employees: Do It Right and Reap the Rewards

The term “onboarding” hasn’t yet graduated from mere business jargon to an entry in the Webster’s Dictionary. Still, it’s a term that’s common in today’s business world. It refers to “the process of helping new hires adjust to social and performance aspects of their new jobs quickly and smoothly,” according to the Society for Human Resource Management (SHRM). The sooner new employees are truly on board, the faster they can be productive.

It’s no longer considered sufficient to show new employees around, introduce them to a few coworkers, complete basic legal paperwork and then wish them good luck. SHRM research suggests that devising a formal onboarding program and implementing it methodically will deliver better and faster results than a seat-of-the-pants approach.

In particular, a comprehensive onboarding program promises to deliver:

·    Higher performance,

·    Higher job satisfaction,

·    Organizational commitment,

·    Reduced stress, and

·    Career effectiveness.

Assimilation at IBM

What does a comprehensive program look like? Large employers like IBM have been very intentional about integrating new employees, long before the term “onboarding” was used. About 20 years ago the company created what it called its three-stage “assimilation process:”

·    Stage 1 (“affirming”), begins before new hires start to work. It involves designating a coach for the new worker, getting the workstation prepared, and welcoming him or her to the company.

·    Stage 2 is when the employee officially begins work, procedures are in place to assure that the new employee is greeted, necessary paperwork is handled expeditiously, and, for the first 30 days, regular “check-in” times are scheduled with managers to create opportunities for any settling in issues to be addressed.

·    Stage 3, labeled “connecting,” lasts an entire year. It features scheduled interaction with a coach who, after making sure the new employee is basically integrated, assesses his or her accomplishments.

The informality of the coaching relationship gives new workers a greater comfort level in seeking and receiving advice than is often possible with a supervisor. New employees are, naturally, reluctant to ask questions that they think might make them appear incompetent.

Similarly, trusted mentors can help new employees feel their way through the “political” dynamics of the organization before they are fully acculturated.

Not every organization is large enough to have people available to serve as coaches and mentors, of course. What’s most essential is acting proactively to detect and address any employee integration issues before they blow up; don’t expect new employees to bring them to you.

The 4 Dimensions

Here’s a template for onboarding programs developed by Talya N. Bauer, Ph.D., an expert on the topic and professor in the Portland State University’s School of Business Administration (in Oregon). It features four dimensions:

1. Compliance — teaching employees basic legal and company policy rules,

2. Clarification — ensuring that new workers understand their jobs and all related expectations,

3. Culture — acquainting employees with the workplace ethos and organizational norms, and

4. Connection — developing relationships with other employees and information networks required for them to truly fit in.

Pulling the Levers

According to Bauer’s research, there are several social and job-specific “levers” related to those dimensions that can be pulled to smooth the new employee’s transition to becoming a highly productive worker. One is employee self-confidence.

While that attribute cannot be manufactured and handed to employees on a platter, a key aim of onboarding programs is precisely to instill self-confidence. Greater self-confidence can lead to great motivation and better job performance.

Another lever, clarity, pertains to how well a new employee understands his or her role. Performance will be disappointing if expectations are cloudy. “Measures of role clarity are among the most consistent predictors of job satisfaction and organizational commitment during the onboarding process,” Bauer stated in a study published by SHRM, “Onboarding New Employees: Maximizing Success.”

A third lever, social integration, can be accelerated in the onboarding process by connecting new employees to a variety of seasoned employees, both peers and others higher up in the organizational chart. “Failure to establish effective working relationships” Bauer writes, “is a commonly cited cause of unsuccessful hires, and the onboarding program is the best tool to prevent that from happening.”

Finally, pulling the lever of cultural fit is a key goal and purpose of onboarding. “Understanding an organization’s politics, goals and values, and learning the firm’s unique language are all important indicators of employee adjustment and down the line are associated with commitment, satisfaction and turnover,” according to Bauer.

© Copyright 2016.

Compare and Contrast the Republican and Democratic Tax Platforms

With both major political party conventions finally behind us, it’s time to focus on the upcoming national election. Among their many differences, the Republicans and Democrats have widely divergent tax platforms. While platforms are always relatively nonspecific and not necessarily synced with what the presidential candidates have in mind, it’s still good to know what tax positions the two parties and their presidential candidates have staked out. Here’s a quick summary.

Democratic Party Tax PlatformRepublican Party Tax Platform
The 2016 Democratic national platform was adopted on July 25. It includes generalized goals that you might expect from the Democrats, such as closing tax loopholes that benefit wealthy individuals and supporting small businesses by providing tax relief and simplifying the tax code.

More specific proposals include:

·    Helping fund Social Security by taxing certain individuals with annual earnings above $250,000,

 

·    Creating a surtax on multimillionaires and restoring fair taxation on multimillion-dollar estates to ensure that wealthy individuals pay their fair share of federal taxes,

 

·    Expanding the earned income tax credit program for low-wage workers who aren’t raising children,

 

·    Expanding the child credit by making more of it refundable and/or indexing it to inflation,

 

·    Reducing the tax penalties and simplifying the reporting requirements for Americans living abroad,

 

·    Clawing back tax breaks for companies that ship jobs overseas, cracking down on inversions and other methods that companies use to “dodge their tax responsibilities,” and ending tax deferral on foreign business profits,

 

·    Implementing a tax on financial transactions to curb excessive speculation and high-frequency trading,

 

·    Providing tax incentives for clean energy and other green business practices, while eliminating special tax breaks and subsidies for fossil fuel companies, and

 

·    Repealing the Affordable Care Act’s (ACA’s) 40% excise tax on high-cost health insurance, which is scheduled to take effect in 2020.

The 2016 Republican national platform was adopted on July 18. In general, the Republicans want to promote economic growth and eliminate unspecified special-interest loopholes, while being mindful of the tax burdens that are imposed on the elderly and families with children.

More specific proposals include:

·    Making the Internal Revenue Code so simple and easy to understand that the IRS becomes obsolete and can be abolished,

 

·    Removing all marriage penalties from the tax code,

 

·    Repealing the Affordable Care Act (ACA) and any ACA-related tax increases,

 

·    Replacing the ACA with an approach to improving healthcare that’s based on competition, patient choice and timely access to treatment,

 

·    Considering options to preserve Social Security benefits without tax increases,

 

·    Reducing the corporate tax rate to be on a par with (or below) the rates of other industrialized nations,

 

·    Simplifying the tax rules for U.S. citizens who live overseas, including repealing the Foreign Account Tax Compliance Act (FATCA) and the Foreign Bank and Asset Reporting (FBAR) requirements,

 

·    Adopting a balanced-budget amendment that would impose a government spending cap and require a supermajority approval for any tax increases (except in the case of war or legitimate emergencies),

 

·    Tying any new value added tax or national sales tax to the simultaneous repeal of the Sixteenth Amendment, which authorizes the federal income tax, and

 

·    Opposing any legislation that would impose a carbon tax on businesses or individuals.

Clinton on TaxesTrump on Taxes
So far, Democratic presidential nominee Hillary Clinton has provided more specific details on her tax proposals than her opponent. Some of these ideas elaborate on (or contrast with) her party’s platform.

Individuals. Clinton’s plans include higher income tax rates for wealthy individuals. She advocates a 4% fair-share surcharge on individuals who earn more than $5 million per year. And she’d ask the wealthiest to contribute more to Social Security. In addition, she proposes limiting certain itemized deductions for high-income individuals and disallowing IRA contributions for individuals who have large IRA balances.

Capital gains. Clinton proposes a graduated tax rate regime where the capital gains tax rate decreases from 39.6% to 20% over a six-year period. (The 3.8% net investment income tax would still apply, however.) The idea is to encourage long-term investing. The biggest impact would be on assets held for more than one year but not more than two years: Tax rates on gains from those assets would nearly double.

Businesses. Clinton would like to impose new restrictions and tax increases on U.S. companies with foreign operations. Her plans also include a risk fee on large banks and financial institutions, as well as curbing tax subsidies for oil and gas companies.

She’d also offer a 15% tax credit for employers that share profits with workers and a $1,500 tax credit to businesses for each new apprentice that they hire and train.

Estate tax. She proposes reducing the federal estate tax exemption to $3.5 million (from $5.45 million) and the lifetime federal gift tax exemption to $1 million (from $5.45 million). Her plans also would raise the federal estate and gift tax rate to 45%.

Healthcare. Clinton proposes a 20% credit to help taxpayers offset caregiving costs for elderly family members (up to a maximum credit of $1,200).

In addition to liberalizing the existing premium tax credit to make healthcare coverage more affordable, she’d establish a tax credit of up to $5,000 per family for buying health coverage on ACA exchanges.

Republican presidential nominee Donald Trump has several ideas to simplify our tax system, which don’t always sync with the Republican platform.

Here’s what’s been discussed on his website or on the campaign trail to date.

Individuals. Trump proposes fewer tax brackets and lower tax rates for individuals. His plan now calls for three federal income tax brackets: 12%, 25% and 33%.

Currently, individuals can fall into seven federal income tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. He’d also like to abolish the alternative minimum tax.

His plans would curtail some existing individual write-offs, but he’d retain the deductions for home mortgage interest and charitable donations that the tax code currently allows. He also recently proposed making U.S. families’ child-care costs tax-deductible.

Capital gains. His proposed tax rates on long-term capital gains and dividends would be 0%, 15% and 20%.

Businesses. Trump proposes cutting the corporate tax rate to 15% (from the current 35%). His proposed 15% tax rate would also apply to business income from sole proprietorships and business income passed through to individuals from S corporations, limited liability companies and partnerships.

He’d impose a cap on business interest deductions. Trump would eliminate the tax deferral on overseas profits and allow a one-time 10% rate for repatriation of corporate cash that’s held overseas.

His plan also ends the current tax treatment of carried interest for speculative partnerships that don’t grow businesses or create jobs and are not risking their own capital.

Estate tax. Trump would like to eliminate the federal estate tax.

Healthcare. Trump would like to repeal the ACA and any ACA-related tax increases, including the 3.8% net investment income tax on wealthy individuals. But he would let individuals fully deduct health insurance premium payments.

© Copyright 2016.

Do you have an active business in Nevada? Learn about the Nevada Commerce Tax

Businesses and individuals that have activity, are licensed and/or organized in Nevada are starting to receive notices in the mail requesting the completion of a Nevada Commerce Tax pre-registration form.  The registration is now required for all entities doing business in Nevada.  If you have sales in Nevada or have an active business license in Nevada, you will be required to register with the Nevada Commerce Tax.  The registration is required in order to file an annual Commerce tax return and pay any Commerce tax liability.

The Commerce tax is imposed on businesses with Nevada gross revenue exceeding $4,000,000 in the taxable year.  However, a simplified annual tax return is required even if you do not have Nevada gross revenue exceeding $4,000,000.   The Commerce tax return is required to be filed annually for the period July through June and due by August 15th.  For example the July 1, 2015 through June 30, 2016 return was due August 15, 2016.

If you have received a notice for the completion of the Nevada Commerce Tax pre-registration form, please visit the Nevada Commerce website at www.nevadatax.nv.gov/#  in order to register and file the annual Commerce tax return online or contact our office by dialing 949-910-2727 or emailing us at jmarshall@cpa-wfy.com.

© Copyright 2016.