This is a not a new topic but the question has come up:
Can an employer setup an IRA for their employees, withhold from their paychecks and remit the monies directly to the financial institution?
You bet.
In Publication 4587, Payroll Deduction IRAs for Small Businesses, the IRS clarifies that an employer can do what we described above. The key point is to keep the employer involvement to a minimum, as the program will not be treated as a retirement plan, with its attendant rules, requirements and filings. With this arrangement there is no minimum number of employees who have to participate, nor is there a discrimination issue. The employee unfortunately has to pay the annual cost for the IRA, if there is one.
Notice what the above does NOT do: the employer cannot make an employer contribution to the plan. All the monies described are the employees’ monies.
Tuesday, June 21, 2011
The 2011 Home Energy Tax Credit
The 2010 Tax Relief Act extended the (IRC Sec. 25C) nonbusiness energy property tax credit through December 31, 2011 – one more year. However, stricter rules apply for 2011 than for 2010.
A taxpayer can claim a 10% credit for “qualified energy property” placed in service in 2011 up to a $500 lifetime limit. Oh yes, you have to reduce the $500 by any credits you claimed previously.
The credit for residential energy property expenditures are limited to:
(i) $50 for an advanced main circulating fan;
(ii) $150 for any qualified natural gas, propane, or hot water boiler;
(iii) $300 for any item of energy-efficient property (with no more than $200 from windows and skylights)
My take: Are you kidding?
A taxpayer can claim a 10% credit for “qualified energy property” placed in service in 2011 up to a $500 lifetime limit. Oh yes, you have to reduce the $500 by any credits you claimed previously.
The credit for residential energy property expenditures are limited to:
(i) $50 for an advanced main circulating fan;
(ii) $150 for any qualified natural gas, propane, or hot water boiler;
(iii) $300 for any item of energy-efficient property (with no more than $200 from windows and skylights)
My take: Are you kidding?
Avoiding Capital Gains Tax - Part II
Let’s return to our article of December 7, 2010 on preserving a gain position in a stock. In that article we talked about buying a put on P&G stock.
P&G closed yesterday at $64.50. Let’s say I am looking at selling a call on P&G for January, 2012, with a strike price at $60. This means that – in January, 2012, someone can require me to sell P&G for $60 a share. For this they will pay me a premium of $3.55. Remembering that options trade in lots of 100, that means that I will receive $355 (before commissions) by selling this call.
Let’s back up. A call means that the buyer of the option can buy the seller’s stock. The buyer pays the seller a premium. In our example, the premium of $355 gives the buyer the right to buy my stock for $60 share. The total price to me is $63.55 a share. Yesterday it traded at $64.50. I am preserving all but a dollar a share of my gain through all of 2011.
The downside? If the stock runs up in price, then I will be leaving profit on the table. The buyer of the call will almost surely exercise the option and keep the profit for himself/herself. That is the reason for buying a call, after all. As a seller, I am making a contrary bet – the price will not run up.
But I may have other reasons. I may be locking in my profit. If I am happy with my profit at $63.55, and happy to receive another year’s worth of dividends, then I may sell the call to lock-in that profit. Perhaps I am guaranteeing my cash flow, such as for a child beginning college in 2012. Perhaps I am minimizing my taxes, if 2011 will be a banner year but I do not expect 2012 to repeat.
The premium of $355 is not taxable to me right away. If I wind up selling the stock, then the premium will be reported as an increase to my selling price for the stock ($60 plus $3.55). If the option lapses, I will have $355 of short-term capital gain in 2012. If I close the position – say by buying a January, 2012 call – then the difference between $355 and what I paid for the new call will be short-term capital gain or loss to me.
P&G closed yesterday at $64.50. Let’s say I am looking at selling a call on P&G for January, 2012, with a strike price at $60. This means that – in January, 2012, someone can require me to sell P&G for $60 a share. For this they will pay me a premium of $3.55. Remembering that options trade in lots of 100, that means that I will receive $355 (before commissions) by selling this call.
Let’s back up. A call means that the buyer of the option can buy the seller’s stock. The buyer pays the seller a premium. In our example, the premium of $355 gives the buyer the right to buy my stock for $60 share. The total price to me is $63.55 a share. Yesterday it traded at $64.50. I am preserving all but a dollar a share of my gain through all of 2011.
The downside? If the stock runs up in price, then I will be leaving profit on the table. The buyer of the call will almost surely exercise the option and keep the profit for himself/herself. That is the reason for buying a call, after all. As a seller, I am making a contrary bet – the price will not run up.
But I may have other reasons. I may be locking in my profit. If I am happy with my profit at $63.55, and happy to receive another year’s worth of dividends, then I may sell the call to lock-in that profit. Perhaps I am guaranteeing my cash flow, such as for a child beginning college in 2012. Perhaps I am minimizing my taxes, if 2011 will be a banner year but I do not expect 2012 to repeat.
The premium of $355 is not taxable to me right away. If I wind up selling the stock, then the premium will be reported as an increase to my selling price for the stock ($60 plus $3.55). If the option lapses, I will have $355 of short-term capital gain in 2012. If I close the position – say by buying a January, 2012 call – then the difference between $355 and what I paid for the new call will be short-term capital gain or loss to me.
Avoiding Capital Gains Tax - Part 1
As part of year-end tax planning, it is common to review a client’s investment portfolio. If there are capital gains (and yes, this year there are), we go looking for capital losses to offset those gains. What is the point of sitting on capital losses when the alternative is to send Uncle Sam a check for taxes on capital gains? This process is called “loss harvesting,” which term I find to be both humorous and macabre.
Let’s go the other way. What if the client has capital gains but is concerned that the gains may evaporate. Sell the stock, we would say. No, says the client; the stock is a winner. The client however is concerned about market swings before getting to the long-term. What if he or she needs the money and the swing is down? Given market behavior since 2007, this is not an unreasonable fear. What if he/she is just wrong about the stock?
There are a few things you can consider to protect that gain. Today I want to talk about one. We will come back and talk about other techniques, but let’s do it another day.
The technique today uses protective puts. Yep, we are talking options.
You may remember that there are two basic types of options: calls and puts. If a sell a call to you, you have the right to buy my stock. If I sell a put to you, you have the right to sell me your stock. The direction I want here is to buy a put. That means I can require you to buy stock that I own. Since I am buying, this is going to cost me money.
An example is the way to go.
P&G closed today at around $62. Let’s say I believe that P&G is a good long-term hold (which I do, by the way), but I want to hedge my bets. I bought P&G at a great price, say $42. Nice unrealized gains here. Let’s say I have been reading articles by Nouriel Roubini and am terrified of imminent economic collapse. What if P&G goes to $20 before it goes to $100?
I will buy a $60 put for January 2012. That means that – until January, 2012 – I can require you to buy my P&G at $60 a share. You are not going to do this from the goodness of your heart. I am going to pay you approximately $5 for the right. This $5, by the way, is called the “premium.” You can look it up on stock market websites. You do not believe that P&G is going to crash. You believe that it will trade within a range or maybe even go up. You know that I would never sell you the stock if it stays above $60. Even if I do, I paid you $5, so your net cost is $55 ($60 - $5) for the stock.
If the stock goes up or moves sideways, I will likely allow the put to expire. I am not going to sell you stock at $60 when I can call Fidelity and sell at a higher price. I wasted $5 on the premium.
Say the stock goes to $40. Different answer. I exercise the put and require you to buy the stock. I sell at $60. I paid $5. I cleared $55, and I can turn around and buy the stock at $40. There is no wash sale, because I sold at a profit. The wash only applies when one sells at a loss.
There is a non-intuitive tax result in here, by the way. Let’s say that I let the put expire. My first response is that I have a $5 capital loss, which is the premium I paid for the put. I am partially right. I do have a $5 loss, but the IRS will not let me deduct it. Since I still own the stock, the IRS requires me to increase my basis in P&G by that $5. I will get it back someday – when I sell the stock. The technical reason is that the protective put creates a tax “straddle,” and the result I described is the general result for tax straddles.
Let’s go the other way. What if the client has capital gains but is concerned that the gains may evaporate. Sell the stock, we would say. No, says the client; the stock is a winner. The client however is concerned about market swings before getting to the long-term. What if he or she needs the money and the swing is down? Given market behavior since 2007, this is not an unreasonable fear. What if he/she is just wrong about the stock?
There are a few things you can consider to protect that gain. Today I want to talk about one. We will come back and talk about other techniques, but let’s do it another day.
The technique today uses protective puts. Yep, we are talking options.
You may remember that there are two basic types of options: calls and puts. If a sell a call to you, you have the right to buy my stock. If I sell a put to you, you have the right to sell me your stock. The direction I want here is to buy a put. That means I can require you to buy stock that I own. Since I am buying, this is going to cost me money.
An example is the way to go.
P&G closed today at around $62. Let’s say I believe that P&G is a good long-term hold (which I do, by the way), but I want to hedge my bets. I bought P&G at a great price, say $42. Nice unrealized gains here. Let’s say I have been reading articles by Nouriel Roubini and am terrified of imminent economic collapse. What if P&G goes to $20 before it goes to $100?
I will buy a $60 put for January 2012. That means that – until January, 2012 – I can require you to buy my P&G at $60 a share. You are not going to do this from the goodness of your heart. I am going to pay you approximately $5 for the right. This $5, by the way, is called the “premium.” You can look it up on stock market websites. You do not believe that P&G is going to crash. You believe that it will trade within a range or maybe even go up. You know that I would never sell you the stock if it stays above $60. Even if I do, I paid you $5, so your net cost is $55 ($60 - $5) for the stock.
If the stock goes up or moves sideways, I will likely allow the put to expire. I am not going to sell you stock at $60 when I can call Fidelity and sell at a higher price. I wasted $5 on the premium.
Say the stock goes to $40. Different answer. I exercise the put and require you to buy the stock. I sell at $60. I paid $5. I cleared $55, and I can turn around and buy the stock at $40. There is no wash sale, because I sold at a profit. The wash only applies when one sells at a loss.
There is a non-intuitive tax result in here, by the way. Let’s say that I let the put expire. My first response is that I have a $5 capital loss, which is the premium I paid for the put. I am partially right. I do have a $5 loss, but the IRS will not let me deduct it. Since I still own the stock, the IRS requires me to increase my basis in P&G by that $5. I will get it back someday – when I sell the stock. The technical reason is that the protective put creates a tax “straddle,” and the result I described is the general result for tax straddles.
The Old and New IRA Charitable Distribution
You may remember that taxpayers were allowed to distribute $100,000 directly from their IRAs to charity. No deduction was allowed for the contribution, but then the IRA distribution was not included in income. When you also remember that contributions are limited to 50% of income, this rule was very favorable indeed for someone making very generous contributions relative to that year’s income.
This deduction expired in 2010 as Congress played Russian Tax Roulette.
The new tax bill brought it back.
Taxpayers 70 1/2 or older can again make tax-free distributions to a charity from an IRA up to $100,000. These distributions aren't subject to the charitable contribution percentage limits nor are they included in gross income. These rules are good for one year more - through 2011.
Here’s the unexpected part:
In addition, a taxpayer can elect a distribution made in January, 2011 to be treated AS IF it were made on December 31, 2010. Therefore a distribution made in January, 2011 may be (1) treated as made in the taxpayer's 2010 tax year and counted against the 2010 $100,000 limitation, and (2) treated as made in the 2010 calendar year and used to satisfy the taxpayer's minimum distribution requirement for 2010.
The problem here is that prudent tax planning would have required an age 70 ½ taxpayer to have taken his/her2010 required minimum distribution by December 31, 2010. This taxpayer would therefore not need another 2010 distribution, unless he/she simply wanted to maximize charitable contributions. The question has been raised whether a taxpayer who did take a 2010 RMD because of tax law uncertainty can put the monies back in – to “recontribute” the monies. The IRS has just clarified that this cannot be done, as the tax bill did not include this option.
This deduction expired in 2010 as Congress played Russian Tax Roulette.
The new tax bill brought it back.
Taxpayers 70 1/2 or older can again make tax-free distributions to a charity from an IRA up to $100,000. These distributions aren't subject to the charitable contribution percentage limits nor are they included in gross income. These rules are good for one year more - through 2011.
Here’s the unexpected part:
In addition, a taxpayer can elect a distribution made in January, 2011 to be treated AS IF it were made on December 31, 2010. Therefore a distribution made in January, 2011 may be (1) treated as made in the taxpayer's 2010 tax year and counted against the 2010 $100,000 limitation, and (2) treated as made in the 2010 calendar year and used to satisfy the taxpayer's minimum distribution requirement for 2010.
The problem here is that prudent tax planning would have required an age 70 ½ taxpayer to have taken his/her2010 required minimum distribution by December 31, 2010. This taxpayer would therefore not need another 2010 distribution, unless he/she simply wanted to maximize charitable contributions. The question has been raised whether a taxpayer who did take a 2010 RMD because of tax law uncertainty can put the monies back in – to “recontribute” the monies. The IRS has just clarified that this cannot be done, as the tax bill did not include this option.
Gates v. Commissioner
I’ve come across the Gates decision several times this past year.
Here are the facts: the gates owned and used a house as their principal residence for 2 years. They thought of remodeling the house, but instead they decided in 1999 to demolish and rebuild. They never moved in to the new house. In 2000 they sold and realized an almost $600,000 gain. They claimed the gain was excludable under the principal residence exclusion.
Let’s address the easy one. Only $500,000 of the gain is excludable. Any excess over that will be taxable.
The big issue is whether the house they lived in was the same house they sold. They had owned and occupied the OLD house for the required two out of five years. Taxpayers argued that the land and improvements should somehow meld, so that occupancy in the former house should carryover to the newly-constructed house because the new house sat on the same land as the former. This is the house into which they never moved, by the way. The Tax Court reviewed decisions in which land was considered part of a principal residence. The Court was greatly pressed to argue from the reverse direction – that the sale of the land would drag along whatever improvements sat on it.
The Tax Court decided this was an argument too far and that the entire gain (of almost $600,000) was taxable.
My take: I doubt there the Gates sought out any tax advice before selling the house. I think that almost any competent tax professional would have sensed that they were pressing the point too far. They could have, for example, moved into the new house while it was being sold. They may not have gotten the full two years in, but they at least would have qualified for the prorated exemption. Alternatively, one wonders what the result would have been if they had left some walls standing. The closer to a renovation – and the further from a new build - the better their argument becomes.
Here are the facts: the gates owned and used a house as their principal residence for 2 years. They thought of remodeling the house, but instead they decided in 1999 to demolish and rebuild. They never moved in to the new house. In 2000 they sold and realized an almost $600,000 gain. They claimed the gain was excludable under the principal residence exclusion.
Let’s address the easy one. Only $500,000 of the gain is excludable. Any excess over that will be taxable.
The big issue is whether the house they lived in was the same house they sold. They had owned and occupied the OLD house for the required two out of five years. Taxpayers argued that the land and improvements should somehow meld, so that occupancy in the former house should carryover to the newly-constructed house because the new house sat on the same land as the former. This is the house into which they never moved, by the way. The Tax Court reviewed decisions in which land was considered part of a principal residence. The Court was greatly pressed to argue from the reverse direction – that the sale of the land would drag along whatever improvements sat on it.
The Tax Court decided this was an argument too far and that the entire gain (of almost $600,000) was taxable.
My take: I doubt there the Gates sought out any tax advice before selling the house. I think that almost any competent tax professional would have sensed that they were pressing the point too far. They could have, for example, moved into the new house while it was being sold. They may not have gotten the full two years in, but they at least would have qualified for the prorated exemption. Alternatively, one wonders what the result would have been if they had left some walls standing. The closer to a renovation – and the further from a new build - the better their argument becomes.
The 2011 Gift Tax
The tax bill that the President signed on December 17, 2010 raised the estate tax exemption to $5 million. For a married couple, this means that – with relatively simple planning – they can transfer up to $10 million free of estate tax to their heirs.
There is something else in this tax bill. The gift tax exemption is being reunified with the estate tax exemption. This means that you can now gift up to $5 million ($10 million for marrieds) without gift tax. And, starting in 2012, this exemption will be indexed for inflation. Previously the estate tax exemption was at $3.5 million whereas the gift tax exemption was much lower – at $1 million.
The gift tax rates are remaining the same – 35% for both 2010 and 2011.
There is something else in this tax bill. The gift tax exemption is being reunified with the estate tax exemption. This means that you can now gift up to $5 million ($10 million for marrieds) without gift tax. And, starting in 2012, this exemption will be indexed for inflation. Previously the estate tax exemption was at $3.5 million whereas the gift tax exemption was much lower – at $1 million.
The gift tax rates are remaining the same – 35% for both 2010 and 2011.
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