All Nerd's Eye View Articles On Income Tax Planning

Weighing A Qualified Charitable Distribution (QCD) From An IRA Vs Donating Appreciated Investments?

September 28, 2016 07:01 am 25 Comments CATEGORY: Taxes

For those who already have a charitable intent and are over age 70 ½, the now-permanent rules permitted a Qualified Charitable Distribution (QCD) directly from an IRA to a charity provide an appealing means to minimize the tax bite of an RMD. Of course, it’s always possible to simply donate to charity and claim a charitable deduction to offset the income of an RMD, but given that in practice the income and deduction rarely offset each other perfectly, the QCD offers a slightly better potential tax outcome.

However, while donating from an IRA to satisfy an RMD obligation may be more effective than separately taking the RMD and donating cash (or writing a check) to the charity, it is usually not as good as donating low-basis stock or other appreciated investments instead. The reason is that while a QCD is a “perfect” pre-tax contribution, donating investments allows for a pre-tax contribution that also permanently avoids a long-term capital gain.

On the other hand, the reality is that charitable donations often have limits of their own, from the fact that they’re only valuable for those who itemize deductions in the first place, to the 30%- and 50%-of-AGI charitable contribution limits that may apply as well. Furthermore, donating low-basis stock may still not fully offset the income from an RMD, where that income increased AGI and triggered the phase-in of Social Security taxation or the phase-out of other significant deductions.

Ultimately, then, the relative benefits of QCDs will depend significantly on the facts and circumstances of the situation, driven primarily by whether or how much a donation of low-basis investments could really be claimed as a full deduction in the first place. On the other hand, it’s also important to remember that for those who don’t have a charitable intent in the first place, the optimal strategy is still to just take the RMD, pay the taxes, and keep the remainder; QCD strategies are still only best for those who want to maximize the tax benefits of charitable giving they already planned to do in the first place!

IRS Eases Process To Fix IRA 60-Day Rollover Mistakes And Errors

August 31, 2016 07:01 am 8 Comments CATEGORY: Taxes

With its ability to accept a “rollover” from almost all other types of tax-qualified retirement accounts, the IRA has become the most popular type of retirement account, now accounting for a whopping $7.4 trillion of assets (according to ICI). Yet to prevent abuse, IRA rollovers have very specific rules, including only being permitted to do one IRA rollover in a 12 month period, and that any rollover contribution must be completed within 60 days of when the prior account distributed the money.

And unfortunately, the growth in the number of IRA accounts and related rollovers, combined with strict time-based deadlines, has perhaps inevitably led to more and more situations where individuals fail to complete a rollover in a timely manner, which can cause the entire amount of the rollover to become taxable. In turn, this led Congress to grant the IRS the ability to provide individuals a process for requesting a "hardship waiver", via a private letter ruling, to fix a rollover mistake. But the sheer volume of demand for relief has caused the IRS to repeatedly raise the cost of a PLR for a rollover fix, from $95 in 2003 to as much as $3,000 in 2006 and now as high as $10,000 in 2016.

Now, in the new Revenue Procedure 2016-47, the IRS has announced a new and greatly expedited process to receive relief and the ability to fix a botched IRA rollover. If the 60-day deadline was missed for any of 11 different reasons specified in the new guidance – from a natural disaster to an illness or death in the family to an error of the financial institution – the individual can now complete a late rollover contribution as soon as practicable, and simply provide the financial institution a “self-certification” that the rollover was permissible based on one of the specified reasons. And the IRS has even provided a Model Letter for Self-Certification that any individual can use.

Ultimately, the new process won’t resolve every possible scenario where an IRA rollover might be late, most notably where the taxpayer just botches the timing by not paying attention, due to aggressively using the rollover as a temporary personal loan, or due to bad advice from a financial advisor. Nonetheless, for what are likely the overwhelming majority of scenarios, the new self-certification process will make it fast and easy for most individuals to fix legitimately innocent rollover mistakes… though the IRS still reserves the right to evaluate the situation after the fact, and make an adjustment if the individual was not forthright in the process!

Rules And Requirements For Doing A Qualified Charitable Distribution (QCD) From An IRA

June 15, 2016 07:01 am 94 Comments CATEGORY: Taxes

For nearly a decade, the rules allowing for a tax-free Qualified Charitable Distribution (QCD) directly from an IRA to a charity has been on-again, off-again, a part of the infamous Tax Extenders that would lapse and be reinstated every other year.

With the Protecting Americans from Tax Hikes (PATH) Act of 2015, though, the QCD rules have finally been made permanent, making it easier to engage in proactive charitable giving strategies that help to minimize the tax bite of an IRA’s Required Minimum Distribution (RMD) obligations.

However, obtaining the tax benefits for doing a QCD from an IRA to a charity requires meeting very specific requirements, including a minimum age limitation, a maximum dollar amount limitation, and contributing to only certain types of eligible (public) charities (rendering private foundations, donor-advised funds, and split-interest charitable trusts all ineligible).

In addition, there is the most stringent requirement – though also the easiest to satisfy – that for an IRA distribution to qualify as a QCD, the check cannot be made payable to the IRA owner and instead must be made payable directly to the charitable entity (though the check payable to the charity can be sent to the IRA owner and forwarded on to the charity).

Fortunately, though, with QCDs made permanent under current law, at least IRA owners have the entire year to strategize and decide whether to engage in charitable giving – but remember that once an RMD has been distributed, there’s no way to undo it and turn it into a QCD later!

President’s Budget Proposes Elimination Of Backdoor Roth, Stretch IRA, and Step-Up In Basis At Death!

February 10, 2016 12:45 pm 18 Comments CATEGORY: Taxes

Every February, the President formulates a budget request for the Federal government, which Congress then considers in coming up with its own budget resolution. And while many provisions of the President’s budget pertain to actual recommendations on appropriations for various government agencies, the proposals often include a wide range of potential tax law changes, recorded in the Treasury Greenbook.

Given that this is an election year and already within less than 12 months of the end of President Obama’s term, there is little likelihood that any of the President’s substantive tax changes will actually come to pass, from a version of the so-called “Buffet Rule” (a “Fair Share Tax” for a minimum 30% tax on ultra-high income individuals), an increase in the maximum capital gains rate to 24.2% (which would total 28% including the 3.8% Medicare surtax on net investment income), or a rewind of the estate tax exemption back to the $3.5M threshold from 2009.

However, the President’s budget proposals do provide an indication of what’s “on the radar screen” inside Washington, including a wide range of potential “crackdowns” and “loophole closers” that could appear in legislation (as was the case with the crackdown on Social Security file-and-suspend and restricted-application claiming strategies last year).

And in this context, it’s notable that the President’s budget proposal does include a wide range of potential crackdowns on individuals, from a new cap on the maximum gain to be deferred in a 1031 like-kind exchange of real estate, to the addition of lifetime Required Minimum Distributions for Roth IRAs after age 70 ½, the elimination of stretch IRAs and step-up in basis at death, shutting down the “backdoor Roth contribution” strategy, and more!

Congress Approves (Mostly Permanent) 2015 Tax Extenders Legislation For QCDs And More!

December 16, 2015 11:15 am 19 Comments CATEGORY: Taxes

Late last night, the House Ways and Means committee came to an agreement for key legislation to renew the so-called “Tax Extenders”, a series of tax provisions that have lapsed and been reinstated (i.e., “extended”) repeatedly over the past decade. The new legislation, entitled the Protecting Americans from Tax Hikes (PATH) Act of 2015, will once again retroactively reinstate for 2015 the tax extenders that were renewed for and then expired at the end of 2014.

Unlike past tax extenders legislation, though, this time many of the provisions are permanently renewed. From the popular qualified charitable distribution (QCD) rules for making charitable contributions from an IRA for those over age 70 ½, to the American Opportunity Tax Credit for college, and the deduction for state and local sales taxes, this will be the last time that these key tax planning provisions remain in an end-of-year limbo!

However, not all tax extenders provisions were made permanent; a few, such as 50% bonus depreciation for businesses and the work opportunity tax credit, are only extended a few years. The legislation also includes a few new “tweaks”, from a slight expansion of how qualified distributions from section 529 plans can be used, to the elimination of in-state-plan requirement for the coming new 529-ABLE plans for disabled beneficiaries.

Although the PATH legislation has not quite passed yet – it still needs to be Omnibus Appropriations legislation that sets the government’s budget through September 30 of 2016 – the tax extenders expected to pass in its agreed-upon form in a matter of days, once the remainder of the rulemaking process is completed.

And notably, the final version of the Omnibus legislation will not include any changes to the Department of Labor’s fiduciary proposal, which remains intact and on track for the DoL to issue its final year in the coming months!

How PEP And Pease Don’t Actually Penalize Deductions, They’re Just 1% Surtaxes On Income

November 25, 2015 07:01 am 3 Comments CATEGORY: Taxes

Back in 1991, Congress first enabled the "Pease limitation" phasing out itemized deductions, and the "Personal Exemption Phaseout" (PEP), which were designed to limit the tax benefits of those deductions for higher-income taxpayers. While the PEP and Pease limitations were themselves phased out in the mid-2000s, the American Taxpayer Relief Act of 2012 re-enacted them beginning in 2013, making them a current tax planning issue.

Yet the irony is that while they are referred to as "phaseouts of itemized deductions" and a "personal exemption phaseout" the reality is that the Pease limitation and PEP are applied primarily based on the extent by which someone’s income is over specified thresholds. As a result, while they're labeled as penalties to deductions and exemptions, the Pease limitation and PEP actually function more like surtaxes on income, amounting to a 1% marginal tax rate increase for the Pease limitation, and another 1% rate increase per family member for the PEP.

The reason why this distinction matters is that ultimately, as surtaxes on income, the PEP and especially the Pease limitation are not actually disincentives against deduction-producing strategies; for instance, with almost all taxpayers, the tax savings of charitable giving is actually identical with or without the Pease limitation! In the end, this means that advisors and their clients should be cautious about trying to avoid deductions when faced with PEP and the Pease limitation; instead, simply recognize their 1% surtax effects, and focus planning on income given the higher marginal tax rates that result!

How To Do A Backdoor Roth IRA (Safely) And Avoid The IRA Aggregation Rule And Step Transaction Doctrine

August 12, 2015 07:01 am 92 Comments CATEGORY: Taxes

Since the income limits on Roth conversions were removed in 2010, higher-income individuals who are not eligible to make a Roth IRA contribution have been able to make an indirect “backdoor Roth contribution” instead, by simply contributing to a non-deductible IRA (which can always be done regardless of income) and converting it shortly thereafter.

However, in practice the IRA aggregation rule often limits the effectiveness of the strategy, because the presence of other pre-tax IRAs and the application of the “pro-rata” rule limits the ability to convert just a new non-deductible IRA. On the other hand, those with a 401(k) plan that allows funds to be rolled in to the plan can avoid the aggregation rule by siphoning off their pre-tax funds into a 401(k) plan, and then converting the now-just-after-tax IRA remainder.

Perhaps the greatest caveat to the backdoor Roth contribution strategy, though, is the so-called “step transaction doctrine”, which allows the Tax Court to recognize that even if the individual contribution-and-conversion steps are legal, doing them all together in an integrated transaction is still an impermissible Roth contribution for high-income individuals to which the 6% excess contribution penalty tax may apply. Fortunately, though, the step transaction doctrine can be navigated, by allowing time to pass between the contribution and subsequent conversion (although there is some debate about just how much time must pass!). But perhaps the easiest way to avoid the step transaction doctrine is also the simplest – if the goal is to demonstrate to the IRS and the Tax Court that there was not a deliberate intent to avoid the Roth IRA contribution limits, stop calling it a backdoor Roth contribution in the first place!

Understanding The IRD Deduction That Inherited IRA Beneficiaries Often Miss

June 24, 2015 07:01 am 21 Comments CATEGORY: Taxes

Pre-tax assets like IRAs can face a significant income tax burden as their value grows, a challenge that is only made worse for those who are subject to estate taxes on those assets as well. In the extreme, the combination of the two can consume the majority of the value of an inherited IRA bequeathed to a beneficiary.

To help mitigate the combined income-and-estate-tax effect, the Internal Revenue Code allows for an “Income in Respect of a Decedent” (IRD) deduction under Section 691(c). Claimed by the beneficiary of an inherited IRA to the extent of any estate taxes that were caused by the account, the deduction can be material – as much as 40% of the value of the account!

Yet despite its size, beneficiaries in practice often “miss” the IRD deduction, not realizing it was there to claim, or perhaps “losing track” of it when changing accountants or tax preparation software. Fortunately, an amended tax return can be filed to claim a missed IRD deduction from recent years – but only the past 3 years. Which means going forward, anytime an inherited IRA appears with a new client, a good best practice for all advisors is to ask: “did the decedent who left you this account pay any estate taxes?” and if so, be certain the IRD deduction is claimed properly!

And notably, in the end the IRD deduction applies not only to inherited IRA accounts, but also other employer retirement plans, inherited non-qualified annuities, employer non-qualified stock options, deferred compensation, employer NUA stock, and more!

Strategies And Tactics When Using Donor-Advised Funds For Charitable Giving

June 17, 2015 07:01 am 32 Comments CATEGORY: Taxes

The primary benefit of a donor-advised fund (DAF) is that it allows someone to donate assets for charity today – and receive a tax deduction now – even though the actual funds may not be granted to the final charity until some point in the future. In other words, the donor-advised fund essentially functions as a conduit, where the donor receives a tax deduction when the money goes into the DAF, but has discretion about when the assets will finally leave the DAF and actually go to the charity… and in the meantime, assets inside a donor-advised fund grow tax-free.

Given the potential of a donor-advised fund to separate the timing of the contribution and tax deduction, from the final donation to the charity itself, the most common strategy for using a donor-advised fund is to “front load” charitable contributions in a high income year – when the tax-deduction threshold for charitable contributions will be higher – and then use the DAF to make subsequent distributions to the charities themselves in the future. By using the strategy, the donor can maximize the value of the tax deduction in a high-income year, but retain the flexibility to decide in the future to which charities the funds will actually go.

Notably, though, the donor-advised fund as a vehicle provides a mechanism for other charitable giving tactics as well. For instance, the donor-advised fund can facilitate giving anonymously, or creating an “In Memoriam” fund. The DAF can also help facilitate donating appreciated securities to a smaller charity that doesn’t have the means of handling the donation directly. And for some families, the donor-advised fund can function as a less expensive alternative to a private (non-operating) foundation, providing a means for the whole family to engage in the process of charitable giving, while allowing the tax-free growth of a family’s charitable legacy.

Deducting Financial Planning And Retainer Fees, And The (Tax) Problem With Bundled AUM Fees

May 20, 2015 07:01 am 24 Comments CATEGORY: Taxes

Under the Internal Revenue Code, expenses for investment management are tax deductible. Accordingly, taxpayers are permitted to deduct the typical assets-under-management (AUM) fee of an investment manager. However, financial planning fees not specifically attributable to investment management (or tax planning) are non-deductible, treated instead as a personal expense.

With the rise of wealth management, though, it is increasingly common for consumers to pay a single “bundled” AUM fee, that covers not only (deductible) investment management services, but also (non-deductible) financial planning as well. Which means technically, those clients should probably only be deducting a portion of the AUM fee, not the entire amount – at least, where the AUM fee covers a “material” amount of financial planning services. And the issue is especially concerning when it comes to retirement accounts like IRAs, where paying a personal financial planning fee with retirement assets could trigger a (taxable) deemed distribution, or at worst disqualify the entire IRA as a prohibited transaction!

Ultimately, the easiest solution to the problem – at least from a tax perspective – is simply to unbundle the financial planning and investment management fees. And in fact, unbundling is now required under new IRS regulations when it comes to the investment management vs administration and other fees for estates and trusts. Yet for some firms, unbundling fees can present other business challenges about communicating the value of their services.

Fortunately, the issue may not receive scrutiny anytime soon, given that many advisory firms with bundled fees are still charging the same as investment-only firms (implying the financial planning fees may not be "material" from a tax perspective). Nonetheless, as long as the tax treatment is different for financial planning versus investment management fees, advisors should at least be cautious about how those various financial advisor fees are characterized by clients, especially when extracted directly from an IRA!