Personal Wealth Law News

Archive for the 'Income Tax' Category

It’s Still Worth Considering A Roth IRA Conversion

Posted by Robert Louis on 29 Jun 2010 | Tagged as: Retirement Planning, Income Tax

At the beginning of this year (2010), there was discussion in the press and in legal publications about the ability to convert IRAs and qualified plan accounts to Roth IRAs. This conversion involved paying taxes now and then being free of them thereafter, plus avoiding the necessity of minimum distributions during life. In effect, for those people who really didn’t need the amount being converted, conversion was a very effective multi-generational planning technique. To the extent you believe income tax rates will be higher in the future (a good bet), conversion makes sense. There’s a choice you can make when converting, whether to pay taxes this year at this year’s rates or over the next two years at whatever the rates will be then. Some people prefer to pay this year, because they like knowing what the tax rates will be.

Another advantage of conversion now is that security values are still low. The stock market is still far off its high values of a few years ago, so conversion now, before (we hope) the stock market recovers, is a good idea. Conversion is not for everyone. It requires some thinking about the future and personal planning. But there is still time to begin that process.

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Is it possible?

Posted by Robert Louis on 25 Jun 2010 | Tagged as: Estate Planning, Income Tax

Is it possible that Congress will do nothing for the rest of the year to restore the federal estate tax? Given the other items on its agenda, and the fact that this is an election year, it’s very possible. But then what? At the end of the year, the so-called Bush tax cuts expire. That means that the estate tax will return, at its earlier rates and exemption level: a maximum graduated rate up to 55% and an exemption of only $1,000,000 (as compared to the $3,500,000 that was in effect in 2009). Many more people will be subject to federal estate tax, and that will affect the planning they should be doing now.

In addition, the lower income tax rates that were in effect will expire. Capital gains rates will return to their prior, higher levels, and regular income tax rates will also rise. Congress has the ability to extend the lower rates, but it must take some action to do that. And we have seen that on tax issues, it’s difficult to get changes enacted. What if Congress does nothing, or if efforts to extend the lower tax rates fail? Higher taxes. It’s probably a good idea to start planning with respect to income taxes now, in anticipation of eventual higher tax rates: possibly postponing deductions to next year and accelerating income into this year. All of this could change, but it’s probably wiser to assume that nothing will happen.

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Stimulus Package Includes Another AMT Patch

Posted by Robert Louis on 22 Feb 2009 | Tagged as: Income Tax

The alternative minimum tax, which grew from an effort to provide some level of taxation on those who used various tax-avoidance techniques into a monster that threatens to swallow the entire federal income tax system, is the subject of tax relief in the recently-signed stimulus legislation. The exemption from AMT is scheduled to fall each year and engulf many millions of taxpayers, unless a “patch” is applied. The patch temporarily increases the exemption, and is reenacted every year. In the stimulus legislation, the patch was increased to the following levels:

Single and head of household $46,700
Married filing jointly $70,950
Married filing separately $35,475

The rates remain the same: 26% on the first $175,000 of AMT taxable income ($87,500 if married filing separately), and 28% on the balance.

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Stimulus Bill Advances

Posted by Robert Louis on 09 Feb 2009 | Tagged as: Income Tax

The U.S. Senate has just passed a cloture motion, which means that the stimulus bill will continue to advance to likely Senate passage, followed by negotiations with the House and an eventual compromise bill. The new legislation will contain a number of tax-cutting provisions. As soon as we know what the final provisions will be, another article will be posted on this website to explain the changes.

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Two Planning Ideas to Consider

Posted by Robert Louis on 04 Jan 2009 | Tagged as: Retirement Planning, Income Tax

Tax legislation that was passed unanimously by both houses of Congress and quickly signed by the President offer some helpful ideas for retirement and estate planning.

First, required minimum distributions from defined contribution retirement plans and individual retirement accounts are suspended for 2009. This means that if you have reached age 70 1/2 and are required to take out a calculated minimum amount for 2009, you will not have to do so. This relief is to help account owners who suffered substantial losses in 2007 and 2008, by not requiring them to liquidate assets with depressed values to make the minimum payments. Most people who have retirement accounts and have reached age 70 1/2 need to take distributions for their living expenses, but for those who do not, this temporary change in the law might be helpful. It does have a revenue effect for the Treasury, because if less than the minimum amounts are withdrawn, less will be paid in taxes for 2009.

Second, a change has been made in distribution rules from qualified plans. This is how it works. Most qualified plans provide that if the participant dies leaving an account balance, that balance must be paid out promptly to the participant’s beneficiary. If the beneficiary is the participant’s spouse, the spouse can roll over the balance to an individual retirement account and avoid immediate taxation. But if the beneficiary is a child, for example, it was long the rule that no rollover was permissible. Therefore, the child would be taxed on the distribution immediately, rather than being able to stretch out distributions through an IRA rollover. A few years ago, legislation was passed to permit rollovers by non-spouse beneficiaries, but it appeared that this would only be permitted if the retirement plan specifically allowed it. There was confusion as to whether Congress meant that this provision should be optional, and the recently enacted tax legislation has now made it mandatory for qualified plans, beginning for plan years after December 31, 2009. This can be a very valuable planning technique for retirement benefits. It’s a good idea to find out what your employer’s plan provides at a participant’s death, and to ask that the non-spousal rollover provisions be added as soon as possible.

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Tax Provisions of the Bailout Bill

Posted by Robert Louis on 03 Oct 2008 | Tagged as: Income Tax

On October 3, 2008, the House of Representatives passed the so-called “bailout bill”, designed to avoid a further deepening of the economic crisis, and President Bush has already signed the bill. To make the proposals more acceptable to some members of Congress, some provisions were added that affect the tax liability of individuals. Here is a brief summary of a few of those changes.

1. The provision permitting individuals age 70 1/2 or older to make direct transfers from individual retirement accounts to charities, in amounts up to $100,000 per year, has been extended to the end of 2009.

2. The ability to deduct state and local sales taxes in lieu of state and local income taxes has been extended to the 2009 tax year.

3. The deduction for qualified tuition and related expenses, within certain income limits, has been extended through tax year 2009.

4. The deduction for certain expenses of elementary and secondary school teachers has been extended through tax year 2009.

5. The exemption from the alternative minimum tax has been extended and increased. For joint filers and surviving spouses, the exemption is $69,950 for 2008, up from $66,250 for 2007. For others, the exemption for 2008 is $46,200 for 2008, up from $44,350 in 2007. Without this extension and increase, millions of additional taxpayers would become subject to the AMT.

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‘The Dean is Furious! He’s Waxing Wroth!’

Posted by Robert Louis on 24 Jul 2008 | Tagged as: Retirement Planning, Income Tax

This was the only quote I could think of to introduce a discussion of planning with Roth IRA and retirement plan benefits. In response to this statement, Groucho Marx said: “Is Roth here too? Tell Roth to wax the Dean for a while.”

Delaware Sen. William Roth gave his name to this type of retirement benefit. It’s simple, sort of. You don’t get a tax deduction when the contributions are made, but you don’t pay taxes when the account is distributed at retirement. You give up a current tax saving in exchange for a greater one later. Is this a good deal? The answer is definitely, sometimes.

If you knew that you would pay a higher tax rate in retirement, Roth tax treatment would clearly be better. Conversely, if you knew that your tax rate would be much lower in retirement, it might be better to stay with the traditional method of planning: a deduction up front and taxation later. Opinions vary on this subject, and studies have been made to try to determine when and whether one method is superior to the other. There are some unknown elements: not only your own tax rate but tax rates in general. Who can predict what income tax rates will be 10 or 20 years from now? Or that Roth treatment will still be in effect?

For now, here are two situations in which Roth treatment makes sense. First, if you have a child who has a summer job, it makes sense that the child have a Roth IRA. In most cases, kids with summer jobs have little or no income tax liability anyway, so a deduction for an IRA contribution is of no value to them. Then, they will have many years in which the Roth IRA can grow tax-free. When the funds are distributed, perhaps 50 years later, the small contributions from summer jobs could be a large amount.

Here’s another possible benefit: Roth IRAs do not have minimum distribution rules, unlike standard IRAs and qualified plans. If an individual has other assets such that he or she won’t need the Roth money, the balance can be left in for the rest of the individual’s life and be paid out only in the next generation. This extremely long-term accumulation period, followed by no tax on distribution, can make Roth a valuable planning benefit.

People with standard benefits can convert them to Roth benefits by paying taxes on them now. After that, any distributions will be free of tax. The ability to convert is limited to those with income below certain levels, but that restriction will end by 2010. At that time, anyone will be able to convert to Roth treatment. This opens up the possibility of interesting estate planning with Roth benefits, which we’ll discuss in another blog.

Republished with permission of The Legal Intelligencer.

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Retirement Havens: Florida, Arizona…Pennsylvania

Posted by Robert Louis on 16 Jun 2008 | Tagged as: Retirement Planning, Income Tax

Part of planning for the future is deciding where to spend the golden years, as marketing types like to call them. For those people who have an option where to live in retirement, there are the usual suspects: Florida, Arizona, North Carolina and there is the state that is one of the most popular among retirees, Pennsylvania.

By the way, the idea that you need to remain in the city where your law practice is located in order to continue to have an involvement in that practice is fast fading away. Just last week, a lawyer from a suburb of Detroit, who is suing one of my clients, called me from somewhere deep in the heart of North Carolina, from where he is able to be heavily involved in the frivolous litigation he is pursuing.

Why is Pennsylvania so popular among retirees, especially those in the neighboring states of New York, New Jersey, Delaware and Maryland? One important reason is the taxation of retirement income, such as Social Security and retirement plan distributions. There is no income tax imposed by Pennsylvania on bona fide retirement income, which is not the case in the neighboring states. If your income in retirement consists only of Social Security benefits and amounts you withdraw from a 401(k) plan, for example, your Pa. income tax will be zero. That is not the case, again for example, in New Jersey. And if you worked in New Jersey to earn a retirement benefit, New Jersey can’t reach across the river to tax it if you move to Pennsylvania, under federal law. (But here’s a caveat: Be sure to check the Pennsylvania rules to be certain that your retirement distributions qualify. Nearly all distributions after age 59 1/2 will qualify, but check the rules anyway.)

Yes, we have a sales tax, which Delaware does not have (although there are a large number of “big box” stores suspiciously close to the Pennsylvania border) and yes, we still have the state store system (again, some really good wine stores just across the border in New Jersey and Delaware, I’m told), but Pennsylvania has a big advantage in the taxation of retirement income. That, combined with reasonable property taxes and access to a world of sports, culture and recreational activities, is why Pennsylvania has one of the largest populations of retirees of any state.

Republished with permission of The Legal Intelligencer.

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Send Lawyers, Internal Revenue Codes and Money

Posted by Robert Louis on 09 Jun 2008 | Tagged as: Estate Planning, Income Tax

Actually, the Warren Zevon song refers to “Lawyers, Guns and Money,” but the Internal Revenue Code can also be a dangerous weapon. Now that the campaign for president has reached the general election stage, it’s time to realize that whoever wins the election; there are massive changes in our federal tax system looming ahead. These changes will affect us and our clients in various ways. In some cases, there will be little that can be done but to accept the changes; in other situations, there may be planning that can be used to reach a better result. Here are a couple of areas where change may occur:

Federal estate tax: This discussion has been going on for several years, with much misinformation being spread about. (Read “Wealth and Our Commonwealth” by William H. Gates and Chuck Collins for a good review of this debate.) But there will be changes in our federal estate tax system in the future because leaders in both parties agree that the tax must be revised to include only the truly wealthy, not those who bought a home in a good neighborhood. There might be relief for small businesses and farmers, but in general the tax should be one that allows people to pass on some of the fruits of their life’s work without destroying the incentive of the next generation to take part in life’s struggle.
Federal income tax: The reductions in income tax rates that were enacted in 2001 are scheduled to phase out in a few years. One solution is to extend indefinitely, but this easy answer has to be balanced against the colossal budget deficits that have resulted, in part, from those tax reductions. The view that those budget deficits can go on forever and will somehow be resolved or will disappear as a result of future growth is now classified with bedtime stories.
Alternative minimum tax: Whose idea was this anyway? In the past few years, we’ve had small bandages applied to this gaping wound in our tax system. Some have suggested just repealing it, which would only result in even larger budget deficits. But reducing its effect to those who are perceived as not paying a fair share of taxes, which was the original intent of the law, will require that some difficult choices be made. Doing nothing (which is a skill of both political parties): not an option.
Social Security taxes: Someone will have to finally accept that this problem also can’t be ignored or magically wished away with private accounts, and that higher taxes will only be acceptable to a limited degree. As last week’s blog indicated, you can either increase revenues or reduce benefits; there’s no third way.

All of these problems will have to be addressed by our next president, either John or Barack. In the course of resolving them, many provisions of our tax laws will be placed on the table: taxation of life insurance, employee benefit taxation, relief for older taxpayers and those with children. Many constituencies will be contending for their interests. It’s important for all of us to know what’s happening, and to plan for change, for us and for our clients.

Republished with permission of The Legal Intelligencer.

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The Giant Rat of Sumatra

Posted by Robert Louis on 28 Apr 2008 | Tagged as: Estate Planning, Income Tax

This title will be familiar to readers of the adventures of Sherlock Holmes. It’s a story mentioned in one of the Holmes stories as one for which the world was not yet ready. Apparently, the world was never ready for the story, because the author died without having written about a giant rat, from Sumatra or elsewhere.

I think of this passage in the works of Sir Arthur Conan Doyle as an example of things left undone. We often have plans we would like to carry out but for some reason can’t get to. Sometimes, like Doyle, we never get to them. In my practice, I see this kind of procrastination frequently when the subject of life insurance comes up. (By the way, I neither sell nor benefit from the sale of life insurance.) Life insurance is a product with many useful tax characteristics, and its use has become more…useful in recent years because of developments in the insurance industry and businesses related to the insurance industry.

Among the valuable tax benefits of life insurance is that the receipt of the proceeds is generally free of federal income tax. I say generally because it’s possible to lose that tax exemption if, for example, the insurance policy is transferred for value, such as by selling it. There are ways of avoiding that problem, depending on the type of transfer.

The proceeds of life insurance may be subject to federal estate tax, which could reduce the amount of the proceeds significantly. But there’s a way to avoid estate taxation that is frequently used, especially for large amounts of insurance. If the life insurance policy is not owned by the insured but instead by an irrevocable life insurance trust, the proceeds will escape federal estate taxation. The trust document will determine where the proceeds will go. Often they’re held in trust for the surviving spouse for life and then paid to the children. Not having to pay estate tax, in addition to the exemption from income tax, is a doubly valuable benefit.

But if the trust is irrevocable, it’s difficult, if not impossible, to change it. Suppose you change your mind about where the proceeds should go, which could happen for any number of reasons. Are you stuck leaving the proceeds to those you might consider the wrong people, or the right people but on the wrong terms? One solution that people have considered is to set up a new trust and sell the policy, for its fair market value, from the old trust to the new trust. But that creates the potential transfer for value problem described above. Is there a way around this problem?

The IRS has just issued a revenue ruling, 2008-22, which confirms the ability to make such a transfer without jeopardizing either the income tax or the estate tax exemption. If the new trust is a grantor trust, which means a trust that is treated effectively as the same person as the grantor, then the transfer for value rule won’t apply. (In this situation, the grantor would be the insured.) But how do you make the trust a grantor trust? The Internal Revenue Code says that one way is to give the grantor the right to substitute property of equal value for the property in the trust. The grantor might never make such a substitution, but the right to substitute is enough. The ruling just issued tells us that having such a power need not cause the proceeds to become subject to federal estate tax. It’s one of those intricate drafting situations that actually works very simply and preserves the excellent tax benefits life insurance offers.

Like writing a will, buying life insurance is something that people sometimes avoid, with its suggestion of mortality. There are some complexities to it, but careful planning can make it an important part of your financial “story.”

Republished with permission of The Legal Intelligencer.

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Personal Wealth Law News

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Archive for the 'Income Tax' Category

It’s Still Worth Considering A Roth IRA Conversion

Is it possible?

Stimulus Package Includes Another AMT Patch

Stimulus Bill Advances

Two Planning Ideas to Consider

Tax Provisions of the Bailout Bill

‘The Dean is Furious! He’s Waxing Wroth!’

Retirement Havens: Florida, Arizona…Pennsylvania

Send Lawyers, Internal Revenue Codes and Money

The Giant Rat of Sumatra

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