Senator Baucus Wants To End Stretch IRAs

Congress is looking to take away a planning option for IRAs as it seeks more money to fund its spending.

The proposal was snuck into the Highway Investment, Job Creation and Economic Growth Act of 2012. The bill was heard by the Senate Finance Committee, and Chairman Max Baucus (D., Mont.) recommended a provision curtailing the use of “stretch” IRAs.

What is a “stretch” IRA? Say you leave your IRA, or part of your IRA, to your son and daughter. Upon your passing, they take over (separate) IRA accounts. They cannot wait until 70 ½ to begin distributions, as these are inherited IRAs. They have to begin distributions by December 31 of the year following your death, but they are allowed to reset the distribution period to their own life expectancy. This allows the opportunity to have the IRA compound – or “stretch” – over their much longer life expectancy.

Truthfully, the numbers can be astounding. Consider a 78 year-old grandfather passing a $100,000 IRA to his granddaughter, who, upon her passing, transfers the remaining stretch IRA to her son or daughter. This wealth compounding is a reason financial planners like to work with stretch IRAs.

It is of course unpalatable to allow one to decide how to distribute the monies in his/her IRA, so Sen. Baucus has stepped-in to decide this matter for you. Under his proposal, most nonspouse inheritors would have to withdraw the entire amount from the traditional IRA over a period of five years. There would be exceptions for beneficiaries who are disabled, chronically ill, a minor, or a beneficiary no more than 10 years younger than the IRA owner.

Roth IRAs would remain unchanged. Nonspouse beneficiaries must begin distributions from the Roth by December 31 of the year after inheriting, but they can draw these out over their own expected life expectancies.

Why are people concerned? Here is a statistic: approximately 40% of the stock market is tied-up in 401(k)s, 403(b)s, IRAs and similar vehicles. It is an attractive target.

Form 1099-K Reconciliation Cancelled

The IRS has decided that businesses will not be required to reconcile their gross receipts with merchant card transactions reported on the new 1099-K form.

Steven T. Miller, IRS deputy commissioner for services and enforcement, wrote to the National Federation of Independent Business that no reconciliation will be required on 2012 or future business tax returns. Last October the IRS had earlier said that no reconciliation would be required for only the 2011 tax returns.

In the way of history, the Housing and Economic Recovery Act of 2008 required the IRS to begin collecting a new Form 1099-K from payment-settlement entities, such as credit card companies, for merchant transactions such as credit and debit card payments. The payment settlement entity is required to issue a 1099-K to a merchant if the merchant’s business for the previous year exceeded either $20,000 or 200 transactions.

Why would businesses complain? Well, for one, if the taxpayer identification number and legal name do not match with IRS’s files, there is back-up withholding of 28% of the transaction. How is the business to account for refunds or returns? For sales taxes? How is the 1099-K to be reconciled with accounting systems which are geared to track sales by product or type, not by payment type? How will one account for fiscal years, when the 1099-K’s will all be on a calendar year? And who is going to pay for the accountant to reconcile all this nonsense?

Couples Must Now File Separate Powers of Attorney

Starting March 1, 2012 married couples will have to file separate powers of attorney for their tax representative.

It used to be that both spouses could sign one power naming a representative. You may recall that you signed near the top of page 2. That has changed because of increased sensitivity to privacy and data security.

There is another change on the power, but the change applies to tax representatives. The representative must now include his/her PTIN on the power. Tax advisors may remember that the IRS has discussed increased practitioner enforcement, including automatic referral to the Office of Professional Responsibility of a practitioner associated with a substantial understatement penalty. The PTIN is a way to identify a specific return to a specific tax preparer.

The Backdoor Roth IRA

The following question came up recently:

I make too much money to contribute to a Roth. Is there another way to make an additional contribution to my retirement savings?

How much is too much money? If you are single the upper limit is $122,000. If you are married the upper limit is $179,000. We are assuming, by the way, that you are covered by a plan – say a 401(k) - at work.

So what do you do?

Fund a nondeductible IRA. What is this? It is the third “flavor” of an IRA. We all know the regular IRA, where you put away money, deduct it on your tax return and pay tax on the monies down the road when you take the money out. For a Roth, you put away money, take no deduction but pay no tax when you take out the money. Then there is the nondeductible. You get no deduction and the money is (partially) taxable when you take it out.

For example, say that you put away $50,000 in nondeductibles which are worth $250,000 when you start drawing. The withdrawal is 20% nontaxable ($50,000/$250,000). Another way to say this is that 80% will be taxable.

Nondeductibles are the stepchild of IRAs. You want to fund a Roth (if you can) before considering a nondeductible.

Say that you are single, in your 40s and make $200,000 per year. I recommend that you fund a nondeductible IRA for $5,000, because $5,000 is the best you can do. You have to fund your IRA by April 15^th under all flavors of IRA. Let April 15^th pass and convert the nondeductible to a Roth. How do you do that? It may be as easy as going on the broker’s website and moving the monies between the two IRAs. Think of it as moving monies between a savings and checking account.

It used to be that one could not do this, but the tax rules have been changed to allow it.

What is the downside? There are two, and the second one can be an insurmountable hurdle to some taxpayers.

(1)    First, any income in the nondeductible becomes immediately taxable. In our example, if the $5,000 is now worth $5,450, you will have $450 of taxable income. If you do what I recommend, chances are the income will be negligible as you did not leave the monies in the nondeductible for very long.

(2)    Second, the pro rata rule. If you have monies in other IRAs, you have to use a fraction. The numerator is the amount you have in the nondeductible. The denominator is the total you have in all IRAs. For example, if you have a $5,000 nondeductible and $95,000 in a regular IRA, your ratio will be 5% ($5,000/ ($5,000 + $95,000). If you convert in this scenario, the conversion will be 95% taxable.

How do you handle issue (2)? If you have a retirement plan at work and the plan allows you to roll-in, then you would roll-in your $95,000 regular IRA. At this point the only IRA you have is the $5,000 nondeductible. Your ratio now is $5,000/$5,000, meaning that 0% is taxable.

The nice thing about a nondeductible is that there is no income limit. If you make $1 million per year, you can still contribute to a nondeductible.

How long do you let the money cool before converting? Tax advisors disagree. Some advisors recommend at least six months, whereas others say that you can do so the next day. I would recommend more than a day and not more than December 31^st of the year of the conversion.

One more bit of advice. If you fund a nondeductible, put it in its own account, preferably titled “Nondeductible.” Do not commingle your IRAs. This is not Neapolitan ice cream.

Taxpayers Keep Leaving The United States

The number of expatriates continues to increase. The number for 2011 was 1,781 and represents more than a 15% increase from 2010.

Not all expatriates are wealthy and seeking to sidestep what they perceive as harsh and confiscatory government policies. The IRS itself estimates that up to seven million U.S. residents reside abroad. I have family overseas, for example, and they have no intention of returning. They must nonetheless file a U.S. tax return annually, file a FBAR and, assuming that they have not spent every nickel they ever earned, have to deal with FATCA reporting. Did you know that there are tax restrictions on a U.S. citizen marrying a non-U.S. spouse? Does that make sense to you?

The most recent assault by Treasury on non-U.S. financial institutions, such as UBS, has had the perverse effect of these institutions dropping U.S. clients – and certainly not accepting new ones. I am not condoning the uber-wealthy hiding their income and assets from the U.S., but it is a far reach to argue back that a U.K. bank should report electronically on the bank activity and balances of my family.

Here is a chart on the number of expatriates over recent years. Kudos to Andrew Mitchel for the graph. Draw your own conclusion, if a conclusion is there to be drawn.

               

Paying a Fair Share Act

U.S. Senator Whitehouse (D-R.I.) has introduced a tax bill named the Paying a Fair Share Act.

This is the Buffett Rule. It would apply only to taxpayers with income over $1 million. At income levels over $2 million, there would be a flat 30% tax. At income between $1 million and $2 million there would be a phase-in to get the effective tax rate to 30%.

The bill is co-sponsored by the following:

·         Sen Daniel Akaka, D-Hawaii

·         Sen Mark Begich, D-Alaska

·         Sen Richard Blumenthal, D-Conn.

·         Sen Tom Harkin, D-Iowa

·         Sen Patrick Leahy, D-Vt.

·         Sen Bernie Sanders, I-Vt.

·         Sen Chuck Schumer, D-N.Y.

It is very doubtful that this bill is going anywhere.

Here is another proposal. We can call it the Biden Rule:

         Politicians who stay in Washington more than 10 years pay a 100% tax rate.

IRS Modifies Streamlined Installment Payment Program

The IRS issued a memorandum on January 20, 2012 liberalizing streamlined installment agreements. I am happy with this change.

As a refresher, the advantage of the “streamlined” is that one does not have to provide financial information to the IRS. If you have gone through this effort, you may remember IRS Form 433 – the financial information form. This is where you provide financial detail such as monthly deposits and expenses. You will also attach documentation, including copies of bank statements as well as copies of your mortgage or rent advice and certain other expenses. 

The IRS has standards for broad household expenses, such as mortgage and utilities, clothing and personal effects, medical expenses and vehicle payment and operating expenses. The IRS is inclined to use their numbers, although they will allow you to document higher or additional expenses. You then have to persuade them that your numbers are better than theirs and do not reflect a “lavish” lifestyle or incorporate”excessive” expenses. To give you an idea, the IRS does not allow for payments on your credit cards. I am not sure if they consider credit card payments to be “lavish” or “excessive.”

The “streamlined” allows you to fast-forward through this.

The liberalized streamlined rules apply only to an individual taxpayer. They do not apply to corporations and other types of businesses. You can now enter streamlined if your assessed balance (taxes, interest and penalties) is less than $50,000, an increase from the previous $25,000. In addition, you now have 72 months to pay, an increase of one year from the previous 60 months.

The IRS does charge a small fee (either $104 or $52, depending on whether you permit direct deposit) for the payment plan. Any streamlined over $25,000 must be on direct deposit.

To clarify, you do not have to enter streamlined, even if your assessed balance is less than $50,000. You can go the normal route, provide information and pursue a more favorable payment plan.  You would do that if you are pursuing a partial pay, for example. You would certainly have to go that route if you are pressing for an offer in compromise. For many people, however, the increase from $25,000 to $50,000 and an additional year to pay may make all the difference.

Why would someone hesitate to provide a 433? For one, it can be a pain to assemble and complete. Also, you have to disclose your bank accounts, including bank account numbers, on the 433. Some people believe this makes it easier for the IRS to levy your bank account. Whether correct or not, you have provided the IRS a roadmap to your finances.