EisnerAmper Trends and Developments February 2010
Persons named as a beneficiary of a deceased individual’s Individual Retirement Account (“IRA”) are often confused as to how to handle such a bequest. One choice is to take all of the funds out of the account, but with a traditional IRA this will generally cause the amount to be taxed immediately at ordinary income tax rates. In the case of a Roth IRA, the distribution may not be taxable. However, for many people, it may be preferable to leave some or all of the funds in an IRA (including a Roth IRA) and comply with the rules for required minimum distributions. Failure to comply with these rules will cause a 50 percent excise tax to apply.
While the rules may appear somewhat complex, for those IRA owners and their beneficiaries who can afford to leave the assets in their IRAs for as long as possible, it is important to have a full understanding of the alternatives in order to maximize the period of tax deferral or (for a Roth IRA) exemption.
The choices available to an IRA beneficiary can be isolated by three factors:
1. Is the beneficiary the spouse of the deceased IRA owner?
2. Is the IRA a Roth IRA or a traditional IRA?
3. For a traditional IRA, had the deceased IRA owner reached age 70½ at the time of death?
I. Spouse is the Beneficiary
A. Traditional IRA
Where a surviving spouse is the sole designated beneficiary of a traditional IRA, he or she can either (a) elect to treat the existing IRA as if he or she was the original owner or (b) roll over the existing IRA to his or her own IRA. In either case, the surviving spouse should name a new beneficiary on the account and will be required to start taking required minimum distributions by April 1 of the year following the year in which he or she reaches age 70½. If the surviving spouse has already reached that age, the required minimum distributions to the surviving spouse would commence for the year of death, unless the deemed IRA owner had already taken the required minimum distribution for that year.
Another available option is for the surviving spouse taking distributions from the deceased spouse’s traditional IRA by December 31 of the year following the calendar year of the spouse’s death. Under this alternative, the surviving spouse must withdraw the funds over his or her remaining life expectancy (using IRS tables). This life expectancy is revised each year using the IRS tables.Some surviving spouses would be better off not rolling over the IRA or treating the IRA as his or her own. For example, if the surviving spouse is under age 59½, withdrawals from the decedent’s IRA can be made without paying a 10 percent penalty. Where the sole designated beneficiary is the deceased IRA owner’s surviving spouse, a special rule allows the surviving spouse to delay taking distributions until the end of the calendar year in which the deceased IRA owner would have attained age 70½ (assuming such date is later than December 31 of the year immediately after the year of the IRA owner’s death). This could be of interest where the surviving spouse is significantly older than the deceased spouse. In some cases, it may be advantageous for the surviving spouse to disclaim his or her interest in the IRA so that the account would go to the secondary beneficiary. The disclaimer can be made without being a taxable gift if made within nine months of death, but not if the account has been rolled over.
B. Roth IRA
With a Roth IRA, if the surviving spouse is the sole beneficiary, he or she is usually treated as the account owner and does not have to take any distributions during his or her lifetime. Thus, a surviving spouse who inherits a Roth IRA has flexibility and can let the account grow tax-free for children, grandchildren, or other persons (even a new spouse). If the surviving spouse wishes to take distributions from the Roth IRA in excess of cumulative contributions, he or she may do so income tax and penalty free provided the Roth IRA has been in existence for at least five years and the surviving spouse has reached age 59½ . A particular Roth IRA plan may contain a provision for a spouse who is sole beneficiary to make an election not to treat the Roth IRA as the surviving spouse’s, thereby requiring distributions over a period no longer than the life expectancy of the surviving spouse. Such distributions must begin by the later of (a) December 31 of the calendar year in which the deceased spouse died or (b) December 31 of the calendar year in which the deceased spouse would have attained age 70½.
II. Beneficiary is not Decedent’s Spouse
A. Traditional IRA
Where a person other than the decedent’s spouse is the beneficiary of a traditional IRA, there are two alternatives for satisfying the required minimum distribution rules when the deceased IRA owner dies before April 1 of the year after the year in which the deceased IRA owner would have reached age 70½:
- One choice is to distribute the entire interest in the IRA to the beneficiary not later than December 31 of the calendar year of the fifth anniversary of the IRA owner’s death (the “five-year rule”). For a beneficiary who desires to maximize the tax deferral advantages of an IRA, this is not the best choice.
- The second, and usually preferable, choice is to commence distributions by December 31 of the year after the IRA owner’s death and take them over the beneficiary’s life expectancy (or shorter period) using the IRS Tables. Once this life expectancy is determined, for each subsequent year the distribution period is reduced by one for each calendar year that has elapsed after the calendar year of the IRA owner’s death. This is the distribution rule that would apply in the absence of a plan provision or an election to use the five-year rule.
If a person other than the decedent’s spouse is the beneficiary of a traditional IRA and the deceased IRA owner dies after April 1 of the year after the year in which he or she reached age 70½, required distributions must commence by December 31 of the year after the IRA owner’s death. These distributions should be taken over the beneficiary’s life expectancy. However, if the remaining life expectancy of the deceased IRA owner is longer than the beneficiary’s life expectancy (i.e., the beneficiary is older than the deceased IRA owner), then the remaining life expectancy of the deceased IRA owner is used to determined the required minimum distributions.
B. Roth IRA
With a Roth IRA and a non-spouse beneficiary, the beneficiary generally can elect one of two alternative methods to satisfy the required minimum distribution rules.
- One choice is to distribute the entire interest in the IRA to the beneficiary not later than December 31 of the calendar year of the fifth anniversary of the IRA owner’s death. For a beneficiary who desires to maximize the tax exemption advantages of a Roth IRA, this is not the best choice.
- The second, and usually preferable, choice is to commence distributions by December 31 of the year after the Roth IRA owner’s death and take them over the beneficiary’s life expectancy (or shorter period) using the IRS Tables. Once this life expectancy is determined, for each subsequent year the distribution period is reduced by one for each calendar year that has elapsed after the calendar year of the IRA owner’s death. If required minimum distributions do not commence by December 31 of the year after the IRA owner’s death, the five-year rule will usually become operative. It should be noted that some Roth IRA arrangements may mandate payout within five years unless the beneficiary affirmatively elects to use the life expectancy method.
If the beneficiary chooses to start withdrawals before the expiration of five years from the time the decedent opened the Roth IRA, distributions in excess of the cumulative contributions to the Roth IRA by the decedent would be subject to income tax and penalty. However, if the life expectancy method is used, the required minimum distributions are often small enough so that no earnings are deemed distributed in the first five years.
It is important to have a properly designated beneficiary of your IRA account. If there is no designated beneficiary, full distribution is required by December 31 of the calendar year of the fifth anniversary of the IRA owner’s death. Furthermore, failure to take distributions in accordance with the above rules will result in the 50 percent excise tax. For these and other reasons, your beneficiary choices should be reviewed in the context of your overall estate planning and you should make sure that the financial institution that is the custodian of your IRA has a properly completed beneficiary designation form on file. A conformed copy of this form should be maintained with your important papers.
TIME IS SO PRECIOUS. SO IS NETWORKING.
There is never enough time to do all the things we need to do, want to do, and would like to do. Networking is one of those things that can be pushed off to the side, unless we embrace it and make it part of our routine. So, how do we do that?
As long as networking is looked at as “another” activity, it will be just another thing on our evergrowing To Do Lists. However, incorporating it into our daily routine makes it easier, more effective and not a time drain. Here are some tips to start making this happen:
- Talk to everyone you meet at your kids’ school, a community event or a friend’s party. Ask people who they work for, what they do for a living, and what organizations they’re involved with. What about their spouses? Find some common ground to have a dialog.
- Listen for companies and careers that offer you connections that would be helpful for business. Your daughter’s friend’s dad or mom might turn out to be the CFO at a local corporation you would like to work with. Be inquisitive — make it part of your routine.
- Get to know people in the organizations that you like to work with, such as the Girl Scouts, local charities, or the Parent-Teachers Association. Again, ask lots of questions.
- While commuting to the office, think about people you recently met or those from your past that you want to reconnect with. Make a list of their names; do you have their contact information?
- Each week, try sending one person a quick email with the subject line of “Just Catching Up” and simply say “hi” and see how they are doing. Let them know something about you and try to include something about work, making sure to mention your organization’s name in the dialogue. Sign off by telling them how to contact you and to stay in touch. You never know when this contact will come in handy down the road. Keep it alive.
- If you don’t have the person’s contact info, who might? Try a friend or a former colleague and use this as an excuse to touch base with them. Reconnect there also.
- Network in the convenience of your home. Once a week, when you are on the internet at home, sign into a professional social networking site such as LinkedIn to see if you know anyone you want to connect with. Join some LinkedIn Groups for your areas of interest, an alumni group, or seek out a special interest topic. (If you don’t have a LinkedIn account, go to www.linkedin.com to sign-up for a free account.)
- Of course, networking events expand your reach. Choose them wisely. Plan ahead so you have the time and make them enjoyable. Pick a venue that you are comfortable with, whether it’s a seminar, CPE course, community event, alumni gathering, or simply dinner with an old friend. Talk to people, learn something at the event.
- Always follow up to strengthen your relationships. Thank you notes are currency, and it’s very easy to start an email with “Just following up on….” The biggest network in the world doesn’t help if you don’t stay in touch.
IRS WILL BEGIN DETAILED TAX AUDITS IN LATE FEBRUARY
As we previously wrote, the IRS has developed a National Research Program (NRP) on employment taxes. It was previously anticipated that these examinations would begin in November of 2009. The IRS stated on January 22 that training of agents will be completed by mid-February and that agents will have their case assignments once they return to their respective regions. Thus, the first examinations are expected to begin in late February or early March. As with previous NRP projects, the goal of the NRP is, through the conduct of a large number of exams (6,000 under this program), to collect substantial data that will assist the IRS with improving its compliance programs and the utilization of its resources. During the NRP, the IRS will conduct detailed employment tax examinations of employers of various sizes over the threeyear period. The employer’s 2008 tax year will currently be the year subject to exam.
Employers will be receiving letters from the IRS stating either that they are subject to a ‘compliance research examination’ or a ‘3850-B’ examination.
The NRP examination program is expected to last for three years and approximately 2,000 taxpayers will be examined in each of the three years. The examinations may look at any reporting aspect of the return; however, the primary areas of focus are expected to be the ollowing items:
- worker classification (employee vs. independent contractor);
- fringe benefits;
- officer’s compensation;
- backup withholding; and
- Form 1099 reporting.
According to the IRS, the selection process for an NRP examination is based on a statistical sample and does not mean that a Form 941 Employer’s Quarterly Federal Tax Return or Form 945 Annual Return of Withheld Federal Income Tax (the return) was incorrectly filed by a taxpayer.
Taxpayers that have not reviewed their procedures and practices for the above items should take a fresh look at the law and related regulations to ensure that they are in compliance to avoid the potential for harsh penalties and, in case they are selected for examination, to show that they are now in compliance.
Peter Alwardt is the partner-in-charge of Eisner's employee benefits group. You can contact him at 212.891.6022
YOUR HOME CAN REDUCE YOUR INCOME TAXES
While most people are aware that federal tax deductions are available for real estate taxes and mortgage interest derived from their personal residence, many taxpayers do not recognize the limitations on these deductions and that they may not be getting a full (or partial) tax benefit. In addition, we want to inform our readers about two home related tax benefits that are scheduled to expire in 2010.
Real Estate Taxes
Real estate taxes are not deductible in computing the alternative minimum tax (the “AMT”). Someone already subject to the AMT would get no benefit from the real estate tax deduction. For those taxpayers who are close to being in the the AMT without a real estate tax deduction, this deduction could cause the person to be in the AMT and not obtain the full benefit of the deduction.
Mortgage interest on a loan secured by your principal residence (and a second residence) is deductible if the debt was incurred for the acquisition, construction, or substantial improvement of the residence (“acquisition debt”), but only to the extent the interest is on $1 million ($500,000 if married filing separately) of principal amount.
Acquisition debt also includes debt from a refinancing of an existing acquisition indebtness, but only up to the principal of that debt at the time of the refinancing plus any proceeds used to substantially improve your residence.
In addition to acquisition debt, interest on a home equity debt may be deducted to the extent interest is on principal that does not exceed $100,000, as long as the debt is secured by a qualified residence and does not exceed the equity in the residence. However, this interest is not allowable as a deduction in computing AMT if the debt was not used to substantially improve the residence.
If a taxpayer enters into a contract to purchase a principal residence before May 1, 2010 (and the sale closes before July 1, 2010) and the purchase price does not exceed $800,000, he or she may be entitled to a credit as follows:
First-time home buyer: 10 percent, with an $8,000 maximum ($4,000 if married filing separately).
Long-time resident of same principal residence: 10 percent, with a $6,500 maximum ($3,250 if married filing separately).
A “long-time resident” is one who has owned and used the same residence as a principal residence for any five-consecutive-year period during the eight-year period ending on the date of purchase of the new residence. However, the amount of the credit is phased out when modified adjusted gross income on a joint return exceeds $225,000, and is eliminated at $245,000 ($125,000 and $145,000, respectively, for other taxpayers).
A 30 percent (of the cost) credit is available for “qualified energy efficiency improvements” or “residential energy property expenditures” which are installed before January 1, 2011 in the taxpayer’s principal residence located in the United States. There is no income limitation for this credit, but it cannot exceed $1,500 for all qualified property placed in service during 2009 and 2010. Although not all inclusive and subject to various energy efficiency requirements, qualified property includes:
- exterior windows and doors
- metal or asphalt roofs that reduce heat gain
- insulation that reduces heat gain or loss
- electric heat pumps
- central air conditioners
- natural gas, propane or oil water heaters
- stoves using biomass fuel or propane
- a natural gas furnace or hot water boiler
- a qualified oil furnace or hot water boiler
In most cases, your contractor or vendor will know if the improvement qualifies for the credit.
Gain on Sale
Should you be fortunate enough to eventually have a gain on the sale of your principal residence, you may be eligible for an exclusion that allows up to $500,000 of the gain to be tax free, if you file as married jointly and meet the following tests (other taxpayers can exclude up to $250,000 of the gain):
- You owned your home for at least two years;
- You used the home as your principal residence for at least two years, in the aggregate, during the five-year period ending on the date of sale; and
- You have not excluded the gain on a home sale within the last two years.
A pro-rata exclusion is allowed if you fail the above tests as a result of a hardship, which includes a change in employment, health reasons, multiple births from the same pregnancy, divorce or legal separation, or other unforeseen circumstances. The pro-rata exclusion is equal to a ratio computed by comparing the time you used and owned the house as your personal residence within the past two years, divided by two years.
A surviving spouse who has not remarried and sells a principal residence within two years from the date of death of his or her spouse can exclude $500,000 of gain rather than the $250,000.
It is important to keep appropriate records to compute the tax basis of your residence. In addition to the closing statement for the purchase, you should have documents to substantiate the costs of renovations, extensions, and other capital improvements. This documentation can be worth its weight in tax benefits when you sell the home. A gain on the sale of a personal residence in excess of the $500,000/$250,000 exclusion is taxable as a capital gain. However, a loss on the sale of your personal residence is not deductible.
IRS TO SEND 401(k) PLAN SPONSORS QUESTIONNAIRE TO MEASURE TAX COMPLIANCE
The Internal Revenue Service (“IRS”) will, starting this year, begin questioning plan sponsors regarding their compliance with the tax rules covering 401(k) plans including gathering information about their plan’s deferral rates, eligibility standards, and their compliance with nondiscrimination tests. The IRS expects to send the questionnaires beginning in March to 401(k) retirement plan sponsors in an effort to assess the relative level of tax compliance and to determine what type of compliance issues need to be addressed.
While the IRS has not indicated how many 401(k) retirement plan sponsors will be receiving the questionnaire, it is expected that several thousand plan questionnaires will be issued in order to sample a reasonable cross-section of the plans sponsored across the country.
The issuance of a questionnaire with respect to 401(k) plans is a first for the IRS, which typically gathers compliance information through routine audits of the annual Form 5500 filing for the plans and its voluntary compliance program, the Employee Plans Compliance Resolution System (“EPCRS”). After the information is obtained from plan sponsors, the IRS is expected to issue a report on its findings and to develop strategies to deal with any noncompliance trends reflected in the data. Other reviews conducted by the IRS have shown significant noncompliance in 401(k) plans resulting from a lack of internal controls at the plan sponsor (for example, not having a process for verifying that payroll data provided to the plan’s thirdparty administrator is accurate).
401(k) plan sponsors responding to the questionnaire that suspect they may have failed to comply with some of the tax rules covering their plan should consider utilizing the IRS’ EPCRS as noted above. The program, generally, allows a plan sponsor to correct noncompliance issues related to their plan by disclosing the errors to the IRS and paying a set filing fee. By correcting compliance issues through the voluntary program, plan sponsors can avoid having the same issue raised by the IRS during an audit of the plan, which typically results in larger penalties.