Series: From Tax Preparer to Financial Planner: The Road Best Traveled
Part 2: The 1040 Diagnostician: Moving from Tax Compliance to Tax
Planning for Individuals
Tax and Financial Planning for Individuals
AICPA
Presented by:
Robert S. Keebler, CPA, MST, AEP (Distinguished)
Lyle K. Benson, CPA/PFS
Julie A. Welch (Runtz), CPA/PFS
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained
in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties
under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you
would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
Introduction
Moderator
Lyle Benson, CPA/PFS
L. K. Benson & Company
1107 Kenilworth Dr, Suite 302
Baltimore, MD 21204
Phone: 410.494.6680
Fax: 410.494.6682
Lyle@lkbenson.com
Featured Speakers
Robert S. Keebler, CPA, MST, AEP (Distinguished)
Keebler & Associates, LLP
420 S. Washington St.
Green Bay, WI 54301
Phone: (920) 593-1701
Robert.Keebler@keeblerandassociates.com
Julie A. Welch (Runtz), CPA/PFS
Meara Welch Browne, PC
Certified Public Accountants & Consultants
800 W. 47th St., Suite 430, Kansas City, MO 64112
816-561-1400 | 816-561-6296 fax
Julie@meara.com
Personal Financial Planning Section
2
Introduction
About the PFP Section & PFS Credential
• The AICPA PFP Section provides information, resources,
advocacy and guidance for CPAs who specialize in providing
estate, tax, retirement, risk management and investment
planning advice to individuals and their closely held entities
• The CPA/Personal Financial Specialist (PFS) credential
distinguishes CPAs as subject-matter experts who have
demonstrated their financial planning knowledge through
experience, education and testing
Personal Financial Planning Section
AICPA Web Seminar Series:
From Tax Preparer to Financial Planner
Build your financial planning knowledge with this web
seminar series and discover the necessary steps to
transition from tax preparer to financial planner.
Register today at CPA2Biz.com/Webcasts. Discounts available for
PFP/PFS and Tax Section members.
Part 1 Part 2 Part 3 Part 4
Understanding Moving from
the value of
tax
financial
compliance to
planning
tax planning
for individuals
Personal Financial Planning Section
Moving from
tax planner to
holistic
financial
planner
Implementing
a PFP practice
Overview
The IRS Form 1040, when properly analyzed, reflects
a wealth of information and planning opportunities:
•
•
•
•
•
•
•
Current tax mitigation strategies
Long-term tax reduction and retirement strategies
Education funding
Retirement funding
Life insurance planning
Long-term care (LTC) planning
Estate planning
Personal Financial Planning Section
5
Tax Asset ClassesSM
Interest
Income
Capital Gain
Income
Dividend
Income
-Preferential
Rate
-Deferral until
sale
- Taxable
•
•
•
Money
market
Corporate
bonds
US Treasury
bonds
Attributes
• Annual
income tax
on interest
• Taxed at
highest
marginal
rates
Pension
and
IRA Income
Tax Exempt
Interest
•
Equity
securities
Attributes
• Qualified
dividends at
LTCG rate
• Return of
capital
dividend
• Capital gain
dividends
•
Equity
Securities
Attributes
• Deferral
until sale
• Reduced
capital
gains rate
• Step-up
basis at
death
- Tax
Deferred
•
•
•
•
Attributes
• Federal tax
exempt
• State tax
exempt
SM
Personal Financial Planning Section
Bonds issued by
State and local
Governmental
entities
Pension
plans
Profit sharing
plans
Annuities
Attributes
• Growth
during lifetime
• RMD for IRA
and qualified
plans
• No step-up
Real Estate,
Oil & Gas
and Tax
Exempt
Bonds
- Tax
Preferences
Real Estate
• Depreciation
tax shield
• 1031
exchanges
• Deferral on
growth until
sale
Oil & Gas
• Large up
front IDC
deductions
• Depletion
allowances
Tax Asset Classes is a service mark of Robert S. Keebler, CPA, MST, AEP and
Keebler & Associates, LLP
Roth IRA
and
Insurance
- Tax Free
Growth/
Benefits
Roth IRA
• Tax-free
growth during
lifetime
• No 70½
RMD
• Tax-free
distributions
out to
beneficiaries
life
expectancy
Life Insurance
• Tax-deferred
growth
• Tax-exempt
payout at
death
6
Address
Top of Tax Return
• Move to a low-tax or no-tax state before you receive a large
gain
̶ Consider what it takes to be a “resident” of the new state
• Consider state taxability of retirement income and Social
Security
Personal Financial Planning Section
7
Filing Status
Boxes 1 – 5 Filing Status
• Consider filing separately
̶ One spouse with large medical or miscellaneous expenses
• Consider head of household
Lives with
you
Qualifying child
X
Married child or grandchild
X
Parent
Other relative
Personal Financial Planning Section
Qualifies as
your dependent
X
X
X
X
8
Dependents
Basic facts
• Personal exemption $3,800
- No phase-out for 2012 but watch 2013
- AMT may wipe out federal (but not state) benefit
• If divorced, custodial parent claims
- Exception for IRS Form 8332 attached to return
- Release/Revocation of Release of Claim to Exemption
for Child by Custodial Parent
Personal Financial Planning Section
9
Line 7 – Wages & Salaries
Strategies to Reduce Wages
•
•
•
•
•
•
Maximize 401(k) or Roth 401(k) type plan
Evaluate Dependent Care contributions
Evaluate Healthcare contributions
Evaluate Deferred Compensation contributions, if available
401(k) contributions
Fringe Benefits
- Continuing education
- Cell phones
Personal Financial Planning Section
10
Line 8a – Interest Income
Taxable Interest
• Reflects Interest from Investments, Taxable Bonds and
Installments Sales
• Reflects the “Amortization” of Original Issue Discount
• Reflects the “Amortization” of Market Discount
Personal Financial Planning Section
11
Line 8a – Interest Income
• Interest actually paid is reported on the cash basis
of accounting
• U.S. Savings Bonds
– Defer income (either report annually or upon maturity)
– Exclude income on educational savings bonds – higher
education
– Must be age 24 – individual, spouse, or dependent
– Phase out for 2012
– Single 72,850 – 87,850
– MFJ 109,250 – 139,250
Personal Financial Planning Section
12
Line 8b – Tax-Exempt Interest
Tax-Exempt Interest
• Reflects Interest from Tax-Free Money Market and
Tax-Free Bonds
• Reflects the Amortization of Original Issue Discount
on Tax-Exempt Bonds
• Reflects the Amortization of Market Discount on TaxExempt Bonds
• Interest Actually Paid is Reported on the Cash Basis
of Accounting
• Private Activity Interest is Subject to the Alternative
Minimum Tax
Personal Financial Planning Section
13
Line 9a – Ordinary Dividends
Ordinary Dividends
•
•
•
•
IRS Form 1099-DIV, Line 1a
Reflects total dividends less qualified dividends
Cash basis of accounting
Foreign dividends are reported on a gross basis before
withholding
- A foreign income deduction or foreign tax credit is available
Personal Financial Planning Section
14
Line 9b – Qualified Dividends
Qualified Dividends
• IRS Form 1099-DIV, Line 1b
• Need to meet certain requirements
• Treated like long-term capital gains (i.e. taxed at either 0% or
15% in 2012)
• CAVEAT: Treatment goes away in 2013 (unless Congress
extends the law)
Personal Financial Planning Section
15
Line 9b – Qualified Dividends
Capital Gain Distributions
Capital Gain Distributions
• IRS Form 1099-DIV, Line 2a
• Represents certain dividends from mutual fund and/or REITs
• Always treated like long-term capital gains (i.e. taxed at either
0% or 15% in 2012) regardless of how long the taxpayer held
the investment
̶ However, some capital gain distributions are classified as
unrecaptured IRC §1250 gain, IRC §1202 gain or
“collectibles” gain
• Reported on IRS Form 1040, Line 13 (via Schedule D)
Personal Financial Planning Section
16
Line 10 – Taxable Refunds, Credits or
Offsets of State and Local Taxes
Overpayments of state and local income tax are includible in
income in the year received to the extent they reduced tax
payable in the year of overpayment
Not includible in income if the taxpayer did not itemize in the
earlier year
Taxpayers who itemized in the year of the overpayment may not
have received a deduction for the full amount of the
overpayment
• The amount of the benefit is the lesser of the deduction for state
taxes paid or the excess of itemized deductions for the year of
the overpayment over the amount of the standard deduction for
that year
Personal Financial Planning Section
17
Line 10 – Taxable Refunds, Credits or
Offsets of State and Local Taxes
Facts
• Rick and his wife Ann filed a joint return in 2011 claiming a deduction of
$8,000 for state and local taxes and a $5,000 charitable deduction
• In 2012, they received a $2,000 refund on the state and local taxes paid
in 2011
• The standard deduction for 2011 was $11,600
Tax Consequences
• The amount reported on line 10 is the lesser of the amount of the refund
($2,000) or the excess of itemized deductions over the standard
deduction amount ($13,000 - $11,600 = $1,400)
• Only $1,400 is included in income because the last $600 did not reduce
income in 2011
• If AMT applied in 2011 and eliminated the entire benefit, then no amount
is taxable in 2012
Personal Financial Planning Section
18
Line 11 – Alimony Received
Alimony is amounts received from a spouse or
former spouse under a divorce settlement or
separation agreement
Deductible by payor spouse
Recipient can’t report amounts on a Form 1040A or
1040EZ
Recipient must notify payor of recipient’s social
security number
Watch alimony recapture if payments are “front
loaded” during the first three years
Personal Financial Planning Section
19
Line 12 – Business Income or Loss
Reap the benefits of Schedule C
• Retirement plans
• Business expenses not subject to AMT
Independent contractor considerations
Deduct the full cost of equipment, computers, and
furniture
• Section 179 and/or bonus depreciation
Write off 100% of health insurance premiums
Hire children in the business
Personal Financial Planning Section
20
Line 12 – Business Income or Loss
Hobby Losses
If an activity is not engaged in for profit, a taxpayer cannot use
losses from that activity to offset income from other activities
(IRC §183)
The activities most likely to be treated as lacking a profit motive
are horse or dog racing, horse breeding, car racing and weekend
farming or ranching
Meeting the requirements of a safe harbor creates a presumption
that there was a profit motive-• Profit in at least three years out of the five-year period ending with
the current tax year
• Profit in at least two of the last seven years for horse breeding,
showing and racing (Reg. §1.183-1(c))
Personal Financial Planning Section
21
Line 12 – Business Income or Loss
Hobby Losses
If a taxpayer doesn’t meet the safe harbor requirement, the profit motive
determination is made by looking at all the relevant facts
Factors indicating a profit motive
• Reasonable expectation of asset appreciation
• Taxpayer’s previous business success
• Past profits from the activity are substantial in relation to losses
Factors indicating lack of a profit motive-• Failure to run the activity in a business like manner (e.g., not keeping
accurate books and records
• Taxpayer’s lack of expertise and failure to consult experts in the field
• Failure to devote substantial time and effort to the activity or to hire
competent managers
• Taxpayer has much more substantial income from other sources
• Activity generates substantial tax or recreational benefits (Reg. §1.183-2(b))
Personal Financial Planning Section
22
Line 13 – Capital Gain or Loss
Capital Gain or Loss
• This Line Reflects Gains or Losses on the Sale or Exchange of
Capital Assets
- Long-Term Gain or Loss
- Short-Term Gain or Loss
• Capital Losses > Capital Gains are deductible up to $3,000 a year
• The balance is carried forward to future years
Personal Financial Planning Section
23
Line 13 – Capital Gain or Loss
Inefficiency of Capital Loss Offsetting
■ In general, capital losses are more tax effective
if they can be used to offset income taxed at
higher tax rates (e.g. short-term capital gains
and ordinary income)
– Thus, long-term losses used against short-term gains are
more tax-efficient than short-term losses being used
against long-term capital gains
Short-Term Gain
Long-Term Gain
Short-Term Loss
NEUTRAL
INEFFECTIVE
Long-Term Loss
EFFECTIVE
NEUTRAL
Personal Financial Planning Section
24
Line 14 – Other Gains or Losses
Report gains or losses on sales of business property
from Form 4797
Sales of business property generally receive very
favorable tax treatment under IRC §1231
• Gains and losses for the year are netted together
- If there is a net gain, it is treated as capital gain
- Exception for “nonrecaptured losses” during prior 5 years
- If there is a net loss it is treated as an ordinary loss
Exception where gains are treated as ordinary
income because of recapture rules
Personal Financial Planning Section
25
Line 15 – IRA Distributions
■ Line 15a – Gross IRA distributions
■ Line 15b – Taxable amount of IRA distributions
• Need to complete IRS Form 8606 (if non-deductible
contributions (i.e. basis) exists)
Personal Financial Planning Section
26
Line 15 – IRA Distributions
Taxation of IRA Distributions
When an IRA has non-deductible contributions, a
portion of each IRA distribution will be a return of
non-taxable “basis” to the IRA owner
In determining the non-taxable portion of an IRA
distribution, all IRAs and IRA distributions during the
year (including outstanding rollovers) must be
combined for apportioning “basis”
• See IRS Form 8606
Personal Financial Planning Section
27
Line 15 – IRA Distributions
Taxation of IRA Distributions
(1) Current year non-deductible IRA contributions*
(2) Prior year non-deductible IRA contributions
(3) Total non-deductible IRA contributions (1 + 2)
(4) FMV of all IRAs (as of 12/31)
(5) Outstanding rollovers
(6) Distributions
(7) Roth IRA Conversions
(8) Total value of IRAs, distributions and Roth IRA conversions (4 + 5 + 6 + 7)
(9) "Basis" apportionment formula (3 / 8)
* NOTE: This is only applies for non-deductible contributions made during the current
tax year (i.e. 1/1 – 12/31)
Personal Financial Planning Section
28
Line 15 – IRA Distributions
Taxation of IRA Distributions
Current year non-deductible IRA contributions
Prior year non-deductible IRA contributions
Total non-deductible IRA contributions
$
FMV of all IRAs
Outstanding rollovers
Distributions
Roth IRA conversions
Total value of IRAs, distributions and Roth IRA conversions
$
$
$
"Basis" apportionment formula ($7,000 ÷ $380,000)
Gross IRA distribution
Non-taxable portion
Taxable IRA distribution
Personal Financial Planning Section
1,000
6,000
7,000
350,000
20,000
10,000
380,000
0.0184
$
$
10,000
(184)
9,816
29
Line 15 – IRA Distributions
Roth IRA Conversions – Benefits
■
■
■
■
■
■
Lowers overall taxable income long-term
Tax-free compounding
No RMDs at age 70½
Tax-free withdrawals for beneficiaries*
More effective funding of the “bypass trust”
New 3.8% Medicare “surtax” planning
Personal Financial Planning Section
30
Line 15 – IRA Distributions
Reasons to Convert to Roth IRAs
1) Taxpayers have special favorable tax attributes including
charitable deduction carry-forwards, investment tax credits, net
operating losses (NOLs), high basis non-deductible traditional
IRAs, etc.
2) Suspension of the minimum distribution rules at age 70½
provides a considerable advantage to the Roth IRA holder.
3) Taxpayers benefit from paying income tax before estate tax
(when a Roth IRA election is made) compared to the income tax
deduction obtained when a traditional IRA is subject to estate tax.
Personal Financial Planning Section
31
Line 15 – IRA Distributions
Reasons to Convert to Roth IRAs
4) Taxpayers who can pay the income tax on the IRA from
non-IRA funds benefit greatly from the Roth IRA because of
the ability to enjoy greater tax-free yields.
5) Taxpayers who need to use IRA assets to fund their Unified
Credit bypass trust are well advised to consider making a
Roth IRA election for that portion of their overall IRA funds.
6) Taxpayers making the Roth IRA election during their lifetime
reduce their overall estate, thereby lowering the effect of
higher estate tax rates.
Personal Financial Planning Section
32
Line 15 – IRA Distributions
Reasons to Convert to Roth IRAs
7) Federal tax brackets are more favorable for married
couples filing joint returns than for single individuals, Roth
IRA distributions won’t cause an increase in tax rates for the
surviving spouse when one spouse is deceased because
the distributions are tax-free.
8) Post-death distributions to beneficiaries are tax-free.
9) Tax rates are expected to increase in the near future.
10) The new 3.8% Medicare surtax.
Personal Financial Planning Section
33
Line 15 – IRA Distributions
Accounts Eligible for Conversion to Roth IRAs
Convertible accounts
• Traditional IRAs
• 401(k) plans
• Profit sharing plans
• 403(b) annuity plans
• 457 plans
• “Inherited” 401(k) plans (see Notice 2008-30)
Non-convertible accounts
• “Inherited” IRAs
• Education IRAs
Personal Financial Planning Section
34
Line 15 – IRA Distributions
Taxation of Non-Qualified Roth IRA
Distributions (“Seasoning Rule”)
No
Does the taxpayer
meet any of the
other statutory
exceptions?
Is the taxpayer
over age 59½?
Yes
Yes
No
No
FOOTNOTES
IRC Sec. 408A(d)(2)(A)(i)
IRC Sec. 408A(d)(2)(B)
IRC Sec. 408A(d)(2)(A)(ii)(iii)(iv)
• Death
• Disability
• First-time homebuyer expenses
(up to $10,000)
Personal Financial Planning Section
Distribution subject to
income tax
(only to the extent of amounts not
previously taxed)
Has the taxpayer
met the five-year
holding period
2
test?
Yes
Entire
distribution is
tax-free
35
Line 15 – IRA Distributions
Taxation of Non-Qualified Roth IRA
Distributions (“Penalty Box Rule”)
Yes
Is the taxpayer
over age 59½?
No
Is the Roth IRA:
(1) 100% contributory
(2) 100% conversion
(3) Commingled
100%
Contributory
Commingled
100%
Conversion
Is the distribution greater than
prior contributions (i.e.
“basis”)?
No
No
Penalty
Did the distribution occur within five
years of conversion?
Yes
Penalty
applies to “earnings”
(Unless exception applies)
Personal Financial Planning Section
No
Follow the “ordering rules” (see
above chart)
Yes
Penalty
applies to conversion and
“earnings”
(Unless exception
applies)
Exceptions to 10%
early withdrawal
penalty :
1. Death
2. Disability
3. Series of
substantially equal
periodic payments
4. Medical expenses
greater than 7.5%
AGI
5. Health insurance
premiums for
unemployed
individuals
6. Higher education
expenses
7. First-time
homebuyer
expenses (up to
$10K)
36
Line 15 – IRA Distributions
Taxation of Non-Qualified Roth IRA
Distributions (Ordering Rules)
Gross
Distribution
Step 1
Net contributions
1
10% early
withdrawal
penalty
Step 2
Conversion amounts > 5
years2
(taxable portion)
FOOTNOTES:
1. “Net contributions” is: (a) the sum of all
prior Roth IRA contributions reduced by (b)
the sum of all prior Roth IRA distributions
(i.e. “basis first” rule)
2. Distributions attributable to prior
conversion amounts are determined on a
“first-in, first-out” (“FIFO”) basis (e.g. 1998
conversions ,1999 conversions, 2000
conversions, etc.) with the taxable portion
of each prior year conversion coming out
first followed by the non-taxable portion
Personal Financial Planning Section
applies
(Unless exception applies)
Step 3
Conversion amounts > 5
years2
(non-taxable portion)
Step 4
Conversion amounts <= 5
years2
(taxable portion)
Step 5
Conversion amounts <= 5
years2
(non-taxable portion)
Step 6
“Earnings”
37
Line 15 – IRA Distributions
Mathematics of Roth IRA Conversions
■ The key to successful Roth IRA conversions is to
keep as much of the conversion income as possible
in the current marginal tax bracket
• However, there are times when it may make sense to convert
more and go into higher tax brackets
• Need to take into consideration the new 3.8% Medicare “surtax”
• Need to take into consideration the impact of AMT
Personal Financial Planning Section
38
Line 15 – IRA Distributions
Mathematics of Roth IRA Conversions
“Optimum“ Roth IRA
conversion amount
35% tax
bracket
Target Roth IRA
conversion amount
33% tax
bracket
Current
taxable
income
28% tax
bracket
25% tax
bracket
15% tax
bracket
10% tax
bracket
Personal Financial Planning Section
CAUTION: Make sure to
analyze the impact of AMT
on the conversion amount
39
Line 15 – IRA Distributions
Recharacterizations
Taxpayers may “recharacterize” (i.e. undo) the Roth
IRA conversion in current year or by the filing date
of the current year’s tax return
• Recharacterization can take place as late as 10/15 in the year
following the year of conversion
Taxpayers may choose to “reconvert” their
recharacterization
• Reconversion may only take place at the later of the following
two dates:
- The tax year following the original conversion OR
- 30 days after the recharacterization
Personal Financial Planning Section
40
Line 15 – IRA Distributions
Roth IRA Conversion/ Recharacterization
Timeline
Conversion Period
Recharacterization Period
2012
1/1/2012
First day
conversion can
take place
Personal Financial Planning Section
2013
12/31/2012
Last day
conversion can
take place
4/15/2013
Normal filing
date for 2012 tax
return
10/15/2013–
12/31/2013
Latest filing date
for 2012 tax
return / last day
to recharacterize
2012 Roth IRA
conversion
41
Line 16 – Pensions and Annuities
■ Line 16a – Gross distributions
■ Line 16b – Taxable amount of distributions
• Special considerations
̶ After-tax employee contributions
̶ Lump-sum distributions
̶ Net unrealized appreciation (NUA)
̶ 10-year income averaging (only available for taxpayers
born before 1/2/1936)
̶ Special capital gains treatment on pre-1974
contributions (only available for taxpayers born before
1/2/1936)
Personal Financial Planning Section
42
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
Ordinary income recognized on cost basis
Difference between Fair Market Value (FMV) at
rollout and basis is Net Unrealized Appreciation
(NUA)
NUA is taxed long-term capital gain tax rates (0%
and/or 15%)
Personal Financial Planning Section
43
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
If under age 55, a 10% excise tax penalty is imposed
on the basis of the securities
Personal Financial Planning Section
44
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
Fair Market Value (FMV) of stock
Employer basis
Net Unrealized Appreciation (NUA)
Amount taxable if stock is rolled out
Personal Financial Planning Section
$ 750,000
$ 150,000
$ 600,000
$ 150,000
45
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
The $600,000 of NUA
is Deferred Until the Stock
is Sold
Personal Financial Planning Section
46
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
■
■
■
■
15% rate (2012)
20% rate (2013 and beyond)
0% rate (2012)
8%/10% rate (2013 and beyond)
Personal Financial Planning Section
47
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
100% Rollout
100% Rollover to IRA
Partial Rollout / Partial Rollover
Personal Financial Planning Section
48
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
Retiree has $1,200,000 in his qualified plan
The plan is 90 percent invested in employer stock
Step One: Take a $200,000 lump sum distribution
Step Two: Basis in employer stock is taxed at rollout
Step Three: Transfer remaining $1,000,000 to an IRA
Step Four: File proper tax elections
• Basis allocation election
• Taxation of employer basis election
Personal Financial Planning Section
49
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
XYZ Corp. Profit
Sharing Plan
$1,200,000
In-Kind
Distribution
$200,000
IRA
$1,000,000
“Open”
Shares
Personal Financial Planning Section
Hedged
Shares
50
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
On account of employee’s death
After the employee attains age 59½
On account of employee’s separation from service
after the attainment of age 55
After the employee has become disabled (within the
meaning of section 72(m)(7))
Personal Financial Planning Section
51
Line 16 – Pensions and Annuities
Net Unrealized Appreciation (NUA)
If prior year distributions have been made
after one triggering event, the taxpayer
must wait until another triggering event to
qualify for lump sum distribution “within
one taxable year” rule
Personal Financial Planning Section
52
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Flow-through from Schedule E
Loss limitation rules
– At-risk rules
– Passive Loss rules
Personal Financial Planning Section
53
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
At-Risk Rules
Prevent taxpayers from using strategies like non-recourse
financing to create losses that exceed the amount they can
lose in the activity
Loss deduction can be taken only for the amount at risk
Loss is the excess of deductions over income from the activity
(losses from the activity can be used to offset losses from the
activity)
Excess losses are carried forward and can be used when
amount at risk is sufficient
Personal Financial Planning Section
54
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
At-Risk Rules
Amounts at risk (Individuals and Partnerships)
• Amount of money + basis of other property contributed by the taxpayer
to the activity (IRC §465(b)(1))
- (Applies to S Corporations also)
• Amounts borrowed for use in the activity to the extent the taxpayer is
personally liable or the debt is secured by other assets of the taxpayer
(IRC §465(b)(2))
• Taxpayer’s share of any qualified non-recourse financing (IRC
§465(b)(6))
Amounts not at risk
• Amounts borrowed from another person who has an interest in the
activity or from a person related to such a person (IRC §465(b)(3))
• Amounts protected against loss through non-recourse financing a
guarantee, stop-loss agreement or similar arrangement (IRC
§465(b)(4))
Personal Financial Planning Section
55
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Passive Activity Rules
Prevent taxpayers from using losses from tax shelters to offset
salaries, professional fees, business income, dividends and
interest
A passive activity is generally an activity in which a taxpayer is
not an active participant or a rental activity
Passive losses can be used to offset passive income, but not
active income
Disallowed losses can be carried forward until the taxpayer has
sufficient passive income to use them
Disallowed losses can also be used when the investment
activity is closed out
Personal Financial Planning Section
56
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Passive Activity Rules
Generally, any activity in which the taxpayer doesn’t materially
participate
Tests for material participation-• Taxpayer participates more than 500 hours during the tax year
• Taxpayer does substantially all the work required for the activity
• Taxpayer has over 100 hours of participation and no one else
has more hours
• Taxpayer doesn’t satisfy any of the tests for the current year but
did satisfy one or more of them in at least five of the previous 10
years
• Taxpayer has over 100 hours of participation and activities were
regular, continuous and substantial
Personal Financial Planning Section
57
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Passive Activity Rules
Rental activities are generally treated as passive regardless of
participation
Exceptions
• Real estate professional
- More than 750 hours of participation in real estate businesses,
AND
- More than 50% of the services performed by the individual
during the tax year are in real estate businesses
• $25,000 rental real estate exception (IRC §469(i))
- First $25,000 of net passive losses from rental real estate can
be deducted against non-passive income if the taxpayer
significantly participates in the activity
- Phased out as income rises above $100,000 (IRC §469(i)(3))
Personal Financial Planning Section
58
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Oil and Gas Investments
Oil and gas investments
• Working interest not passive regardless of participation if liability for
development and operating costs is not limited (IRC §469(c)(3)(A))
- General partnership interest not passive
- Limited partnership interest is passive
Personal Financial Planning Section
59
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Oil and Gas Investments
Intangible drilling costs (IDCs) provide a large
immediate income tax deduction (up to 85% of the
initial investment)
• Losses, if any, created as a result of IDCs will be ordinary
thus lowering a taxpayer’s AGI)
-
Must be general partner in the first year
Possible AMT add-back issues if IDCs exceed 40% of AMTI
• Depletion and other depreciation (including Section 179
expensing) provide for additional deductions during the term of
the investment
• Additional tax credits may be available to certain oil & gas
ventures
Personal Financial Planning Section
60
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Real Estate Investments – Economic Benefits
■ Financial leverage
• Relatively small down payment controls 100% of return
• Example
– Buy $100,000 worth or property for $10,000 down
– Rent covers mortgage payments and expenses
– Property increases in value by 5% during the year
– 50% return on investment
■ Caveat
• Leverage runs in both directions
• If value declined to $95,000, the investor would have a – 50%
return on investment
Personal Financial Planning Section
61
Line 17 – Rental Real Estate, Royalties,
Partnerships, S Corporations, Trusts, Etc.
Real Estate Investments – Tax Benefits
Depreciation benefits
•
•
•
•
•
•
•
Deduct cost of residential rental property over 27.5 years
Deduct cost of commercial property over 39 years
Apportion as much of cost as possible to improvements rather than land
Deduction with no cash outlay
May be only paper losses (property may increase in value)
Often shelters all income from investment
Excess deduction may also shelter other income subject to limitations
- Passive income
- $25,000 exclusion
- Real estate professionals (Material participation)
Deductions reduce basis
Recapture when property is sold, but timing advantage
Personal Financial Planning Section
62
Line 18 – Farm Income or Loss
Farm Income or Loss
•
•
•
•
From Schedule F
Cash Basis of Accounting
Sale of Animals is Capital Gain
Hobby Loss Rules
Personal Financial Planning Section
63
Line 19 – Unemployment Compensation
Unemployment Compensation
• 100% of Unemployment is Taxable
- Generally there is no withholding so may want to consider
estimated Federal and/or State estimates
Personal Financial Planning Section
64
Line 20 – Social Security Benefits
Social Security Taxation
Start with amount from Form SSA-1099
Part of this amount may be subject to tax
Taxable portion depends on amount of “provisional income”
Provisional income = Modified Adjusted Gross Income (MAGI) +
½ of SS benefit
MAGI = Adjusted Gross Income (AGI) before SS is included
plus:
• Tax-exempt interest on Series EE U.S. Savings Bonds used to
pay tuition
• Adoption assistance payments
• Foreign earned income
• Income from U.S. possessions
• Income from Puerto Rico
• Deductions claimed for student loan interest and qualified tuition
Personal Financial Planning Section
65
Line 20 – Social Security Benefits
Social Security Taxation
First determine if benefits are taxable at all
No inclusion if provisional income does not
exceed the following base amounts—
• $25,000 for single, head of household, qualifying
widow, or married filing separately and not living
with spouse
• $32,000 for married taxpayers filing a joint return
(IRC §86(c))
Personal Financial Planning Section
66
Line 20 – Social Security Benefits
Social Security Taxation
Tier I amounts (Up to 50% inclusion)
If provisional income exceeds the base
amounts listed on the previous slide, tax is
payable on the lesser of:
• 50% of social security benefits received or
• ½ of provisional income in excess of the base amount
Personal Financial Planning Section
67
Line 20 – Social Security Benefits
Social Security Taxation
Up to 85% inclusion of amounts in excess of
“adjusted base amounts”
Applies to–
• single taxpayers with provisional income over $34,000
• Married taxpayers filing jointly with provisional income over
$44,000
• Referred to as adjusted base amounts
Lesser of:
• Tier I amount + Tier II amount, or
• 85% of Social Security benefit received
Personal Financial Planning Section
68
Line 20 – Social Security Benefits
Social Security Taxation
Facts
• John, a single taxpayer, has regular income of
$25,000 and tax-exempt income of $5,000
• John receives social security of $20,000
• John’s provisional income is $25,000 + $5,000 +
$10,000 (1/2 of SS) = $40,000
• Because this exceeds John’s base amount of
$25,000, a portion of the social security will be subject
to tax
Personal Financial Planning Section
69
Line 20 – Social Security Benefits
Social Security Taxation
Provisional Income = $40,000
Tier I income
– ($34,000 - $25,000) x .5 = $4,500
Tier II income
– ($40,000 - $34,000) x .85 = $5,100
Total amount subject to tax
• Lesser of $9,600 ($4,500 + $5,100), or
• $17,000 (.85 x $20,000 of social security benefits)
• $9,600 is subject to tax
Personal Financial Planning Section
70
% Subject to Income Tax
Line 20 – Social Security Benefits
Social Security Taxation
85% Zone
85%
Post 85% Zone
50% Zone
50%
Safe HavenNo Taxation
0%
$32,000 (married) $44,000 (married)
$34,000 (single)
$25,000 (single)
Modified Adjusted Gross Income (MAGI)
Personal Financial Planning Section
71
Line 20 – Social Security Benefits
Ways to Reduce Taxation of Social
Security Benefits
Convert traditional IRA to Roth IRA
Utilize tax-deferred annuities to defer income
Utilize life insurance to turn taxable income into taxfree income
IRA contributions (if “earned income” exists and
taxpayer is under age 70½)
Personal Financial Planning Section
72
Line 21 – Other Income
Any taxable income not reported elsewhere on the return
Examples-• Prizes and awards
• Jury duty pay
• Taxable distributions from a Coverdell Education Savings
Account, qualified Tuition program, Health Savings Account or
Archer MSA
• Gambling winnings
• Reimbursements from amounts deducted in a previous year
• Canceled debts
• Recapture of charitable contributions
Personal Financial Planning Section
73
Line 25 – Health Savings Account Deduction
Eligible taxpayers are those covered under a high
deductible health plan (HDHP)
HDHP requirements for 2011 and 2012
• Annual deductible
- Not less than $1,200 for individual coverage
- Not less than $2,400 for family coverage
• Maximum out of pocket expense
- $5,950 for 2011 / $6,050 for individual coverage
- $11,900 for 2011 / $12,100 for family coverage
• Having other health care coverage generally disqualifies a taxpayer
Personal Financial Planning Section
74
Line 25 – Health Savings Account Deduction
Deduction limits-• Individual only coverage-- $3,050 for 2011 / $3,100 in 2012
• Family coverage-- $6,150 for 2011 / $6,250 for 2012
Catch up contributions up to $1,000/year for
taxpayers age 55 or older and not on Medicare
HSA contributions and deductions are reported on
Form 8889
Excess contributions are subject to a six percent
penalty (reported on Form 5329)
Personal Financial Planning Section
75
Line 32 – IRA Deduction
Deductible contribution amounts for 2011 & 2012-•
•
•
•
$5,000 for single filers
$10,000 for joint return
Extra $1,000 for taxpayer 50 or over on single return and $1,000 for
each spouse 50 or over on joint return
No deduction for taxpayers who reached age 70½ by the end of the
year to which the contribution applies
Personal Financial Planning Section
76
Line 32 – IRA Deduction
Phase-out of deduction for taxpayers covered under
employer’s retirement plan
Phase-out ranges depend on filing status
• Single, head of household or married filing separately and living
apart from spouse for all of 2012-– Phased out from MAGI of $58,000 to $68,000
Examples
» At MAGI of $61,000 the deduction is $4,000
4,000($5,000 x [1 – ({$60,000 - $58,000}/{$68,000 $58,000})] = $5,000 x .8 8= $4,000
» At MAGI of $63,000 the deduction is $2,500 (halfway
through the phase-out)
» At MAGI of $68,000 the deduction is $0
Personal Financial Planning Section
77
Line 32 – IRA Deduction
Married filing joint return and both spouses are active
participants in employer retirement plans or qualifying widow
or widower
•
IRA deduction for both spouses phased out for MAGI of $92,000 to
$112,000
Married filing joint return with spouse and only one spouse was
an active participant in an employer plan
• IRA deduction for non-participant spouse phased out for joint MAGI of
$173,000 to $183,000
• IRA deduction for participant spouse phased out for joint MAGI of
$92,000 to $112,000
Married filing separate return and lived with spouse for at least
part of 2010
• IRA deduction for taxpayer phased out for MAGI of $0 to $10,000
Personal Financial Planning Section
78
Line 32 – IRA Deduction
MAGI--Definition
– Income reported on Form 1040 line 22, minus
• Deductions claimed to arrive at AGI, but
• Without taking into account the IRA deduction to
avoid a circular calculation
Personal Financial Planning Section
79
Line 32 – IRA Deduction
Phase-out—Special rules
• Phase-out amount can be rounded down to the next lowest $10
increment (IRC §219(g)(2)(c))
• Until the phase-out is complete, it can never reduce the
deduction below $200
Example:
• T, a single taxpayer participating in his employer’s retirement
plan has MAGI of $67,900
– Without the $200 minimum deduction rule, T would have
a deduction of $50 ($5,000 x [1 – ($9,900/$10,000)]
– Because of the $200 floor, however, T has an IRA
deduction of $200
Personal Financial Planning Section
80
Line 32 – IRA Deduction
Other Rules
• Individual and spouse must have earned income of at least the
amount of the IRA contribution
• Can’t deduct more than amount of taxable income for the year
• No deduction for contributions to a Roth IRA
• IRA contribution limits apply to the sum of contributions to Roth
IRAs and Traditional IRAs
• Allowable amount ($5,000 for 2012) can be split between the two
in any way the taxpayer wishes
Example:
• T, a single taxpayer under age 50, contributes $1,200 to a Roth IRA
• T can also contribute up to $3,800 ($5,000 - $1,200) to a traditional
IRA and claim a deduction for this amount assuming she has
sufficient taxable income
Personal Financial Planning Section
81
Line 40 – Itemized Deductions
Medical/Dental Expenses (Schedule A, Lines 1 – 4)
• Need to clear 7.5% of AGI
• Consider doubling-up expenses as much as possible
• Need to clear 10% floor for AMT purposes
Personal Financial Planning Section
82
Line 40 – Itemized Deductions
Taxes (Schedule A, Lines 5 – 9)
• Add-back for AMT purposes
• Need to determine timing to maximize tax benefit
• Real estate taxes – need to take into consideration some states
allow for credit for real estate taxes paid in current year
Personal Financial Planning Section
83
Line 40 – Itemized Deductions
Interest Expense (Schedule A, Lines 10 – 15)
• $1.1M limitation on home mortgage interest
• Need to amortize points paid over term of mortgage (unless
certain requirements are met)
• Investment interest expense deductible to the extent of “net
investment income” (i.e. interest, dividends, short-term capital
gains)
- Reported on IRS Form 4952
- Need to consider electing out of long-term capital gains
treatment (on long-term capital gains) to allow for additional
investment interest deduction
Personal Financial Planning Section
84
Line 40 – Itemized Deductions
Charitable Contributions (Schedule A, Lines 16 – 19)
• AGI limitations on contributions
- Cash gifts to “public charities” = 50% AGI limitation
- Cash gifts to private foundations = 30% AGI limitation
- Gifts of appreciated assets to “public charities” = 30% AGI
limitation
- Gifts of appreciated assets to private foundations = 20% AGI
limitation
• Five-year carryover of excess charitable contributions
• Additional reporting requirements for non-cash gifts in excess of
$500
• Additional reporting requirements for gifts of cars, boats,
airplanes, etc.
Personal Financial Planning Section
85
Line 48 – Credit for Child and Dependent
Care Expenses
You may be eligible if you paid someone to care for
any of the following persons—
• Your qualifying child under age five who you claim as a
dependent
• Your disabled spouse who was unable to care for himself and
lived with you more than half the year
• Any disabled person not able to care for himself who lived with
you more than half the year and was a dependent unless-- The person filed a joint return
- The person had $3,800 or more of gross income
- You (or your spouse if filing jointly) could be claimed as a
dependent on someone else’s return
Personal Financial Planning Section
86
Line 50 – Retirement Savings Contributions
Credit (Saver’s Credit)
Taxpayers with income below certain levels who are
not disqualified taxpayers can claim a tax credit of
up to $1,000 ($2,000 if married filing jointly) for an
applicable percentage of contributions to—
•
•
•
•
A traditional or Roth IRA (other than rollover contributions)
A §401(k) §403(b) plans or §457 government plan
A SEP or SIMPLE plan
A qualified retirement plan if the contributions are voluntary
after-tax employee contributions
Personal Financial Planning Section
87
Line 50 – Retirement Savings Contributions
Credit (Saver’s Credit)
Income limitations - 2012
– No credit for the following taxpayers:
• Joint filers—AGI above $57,500
• Heads of Household—AGI above $43,125
• All other taxpayers—AGI above $28,750
Disqualified taxpayers
– Taxpayers under age 18 by the end of 2012
– Taxpayers claimed as a dependent on someone else’s return
– Students
Personal Financial Planning Section
88
Line 50 – Retirement Savings Contributions
Credit (Saver’s Credit)
Applicable percentage - 2012
• Married filing jointly
- 50% up to $34,500 of income
- 20% from $34,500 to $37,500
- 10% from $37,500 to $57,500
• Head of household
- 50% up to $25,875
- 20% from $25,875 to $28,125
- 10% from $28,125 to $43,125
• Single, Married filing Separately or qualifying Widow or Widower
- 50% up to $17,250
- 20% from $17,250 to $18,750
- 10% from $18,750 to $28,750
Attach Form 8880
Personal Financial Planning Section
89
Line 51 – Child Tax Credit
Non-refundable credit of up to $1,000 in 2012
• For each qualifying child under age 17 the taxpayer can claim as
a dependent
• Offsets both regular tax and AMT liability
• Subject to phase-outs above certain income levels
Personal Financial Planning Section
90
Line 51 – Child Tax Credit
Phase-out
– Reduced by $50 for each $1,000 of MAGI
above the following levels—
• $110,000 for joint filers
• $75,000 for single taxpayers
• $55,000 for married taxpayers filing separately
Personal Financial Planning Section
91
Line 58 – Additional Tax on IRAs, Other
Qualified Plans, Etc.
Report special taxes on—
• Early distributions from an IRA, annuity or modified endowment
contract not rolled over to another qualified vehicle
• Excess contributions to an IRA, Coverdell Educational Savings
Account, Archer MSA or health savings account
• Taxable distributions from a Coverdell ESA or a qualified tuition
program
Compute the tax on Form 5329
• Exception—If taxpayer only received an early distribution with
distribution code 1 on Form 1099-- simply multiply taxable amount of distribution by 10 percent
and enter on Line 58
Personal Financial Planning Section
92
Line 65 – Additional Child Tax Credit
Child tax credit is non-refundable
Helps taxpayers who couldn’t claim the full amount
of the child tax credit because they didn’t have
enough income
Additional (refundable) credit
Amount is the greater of—
• 15 percent of earned income over $3,000, or
• For a taxpayer with three or more children, the
excess of social security taxes paid for the year over
the earned income credit for the year
Attach Form 8812
Personal Financial Planning Section
93
Line 66 – American Opportunity Credit
Up to $2,500/year for qualified tuition
• 100% of first $2,000
• 25% of next $2,000
Applies to first four years of undergraduate education
40 percent refundable
• Example
- T has $4,000 of qualified education expenses
- T has no tax liability to apply against the credit
- T can claim a refundable credit of $1,000 (.4 x $2,500)
Attach Form 8863
Personal Financial Planning Section
94
Line 69 – Excess Social Security and Tier 1
Tax Withheld
Social security wage base = $110,100 for 2012
Payroll tax cut reduces employee’s rate from 6.2% to 4.2%
Total tax paid on this amount is $4,624.20 (4.2% x $110,100)
If a taxpayer worked for more than one employer during the tax
year too much social security or RRTA tax may have been
withheld
If the total tax withheld exceeded $4,624.20, the taxpayer can
claim a credit on Line 69
If the taxpayer had only one employer for the year, no credit is
allowed on Line 69
• Employer must adjust the tax instead
Personal Financial Planning Section
95
Q&A
Personal Financial Planning Section
96
AICPA PFP Section Resources
Additional materials
• Roadmap to Developing and Managing a CPA Personal
Financial Planning Practice (aicpa.org/PFP/pathway)
• Checklist: Analysis of a Tax Return for Personal Financial
Planning (aicpa.org/PFP/pathway)
• PFP Practice Center (aicpa.org/PFP/practicecenter)
• Forefield Advisor (aicpa.org/PFP/forefield)
• Keebler Roth Materials (aicpa.org/PFP/Roth)
AICPA Advanced Personal Financial Planning Conference
(cpa2biz.com/PFP)
• 2-day sessions for those in earlier stages of PFP
o Implementing PFP Services: Step by Step Plans for Success
o CPA/PFS Review Class
For the full calendar of upcoming PFP Section events, visit
www.aicpa.org/PFP and click on CPE & Events
Personal Financial Planning Section
97 97
AICPA CPA/PFS Program
PFS exam review
• Self-study, web review and live review options available to
purchase at cpa2biz.com
PFS exam registration
• Learn more & register at aicpa.org/PFSexam
• Summer and winter exam window each year
PFS education
• In-depth self-study courses available to purchase at
cpa2biz.com
2012 PFS exam sponsorship program
• Summer deadline: June 18, 2012
• Winter deadline: December 26, 2012
For more information, visit www.aicpa.org/PFP/PFS
Personal Financial Planning Section
AICPA Web Seminar Series:
From Tax Preparer to Financial Planner
Build your financial planning knowledge with this web
seminar series and discover the necessary steps to
transition from tax preparer to financial planner.
Register today at CPA2Biz.com/Webcasts. Discounts available for
PFP/PFS and Tax Section members.
Part 1 Part 2 Part 3 Part 4
Understanding Moving from
the value of
tax
financial
compliance to
planning
tax planning
for individuals
Personal Financial Planning Section
Moving from
tax planner to
holistic
financial
planner
Implementing
a PFP practice
Circular 230 Disclosure
Pursuant to the rules of professional conduct set forth in Circular 230, as
promulgated by the United States Department of the Treasury, nothing contained in
this communication was intended or written to be used by any taxpayer for the
purpose of avoiding penalties that may be imposed on the taxpayer by the Internal
Revenue Service, and it cannot be used by any taxpayer for such purpose. No
one, without our express prior written permission, may use or refer to any tax
advice in this communication in promoting, marketing, or recommending a
partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information
about the tax and other laws applicable to retirement benefits. The author, his firm
or anyone forwarding or reproducing this work shall have neither liability nor
responsibility to any person or entity with respect to any loss or damage caused, or
alleged to be caused, directly or indirectly by the information contained in this work.
This work does not represent tax, accounting, or legal advice. The individual
taxpayer is advised to and should rely on their own advisors.
Personal Financial Planning Section
100
Analysis of a Tax Return for Personal Financial
Planning
Personal Financial Planning Section
101
Analysis of a Tax Return for Personal Financial Planning,
page 2
Personal Financial Planning Section
102
Analysis of a Tax Return for Personal Financial Planning,
page 3
Personal Financial Planning Section
103
Robert S. Keebler, CPA, MST: The Roth IRA Conversion Decision
Should a client convert to a Roth IRA?
Yes
Yes
A Roth
conversion
likely not
beneficial
Run the
numbers
Yes
Yes
A Roth
conversio
n could be
beneficial
– Run the
numbers
Yes
Yes
A Roth
conversion
will most
likely be
beneficial
Run the
numbers
1
Yes
Yes
© 2012 Keebler & Associates, LLP
All Rights Reserved
Does client anticipate being in a
much lower marginal tax bracket in
future?
Will client die with a substantial
charitable bequest?
Does client need the IRA funds
to meet annual living expenses?
Does client have outside funds
to pay tax on the conversion?
Will the client incur an estate tax
upon death?
Does client have a long time
horizon to let the funds grow?
Does client plan to utilize their
Unified Credit or GST exemption
(if applicable) with IRA assets?
Does client have favorable tax
attributes that can help offset the
majority of the conversion income?
11 Reasons to Convert to a Roth IRASM
Bob’s Roth
Conversion
ObservationsSM
1. After determining the
“optimum” conversion
amount, additional amounts
converted may be
detrimental in that they
increase the effective tax
rate on the conversion.
2. Always convert more than
the initial numbers suggest
and recharacterize if
warranted.
3. Recharacterize depressed
accounts in November of the
year of conversion and
reconvert in January.
4. The Roth IRA is the most
powerful asset with which to
fund a GST exempt trust.
5. There is no bright line rule
or “optimum” conversion
amount for all individuals,
considering that each
individual’s financial, income
tax, and wealth situations
are different. If several of
the ten reasons are met, it is
likely the individual is a good
candidate for a Roth IRA
conversion.
6. Partial conversions generally
provide a better quantitative
result than 100%
conversions.
1.
Taxpayers have special favorable tax attributes, including a high basis ratio,
charitable deduction carry-forwards, investment tax credits, net operating
losses (NOLs), etc. This is because these attributes reduce the effective tax
rate of the conversion.
2.
Suspension of the minimum distribution rules at age 70½ provides a
considerable advantage to the Roth IRA holder. This allows for additional
tax-free deferral.
3.
Taxpayers benefit from paying income tax before estate tax (when a Roth IRA
election is made) compared to the income tax deduction obtained when a
traditional IRA is subject to estate tax. This is because the IRC § 691(c)
deduction is inefficient.
4.
Taxpayers who can pay the income tax on the IRA from non IRA funds benefit
greatly from the Roth IRA because of the ability to enjoy greater tax-free
yields. This is because of the ability to move funds from a “taxable” to a “taxfree” tax asset class.
5.
Taxpayers who need to use IRA assets to fund their Unified Credit bypass
trust are well advised to consider making a Roth IRA election for that portion
of their overall IRA funds. This is because the exemption is funded on an
after-tax basis.
6.
Taxpayers making the Roth IRA election during their lifetime reduce their
overall estate, thereby lowering the effect of higher estate tax rates.
7.
Because federal tax brackets are more favorable for married couples filing
joint returns than for single individuals, Roth IRA distributions won’t cause an
increase in tax rates for the surviving spouse when one spouse is deceased
because the distributions are tax-free. (See chart on page two.)
8.
Post-death distributions to beneficiaries are tax-free. This is possibly the
most advantageous aspect of a Roth IRA conversion.
9.
Tax rates are expected to increase in the very near future. Higher tax rates in
the future means more tax will be paid on taxable IRA distributions than the
tax that would be paid on a conversion at a lower rate.
10. The ability to recharacterize allows the taxpayer 20/20 “hindsight”,
effectively allowing them to “undo” conversions that were not advantageous.
This allows the client to create a powerful “heads you win, tails you tie”
opportunity that protects against adverse market swings. Later
recharacterized funds can be “reconverted”.
11. 3.8% Surtax. A conversion will be beneficial for taxpayers.
Important Tax Law
Considerations
Important Financial Considerations
Important Estate Planning and Asset
Protection Considerations
CPA’s Checklist
Financial Advisor’s Checklist
Lawyer’s Checklist
CPA’s Checklist
· Analyze Tax Rates
· Consider Tax Attributes
· Determine Amount to
Convert
· Convert by Asset Class
· Determine Tax Estimates
· Monitor Alternative
Minimum Tax
· Monitor Taxation of Social
Security Benefits and
Increases in Medicare
Premiums
· Monitor
Recharacterization(s)
· Monitor Reconversion(s)
· 3.8% Surtax planning
· Consider oil and gas
investment
Death & Married Rates
· If death of a married
taxpayer is imminent, it
may be more
advantageous to convert
to a Roth IRA while the
taxpayer is still alive in
order to utilize the
preferential married filing
jointly tax rates .
· Post-death distributions
are tax-free
Roth Conversion Before
Death
· If an individual who
converts to a Roth in 2010
and chose the 2 year tax
spread passes away before
the income has been
claimed on his/her tax
return, the income will be
claimed on his/her final
1040 (§408A(d)(3)(E)(ii)(I)).
• Exception: If a surviving
spouse receives the 100%
interest in the Roth IRA
into which the 2010
conversions was made,
that person has the
ability to elect to
continue the deferral of
the two year spread
(§408A(d)(3)(E)(ii)(II)).
Pension Protection Act of
2006
· Non-spousal beneficiaries
are permitted to roll over
a qualified retirement plan
(e.g. 401(k) plan), via
trustee-to-trustee
transfer, into an inherited
IRA effective for tax years
beginning after December
31, 2006.
Alternative Minimum Tax
· If the taxpayer is close to
being exposed to AMT
prior to the
implementation of a Roth
conversion , the
practitioner must be
aware of the effects of
state and local taxes.
· Although federal income
taxes may be offset by an
applicable deduction, state
and local taxes that
typically tag along are not
deductible for AMT
purposes under
§56(b)(1)(A)(ii).
• Work collaboratively with CPA to determine the value of the Roth Conversion including the surtax
• Ensure estate liquidity by considering purchasing life insurance in an ILIT
• Convert by Asset Class (i.e. Roth IRA Conversion Segregation Strategy)
· Taxpayers cannot recharacterize a portion of a Roth conversion by “cherry picking” only those stocks that
decline in value (IRS Notice 2000-39).
· All gains and losses to the entire Roth IRA, regardless of the actual stock or fund re-characterized, must be
pro-rated.
• Monitor Recharacterization(s)
· Taxpayers may “recharacterize” (i.e. undo) the Roth IRA conversion in current year or by the filing date of
the current year’s tax return.
· Recharacterization can take place as late as 10/15 in the year following the year of conversion.
•Monitor Reconversion(s)
· Taxpayers may choose to “reconvert” their recharacterization.
· Reconversion may only take place at the later of the following two dates:
(1) The tax year following the original conversion OR
(2) 30 days after the recharacterization
Conversion Period
State Taxes
· Roth conversions may be
treated differently from
state to state.
· Consider local tax
implications.
The Small Business Jobs and
Credit Act of 2010
·Allows the conversion of
401(k), 403(b) and
governmental 457(b) plans to
Roth accounts.
Keeping the retirement
funds in a Roth 401(k) rather
than converting to a Roth IRA
can be beneficial from an
asset protection standpoint.
However, the
recharacterization option is
not available under this
provision as it would be if
account were converted to a
Roth IRA.
2012
1/1/2012– First
12/31/2012– Last 4/15/2013
–
10/15/2013
–
12/31/2013
day conversion
day conversion Normal filing date
Latest filing date
can take place
can take place for 2012tax return
for 2012 tax
January 1, 2012: First date in which a 2012 Roth conversion may take place.
return/lastday to
December 31, 2012: Last date in which a 2012 Roth conversion may take place.
recharacterize
IRA
April 15, 2013: Due date for the 2012 income tax return and the last date in which the2012 Roth
conversion
tax liability on a 2012 conversion may be paid timely.
A
B
1/1/12
Action
11/30/12
Action
1/1/13
Action
4/15/13
Action
10/15/13
Action
11/30/13
Action
1/1/14
Action
$100,000
Original
$125,000
Hold
$130,000
Hold
$130,000
Hold
$135,000
Hold
$130,000
N/A
$130,000
N/A
$100,000
Hold
$100,000
Hold
$95,000
Recharacterize
$80,000
Reconvert
$85,000
Hold
$90,000
Hold
$100,000
15%
$35,350
$70,700
25%
$85,650
$142,700
28%
$178,650
$217,450
33%
$388,350
$388,350
35%
> $388,350
> $388,350
© 2012 Keebler & Associates, LLP
All Rights Reserved
Original
Conversion
1/1/12
$100,000
Original
4/15/13
$ 75,000
Conversion
1/1/12
D
$17,400
ROTH IRAS
Conversion
1/1/12
C
Single
DISTRIBUTIONS TO BENEFICIARY UNDER IRC § 401(a)(9)
October 15, 2013: Last date in which a recharacterization of a 2012 conversion may be made.
Married Filing Jointly
$8,700
2013
No
Recharacterization
2012 Single vs. Married Rates
10%
Recharacterization Period
• Estate Planning Considerations
Ensure that beneficiary designation forms are updated to seamlessly
integrate the Roth IRA into the overall estate plan.
Consider that post-death qualified distributions are tax free.
Consider utilizing a Roth IRA to fund unified credit trust and/or a generation
skipping transfer tax exempt trust (if applicable).
Ensure that appropriate tax apportionment clauses are addressed in
planning documents. Estate taxes should generally be apportioned
away from the Roth IRA asset thereby enabling the Roth IRA to
continue to grow on an income tax-free basis.
Consider utilizing a charitable split interest trust as a tool in minimizing
income tax in the year of a Roth IRA conversion.
Ensure that an individual’s durable power of attorney will provide the
attorney-in-fact with the right to make any and all tax elections,
including an election to recharacterize the Roth IRA.
Because the ability to recharacterize extends beyond an individual’s death
and is transferred to the individual’s personal representative following
death, ensure that both an individual’s IRA trust and last will and
testament provides for the recharacterization power.
• Asset Protection Considerations
Consider implications on bankruptcy and creditor protection under federal
and applicable state law before converting a qualified plan or
traditional IRA to a Roth IRA.
Consider utilizing a standalone IRA Trust to be beneficiary of the Roth IRA for
asset protection purposes.
$100,000
Original
Conversion
1/1/12
Recharacterize
$80,000
11/30/12
$ 75,000
Recharacterize
11/30/12
Reconvert
5/16/13
$85,000
Hold
$85,000
Hold
$90,000
Hold
$95,000
Hold
$85,000
Hold
$90,000
Hold
$75,000
Recharacterize
$80,000
Reconvert
1/1/13
$90,000
Reconvert
1/1/13
11/30/13
1/1/14
In the chart above, the conversion of four different asset classes (referred to as A through D) is analyzed. All
four asset classes are converted to (4) Roth IRAs on January 1, 2012. In the case of asset class A, the account
increases in value to $125,000 as of November 30, 2012. Due to the increase in value, there is no reason to
recharacterize. The deadline for recharacterization of the January 1, 2012 conversion is October 15, 2013, and
at that time the value of A is $135,000, meaning it will, of course, be held. Asset class B decreases in value to
$95,000 as of April 15, 2013 and it is recharacterized. On May 16, 2013 (31 days after the recharacterization)
the value of B is $80,000, and the account is reconverted to a Roth IRA (the reason for this is the advantage
afforded by paying income tax on $80,000 instead of $100,000). Because the account increases in value after
May 16th, it will be held. Asset class C decreases in value to $75,000 as of November 30, 2012. It is
recharacterized. On January 1, 2013 the value of the account is $80,000 and it is reconverted. Subsequently,
the value increases and the account is held. Asset class D decreases in value to $75,000 as of November 30,
2012 and is recharacterized. When the value is $90,000 on January 1, 2013, the account is reconverted. On
April 15 and October 15, 2013 the account is held; however, when the account decreases in value to $75,000 on
November 30, 2013, it is recharacterized. (This is possible because the account was reconverted on January 1,
2013. Technically, the account could be recharacterized as late as October 15, 2014.) At a value of $80,000 the
account is (again) reconverted on January 1, 2014.
Beneficiary
Beneficiary
Spouse Spouse may defer required distributions until Designated
Inherited IRA the year the owner would have reached age Beneficiary
(No rollover) 70 1/2. In this year and for each succeeding Trust
year, the RMD is calculated based upon
spouse's life expectancy by referencing her
attained age for the year of distribution
based on the Single Life Table.
Spouse Rollover
No RMDs required during spouse’s life.
Non-Spouse
Individual
Designated
Beneficiary
RMDs calculated using the oldest
beneficiary's age in the year of the first
distribution by reference to the Single Life
Table. For succeeding years, this factor is
reduced by one. If the trust is designed
properly and the beneficiary designation
form is filed properly, then each primary
beneficiary may utilize his or her own age in
calculating RMDs.
RMDs calculated based upon corresponding
life expectancy factor for the beneficiary’s
age in the year of the first distribution by
reference to the Single Life Table. For
succeeding years, this factor is reduced by
one. If multiple beneficiaries are named, as
long as the account is segregated prior to
December 31st of the year following death,
each beneficiary may independently
calculate RMDs.
Robert S. Keebler, CPA, MST: Tax-Efficient DrawDownTM Strategies
2012 Income Tax Brackets
Single
Married
Filing
Jointly
Married
Filing
Separately
Head
of
Household
10%
$8,700
$17,400
$8,700
$12,400
15%
$35,350
$70,700
$35,350
$47,350
25%
$85,650
$142,700
$71,350
$122,300
28%
$178,650
$217,450
$108,725
$198,050
33%
$388,350
$388,350
$194,175
$388,350
35%
> $388,350
> $388,350
> $194,175
> $388,350
Three Main Types of Retirement
Investment Accounts
1. Taxable investment accounts – income generated
within the account (i.e. interest, dividends, capital
gains, etc.) is taxed each year to the account owner
2. Tax-deferred investment accounts (e.g. traditional
IRAs, traditional qualified retirement plans, nonqualified annuities) – income generated within the
account is not taxed until distributions are taken
from the account
3. Tax-free investment accounts (e.g. Roth IRAs, life
insurance) – income generated within the account
is never taxed when distributions are made
(provided certain qualifications are met)
Top Ten Tax-Efficient
Retirement Portfolio Strategies
1. Capital loss harvesting
2. Tactical asset sales/specific identification method
3. Tax-exempt interest
4. Tax-deferred annuities
5. Life insurance
6. Oil & gas investments
7. Leveraged real estate investments
8. Net Unrealized Appreciation (NUA)
9. Tax-efficient DrawDownTM
10.Roth IRA conversions
Key DrawDownTM Concepts
1. Tax structure – Determining the “optimum” mix of taxable investments, tax-deferred investments and tax-free investments (i.e. where should retirement savings be
invested?)
2. Tax-sensitive asset allocation – Asset allocation done on an after-tax basis
3. Asset location – How investors distribute assets across taxable accounts, tax-deferred accounts and tax-exempt accounts to create tax advantages
4. Tax bracket management – Short-term timing of income and expenses on a year-by-year basis so as to minimize overall income taxes over the long-term
5. Tax AlphaTM – The improvement in portfolio returns produced by efficient income tax management
Tax Structure Overview
Key factors impacting the tax structure
• Age
• Other sources of income (e.g.
TaxTax-free
pension, Social Security, deferred
deferred
compensation)
• Retirement cash flow needs
Taxable
• Future tax rates
© 2012 Keebler & Associates, LLP
All Rights Reserved
Tax-Efficient DrawDownTM
Decision Matrix
Future income taxed
at same or lower tax
rate
Future income taxed at
higher tax rate
1) Taxable account
2) Tax-deferred account
3) Tax-free account
1) Tax-deferred account
2) Taxable account
3) Tax-free account
Basis Recovery of Retirement
Investment Accounts
Accounts which need to be aggregated for basis recovery
• Roth IRAs – basis out first
• Traditional IRAs – basis pro-rated
Accounts which do not need to be aggregated for basis
recovery
• Life insurance – basis out first
• Qualified retirement plans (e.g. 401(k) plan) – basis pro-rated
• Non-qualified deferred annuities (annuitized) – basis prorated
• Non-qualified deferred annuities (not annuitized) – basis out
last
Robert S. Keebler, CPA, MST: Tax Asset ClassesSM
Tax-Deferred Income Tax-Free Income
Taxable Income
Interest
Income &
NonQualified
Dividends
Short-Term
Capital
Gains
Rents &
Royalty
Income
Taxable as ordinary income
Qualified
Retirement
Plans
(Taxable)
Short-Term Capital
Gains
Rents & Royalty
Income
Qualified
Dividends
Long-Term Capital
Gains
• Bank interest
• Money market
interest
• Corporate bond
interest
• Corporate
dividends which
do not meet
specific
qualifications
• Gains from
investment
assets which are
held 1 year or
less at the time
of sale
• Rental real
estate income
• Limited
partnership
income
• Royalties from
patents,
copyrights, etc.
• Oil & gas
income
• Corporate (both
domestic and
foreign) which
meet specific
qualifications
• Gains from
investment
assets which are
held more than
1 year from the
time of sale
Losses offset other
ordinary income
No
Yes, but only up to
$3,000 losses (in
excess of capital
gains)
Yes, but losses may
be limited under
the passive activity
rules
No
Deferral of income
taxation?
No
Yes, until the asset
is sold
No
Examples
Other
considerations
• May include
income imputed
under IRC §7872
or the Original
Issue Discount
(OID) rules
© 2012 Keebler & Associates, LLP
All Rights Reserved
• Reduced by
short-term
capital losses
• Excess longterm capital
losses may
offset shortterm capital
gains
NonQualified
Deferred
Annuities
TaxExempt
Interest
Income
•
•
•
•
Depreciation
Depletion
Amortization
Intangible
drilling costs
(IDCs)
• IRC §1031
exchanges
Qualified
Retirement Plans
(Taxable)
Qualified
Retirement
Plans (Not
Taxable)
Life
Insurance
Taxable as ordinary income
Taxable as long-term capital
(i.e.
10%, 15%, 25%, 28%, 33%, 35%)
gains (i.e. 0%, 15%)
(i.e. 10%, 15%, 25%, 28%, 33%, 35%)
Interest Income &
Non-Qualified
Dividends
Long-Term
Capital
Gains
Qualified
Dividends
NOT taxed
Qualified
Retirement Plans
(Not Taxable)
Non-Qualified
Deferred Annuities
Tax-Exempt
Interest Income
• Traditional
401(k) plans
• 403(b) annuities
• 457 plans
• Defined benefit
plans
• Traditional IRAs
• Annuities which
do not meet
specific
requirements
• Interest from
state and local
government
bonds
• Interest from
U.S. territory
bonds (e.g.
Puerto Rico,
Guam, USVI)
Yes, but only up to
$3,000 losses (in
excess of capital
gains)
Yes, but losses are
miscellaneous
itemized
deductions subject
to the 2% AGI floor
Yes, but losses are
miscellaneous
itemized
deductions subject
to the 2% AGI floor
No
No
Yes, but losses are
miscellaneous
itemized
deductions subject
to the 2% AGI floor
No
Yes, until the asset
is sold
Yes, until
distributions are
made
Yes, until
distributions are
made
No
Yes
Yes
• Special longterm capital
gains tax
treatment is set
to expire for tax
years after
12/31/2012
• Special tax rates
apply to
depreciation
recapture,
collectibles
gains and
qualified small
business stock
• Required
minimum
distributions
(RMDs) at age
70½
• 10% early
withdrawal
penalty on pre59½
distributions
• If annuity is not
annuitized, then
taxable income
comes out first
before nontaxable basis
• Need to
compare rate
of return
against aftertax rate of
return on
taxable bonds
Life Insurance
• Whole life
insurance
• Universal life
insurance
• Term life
insurance
• Gross income
does not include
proceeds paid
• Taxable income
could occur if
there is a
“transfer for
value”
• Designated Roth
accounts within
a qualified
retirement plan
• Roth IRAs
• No required
minimum
distributions
(RMDs) – Roth
IRAs only
• Need to meet
certain criteria
to be tax-free