Obama’s $3 Million IRA Cap

We have received several calls on the proposed $3 million cap on 401(k)s and IRAs. Some of those discussions have been spirited.

What is it? Equally important, what is it not?

The proposal comes from the White House budget. Here is some text:

The budget will also show how we can provide targeted tax relief to strengthen the economy, help middle class families and small business and pay for it by eliminating tax loopholes and make the tax system more fair. The budget will include a new proposal that prohibits individuals from accumulating over $3 million in IRAs and other tax-preferred retirement accounts. Under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving. The budget would limit an individual’s total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per person per year in retirement, or about $3 million in 2013."

Let us point out several things:

(1)    The proposal would not force monies out of an existing retirement plan. It would instead prevent new monies going into a plan.

This raises a question: should one draw enough to reduce the balance below $3 million, would one be able to again contribute to the plan?

(2)    The proposal uses the term tax “preferred” rather than tax “deferred.”  This indicates that the proposal would reach Roth IRAs. Roth IRAs are not tax deferred, as there is no tax when the funds come out. They instead are tax “preferred.”

There is some rhyme or reason to this proposal. $205,000 is the current IRC Section 415 limit on funding defined benefit (think pension) plans. The idea here is that the maximum tax deduction the IRS will allow is an amount actuarially necessary to fund today a pension of $205,000 sometime down the road. The closer one is to retirement, the higher the Section 415 amount. The farther one is, the lower the Section 415 amount. This proposal is somewhat aligning limits on contribution plans with existing limits on benefit plans.

(3)    The $3 million is an arbitrary number, and presumably it would change as interest rates and actuarial life expectancies change over time. If longevity continues to increase, for example, the $3 million may be woefully inadequate. Some planners consider it inadequate right now, at least if one is trying to secure that $205,000 annual annuity.

(4)    Would the annuity amount increase with inflation? Assuming an average inflation rate of 4.5 percent, one would lose almost three-quarters of a fixed annuity’s purchasing power over 30 years.

The frustrating thing about the proposal is that it affects very few people. The Employee Benefit Research Institute estimates that only 1% of investors have enough to be subject to this rule. This of course feeds into the perceived anti-success, anti-wealth meme of this White House.

(5)    The amount of money to be raised over a decade is also chump change for  the federal government: less than $10 billion.

Something to remember is that account balances in 401(k), SEP, SIMPLE and regular IRA accounts will be taxable eventually. IRAs are subject to minimum distribution rules, for example. The larger the balances, the more the government will take in taxes. Dying will not make the tax go away. In fact, it may serve to accelerate required distributions to a beneficiary and taxes to the government.

The budget was dead on arrival at Capitol Hill. Let us hope that less ideologically rigid minds on the Hill keep it so.

Can You Deduct Burning Down Your House?

Can you take a deduction for burning your house to the ground?

You may laugh, but I was reviewing a recent case on this issue. It is the third case involving a home barbeque I can remember over as many years.

The case from 3 years ago was Rolfs v Commissioner. It was – understandably – considered quite outside the box.

Theodore Rolfs and his wife (the Rolfs) owned a house on a 3-acre lakefront property in Wisconsin. The house was modest, built around 1900 and it would be fair to say that it was in need of an upgrade.

The Rolfs wanted to renovate, but the work required was so extensive that tearing down the house and constructing anew was a very viable option.

They estimated it would cost $10,000 to $15,000 to demolish the house and remove the debris.

They went a different path and donated the house to the fire department. There were restrictions on the donation: the fire department was to use the house for training exercises, with the understanding that the training would happen shortly after the donation. The Rolfs donated only the house. They did not donate the land on which the house sat.

The Rolfs needed a value for their donation. They contacted Richard Larkin, president of Larkin Appraisals, Inc. who valued the house at $76,000.

The Rolfs donated the house and took a charitable deduction of $76,000 on their tax return. They attached the appraisal report and a letter from the fire chief thanking them for the donation.

The IRS disallowed the charitable contribution.

The IRS argued that a charitable donor does not expect a financial benefit in exchange for the donation. The Rolfs however expected a substantial benefit: the $10,000 to $15,000 in avoided demolition costs, for example, not to mention the benefit of the tax deduction itself.

The IRS further argued that the restrictions the Rolfs imposed affected the value of any donation. The fire department could only use the house for training purposes, and the house was to be destroyed shortly after the donation.

The Rolfs countered that they had an appraisal for $76,000.  And what was the IRS talking about with “restrictions?” After the fire department did its thing, there was NO house standing. The fire department did not want a house. They wanted a house they could burn to the ground. Whatever “restrictions” the IRS was talking about went up in smoke.

The case went to Tax Court.

In a Solomonic gesture, the Court reasoned that there might be a donation, but the amount of any donation would be the value of the house over the value of any demolition and clean-up services received.

The Court observed that the Rolfs donated the house without its underlying land. This meant that an independent buyer would have to move the house. The house was very old and badly in need of renovation. What would someone pay for this? Not surprisingly, the house was almost worthless.

The house was not worth more than the demolition and removal services received from the fire department. The Court decided there was no donation. The Rolfs lost their case.

But they made the tax literature.

There are variations that might have resulted in a different outcome. For example, what if the house had enough value to make it worth the cost and effort of moving?

There is another way to help tax-subsidize a house demolition, however. Have you heard of “deconstruction?” This involves dismantling the house rather than razing it under a bulldozer. It is more expensive, but with deconstruction more home materials remain in usable condition. The materials are then donated, generating a tax deduction. If the value of the tax deduction exceeds the additional cost of the teardown, one has effectively tax-subsidized his/her demolition costs.

The value of the materials can add up. I was reading an article where the lighting fixtures alone were worth over $100 thousand. Can you imagine?

White House Says No To Death Star

Have you been or seen the White House website? Did you know that you can post a petition there? Here is the website:

The right to petition your government is guaranteed by the First Amendment of the United States Constitution. We the People provides a new way to petition the Obama Administration to take action on a range of important issues facing our country. We created We the People because we want to hear from you. If a petition gets enough support, White House staff will review it, ensure it’s sent to the appropriate policy experts, and issue an official response.

The following was actually posted:

We petition the Obama administration to:

Secure resources and funding, and begin construction of a Death Star by 2016.

Those who sign here petition the United States government to secure funding and resources, and begin construction on a Death Star by 2016.

By focusing our defense resources into a space-superiority platform and weapon system such as a Death Star, the government can spur job creation in the fields of construction, engineering, space exploration, and more, and strengthen our national defense.

The petition received over 34,000 signatures, prompting the White House to post the following:

The Administration shares your desire for job creation and a strong national defense, but a Death Star isn't on the horizon. Here are a few reasons:

• The construction of the Death Star has been estimated to cost more than $850,000,000,000,000,000. We're working hard to reduce the deficit, not expand it.
• The Administration does not support blowing up planets.
• Why would we spend countless taxpayer dollars on a Death Star with a fundamental flaw that can be exploited by a one-man starship?

Even though the United States doesn't have anything that can do the Kessel Run in less than 12 parsecs, we've got two spacecraft leaving the Solar System and we're building a probe that will fly to the exterior layers of the Sun. We are discovering hundreds of new planets in other star systems and building a much more powerful successor to the Hubble Space Telescope that will see back to the early days of the universe. 

If you do pursue a career in a science, technology, engineering or math-related field, the Force will be with us! Remember, the Death Star's power to destroy a planet, or even a whole star system, is insignificant next to the power of the Force.

COMMENT: OK, technically this is not tax - but it is funny.