Time for Baby Boomers to Pay Up

All you baby boomers who have been stashing away tax-deferred retirement savings, take note: it is getting close to the time to start withdrawing funds from those accounts and, of course, paying taxes on those withdrawals. This includes distributions from traditional IRAs and 401(k)s.

The same Internal Revenue Code that allowed you to save tax dollars when you contributed to those tax-deferred retirement plans also generally requires you to begin withdrawals on the year you reach age 70½. These distributions are called required minimum distributions (RMDs) and are based on annuity tables. Generally, most individuals will utilize the single life table, but the joint life annuity tables are used if the individual’s spouse is more than 10 years younger.

Keep in mind that you can always take as much as you wish from your tax-deferred retirement accounts, but you must take the RMD amount each year, beginning with the year you turn age 70½, or you will be subject to a very severe penalty, which we will discuss later. One exception is that you can delay the payout for the year you become 70½ until no later than April 1 of the following year. However, since you will also need to make an RMD for that following year, you will end up with two years’ worth of distributions being taxed in one year if you use the delayed distribution option.

The following is an abbreviated single life table. The actual table goes to age 111.

Age 70 71 72 73 74 75
Distribution Period (Years) 27.4 26.5 24.7 24.7 23.8 22.9

Required Minimum Distribution – To determine an RMD, first determine the distribution period (life expectancy) based on your current age. So, for the year you turn 70½, the distribution period would be 27.4 years. Next, determine the retirement account’s balance on December 31 of the prior year. The account balance divided by the distribution period equals the RMD. For example, say you will turn age 70½ in 2016 and your tax-deferred retirement account had a balance of $500,000 on December 31, 2015. Your 2016 RMD would be $18,248 ($500,000/27.4).

Failure to Take an RMD Penalty – When the full amount of an RMD is not taken, the penalty is 50% of the amount you didn’t withdraw. Luckily, the IRS is very lenient on this penalty and will generally waive it when an under-distribution is inadvertent or due to ignorance of the law, provided that the RMD amounts are made up as soon as possible once the error is discovered. Avoid RMD problems by having your account custodian or trustee determine the RMD annually and then transfer the distribution directly to your checking, savings or non-retirement plan brokerage account.

Multiple Retirement Accounts – When you have multiple accounts, the question often is, “Which account should I take the RMD from?” All traditional IRAs are treated as one for distribution purposes. So, you can take the RMD for the IRA accounts from any combination of the accounts that you choose. However, that may cause a problem with a trustee of the IRA account(s) from which you didn’t take a distribution, who may think you didn’t take your RMD for the year. So, it is less problematic to take a distribution from each account.

You may wish to simplify the RMD distributions by transferring all of your traditional IRAs into one account, if you have several traditional IRAs. This is best done by having the trustees make direct transfers to the target IRA, rather than you receiving the distributions and then rolling over the funds, since you are only allowed one IRA rollover each twelve months (trustee-to-trustee transfers don’t count as rollovers). Note that spouses must maintain their accounts separately and cannot combine their accounts with yours when figuring RMDs.

If you have a 401(k) account, the RMD for it must be figured separately from any IRA accounts you also have. And, if you have multiple 401(k)s, each 401(k) account’s RMD is figured separately from those of your other 401(k) plans.

Non-Taxable Amounts – If your tax deduction for the contribution was limited when you made your traditional IRA contribution because you were a high-income taxpayer, you would have created a non-taxable basis in your IRA. If this is true, then that non-taxable basis is recovered tax-free in proportion to your distribution.

Roth Conversions – The ability of individuals to convert amounts of their traditional IRAs to Roth IRAs gives rise to some possible tax-saving moves in the years leading up to the RMD age. Things to consider are:

  • Is you tax bracket lower now than it will be after retirement? If so, you might consider converting some portion of your traditional IRA to a Roth IRA now. You will pay tax on the traditional IRA distribution in the year of the conversion, but when you withdraw it from the Roth IRA, it will be tax-free.
  • If you have a low-income year for some reason, and if you are age 59½ or older, it might be appropriate to take a distribution in that year and pay little or no tax. You won’t get a credit against a future RMD by doing so but you will be lowering the balance in the account for the eventual calculation of RMDs.

These types of strategies require careful planning, and you should consult this office first.

Effect on Taxable Income Once RMDs Start – Your taxable income may be increased by more than just the amount of the RMD. Adding your RMD to your income that is already taxed will increase your adjusted gross income (AGI); as a result, the amount of your Social Security benefits that is taxed may also increase. In addition, since the AGI is the amount on which the phaseout or reduction of many tax deductions is based, you may also find that you are getting less tax benefit from such items as medical expenses, charitable contributions, and investment-related expenses – all of which means your tax bill will go up by more than it otherwise would by just adding the RMD to your income.

Plan for Additional Withholding or Estimated Tax – Once you start taking distributions from your IRA or 401(k), and to avoid a potential underpayment of tax penalty, you will likely need to increase your tax prepayments, either by having federal (and possibly state) income taxes withheld from the distributions or by making quarterly estimated tax payments. If you already make estimated tax payments, you may need to increase the installment amounts.

If You Don’t Need the RMD – If you simply don’t need the retirement distribution, after reaching age 70½, you can donate up to $100,000 of IRA funds per year to a qualified charity without having to include the distribution in your income, and it will still count towards your RMD. If you are married and your spouse has an IRA and is also 70½ or older, he or she may also make a charitable IRA distribution of up to $100,000. So, if you are someone who gives substantial amounts to charity each year, this is a distribution strategy you may want to consider after reaching RMD age. CAUTION: To qualify under this provision, the funds must be directly transferred from the IRA account to the charity.

RMD issues can be quite complicated, and it is highly suggested that you consult with this office for pre-RMD planning, determining the correct RMD amounts, and analyzing your withholding and/or estimated tax obligations.

9 Finance Tips All Business Owners Should Follow

Business owners are experts at their industry. You know your products and services well – better than the competition. You know how to reach those customers, too. But, managing what’s behind the scene isn’t always as easy. With the right tools and resources, including a professional by your side, you can enhance the way you do business, reduce your spend, and increase your profit margins. To get started, you need some basic information on finance.

#1: Recognize the Importance of Your Books Invoices, bank statements, and even some accounting work is commonly done through software programs today.

However, it’s more than just accounting for your revenue and losses that’s important. In other words, you need to turn this data into usable information. Your figures can help you know how to grow profits even further if you know how to read them properly.

#2: Stop Putting It Off

It is much harder to manage that stack of papers at the end of the month than it is to spend a few minutes each day entering details. Having a pro to do this for you makes it even easier. If you are procrastinating, though, you’re hurting your short-term and long-term financial goals.

#3: Know Your Risks

A Headway Capital study found that 57% of business owners planned to grow this year. Most companies set out to grow for the year, but they often lack attention spent on minimizing risks. What’s the worst-case scenario? What’s your break-even point? Addressing risks as a part of your financial strategy really can streamline your finances should the year not go as you planned.

#4: You Really Didn’t Budget, Did You?

Some small to medium businesses lack the time it takes to budget. It’s understandable, but that doesn’t make it okay. Budgeting helps address those risks, but it also helps you to make better buying decisions. And, when you have tools in place to help you monitor inventory, expenses, and other unforeseen costs, you can create better budgets that allow you to do more with your profits.

#5: Tax Mistakes Are Common

Small to medium businesses suffer from some of the most complicated taxes. Without having a professional to monitor and guide your taxes throughout the year, your business could suffer significantly. The IRS says that, in 2014, $1.2 billion in civil penalties were placed against small business income tax filers. Most small businesses need reliable support to ensure tax filing and reporting isn’t a secondary importance.

#6: Build from Your Strengths

You don’t have to build your business on new products or start from scratch each time. It’s best to simply build onto what you have. For example, you’ll want to pinpoint where your biggest profit margins come from. Once you understand who your moneymakers are, target them within your business. By identifying and focusing on these areas, you can build your revenue and profits faster, therefore giving you the room to expand in other areas later.

#7: Building a Business Is More Than Hours Worked

It’s very common for business owners to spend a lot of time and hard work building their business on their own. Are you putting in 80 hours a week? If so, you may be limiting your growth potential. Instead, empower professionals and employees to help you with delegated tasks. This can give you more time to spend on what’s really making you money and help you to sleep at night.

#8: Focus on Lean Practices Less really is more.

As a business owner, you’ll want to incorporate the lean philosophy of keeping less on hand so you reduce your overhead. You create more value for your customers with less.

#9: Access Capital When You Can, Not When You Need To

Having a steady stream of income on hand is important. Instead of waiting until you are desperate for funding, and having to show your investors that you are in that place, focus on planning ahead and minimizing the risk of a negative situation.

As a business owner, making wise financial decisions for your company is an ongoing process. But, you don’t have to do it alone. Allow professionals to help you along the way to better manage your money and you could see it grow faster than you thought possible.

Time Is Running Out! Extended Tax Due Date Just Around the Corner

If you could not file your 2015 return by the normal April due date and requested an extension, be aware that the final due date for your return is October 17, 2016. The date is normally October 15, but that falls on a weekend this year, giving you two extra days to meet your individual tax-filing obligation. There are no additional extensions, so this is it!

Even though you have until October 17, you need to be thinking about getting the return completed in advance of the actual due date. Preparing a return takes time, and last-minute issues may need to be resolved before the return is ready to file. In addition, between 10% and 15% of all tax returns are on extension, creating a rush for this office as many people file at once.

If you are self-employed, October 17 is also the final date when you can fund your existing self-employed retirement plan or establish a new one; without completing your return, there is no way to determine how much you can (or want to) contribute to that retirement plan.

The extended deadline for K-1s from partnerships, S-corporations, or fiduciary returns to be sent out was September 15, so if you have not received that information yet, you should make inquiries.

Extended individual federal returns are subject to a penalty of 5% of the tax due for each month (or part of a month) for which the return is not filed by the October 17 due date, with a maximum penalty of 25% of the tax due. In addition, if you end up owing taxes, the IRS will charge you interest on any tax due, going all the way back to the original April due date. If you do not file a required state return and do owe state taxes, the state will also charge a late filing penalty and interest.

If this office is waiting for you to supply missing information to complete your return, we will need that information at least a week before the October 17 due date. Please call this office immediately if you anticipate complications related to providing the needed information so that we can determine a course of action for avoiding potential penalties.

Ingenious Scam Targets Taxpayers

Crooks have tried all sorts of e-mails scams, but almost everyone has figured out that the IRS does not send out notices by e-mail. So crooks have changed their tactics. Now, there are reports of taxpayers receiving by mail (or email) fake notices requiring immediate payment to a P.O. Box. The P.O. Boxes are located in cities where the IRS has service centers, but of course are not IRS P.O. Box addresses.

These scammers have duplicated the look of official IRS mail notices, which to the untrained eye would lead one to believe a notice was really from the IRS.

So be extremely cautious of any notice you may have received from the IRS. If a notice is demanding immediate payment and there has not been any prior contact by the IRS over the issue, then the notice is probably from a scammer. Reports indicate the initial letters were numbered CP-2000.

Here is a sample fake IRS CP-2000 supplied by Iowa State University.


New Business? First-Year Deduction Strategies

If you are planning a new business start-up and are incurring some expenses, you probably anticipate deducting those expenses in the first year of the business’s operation. Unfortunately it is a little more complicated than that. Expenses a business incurs in the beginning can include equipment purchases, vehicle purchases and use, leasehold improvements, organizational costs and start-up expenses, and each receives a different tax treatment.

  • Equipment – The equipment you buy can’t be deducted until it is placed in service. For that reason, you can’t make any equipment deductions until the business is actually functioning. However, deductions for most equipment purchases are very liberal. For most small businesses, this means the entire cost of equipment and office furnishings can generally be written off in the year of purchase, if that is also the year when the equipment is put into service, using the Sec 179 expensing election. However, the deductible amount is limited to taxable income from all the taxpayer’s active trades or businesses (including a spouse’s active trades or businesses if married and filing jointly). Income from trades also includes W-2 income. Sometimes it may not be appropriate to write off the entire cost in the first year, in which case the equipment can be depreciated over its useful life (according to recovery periods established by the IRS). Most office furniture, fixtures and equipment are assigned a 7 year recovery period, but the depreciable period for computers is 5 years. The recovery period of equipment may vary depending on the type of business activity. There is also a 50% bonus depreciation election for the first year the equipment is placed in service.
  • Vehicles – Automobiles and small trucks that are purchased for use by the business are treated like equipment, as above, except their recovery period is 5 years and they are subject to the so-called luxury auto rules. These rules limit the depreciation to a maximum of $3,160 ($3,560 for light trucks and vans) for the first year. If bonus depreciation is elected, add $8,000 to the first-year maximum.
  • Leasehold Improvements – Generally, leasehold improvements are depreciated over 15 years. But through 2019, bonus depreciation may be elected, allowing between 30% and 50% of the cost of interior qualified improvements to non-residential property after the building is placed in service to be deducted in the first year. In addition, the Sec 179 expense deduction is allowed for qualified leasehold property, qualified restaurant property and qualified retail improvements.
  • Start-Up Costs – Taxpayers can elect to deduct up to $5,000 of start-up costs in the first year of a business. However, the $5,000 amount is reduced by the amount of the start-up costs in excess of $50,000. If the election is made, the start-up costs over and above the first-year deductible amount are amortized over 15 years. If the election is not made, the start-up costs must be capitalized, meaning the expenses can only be recovered upon the termination or disposition of the business. Start-up costs include:
    • Surveys/analyses of potential markets, labor supply, products, transportation, facilities, etc.;
    • Wages paid to employees, and their instructors, while they are being trained;
    • Advertisements related to opening the business;
    • Fees and salaries paid to consultants or others for professional services; and
    • Travel and related costs to secure prospective customers, distributors and suppliers.
  • Organizational Expenses – If the new business involves a partnership or corporation, the business can elect to deduct up to $5,000 of organization expenses in the first year of a business. This is in addition to the election for start-up expenses. Like start-up expenses, the $5,000 amount is reduced by the amount of the start-up costs in excess of $50,000. If the election is made, the start-up costs over and above the first-year deductible amount are amortized over 15 years. If the election is not made, the start-up costs must be capitalized. Organizational expenses include outlays for legal services, incorporation fees, temporary directors’ fees and organizational meeting costs, etc.

The foregoing is an overview of some of the expense issues in a business’s first year. As you can see, major decisions and elections need to be made that can have a lasting impact on the new business. You are encouraged to consult with this office for additional details and assistance in preparing a tax plan for your planned new business.

Should Our Olympic Champs Be Taxed On Their Prize Money & Medals?

You may not realize this, but in addition to winning an Olympic medal, winners are compensated by the U.S. Olympic Committee with prize money: $25,000 for a gold medal, $15,000 for a silver medal and $10,000 for a bronze medal. Should Olympic champs be taxed on their prize money & medals?

Oh, and by the way, the gold medals are not solid gold. In fact, they haven’t been solid gold since the 1912 Stockholm Games. This year’s gold medals are 92.5% silver with 24k gold plating. The 2016 Summer Olympics medals are worth roughly $587 in precious metals; however, they can bring many times that in an auction.

According to Sen. Charles Schumer, D-NY, both the prize money and the value of the medals are taxable income to our athletes. Schumer and Sen. John Thune, R-SD, have sponsored legislation exempting the value of medals and prizes awarded to Olympic and Paralympic athletes. The Senate has already passed the bill, but it has not been taken up by the House yet.

Gone (for 30 years now) are the days of Olympic participants being amateurs only. Some oppose exempting U.S. Olympians from being taxed on their awards for a couple of reasons: (1) recipients of other prizes, such as the Oscar swag bags, are required to pay tax on the value of their prizes, so why should Olympic athletes be treated differently? and (2) professional athletes who participate in sports as a business (NBA players, PGA golfers, etc.) can deduct their training and travel expenses as business expenses, and those who participate as a hobby may also be allowed some limited deductions. So is it necessary to exempt the Olympians’ winnings?

Congress is in summer recess and will not reconvene until after the games are completed. So we’ll have to wait for the results post-games.

Don’t Miss out on the Electric Vehicle Credit

If you are considering purchasing a new car or light truck (less than 14,000 pounds), maybe you should consider one of the many electric vehicles currently being offered for sale and take advantage of a federal income tax credit worth as much as $7,500.

The tax credit is actually made up of two parts: the basic amount of $2,500, which requires the electric vehicle to have a battery with at least 5 kilowatt-hours of capacity, and an additional $417 of credit for each kilowatt-hour of battery capacity in excess of 5 kilowatt-hours. The total amount of the credit allowed for any qualified vehicle is limited to $7,500.

However, the credit begins to be phased out for a particular manufacturer’s vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States.

If you are not an electrical engineer, it may seem a little complicated to figure out which vehicles qualify for the credit and for how much. You can usually rely on the information provided by the dealer. However, to be on the safe side, you can verify which vehicles are qualified and the credit amount available, based on the vehicle’s kilowatt-hours and the reduction in credit due to the credit phaseout, by visiting the IRS website. From the list on the linked page, click on the manufacturer of the vehicle you are interested in to find out if the model and year of that vehicle qualify for the credit and the amount of the credit.

To be eligible for the credit, you must acquire the vehicle for use or lease and not for resale. Additionally, the original use of the vehicle must commence with you, and you must use the vehicle predominantly in the United States. The vehicle is not considered acquired prior to the time when its title passes to you under your state’s law. The credit is available whether you use the vehicle for business, personally or a combination of both. The prorated portion of the credit that applies to business use becomes part of the general business credit, and any amount not used on your return for the year when you purchase the vehicle can be carried back to the previous year and then carried forward until used up, but for no more than 20 years.

What a Dealer May Not Tell You – The portion of the credit that is not treated as a general business credit (i.e., the personal use portion of the credit) is non-refundable. That means it can only be used to offset your tax liability for the year when you purchase the vehicle, and any excess credit is lost. Assuming you purchase the vehicle in 2016 and your 2016 tax return will be similar to your 2015 return, you can get an idea of how the credit will apply to you by comparing the amount on line 47 of your 2015 Form 1040 to the credit the vehicle provides. If line 47 is greater than the credit, then you will probably benefit from the entire amount of the credit on your 2016 return. If it is less, then you will only benefit from the amount on line 47 as it will be figured for your 2016 return.

If your 2016 tax return will be significantly different from your 2015 return, or you simply want to verify your benefit from the credit, please give this office a call.

Surprised by the Alternative Minimum Tax?

When looking over your tax return, do you notice an amount on line 45? If an amount is entered there, it is because you are subject to the alternative minimum tax (AMT). The AMT is a generally punitive method of computing income tax that does not allow some of the tax preferences and deductions that regular tax computation allows. When an AMT computation results in a higher tax, the higher tax applies, and the additional tax from the AMT is added on line 45 of your return.

The AMT was originally designed (nearly 50 years ago) to impose a minimum tax on higher-income taxpayers who were avoiding taxes by claiming certain (legal) deductions or other tax benefits (also termed “preferences”). However, years of inflation have caused an increasing number of taxpayers to be subject to the AMT.

It is complicated to determine when an individual will be subject to the AMT, for many tax preferences can trigger the AMT, alone or in combination. The following are some of the items that frequently trigger the AMT for the average taxpayer:

  • Medical Deductions – Deductions for medical expenses are allowed for the AMT computation – but only to the extent that they exceed 10% of the taxpayer’s income. Although the limit is also 10% for regular tax purposes, through 2016, taxpayers age 65 and over enjoy a lower limit of 7.5%, which leads to an AMT adjustment. Sometimes, it is possible to defer or accelerate medical expenses from one year to another (for example, by paying an orthodontist in installments or all at once). If your employer offers a flexible spending plan, consider participating, as such plans allow you to pay medical expenses with pretax dollars while avoiding both regular and AMT deduction limitations.
  • Deduction for Taxes Paid – When itemizing deductions, a taxpayer is allowed to deduct a variety of other taxes, such as real or personal property taxes and state income or sales taxes. However, for AMT purposes, none of these itemized taxes is deductible. For most taxpayers, this represents one of the largest tax deductions, and it frequently triggers the AMT. If you are affected by the AMT, conventional wisdom dictates deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised regarding late-payment penalties and interest on underpayments. In addition, taxpayers can annually elect to capitalize their taxes on unimproved and unproductive real estate. This means foregoing the deduction and adding the tax paid to the cost basis of the real property.
  • Home Mortgage Interest – For both regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a first or second home is deductible as long as it does not exceed the debt limit (generally $1 million). This is also true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the first two homes can also be deducted. However, equity debt is not deductible when computing the AMT; neither is acquisition or equity debt on a motor home or boat that may qualify as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.
  • Miscellaneous Itemized Deductions – Among miscellaneous deductions, the category that includes employee business and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this will often trigger the AMT. Employees with significant employee business expenses should attempt to negotiate an “accountable” reimbursement plan with their employers. Under this type of plan, reimbursement for qualified expenses is tax-free. An employee who has been reimbursed no longer claims a deduction for those expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year that is not affected by the AMT.
  • Personal Exemptions – The AMT computation does not allow a deduction for personal exemptions, which in 2016 is $4,050 each for the taxpayer, his or her spouse (if any) and any dependents. Divorced or separated parents should carefully consider which party should claim the exemption for their children if one of the parents is subject to the AMT.
  • Standard Deduction – For regular tax purposes, taxpayers have the option of itemizing their deductions or taking the standard deduction. However, for AMT purposes, there is no standard deduction. Thus, a taxpayer who ends up with an AMT when taking the standard deduction should try to force itemized deductions, even if the result is less than the standard deduction. The result will be an increased regular tax but a reduced AMT, which could result in overall tax savings. Even the smallest of deductions will benefit those who are taxed at a minimum of 26% (the lowest bracket for the AMT).
  • Incentive Stock Options – Although not frequently encountered, incentive stock options (ISOs) can have a profound impact on a taxpayer’s AMT. Generally, to achieve the beneficial long-term capital gains rates on stock acquired through an ISO, a taxpayer must hold the stock for more than one year after exercising the stock option and two years after the option is granted. However, the difference between the fair market value and the option price must be added to the taxpayer’s AMT income in the year the option is exercised. To avoid this substantial AMT preference income, the taxpayer can sell the stock in the year that the option is exercised and forego long-term capital gains rates. Alternatively, when doing so is beneficial, the taxpayer can exercise the option in small blocks over a period of years.
  • Business Incentives – Taxpayers’ investments in businesses and partnerships sometimes provide tax incentives that the AMT does not allow. There is a long list of these incentives, but the most common are depletion allowances and intangible drill costs. Generally, these items appear on a Schedule K-1 (which the business activity issues to the investor) and are then included in the taxpayer’s AMT calculation.

As you can see, the AMT can be an extremely complicated area of tax law. Careful planning is required to minimize its effects. Please contact our office for further assistance.

Treasury Department and IRS Proposed Regulations May Cause Family-Controlled Entities to Lose Estate-Planning Discount

The Treasury Department and IRS released proposed regulations, which, if finalized, will reduce the valuation discounts when transferring interests in family-controlled entities among family members.

Valuation discounts are frequently used to lessen the value of interests in closely-held entities for estate, gift and generation-skipping transfer tax purposes. These discounts allow a greater amount of property to be transferred to younger generations, by using less of taxpayer’s estate/gift lifetime exclusion. The proposed regulations affect the value of the interests transferred, but not the entities themselves, by reducing or eliminating the ability to apply valuation discounts in certain circumstances. The proposed regulations were issued on August 4, 2016.

In order to be affected by the proposed regulations, the following three criteria must apply:

  1. Family member owners of entities which are corporations, partnerships, LLCs or other arrangements deemed to be a business entity;
  2. Entities which are controlled by family members before and after a transfer:
    • LLCs or other entities:
      • at least 50 percent of the capital interests in the entity or arrangement; or
      • at least 50 percent of the profit interests in the entity or arrangement; or
      • an equity interest with the ability to cause the liquidation of the entity or arrangement in whole or in part.
    • Corporations:
      • at least 50 percent of the total voting power of the equity interest of the entity; or
      • at least 50 percent of the total fair market value of the equity interests of the entity.
    • Partnerships:
      • at least 50 percent of the capital interest in the partnership; or
      • at least 50 percent of the profits interest in the partnership; or
      • a general partner in a limited partnership regardless of their ownership percentage.
  3. Controlled by the transferor and/or family members. Family includes, for this purpose, the spouse of the transferor, any ancestor or lineal descendant of the transferor or their spouses, and any brother or sister of the transferor and their descendants and spouses. If the owner is an entity, look through the entity to the individual owners. If the owner is a trust, look through the trust to current beneficiaries.

These are complex regulations that determine the impact of changes in voting rights, and restrictions could occur when transferring interests in business entities, either by gift during a taxpayer’s lifetime or by bequest at death. These are generally provsions built into shareholder or partnership agreements that indicate the rights of transferees in the interests they receive. This is compared to the rights, powers and restrictions the transferor might have had prior to the transfer. Changes to these rules will substantially limit the transferor’s ability to reduce the value of the interest transferred.

The new valuation rules will generally apply to transfers occurring after the date the final regulations are published. That date will not occur prior to December 1, 2016.

All individuals who might be affected should identify any potential opportunities for lifetime transfers of property that can still use the discounting benefits before the regulations become final. It is also important to determine the impact of the rules on future estate tax liabilities. Business ownership agreements and your current estate planning documents should be analyzed and reviewed.

Contact Us

Contact a Tarlow partner at 212-697-8540, with any questions regarding this article, or any of your estate planning needs.

Partners May Not Be Employees

If your partnership has been treating you and other partners as employees of a disregarded entity owned by the partnership in order for the partners to participate in employee benefit plans and receive other employee benefits, you’d better read this. Temporary tax regulations(1) recently issued by the IRS take aim at this practice and were written to stop it.

Background: A disregarded entity is treated as a corporation(2) for the purposes of employment taxes. Therefore, the disregarded entity, rather than the owner, is considered to be the employer of the entity’s employees for the purposes of employment taxes. However, the owner is not treated as an employee and instead pays self-employment tax on the net earnings from self-employment resulting from the disregarded entity’s activities.

The current regulations do not include an example where the disregarded entity is owned by a partnership, and because of that some taxpayers have interpreted the regulations in a way unintended by the IRS. Under this incorrect interpretation of the regulations, some partnerships have permitted partners to participate in certain tax-favored employee benefit plans, which is contrary to the IRS’s intention.

The IRS and the Treasury have noted that regulations did not create a distinction between a disregarded entity owned by an individual (a sole proprietorship) and a disregarded entity owned by a partnership in the application of the self-employment tax rule. In addition, the IRS does not believe that the regulations alter the long- standing holding(3) that:

  1. A bona fide member of a partnership is not an employee of the partnership, and
  2. A partner who devotes time and energy to conducting the partnership’s trade or business, or who provides services to the partnership as an independent contractor, is considered self-employed and is not an employee.

To resolve this issue, the IRS has issued temporary regulations modifying the original regulations to clarify the rule that an entity disregarded for self-employment tax purposes applies to partners in the same way that it applies to a sole proprietor owner. Accordingly, the partners are subject to the same self-employment tax rules as partners in a partnership that does not own a disregarded entity.

The IRS is allowing any plan sponsored by an entity that is disregarded as an entity separate from its owner to apply the revisions on Aug. 1, 2016, or the first day of the latest-starting plan year following May 4, 2016, whichever is later.

If this issue affects you or your partnership, and you have questions, please give this office a call.

(1) Reg. Sec. 301.7701-2T
(2) Reg. Sec. 301.7701-2(c)(2)(iv)(B)
(3) Rev. Rul. 69-184