Articles About Income Tax Planning

Passed by Congress in December 2019, the “Setting Every Community Up For Retirement Enhancement (SECURE) Act” introduced substantial updates to long-standing retirement account rules. One of the most notable changes was the removal of the ‘stretch’ provision for certain non-spouse designated beneficiaries of inherited retirement accounts and the introduction of a “10-Year Rule” requiring those beneficiaries to deplete the entire balance of their inherited retirement account within ten years after the original owner’s death.

Notably, though, not all beneficiaries will be impacted by this new “10-Year Rule”. Instead, the SECURE Act identifies three distinct groups of beneficiaries: Non-Designated Beneficiaries (i.e., non-person entities such as trusts and charities), Eligible Designated Beneficiaries (i.e., individuals who are spouses of account holders, those who have a disability or chronic illness, those not more than 10 years younger than the decedent, and minor children of decedents or certain “See-Through” trusts benefiting such persons), and Non-Eligible Designated Beneficiaries (i.e., any individual or “See-Through” trust that qualifies as a Designated Beneficiary but is not an Eligible Designated Beneficiary). While Non-Designated Beneficiaries and Eligible Designated Beneficiaries are generally subject to the same rules that were in place prior to the SECURE Act (either the 5-year rule or stretching over life expectancy, respectively), Non-Eligible Designated Beneficiaries are now subject to the new 10-Year Rule, from trusts to adult children and more.

Given these substantial changes, there are many strategies that advisors can use to help their clients impacted by the new more-restrictive stretch rules, whether they be the (Non-Eligible) designated beneficiary of an inherited retirement account (trying to manage the compressed time window for distribution) or the original account owner themselves still planning for the future (to minimize the tax burden of account distributions in what is now a non-stretch world for many).

Some options available to Non-Eligible Designated Beneficiaries include spreading distributions out across a time frame for as long as possible to reduce annual income from the account, strategically timing withdrawals such that larger distributions are made in years with lower taxable income (e.g., after retirement), or simply leaving the account balance alone for as long as possible (and withdrawing everything at the end of the tenth year when required to do so).

Account owners themselves also have options to mitigate the tax impact for their heirs, including increasing the number of beneficiaries on their accounts to spread out and therefore decrease taxable income received by each beneficiary, and strategically allocating account shares based on beneficiaries’ anticipated income tax brackets to maximize the tax efficiency of those distributions. Alternatively, lifetime partial Roth conversions of tax-deferred retirement accounts can reduce (or eliminate altogether, if converting the full account) the tax burden on beneficiaries, though a careful analysis should accompany this strategy to determine how much of the original accounts should be converted to begin with (to avoid simply causing an even-higher tax burden today). Charitable Remainder Trusts can also be used to provide a potentially steady income stream for the beneficiaries (along with providing a gift to a qualified charity at the end of the trust’s term).

Ultimately, the key point is that, while Non-Eligible Designated Beneficiaries must now contend with the new SECURE Act 10-Year Rule for inherited retirement accounts, advisors can use several strategies to help clients minimize the tax impact of distributions from those accounts. Some can be implemented for the beneficiary after they inherit the account, while others can be used by the account owner themselves during their lifetime before the account transfers to the beneficiary. Although, in some cases, the best strategy may be simply to accept the 10-year rule as is, leave the account alone for as long as possible, and liquidate the inherited retirement account as required at the end of the 10-year window!

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Passed into law in December 2019, the “Setting Every Community Up For Retirement Enhancement (SECURE) Act”, introduced a plethora of substantial updates to longstanding retirement account rules. One of the most notable changes was the elimination (with some exceptions) of the ‘stretch’ provision for non-spouse beneficiaries of inherited retirement accounts. As prior to the SECURE Act,  beneficiaries of inherited retirement accounts were able to ‘stretch’ out distributions based on their own entire life expectancy, but now most non-spouse beneficiaries will be required to deplete their accounts within ten years after the original owner’s death. (Unlike RMDs, though, the new 10-Year Rule offers flexibility around the timing of distributions, as it does not require annual withdrawals – funds can be withdrawn in any amount, at any time over the course of the 10-year term – as long as the entire amount is withdrawn by the end of the 10^th year.)

However, not all beneficiaries will be impacted by this new “10-Year Rule”. Instead, the SECURE Act identifies three distinct groups of beneficiaries: Non-Designated Beneficiaries (i.e., non-person entities such as trusts and charities), Eligible Designated Beneficiaries (i.e., individuals who are spouses of account holders, those who have a disability or chronic illness, those not more than 10 years younger than the decedent, minor children of decedents, or “See-Through” trusts), and Non-Eligible Designated Beneficiaries (i.e., any individual who qualifies as a Designated Beneficiary but is not on the list of Eligible Designated Beneficiary).

This distinction matters because Non-Designated Beneficiaries and those who are part of the newly created Eligible Designated Beneficiaries group are generally subject to the same rules prior to the SECURE Act (either the 5-year rule or stretching over life expectancy, respectively), it is the Non-Eligible Designated Beneficiaries that are now subject to the new 10-Year Rule, from trusts to adult children and more. Fortunately, the 10-year rule does still facilitate at least some flexibility – as the rule simply requires that all funds be distributed by the end of the 10^th year after death of the original account owner, but the beneficiary has discretion over when to take the dollars out over that time window – though such a mandatory distribution window may introduce new challenges for certain types of See-Through trusts (where the flexibility eliminates ‘automatic’ annual conduit distributions to beneficiaries and could trigger the sudden liquidation of both the IRA and trust at the end of the 10-year window).

Ultimately, the key point is that, while there are now three distinct groups of beneficiaries under the SECURE Act, only one of these groups (i.e., the Non-Eligible Designated Beneficiaries) must now contend with the new SECURE Act 10-Year Rule for inherited retirement accounts. For the other two groups (i.e., Eligible Designated Beneficiaries and Non-Designated Beneficiaries), very little has changed for Non-Designated Beneficiaries, and Eligible Designated Beneficiaries still follow the same rules (with few exceptions) as the pre-SECURE Act Designated Beneficiaries.

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Prior to the passage of the Tax Cuts and Jobs Act in 2017, W-2 employees had the ability to deduct unreimbursed job-related expenses paid with personal funds as miscellaneous itemized deductions on their personal income tax returns. But the TCJA suspended most miscellaneous itemized deductions (including unreimbursed employee business expenses) through 2026, eliminating the opportunity for employees (including S corporation owners who also serve as employees of those companies) to deduct business expenses on their individual returns.

But the good news for S corporation owner-employees is that, by implementing an “Accountable Plan” a (a reimbursement program which meets certain IRS regulations), S Corporation owner-employees can continue to deduct business expenses that they pay for personally by “passing” them along to the business. Essentially, an Accountable Plan is an IRS-approved reimbursement program that allows a business to reimburse employees for business expenses they incur as part of their work. The business is then able to deduct those reimbursed amounts as if the business had incurred the initial expense, itself.

When using an Accountable Plan, reimbursements for business expenses are not considered compensation to employees thus, don’t increase payroll taxes due on wages or an employee’s income tax liability. However, it’s important to note that the deductibility of an expense incurred by an employee isn’t changed when submitted for reimbursement to an employer. Thus, any limitations or restrictions inherently associated with a deductible expense remain in place (e.g., the 50% deductibility of meal expenses).

There are three simple guidelines an Accountable Plan must follow to be considered valid: 1) all expenses to be reimbursed through the plan must have a business connection, 2) expenses must be “timely substantiated,” and 3) any excess advances provided to the employee must be “timely repaid.” While the actual definition of “timely” (with respect to substantiation and repayments of advances) is somewhat ambiguous, the IRS has provided several “safe harbor” options.

Since Accountable Plans are so simple to establish, and since they offer such flexible rules around to whom they can apply, and to which expenses they will cover, there is generally no reason for most S Corporations not to implement them. For example, the Accountable Plan can be designed so that only certain expenses can be reimbursed, and/or so that only specific employees can participate.

Despite their simplicity, though, business owners should understand that if the IRS does not deem their plan in compliance with the Accountable Plan rules, their plan will be treated instead as a “Non-Accountable Plan”. In such instances, any reimbursements will be added the employee’s wages. Even though employee wages reduce gross business revenue, that reduction is offset by the increase in wages. And to top it off, the impact of higher FICA taxes as a result of those wages means that the total tax liability will be higher than if the expense hadn’t been reimbursed in the first place!

Ultimately, the key point is that an Accountable Plan is a simple way for S Corporation owner/employees to shift deductibility of business expenses from the employee to the employer and offers the ability to mitigate tax liability by allowing business owners to choose which expenses are reimbursable and which employees will be eligible to submit reimbursements. Thus, in light of TCJA and the suspension of miscellaneous itemized deductions, for S Corporation owner-employees, in particular, Accountable Plans are an especially effective tax planning tool.

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Touted as the most significant update to the Internal Revenue Code in decades, the Tax Cuts and Jobs Act of 2017 (TCJA) did indeed introduce several noteworthy changes, including the new 20% qualified business income owners of (some) pass-through entities, a (much) lower corporate tax rate, a (much) higher estate tax exemption, lower individual tax rates for the vast majority of taxpayers, and a slightly higher total standard deduction (which combined both the existing individual standard deduction and the per household personal exemption). Ironically, though, while the TCJA legislation largely accomplished its objective of simplifying the process of filing taxes, it did so largely by making it a lot harder for households to itemize deductions at all going forward!

As while the new standard deduction isn’t that much higher than the combined prior standard deduction and personal exemption, the threshold for itemizing deductions in the first place is significantly higher than it was before, simply because the personal exemption wasn’t part of the equation when calculating the prior deduction threshold. Moreover, the TCJA also either eliminated completely or curtailed many of the most popular itemized deductions that got people over the hurdle to itemize in the first place, including moving expenses, many miscellaneous itemized deductions, and unreimbursed employee expenses (to name just a few). The end result: the number of households eligible to itemize deductions at all is anticipated to fall from approximately 30% of US households to “only” 10%.

Regardless, despite the upheaval, itemizing deductions is still a viable strategy to reduce overall tax obligations, and there are still six core deductions available to taxpayers, including: medical expenses (to the extent that they exceed 10% of Adjusted Gross Income – up from 7.5% in 2018); taxes paid to other governmental entities (both state or local municipality taxes as well as foreign governments, but with a $10,000 maximum deduction limit… regardless of filing status!); at least some types of interest paid (for not only mortgage interest – up to a $750,000 principal limit – but for investment purposes as well); charitable giving (but with limits); casualty and theft losses (but, for individuals, only if they were attributable to a Federally declared disaster); and other (miscellaneous-but-not-subject-to-the-2%-of-AGI-floor) deductions (such as gambling losses and Ponzi scheme losses, among others).

It’s important, meanwhile, to note that most of the still-available itemized deductions simply don’t occur regularly, and there are even fewer large enough to get taxpayers close enough to the new standard deduction threshold to make itemizing “worth it” on a recurring basis. Those items include big mortgages (particularly when mortgage rates are still at historically low levels), large ongoing charitable deductions (even though the deduction amount will necessarily be much less than the amount given), big state and local tax deductions (at least for individuals, where the $10,000 SALT cap gets them close to a standard deduction that is “only” $12,000), high margin investing (since interest paid on investments is deductible… as long as the returns on the investments are taxable in the first place), big long-term care events (which, while undesirable, can require large ongoing medical expenses), and significant stretch-IRAs that are eligible for the Income in Respect of a Decedent (IRD) deduction (to the extent that the IRA was inherited from someone who actually had to pay Federal estate taxes).

While few households will be able to meet the standard deduction threshold every year using just those big-ticket items, though, it is feasible (and perhaps even much more likely) that taxpayers will be able to itemize on an intermittent basis, by combining a few (or several) additional deductions on top of other (lower-but-recurring) deductions. For instance, a taxpayer might combine ongoing mortgage interest, property taxes, and state income taxes with a large charitable contribution to push past the standard deduction threshold in order to take advantage of additional tax benefits.

Ultimately, the key point to realize is that the combination of a higher Standard Deduction threshold and the curtailment of itemized deductions, makes it much harder to itemize than it once was (if only because the new standard deduction provided a more substantive and generous tax benefit in the first place). Yet while fewer households are able to itemize each and every year, some may still be able to do so, either on an ongoing basis, or at least intermittently by stacking infrequent clusters of additional deductions on top of recurring items that typically aren’t large enough to matter from a tax planning perspective. Which is important, because at the margin it’s still valuable to identify and plan for the (few) years where itemized deductions will still be available, as those are the years when there’s the most tax benefit to stacking any other possible “add-on” deductions on top for more tax savings!

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At the end of 2018, Americans had nearly $9 trillion in IRAs. Most of that money was (and continues to be) invested in “traditional” types of investments, such as stocks, bonds, mutual funds, ETFs, and annuities. But for those investors who wish to look elsewhere for returns, IRAs can provide a substantial amount of flexibility.

One investment option that is particularly popular when it comes to non-traditional IRA assets is direct-owned real estate. Direct-owned real estate refers to properties in which an owner (or a company controlled by that owner) has direct title to the property. But while the allure of non-traditional, non-stock-market-based investments like direct real estate can be an attractive proposition for many investors – especially in times of increased market volatility – such investments can also create unique planning challenges not normally associated with traditional investments.

Notably, though, direct-owned IRA real estate increases the likelihood of running afoul of the prohibited transaction rules. IRA owners, for instance, are prohibited from personally using their IRA-owned real estate, or performing even the smallest of repairs on the property themselves. Purchasing or leasing such properties personally is also off-limits, even when such arrangements are done as an “arms-length” transaction at a fair market value/rate.

But the list of potential challenges doesn’t stop there. Cashflow problems are also more prevalent when low-liquidity assets like direct-owned real estate are purchased within an IRA. The IRA, for instance, must have enough cash on hand to cover all of its “investment” expenses, including repairs and maintenance, taxes, and even the purchase of a property in the first place. And while an IRA can secure financing in the form of a non-recourse loan (i.e., a mortgage), such loans tend to limit the amount of capital that can be borrowed and can lead to Unrelated Debt Financed Income, which can complicate things even further by creating an income tax bill that must be paid by an investor’s IRA! All while other tax benefits normally associated with real estate, such as depreciation and the 20% pass-through deduction, are forgone (since the investment is owned in the tax-deferred IRA “shell”).

Real estate is also more difficult to value than assets that are frequently traded across an exchange or other platform. Which is unfortunate, because formal valuations of direct-owned IRA real estate are often required in the event an IRA owner takes a distribution, including (and especially when) there is a Roth conversion or a Required Minimum Distribution (RMD) obligation, adding an additional cost layer for otherwise-basic tax reporting.

Despite these risks, however, some investors still view these alternative/non-traditional IRA investments as their best avenue to grow their retirement savings... and do so with their IRAs if only because that’s where the available dollars are to invest in the first place. For such persons, a thorough understanding of these technical and tax compliance challenges is critical.

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Benjamin Franklin famously quipped, “In this world, nothing can be said to be certain, except death and taxes.” For as long as anyone claims the rights and privileges of their sovereign nation in which they are citizens, the governments of those countries reserve the right to tax their citizens in order to provide the government’s services and infrastructure. Except, sometimes, in the case of people who are citizens of one country, but live – temporarily or permanently – in another… taxation is suddenly not so certain after all.

Because the reality is that countries generally only have a right to those people who reside within their borders, and/or who generate income within their borders. While, by limitations of jurisdiction, or coordination of treaties, those who are neither citizens nor residents, generally don’t have to pay taxes on any income not earned within the country’s borders.

In this guest post, Sahil Vakil, founder of Myra Wealth, which specializes in working with immigrants to the US (who may or may not be US citizens or residents), provides guidance on what advisors need to know about navigating the rules of non-US citizens, who may or may not be residents of the US, and who may have income both within and outside the US.

When it comes to non-US citizens living in the US – known as “aliens” by virtue of being non-US citizens – the key question is whether that person at least qualifies as a “resident” of the US, either by meeting the Green Card Test or the Substantial Presence Test. Those who do are resident aliens, and must declare and pay taxes on all their income worldwide (similar to US citizens), and are also subject to special Foreign Bank Account Report (FBAR) and must follow the Foreign Account Tax Compliance Act (FATCA), which can introduce substantial additional tax reporting burdens.

By contrast, nonresident aliens are generally not subject to FBAR and FATCA, and only must report and pay taxes on their income earned in the US (either by being Effectively Connected Income to the US, or be Fixed or Determinable, Annual, or Periodic (FDAP) income (e.g., passive portfolio income). Which in turn may be eligible for special tax rates (at least on FDAP), but also special tax withholding rules.

And ultimately, these rules are important not only for the taxation of resident and nonresident aliens themselves but also the tax strategies that emerge (e.g., resident aliens contributing to US retirement accounts to receive the deduction at current US tax rates on worldwide income, but liquidating them after returning to the home country when they will only be taxed on US income as nonresident aliens). On the other hand, the limitations on tax rules for resident and especially nonresident aliens can also complicate traditional tax planning strategies (e.g., the unlimited marital deduction is not available for nonresident alien spouses, forcing the use of a Qualified Domestic Trust [QDOT] instead).

The bottom line, though, is simply to understand that, while for US citizens, there may be nothing more inescapable than death and taxes, when it comes to non-citizen “aliens,” the rules in fact are far more nuanced and the situation is less clear… presenting both opportunities, and traps, to be aware of!

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One of the most significant changes made by the Tax Cuts and Jobs Act of 2017 was the creation of new IRC Section 199A, which provides small business owners with an up-to-20% deduction on the profits of their business. High income business owners have a number of complicated restrictions and/or “tests” that can reduce or eliminate that deduction, but for taxpayers with income below the start of their applicable phaseout range ($160,700 for single filers / $321,400 for joint filers) the deduction calculation is far more straightforward. Taxpayers “simply” receive a deduction equal to 20% of their (combined) qualified business income. Or, if lower, simply 20% of their taxable income (less capital gains and qualified dividends).

Notably, this potentially-lower 20%-of-taxable-income limit on the Qualified Business Income (QBI) deduction means that small business owners need to have some level of non-QBI income, to absorb the various tax deductions (e.g., the standard deduction or itemized deductions) they claim on their personal return, or they may not get the “full” QBI deduction on their business income. And while some business owners do have substantial amounts of non-qualified-business-ordinary-income, enabling them to receive the 20% deduction on the full amount of their Qualified Business Income, other business owners’ incomes are completely (or, at least, substantially) comprised of only Qualified Business Income. In such situations, the business owner’s deductions effectively get applied against their Qualified Business Income, reducing their QBI deduction (to “just” 20% of taxable income after those deductions).

However, not all deductions claimed on the personal tax return create this QBI deduction “problem” for small business owners. Some above-the-line deductions, such as the deduction for SE tax, SEP IRA contribution, and self-employed health insurance reduce both qualified business income and taxable income. Other above-the-line deductions, such as the deductions for IRA contributions, HSA contributions, and student loan interest, along will below-the-line deductions (either itemized deductions or the standard deduction) reduce only taxable income, potential limiting what could be a higher QBI deduction to 20% of taxable income.

Thankfully, though, this complication also presents taxpayers with a significant tax planning opportunity. By accelerating income, a portion of the tax liability that would normally be attributable to the increased income can be covered by a corresponding increase in the taxpayer’s 199A QBI deduction. And ultimately, this can lead to the “Deduction-Production” income being taxed at “just” 80% of the otherwise-applicable tax rate. And this Deduction-Production income strategy can continue to produce favorable results until a taxpayer’s total ordinary income, which is not qualified business income, equals the total of their deductions that reduce taxable income, but not qualified business income.

Of all of the ways in which a taxpayer can accelerate their income and engage in 199A QBI Deduction-Production, the “best” way will most likely be via Roth conversions. Not only do such conversions allow the business owner to reap the benefits of the “discounted” (via Deduction-Production) effective tax rate today, but they also help manage future taxes via continued tax-deferral and future tax-free distributions from the Roth account. Roth conversions are also easy to initiate and allow the business owner to precisely control the amount of income generated.

For those business owners who would benefit from Deduction-Production income, but who cannot make Roth IRA conversions, other options include earning additional W-2 wages, transitioning qualified dividend-producing investments to investments that generate ordinary income, taking distributions from non-qualified annuities, and simply timing deductions so that they occur in other years.

Of course, generating Deduction-Production income only works when the addition of more taxable income would increase the business owner’s 199A deduction. For high-income (taxable income of more than $160,700 for single filers, and more than $321,400 for joint filers for 2019) owners of specified service trade or businesses (SSTBs), additional income may reduce the current QBI deduction further, even if it’s currently constrained by the taxable income limitation, making Deduction-Production income a moot point. The same issue may also present itself to high-income owners of non-SSTBs if their QBI deduction is impacted by the wage or wage-and-depreciable-property tests.

In the end, though, the important thing to remember is that tax planning is first and foremost about trying to pay taxes at the lowest possible rate… something that is a lot easier to do when 20% of your income is effectively tax-free thanks to a deduction that increases in tandem with your income. Thus, for business owners who have their QBI deductions restricted by the taxable income limitation, accelerating “Deduction Production” income must be given adequate and careful consideration.

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On October 31, 2008, the person (or persons) going by the name of Satoshi Nakamoto first posted the paper titled, “Bitcoin: A Peer-to-Peer Electronic Cash System.” Within months, the first Bitcoin had been “mined” setting off a technological and cultural revolution. And over the next decade, Bitcoin and other cryptocurrencies would see a dramatic rise in distribution and price, culminating in an epic 2017 that saw the value of many cryptocurrencies grow by more than 1,000%!

Unfortunately, just as public infatuation with cryptocurrencies seemed to reach a peak, so did its price, leading to a disastrous 2018. During the year, many cryptocurrencies lost upwards of 80% of their value, leaving investors with sizeable losses, and questions about what to do, if anything, to make the most of their losses (at least from a tax perspective).

Fortunately, to that end, back in 2014 the IRS released IRS Notice 2014-21, providing its first substantive guidance on the taxation of Bitcoin and cryptocurrency transactions. Notably, the IRS determined that cryptocurrencies are “property” for Federal tax purposes, and not currency. Thus, the sale of cryptocurrency results in capital gains and losses, rather than ordinary income.

In general, the basis of a taxpayer’s cryptocurrency is the price paid to acquire the currency (in U.S. dollars) from its previous owner, typically via an exchange. In other words, the basis of an investment is what you paid to acquire it. In the context of cryptocurrency that is mined, though, there is no “purchase” transaction in the first place. Instead, the act of mining itself is treated as an income-producing activity, such that the fair market value of the cryptocurrency is included in gross income when it is mined. In turn, that fair market value becomes the miner’s cost basis in the cryptocurrency property going forward.

For taxpayers who liquidated cryptocurrency positions at a loss in 2018, the “planning” options are unfortunately somewhat limited. At this point, the best that can be done is to use any 2018 cryptocurrency losses to offset other 2018 capital gains and up to $3,000 of ordinary income. Any additional (cryptocurrency and other capital) losses must be carried forward for use in future years.

Taxpayers who currently hold cryptocurrency positions with unrealized losses can still choose to liquidate those positions in 2019 and use those losses to offset other portfolio gains (e.g., enabling investors to minimize the impacts of rebalancing out of other investment positions that have accrued substantial capital gains).

Unfortunately, though, harvesting cryptocurrency capital losses may be easier said than done, particularly for long-term cryptocurrency investors whose early purchases have accumulated in value, as FIFO tax treatment for multiple lots of cryptocurrency is likely required. On the other hand, because cryptocurrency is “property” but not (at least at this point) treated as an investment security, it appears the Wash Sale Rule does not apply to sales of cryptocurrency. Thus, positions with losses can be sold in order to be able to use the loss for planning today (or to “bank” the loss for future use), and still repurchased shortly thereafter (for those who want to continue to HODL), enabling the investor to continue to participate in future appreciation (at least if they’re still optimistic about cryptocurrency investment potential in the first place).

Finally, it’s worth noting that the digital nature of cryptocurrency makes it more susceptible to theft-by-hack (or other means), while its ethereal nature makes it more likely to be truly lost (via lost keys or cold-storage hardware) than other assets. Which is important because unfortunately, such losses would be treated as casualty losses which, after the Tax Cuts and Jobs Act, are generally no longer deductible at all!

Many crypto-advocates believe its long-term growth potential and viability as an asset class remains strong. Nevertheless, many investors first entered into the crypto-game in 2017 – when interest in the asset class grew exponentially due to its dramatic rise in price – and are now left trying to make the most of their losses.

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