Keep records for at least 7 years

It is that time of the year when people like to get rid of the excess paper that we tend to let pile up in our office or houses.

The general rule of thumb is to keep all financially related documents (especially if it was used in the preparation of your tax return) for at least seven years (as the audit period for the IRS can be up to six years). Tax returns, W-2s, brokerage statements, real estate purchase or sale documents should be kept permanently.

Why, you ask? Some of the information on these returns and other tax documents can be helpful on future tax returns or calculations. I have also heard of situations where the Social Security Administration did not have a year of wages recorded from more 20 years ago and all of the documentation the government has related to those wages have been destroyed. Your copy of the W-2 may be the only thing that would help you in getting more in additional benefits.

For businesses, the documentation that you need to keep is just about every invoice in which you were paid from a customer as well as every receipt and invoice you paid to a vendor or supplier.

For individuals, you need to keep details of all deposits into your personal bank account(s) (to show whether it was income, a gift, a refund or something else that is not income) as well the expenses that you paid that you claimed on your individual tax return.

Remember that you do not have to keep all of the documentation on paper. So, if you are good with electronic storage and can scan the documents and store them on your computer, you can destroy the paper. But be sure that you are backing up your hard drive to a separate drive or to an online service. I have heard many horror stories of lost data that cannot be recovered and it can cost your dearly later.

Also, note that I said to destroy the documents. This means that it needs to be shredded. Most of us hear the hacking stories of identity theft, but there are many people who still do what is called “Dumpster diving” to get that financial information to take your hard-earned money.

Please note that you should consult your tax professional or attorney to understand the retention policy for employment records, insurance policies, time logs, etc., because they can be different.

Tax savings strategies for recent retirees with substantial tax deferred retirement accounts

Now that the tax season is over, I want to highlight a few ways in which taxpayers with tax deferred retirement accounts between ages 59.5, when there is no longer an early distribution penalty, and age 70.5, when mandatory distributions come into play, may be able to save tax dollars by taking action before the end of the next tax year.

The first item I want to highlight is a situation in which the taxpayer has retired and during his or her working years has followed the advice of financial planners and saved substantial tax deferred dollars in a retirement plan. IRS rules require that these tax deferred savings be taxed according to the minimum required distribution (MRD) rules beginning at age 70.5. Often people retire early, or if not fully retired, work less than full time at reduced wages prior to fully retiring. They may have several years before they need to begin tapping into their retirement saving, as they are able to live on their Social Security and/or part-time employment earnings.

This situation may present an opportunity for some tax planning. As a tax preparer who not only prepares but also advises, I suggest that people take funds out of their tax deferred accounts before the mandatory requirement date, if they can do so in a lower tax bracket. I had one client this year who told me that he and his wife were able to live on their Social Security. He also made me aware that he had substantial tax deferred savings. He and his wife were both age 65 and had $40,000 of Social Security income. Because Social Security income does not start being taxable for those filing jointly until half of Social Security income plus other taxable income exceeds $32,000, he could have taken about $19,000 out of his tax deferred accounts and not paid any federal tax at all. Some state taxes would be due. Chances are if he waited until he was 70 and began taking his MRD, he would have to take out a higher amount, which would have made more of the Social Security taxable and as a result, he would pay more in federal taxes.

When I advised him to do this, his response was that he didn’t need the money, so why take it out? Taking it out does not mean you have to spend it. The tax laws allow people with tax deferred savings in an IRA account to convert those funds to a Roth IRA. He could convert the funds to a Roth, and in this case, take advantage of their tax bracket, save tax dollars and reinvest them the same way they had previously been invested. Once in a Roth, there are no MRD requirements for him and it offers some excellent estate planning features. The example I have given here is savings due to being in a zero tax bracket, but the same goes for being able to save by taking out when one is in the 10 percent or 15 percent bracket as opposed to what could potentially be a 25 percent bracket.

A second item I want to highlight is the fact that because Social Security income is taxable, one has to plan carefully if one needs funds for a major purchase or for an emergency and decides to take funds from a tax deferred account. Even when they have taxes withheld, taxpayers often face a large tax bill at tax time because they did not anticipate the fact that the distribution caused a substantial amount of their Social Security income to be taxed. If one requires funds and is in this situation, with a little foresight, one can borrow the funds through a home equity loan and may save substantial tax dollars.

A third situation encountered this year for the first time are taxpayers who took funds out of their tax deferred accounts and who also participated in the healthcare marketplace for health insurance and received an advanced premium tax credit as a subsidy toward the insurance. When they applied for the credit, they had not anticipated the extra income from their tax deferred distribution. This meant their income was higher than predicted and required them to repay part of the credit when taxes were filed. One of these clients was in a situation where he was able to mitigate the repayment substantially because he had some earned income, allowing him to reduce his taxable income by putting money into a traditional IRA, as this is permitted up until April 15 for the prior tax year.

This blog discusses three situations in which taxpayers who are in their early retirement years but prior to needing to take mandatory distributions from tax deferred funds can reduce their tax liability by doing advance planning. My advice is to use a tax preparer with a good understanding of tax law and be proactive in asking questions before deciding to take a distribution from a tax deferred account.

When doing nothing is the best tax strategy when selling your house

Many residential real-estate markets are recovering. Some are booming. That means more people, especially seniors, have homes that have substantially increased in value. If you fit into this category, please don’t sell without considering the heavy tax hit that would result. Here are the details — and a tax-saving strategy to consider.

Hugely-appreciated home sale basics

If you sell a principal residence that is worth much more than you paid for it, your profit will exceed the federal home sale gain exclusion. That means part of the profit will be taxed as capital gain (unless you have offsetting capital losses). The maximum exclusion is $500,000 for married couples and $250,000 for singles.

If you sell this type of home and it is not your principal residence (like a vacation home), you get no gain exclusion break. So the entire profit will be taxed as capital gain (unless you have offsetting capital losses).

Example: You and your spouse bought your home many years ago for $300,000. Over the years you made $200,000 in improvements, so your tax basis in the property is $500,000 ($300,000 + $200,000). If you sell the place, you would net $3 million. Your Form 1040 would show a whopping taxable gain of $2 million ($3 million sale price - $500,000 basis - $500,000 gain exclusion).

If the same numbers apply to a vacation home, selling would trigger an even-more-whopping $2.5 million taxable gain ($3 million sale price - $500,000 basis), because there’s no gain exclusion break for vacation homes.

Tax rates

A big tax gain is one thing. The actual tax hit depends on the applicable tax rate.

Federal Capital Gains Tax: Under the current rules, the maximum federal long-term capital gains tax rate is 20%. That maximum 20% rate will apply to huge taxable gains from home sales.

3.8% Medicare Surtax: Folks with huge home sale gains will also owe the 3.8% Medicare surtax on net investment income, which is defined to include the taxable portion of gain from selling a principal residence and gain from selling a vacation home.

State Capital Gains Tax: Most states that tax personal income also tax capital gains — including taxable home sale gains — at the same rates as ordinary income. If you live in California, where many of these homes that have soared in value happen to be, the maximum state income-tax rate on capital gains is a whopping 13.3%. If you live in New York City, the maximum combined state and city income-tax rate is 12.9%. Other jurisdictions have lower rates, but state tax bills can still be substantial. (If you live in a state with no personal income tax, congratulations: you only have to worry about the federal tax hit.)

Adding the rates up

If you have a whopping home sale gain, the federal tax hit could be as high as 23.8% (20% capital gains rate + 3.8% Medicare surtax).

If you live in California or New York City, the state and local tax hit on such a home sale gain could be around 13%, which would amount to a combined federal, state and local tax rate in the 37% range. Now do the math on a big taxable home sale gain. Yikes!

While tax rates in other states are lower, they can still be painful.

The tax-saving solution: Hang on until the bitter end

The basic tax-saving strategy in the hugely-appreciated home scenario is to do nothing. Hang onto the home. Don’t sell it! Here’s why. For federal income tax purposes, the tax basis of the portion of a personal residence that you own is stepped up to fair market value (FMV) as of: (1) the date of your death or (2) six months after that date, if the executor of your estate so chooses. Source: Internal Revenue Code Section 1014(a).

• If you’re the sole owner of your home, the basis step-up rule applies to the entire residence after you die. When your heirs sell the property, federal capital gains tax will only be due on the additional appreciation (if any) that occurs after the magic date.
• If you and your spouse own the property together, the tax basis of the portion you own will be stepped up when you die. The tax basis of the remaining portion will be stepped up when your spouse dies. Once again, your heirs will probably owe little or nothing to Uncle Sam when the property is sold.
• If you and your spouse own the home as community property in one of the nine community property states (one of which is California), the tax basis of the entire residence is generally stepped up to FMV when the first spouse dies — not just the half that was owned by that person. This weird-but-true rule means the surviving spouse can then sell the place and owe little or nothing in federal capital gains tax. Source: Internal Revenue Code Section 1014(b)(6).
• If these taxpayer-friendly basis step-up rules also apply in your state, the hang-onto-your-home strategy will work the same tax-saving magic for state income tax purposes.

The bottom line

Doing nothing is not usually a great tax planning strategy, but this scenario is an exception. One more thing: if you think you can’t afford to hang onto your hugely-appreciated home until the bitter end, consider taking out a reverse mortgage to get the cash you need. The interest and transaction costs of a reverse mortgage could be a very small fraction of the tax cost you would avoid by hanging onto your hugely appreciated home.

5 Retirement-Plan Myths Busted

You can still have a company retirement plan, even if you’re a company of one.

It’s true. Such plans aren’t just for workers at large corporations with generous benefits packages. If you run an owner-only business, you are eligible for a qualified retirement plan called a Solo 401(k), which also provides tax benefits.


But many entrepreneurs put their own retirement planning on the back burner. It could be the 15-hour days spent building a company. They also may be hesitating because of some common myths about retirement planning for small-business owners.

Let’s explode five of those myths now, so you can get started planning.

Myth #1: My business is too small for a retirement plan

If you’re running an owner-only business, you’re not required by law to have a qualified retirement plan. But a Solo 401(k) is a great way to start securing a better financial future. It also offers significant tax savings.

According to the IRS, this self-directed retirement product, sometimes called a One-Participant 401(k) plan, “is a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse.”

All contributions and investment gains within the plan are tax-deferred (or tax-free if you choose a Roth account). In addition, the cost of setting up the retirement plan can qualify as a tax-deductible business expense.

To qualify, an owner doesn’t even have to work full time in the business. By showing self-employed business activity, he or she will qualify. With this low-cost, individualized 401(k) product, there is really no business too small for a retirement plan.

Myth #2: All retirement plans have to invest in stocks and bonds

As an entrepreneur, investing in a plain-vanilla target date fund might seem like an uninspiring option. You may prefer to invest in sectors you’re interested in—such as technology, energy or financial services.

A self-directed Solo 401(k) gives you a wide range of investment options, including real estate, private businesses, precious metals and more. You can take the driver’s seat and direct your investments without the involvement or costs associated with third-party custodians.

Myth #3: I can’t meet the minimum requirement

With a Solo 401(k), the contributed amount for each year is totally at the discretion of the plan owner. You can put in as little as you like or even suspend contributions during a challenging year for your business.

What about contributions during a good year? This retirement savings plan can accommodate higher contributions than most retirement plans. In 2015, a Solo 401(k) participant can contribute up to $53,000 annually. Those older than 50 can put in an additional $6,000 as a catch-up contribution. So a Solo 401(k) can serve as a great tax-sheltering strategy for you personally, as well as for your business.

Myth #4: Retirement plans are too expensive

It is good to be concerned about the costs and fees of a retirement plan. Too many traditional plans come with hidden expenses.

Switching to a self-directed retirement plan is a great way to save on management and custodian fees. Since you, the plan owner, can act as both the plan trustee and plan administrator, there are no transaction or asset-based fees. A Solo 401(k) eliminates the role of custodian altogether.

Myth #5: All retirement plan providers are the same

All retirement plans are regulated by the IRS, but specific features of a plan can be restricted by the plan provider. Choosing the right provider can be crucial, especially for business owners who would like to take advantage of a self-directed option.

With a Solo 401(k), there are three types of plan providers. First are traditional banks and brokerage firms. Although the IRS allows a Solo 401(k) to invest in almost any asset, these institutions often restrict the investment products they offer.

The second category includes self-directed custodians and trust companies. You’ll have the option of investing your retirement fund into alternative assets, but your custodian will remain between you and your retirement account. This means you’ll have to pay various fees, such as a holding fee or a fee per asset. You’ll also need the custodian’s approval before adding any investment to your plan.

The last type of Solo 401(k) provider is the one with a truly self-directed option. Unlike the first two, these plan providers do not sell any investment products and give you total control over your investments. There is no restriction on investment choices, no approval needed and no transaction or holding fees.

The bottom line: Investment returns grow exponentially—small contributions now can make a big difference down the road. Don’t let these retirement planning myths stand between you and your future. Get started on a retirement plan today.

Estate Planning 101: How Singles Can Protect Their Loved Ones

If you’re single, you might think you don’t need an estate plan. However, this is not true. Singles face a unique situation when it comes to dividing assets, making it necessary to have directives in place. When it comes to married couples without a will, if one spouse dies, most of the property will usually be passed on to the other spouse. However, with singles, the situation is not so cut and dried.

Laws vary by state, but generally if you’re single and die without a will (known as dying intestate), your assets will be distributed among your closest relatives. If you have children, assets would first be passed on to them. Next in line would be your parents, your siblings, and then distant relatives. If you do not have any relatives who are still alive, your assets would go to the state. If you’re among the nation’s more than 105 million singles, it will be important for you to have an estate plan, as without one you’ll have no say over who gets what.

“If you’re single and die without a will, you may find that your assets could be disbursed in ways you never wanted. Typically, your state’s statute will direct the assets to your close relatives (children, parents, or siblings), and will do so in percentages by the statute. To avoid the state deciding how your assets are distributed, you should speak with your estate planning lawyer about putting in place a will and other appropriate documents that ensure your wishes will be carried out,” Doug Rothermich, managing director of wealth planning strategies at TIAA-CREF, told The Cheat Sheet.

Getting started

Although respondents in a survey conducted by WealthCounsel and WealthManagement.com said they want to protect assets (22%) and avoid probate (59%), most Americans do not put an estate plan in place because they aren’t clear on why they should do so or how to begin.

“Your estate planning documents should clearly spell out who will receive your assets, or if you have specific wishes about supporting charities or causes with your assets when you die. Understanding the many tools available to you and choosing the right family members, friends, or other representatives to carry out your wishes are critical components of the estate planning process for single people,” said Rothermich.

Transferring assets

If you have no children or close relatives to whom you would like to distribute assets, you may want to choose a charity or friends instead. Fortunately, if you decide to give money to relatives or donate to charitable causes, this can reduce the value of your estate and your estate taxes.

Said Rothermich,“In addition to gifts to individual beneficiaries, you may reduce your estate value and tax liability through charitable giving. Such gifts to qualified 501(c)(3) organizations can also be tax-deductible for income tax purposes, and will reduce the value of the estate by the amount of the gift.”

In addition, a trust can be another key tool for planning your estate. “A trust is an entity that holds assets for the benefit of a third party. There are many different kinds of trusts used for passing assets to a spouse, children, charitable organizations or other beneficiaries. Trusts may offer tax or other advantages,” said Rothermich.

Keep taxes in mind

Estate taxes will depend on what type of ‘single’ you are. Each situation will have its own unique outcome. There are different rules depending on whether you are a widow or widower, never married, or divorced.

“If you’re not married, taxes on your estate will depend on whether you never married (or are divorced) versus whether you’re a widow or widower. If you are single, your estate will not incur federal taxes until it exceeds the value of the individual estate tax threshold applicable to you. In 2015, that’s $5.43 million minus any taxable gifts you’ve given during your lifetime. Taxable gifts are those that exceed the annual exclusion amount, which is $14,000 in 2015,” said Rothermich.

Rothermich says if you are a widow or widower, the federal exclusion amount not only includes the individual estate tax threshold, but may also include the unused portion of your deceased spouse’s estate tax exemption (depending on when your spouse died). “This is referred to as portability. In order for it to apply, your executor must elect to add your deceased spouse’s exemption to yours on his or her estate tax return by filing IRS Form 706 within nine months of the deceased spouse’s date of death,” said Rothermich.

IRA withdrawals with Social Security benefits can pile up taxes

The United States tax code is confusing, to say the least.

Some sections are easier to follow than others; the taxation of Social Security benefits is not one of those.

Prior to 1984, Social Security retirement income was not taxed. But with bipartisan support after the Greenspan Commission recommended taxing a portion of benefits to help shore up the system, former President Ronald Reagan signed the law allowing taxation of up to 50 percent of benefits, depending on the taxpayer’s other income. In 1993, within the contested Omnibus Budget Reconciliation Act, President Clinton presided over increasing that maximum to 85 percent. 

And once the door to a tax is opened, it’s tough to shut it again.

So who does include Social Security benefits in their income? Since it coordinates with other income, not everyone. For a taxpayer who only has Social Security income, the benefit will not be taxed. Up to a certain income limit, the benefit will still not be taxed. But after crossing that line of taxation, the amount taxed goes up swiftly.

Taxation happens in stages

Social Security taxation happens in stages, and is based on your provisional income. Provisional income is made up of your modified adjusted gross income (MAGI), plus one half of Social Security income, plus tax-exempt interest.

Modified adjusted gross income is adjusted gross income (AGI), plus any amounts excluded under an employer’s adoption assistance program, student loan interest deductions, tuition deductions and foreign earned income.

Adjusted gross income is the number at the bottom of your Form 1040, and includes all taxable income, less things like the MAGI adjustments just mentioned, IRA deductions, self-employed health insurance deductions, health savings account deductions and some others.

The first stage of taxation, with up to 50 percent of benefits taxed, happens when provisional income reaches $25,000 for single taxpayers and $32,000 for married couples. That 50 percent maximum of benefits taxed holds until the second stage is reached, at $34,000 for singles and $44,000 for married couples. At that point, up to 85 percent of benefits are taxed. The calculation of the exact amount of benefit included in your income requires a 19 line IRS worksheet to figure out, found in Publication 915. If you anticipate any of your Social Security income being taxed, I recommend getting help preparing your taxes, either through software or a professional. Note that being taxed does not necessarily equal having to pay tax on it. It is included in income that is taxed, but your deductions and exemptions come off before the tax is calculated.

First and second thresholds

For taxpayers under the first threshold (nothing taxed) or well over the second (85 percent taxed) things are pretty straightforward. The same for married couples living together at any point during the year but filing separately; 85 percent of their benefit is automatically included in income. But for folks in the middle, tax planning can avoid unpleasant surprises.

Let’s use the example of Betty, a widow, living on a modest income of Social Security and a pension. None of her Social Security benefits are taxed. In fact, her taxable income is zero so she has no federal tax liability at all. Betty decides to withdraw $10,000 from her IRA account to spend the winter in Florida. Some of her Social Security becomes taxable (25 percent in this case), and her total tax is now about $1,000. Not bad, at 10 percent of her withdrawal.

Let’s say Betty decides to add a second withdrawal this year of $5,000 for home repairs. Now about 50 percent of her Social Security is taxed, and her tax due will be $2,400. That additional $5,000 withdrawal cost her $1,400 more, or 28 percent, in tax.

What happens if Betty wants to go to Florida next year too and takes the $10,000 this December to get a jump on the rental? Her total withdrawals now sit at $25,000, and that last $10,000 adds $3,700 to her taxes, meaning she was taxed on it at 37 percent. Ouch. Had Betty planned and spaced out her withdrawals, her taxes could have been quite a bit less. That’s what we call a stealth tax.

Since the tax was imposed to help stabilize Social Security, most of the revenue goes into the Social Security system. A portion of the tax imposed on “high income beneficiaries,” those taxpayers exceeding the $34,000/$44,000 secondary threshold, goes into the Medicare Part A system.

Isn’t this double taxation though? After all, we’ve been taxed on the money we paid in once already. How does the government justify taxing it again? Actually the rationale for the 50 percent number had its basis in the idea that employees only pay in 50 percent of their Social Security tax; the employer pays the other half. So really, it’s not all your money — that line of thinking goes anyway. For the 1993 change, the ideology was that the higher 85 percent more closely mirrors private pension plans, where the growth and employer contribution are taxed but not the money you contribute. It was interesting to me to learn that there really was an attempt at justification.

Six Questions to Ask Before Rolling Over a Retirement Account

FROM WEALTHMANAGEMENT.COM

Many advisors conduct retirement plan rollovers. But casually and carelessly moving all of the money from a client’s 401(k) or 403(b) to a self-directed IRA can mean lost opportunities, higher taxes, and unnecessary costs to the client.

Before you initiate a transfer from a client’s at-work retirement plan to an IRA under your management, consider these questions:

1. Is there any company stock?

A soon-to-be-retired employee who owns highly appreciated company stock within a tax-sheltered retirement plan has a tremendous opportunity to reduce the taxes that would otherwise be due upon a typical distribution.

The potential break comes from a special exemption known as “net unrealized appreciation,” or “NUA.”

First, the client would take an in-kind distribution of some or all of the company stock. The cost basis of the distributed stock is taxable to the client at the time of distribution, and is taxed as ordinary income.

At a minimum, you may want to wait until the client is retired and in a lower tax bracket to initiate the in-kind distribution of the stock.

Also, since an additional 10 percent penalty may apply to the cost basis amount if the client is under age 59 ½ at the time of distribution, it might make sense to leave the stock in the current at-work plan at least until the client reaches that age.

Once the stock has been distributed in kind from the retirement plan, it can be sold at any time. The difference between the original cost basis of the stock and the sales proceeds is taxed at favorable long-term capital gains tax rates.

Ideally, you and the client will be able to delay the sale of the stock until the client can make the sale and still stay below the top of the 15 percent federal income-tax bracket. Then the federal long-term capital gains tax rate on the sale will be zero.

2. Are some investments irreplaceable?

Many employer-sponsored retirement plans offer “stable value” accounts, or fixed-rate annuity investment options.

Depending on the interest rate paid and the discernible strength of the investment provider, it may be impossible for you to duplicate the safety, liquidity and yield the client could earn on these relatively conservative options.

Therefore, it may be better to leave an appropriate portion in the plan and in these accounts, and invest the rest in complementary vehicles in the client’s self-directed IRA.

3. Will they need the money in their 50s?

If clients might need to tap retirement accounts before turning 59 ½, they may pay a 10 percent penalty if they pull the funds from an IRA.

It’s possible to dodge the penalty if they use the complicated “substantial equal payments” strategy, or use the funds for a limited number of qualified expenditures. But if they leave some money in their at-work retirement plans, they may be able to avoid the penalty completely regardless of the reason.

Withdrawals from 457(b) plans are considered taxable income, but are not subject to the 10 percent early withdrawal penalty, regardless of the owner’s age.

401(k) and 403(b) owners who are at least 55 and have separated from their employers can also make penalty-free withdrawals from their accounts for any reason.

4. Any after-tax contributions?

Retiring or separating employees with after-tax contributions to at-work retirement plans can roll that portion of the account into a Roth IRA—tax-free.

But the clients can only roll over the entire after-tax portion to the Roth IRA if they are rolling over all of the rest of their retirement account assets as well. Otherwise, the portion of any partial withdrawal moved tax-free to a Roth IRA has to represent the same ratio of after-tax contributions to pre-tax contributions.

For instance, if a client has a $500,000 401(k) and $100,000 of that account represents after-tax contributions, only 20 percent of any partial distributions can be moved tax-free to a Roth IRA.

5. Is a conversion to a Roth IRA feasible?

When a client is ready to roll an at-work retirement plan to an IRA, it usually means she is either going to retire or be unemployed, and therefore likely won’t have much if anything in the way of taxable income. Seize this opportunity to convert a portion of her pretax retirement plan to a Roth IRA, especially if you can keep her taxable income (including the converted amount) below the top of the 15 percent federal income-tax bracket.

Taxable income is displayed on Line 43 of the client’s 1040 tax form, and for 2015 the top of the 15 percent tax bracket is at $37,450 for singles, and $74,900 for married couples filing jointly.

You can use the tool at tinyurl.com/2015est to calculate how converting various amounts will affect your client’s taxes and tax rate.

And of course, if it turns out that the conversion made in a particular year generates a bigger tax bill than the client would prefer, the conversion can be reversed by April 15 of the subsequent year (or Oct. 15 if the client files for an extension).

6. Can they now make IRA or Roth IRA contributions?

You probably already contact your working clients in the first part of the calendar year to see if they are interested and able to make contributions to IRAs or Roth IRAs for the prior tax year. But don’t forget about clients who have retired in the previous year.

Since the recent retirees only earned a partial year’s salary, they may be eligible to make Roth IRA (and spousal Roth IRA) contributions that would have otherwise been prohibited by a higher, full year’s worth of earnings.

Better yet, if their modified adjusted gross income figure is low enough, they may be able to make contributions to tax-deductible IRAs (and spousal IRAs), even if they contributed to a plan at work during the previous year.

You can verify if the clients are eligible to make an IRA or Roth IRA contribution by running it past their tax preparer, or see Publication 590-A at www.irs.gov.

Tax Planning: Should Wealthy Individuals Move?

FROM ONWALLSTREET.COM

"Location, location, location" the well-known real estate mantra, is a notion that advisors of high- and ultrahigh-net-worth clients might also want take to heart.

"Residency drives how much sophisticated wealth structuring and asset protection you can do," says Merrill Lynch advisor Adam Katz.

While the concept that it's better to live in low or no tax states isn't complicated, the strategies for advising and taking advantage of tax mitigation by location are anything but simple, say advisors.

"The bottom line is that it's really complicated, nuanced, and not a perfect one-size-fits-all," says Katz.

TOO TAXING?

"The first thing everyone wants is to be in a zero percent income tax state for tax purposes," says Lisa Featherngill, managing director of wealth planning at Wells Fargo's Abbot Downing group. "But the most important thing is whether or not it makes sense for the client."

For example, if a client changes residence to Florida, a no income tax state, that can mean a 10% savings, she says, but that also means the client has to spend at least half the year there. If the client can't or doesn't want to spend enough time in another state to be a legal resident for tax purposes, the savings won't be worth the disruption.

And while Florida has no estate or inheritance tax, says Featherngill, the state is known for its heavy probate fees, so advisors may suggest setting up revocable trusts.

RELOCATION

The most aggravating disruptions in residence changes can be meeting and proving state requirements, especially where clients divide their time between several states, which have different rules. Advisors recommend working closely with experienced accountants and tax lawyers because clients will have to change more than their mailing addresses – sometimes they will have to provide detailed accounting to the state, which can also ask for bank, credit card and phone records to establish whether an individual has community connections and financial relationships in the state.

Featherngill has even seen concern about the location of an advisor entering the picture. "We've seen people changing advisor relationships to find an advisor in the new state," she says. "Maybe the advisor should move with them, if it’s a significant enough client." But she adds that it might be just as effective if the advisor makes sure to travel to the client’s new home state for in-person talks, as opposed to having meetings in the client’s previous state.

TRUST STRATEGIES

Setting up a trust in another state can sometimes benefit HNW clients without any need to change residency. More than a dozen states allow self-settled trusts, which offer creditor and estate tax protection.

Some states, like Delaware, have no income tax on trusts, so there may be opportunities for tax mitigation for clients without a need to move, says Katz, vice president of Merrill's Bodner Sax Group in New York.

"It’s very nuanced and complicated stuff, but definitely something to think about," he says.

For example, a Delaware incomplete non-grantor trust, or ING, allows the resident of a high-tax state to re-domicile ownership of a business to Delaware, where the owner still has full control and assets without home state tax liability.

Katz points out that New York disallowed its residents from taking state tax advantages of INGs, but that New Jersey still permits them.

"There’s a lot of complexity to where you spend your time and where your business makes money," says Katz. Advisors need to work closely with tax experts and lawyers to make sure that no one is blindsided.

"You don’t try to guess about the way it works," he says.

'DECISION TREE'

In fact, any time he thinks about setting up an ING trust, he makes sure that his team goes to the IRS to get pre-approval. "It costs money, not only to have the IRS review it, but to have an attorney provide and document all the moving parts of that ING trust," Katz says.

Despite the added costs, Katz says that he has frequent discussions with the wealthy entrepreneurs he advises about such approaches, bringing in other experts and making sure his clients understand "the decision tree".

"It’s definitely an upfront investment of time and money," he says. "It doesn’t mean it’s not worth it, but it definitely adds complexity to your life.

C Corp, S Corp Or LLC? Six Considerations In Making Your Decision

When I address a group of business owners, I invariably get asked the unanswerable question, “For tax purposes, should I be a C Corp, an S Corp or an LLC?”

I wonder if a nutritionist feels this way when asked, “Should I go with a low-carbohydrate, high-protein or an all-cabbage diet?”

The question – the one about tax status, not the diet – is an important business decision and one I don’t feel comfortable sloughing off and deferring to their tax advisor. The decision has a long­-term financial impact on the owner’s business and finances, and it involves more than just taxes. These six major considerations should be part of your conversation with your advisor team. If you have a handle on these issues, your advisors can better help you determine the best business structure strategy, including your tax structure.

1. Ignoring taxes, what legal structure makes sense for your business? Keep in mind that tax structure and legal structure aren’t necessarily the same. For example, an S Corp can be either an incorporated business or an LLC that has elected S Corp status. And, a corporation can be either a C Corp or an S Corp. So, before you decide tax status, you should first address what legal structure you want for your business. An LLC offers simplicity and flexibility. Incorporating, however, creates business perpetuity with centralized management. Even if you go with an LLC, you must decide whether the business will be “member managed” or “manager managed.” These non-tax issues are fundamental to doing business. Don’t let the cart get before the horse.

2. What state law considerations apply to your business? When I teach my grad students about incorporating a business, I have to mention states that follow the Model Act, the Revised Model Act, the Delaware law … and other regimes. Every state has both LLC and incorporation laws, but that’s where the similarity ends. Some states have special closely-held corporation rules that relax corporate formalities while others do not. There is not one standard LLC law any more than there is one uniform corporate law.

Other state-based legal issues fit into the mix as well. For example, in some states, an LLC structure offers added asset protection from creditors, and companies will try to be subject to these laws. In other states, professional firms are limited in what business structure they can elect. Additionally, due to state business taxes, the cost of doing business as a particular business entity varies from one state to the other. Some have franchise taxes on S Corps while others have such taxes on LLCs.

3. Who are the owners of the business? Before the “which way should I be taxed” question goes too far, consider the company’s ownership structure. Ownership, control and voting rights play important roles not only in the governance of the business but also in estate and tax planning for the owner. Depending on the owner’s financial needs, one business structure may offer flexibility that another business structure may lack.

S Corp rules in particular are precise about who can and can’t be owners. These rules limit the total number of owners to 100 individuals. The owners must be U.S. residents. And shares by and large cannot be owned by non-natural entities. LLCs don’t have these restrictions. C Corps on the other hand offer myriad options as to ownership, dividend participation, liquidation preferences and voting rights. It all comes down to what flexibility is needed and at what tax cost

4. How will payments be distributed? Deciding on salaries versus dividends is, again, like asking, “Should I focus my diet on carbohydrates or proteins?” It depends on the particular situation. The basic tax scenario is that wages are deductible to the company, but the employee is subject to income and employment taxes on those wages. Dividends and other owner distributions are not deductible. A complicating wrinkle is that if an LLC has chosen to be taxed as a partnership, potentially all distributions to owners can be subject to employment taxes. With an S Corp, however, only the owner’s wages are subject to FICA tax. So, a common issue for small businesses is whether to choose partnership taxation or S Corp taxation, not because of income tax, but because of payroll tax.

A company should consider how many owners are actually going to draw a salary and how much employment tax can be legitimately saved. In some cases, an LLC may fare better by continuing to be taxed as a partnership. For what little they lose in employment tax, they gain in flexibility – both in how they distribute profits and how they handle an exiting owner.

5. What is your fringe benefit structure? Fringe benefit taxation rules are generally better for C Corp owners than for owners of other businesses structures. Employees who have a 2 percent or more ownership in an S Corp and LLC don’t get to join in the positive tax advantages of several fringe benefit programs. For example, with group life insurance, salary continuation plans and health insurance, they have to recognize the employer premiums paid on these coverages in their personal income.

Similarly, owners of pass-through businesses such as S Corps and LLCs don’t enjoy the same tax benefits of nonqualified deferred compensation plans that that non-owners enjoy. For example, if you are a 25 percent owner of an S Corp that offers a nonqualified deferred compensation plan for its executives, one quarter of what you defer from your wages will just show back up in your share of K-1 income. Yes, you deferred taxes on a quarter of your wages, but that deferred salary returns to your tax return in the form of an owner share in profits.

6. What is your personal tax bracket? This has been a hot tax issue since the American Taxpayer Relief Act was passed in 2013. The issue is whether C Corp status might now offer some tax leverage that hasn’t existed for years. In the past, corporations and individuals shared the same top marginal tax bracket of 35 percent. Now, however, the top bracket for an individual is a combination of the 39.6 percent income tax bracket, plus the 3.8 percent surtax on net investment income – a potential 43 percent tax rate. This leaves an 8 percent spread between personal and corporate top brackets. For some high-income individuals, it may make sense to choose a C Corp structure to limit current income taxation to 35 percent. Yes, there will eventually be a tax to pay when earnings are distributed, but that may be a far-off event. In the meantime these owners enjoy a lower tax bracket and better fringe-benefit taxation.

C Corp, S Corp or LLC? It’s not as simple as the latest diet fad. And it’s a big decision not just a tax decision. Choose wisely.