How does a tax-deferred IRA differ from a Roth?

Tax-deferred savings (to an IRA or employer pre-tax retirement plan) reduce your tax liability today BUT are fully taxable (including gains) on withdrawal. The tax-deferral accounts are an excellent way to minimize your current taxable income. The goal is to use what would have been tax dollars as part of your savings. The main rules to keep in mind are that withdrawals shouldn’t be expected before age 59.5 AND that you MUST take mandated distributions (called RMD) when you reach age 72 (according to the new tax rules). Unfortunately, these accounts are now also not inherited in the same beneficial manner as in the past (these now follow the new Secure Act of 2019 rules).

A Roth on the other hand, doesn’t provide tax deferral when saved but it does provide tax-free dollars, on withdrawal. Contributions to a Roth are limited in amounts each year and not easily available for high earners. Whereas Roth conversions require income tax payment on converting pre-tax IRA dollars, not everyone is permitted to make Roth conversions. Fortunately, Roth IRAs are not impacted by the Secure Act of 2019 and remain free of RMD. They are also still inherited tax-free to individual or trust beneficiaries and are likely to be favored for those considering leaving a legacy.

As income tax rises (likely, given our debt load), Roth accounts will become even more powerful tools in retirement for those in the higher tax brackets. Currently they help us regulate your taxable income and keep taxes and Medicare costs reasonable during retirement.

We’d like to consider Roth conversions for you in years when you expect a lower tax rate. It is particularly useful when tax-deferred accounts are undervalued and when you have accumulated large tax-deferred accounts.

The basic takeaway is that a tax-deferred account should be maximized during years with high earnings (to reduce taxes) and high tax rates. When you expect a low earning year then a Roth conversion may provide you with an ideal situation BUT ONLY IF your retirement tax rate is expected to be high enough to trigger additional taxes or Medicare costs.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

New tax rules (Secure Act of 2019)

As you know, we believe strongly that managing tax liability is essential to building wealth. The Secure Act of 2019 has made significant changes which we will use to create and action strategies best suited for each of you.
Everyone, near retirement, is aware that there was an extension to the Required Minimum Distribution (i.e., RMD) from age 70.5 to age 72. This is good for many since it gives you more control over your tax liability early in retirement, but it also has made the Roth accounts an even more powerful tool for some.

Sadly, the Secure Act of 2019 has made inherited IRAs a big tax burden for beneficiaries, particularly trust beneficiaries. Because of this, IRA accounts that use a trust as a beneficiary may need to be re-examined to ensure that the language allows beneficiaries to minimize their tax liability.
Let me know if these topics are of interest and we’ll include them at our next financial planning meeting.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

The TCJA Tax Act Several Months In

I’ll quickly summarize the impact of the TCJA (Tax Cuts and Jobs Act) that we’ve observed on personal taxes and then I’ll switch to the impact on small business owners by covering QBI (the Qualified Business Income) and changes to deductions.

The tax bracket has dropped significantly for personal federal taxes since the top rate is now 37% AND the higher tax brackets begin at much larger taxable income. Though this sounded like a great opportunity to reduce the family tax liability it was combined with drastic changes to the estimated tax deductions and elimination of exemptions. The net result for residents of high-income tax rate states (such as California) and who used Schedule A itemized deductions is that their taxes actually increased. Most others found no change or a small reduction in their tax liability in 2018 from the new rules EXCEPT for small business owners. We expect the same in 2019.

Small business owners have a unique new tool in the TCJA – the QBI deduction. This tool provides a real opportunity to reduce taxable income and therefore tax liability. The QBI deduction is available from 2018-2025 and is only for pass-through entities (businesses that are not C Corporations). This deduction is available without income restrictions for businesses that are deemed a ‘Qualified Business”.

The chart above specifies that to qualify for this deduction you must be a Qualified Business. To be a Qualified Business it can’t be a service business or be a trade or business that involves the performance by the employer of services as an employee. The following are NOT a Qualified Business: doctors, lawyers, accountants, performers, athletes, health care professionals, financial and broker service providers, partnership interests. Only two service providing businesses are considered a Qualified Business: engineering and architectural firms. Though unclear in the code as to how gray areas would be decided the key catchall is that you can’t be a ‘Qualified Business’ if the business’ principal asset is the reputation or skill of one of the owners. Most of our clients own excluded (non-qualified) businesses.

As an excluded business owner (such as attorneys, consultants, etc.) you MAY STILL qualify for this QBI deduction IF your personal taxable income falls below the limits of $315K and $157.5K (married filing jointly and single filer respectively).

The QBI rule allows a Qualified Business (or excluded businesses that qualify under the taxable income limits) to reduce their taxable income by 20% of their QBI (QBI is business profit, not W2 income). An IMPORTANT CAVEAT is that the 20% deduction is the lesser of QBI or taxable income.

For example, if your business profit is $200K and your taxable income is $100K the actual deduction is $20K not the $40K that you might have expected. Regardless this new tool does provide for a way to reduce taxes.

When I initially reviewed the code, I was very excited for the Qualified Businesses owned by our clients since they were to benefit regardless of income. It was not until the last few months that a complicated wrinkle has limited this excitement. We’ve found that even Qualified Businesses have hurdles if the taxable income exceeds these same limits ($315K/$157.5K for married filing jointly and single filer respectively). If the business owner’s taxable income exceeds these income limits, then two additional rules are used rather than just receiving a deduction of 20% of QBI. For Qualified Businesses in excess of these limits there is a two-pronged test to measure the lesser of 20% of QBI (profit) OR the greater of either 50% of all W2 wages or W2 wages plus 2.5% of your qualified equipment/land costs. Yes, after jumping all of these hoops we found that some QB businesses didn’t qualify for 20% of QBI because the W2 weren’t high enough. Even so, the business owner did obtain a deduction though not as high as was initially estimated.

Added to the QBI deduction the TCJA rules also include these changes:

1. Entertaining clients is no longer a business expense that is deductible federally (it used to be 50% deductible). Office parties are still 100% deductible.

2. Businesses supported by debt financing can only deduct 30% of the owner’s adjustable taxable income BUT don’t despair since it will only apply to small businesses that have gross receipts of $25M for each of the last three years.

3. NOL deduction (Net Operating Loss) which is often carried back two tax years or future 20 years will now be only allowed for years going forward AND limited to 80% of income in that year.

I’m providing this education article to give perspective on how you benefit from the TCJA tax rules. Our ultimate goal is to have you knowledgeable enough to understand the critical role of taxes in your planning. If you have additional questions feel free to ask us or your tax preparer.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax Planning: Year-End Items to Consider

Tax planning consists of ensuring that tax liability is appropriate (given the tax code, family finances, and family goals) and that required actions are completed by the deadlines. At year-end, we identify relevant actions and relevant timeline.

Current Year actions …

  1. Estimate total earnings and total tax withholdings along with any tax-deferral that has or will be made for the current year. Use these and your deductions to estimate Federal and State tax liability.
  2. Ensure that expected tax liability has been paid either through payroll or through estimated tax payments. It is always best to pay taxes through payroll.
  3. For the self-employed, estimating taxes and ensuring that enough but not too much tax is paid throughout the year is part of tax planning. This is particularly important for businesses that have no payroll and pay their income tax and self-employment tax (i.e. Medicare and Social Security) simultaneously. Without tax planning, it is common for these businesses to underpay their Federal tax liability.
  4. Again, estimating profit from business entities (S Corp, C Corp, LLC, or sole proprietorship) allows business owners to adjust cash flow and meet tax deadlines. Business owners often create or contribute to various tax-deferral plans. The largest pre-tax contributions are for plans that have to be created prior to year-end.
  5. Any deductible contributions to H.S.A., Traditional IRAs or other accounts need to be made by their specific deadlines. These contributions might lower taxable income today (Traditional IRA, pension and 401K) or be tax free in the future (Roth) or both tax free now and in the future (H.S.A.).
  6. Year-end provides an opportunity to harvest investment accounts and therefore reduce or increase capital gain. Capital gain can be countered against capital losses to provide a net gain or loss which will either increase or decrease tax liability for any given year. We can reduce tax liability by adjusting what we buy/sell (i.e. the lot) at year-end depending on the overall tax burden. Keep in mind that tax rates differ based on taxable income. The federal tax rate for gain can be from zero to 23.8%.
  7. Estimating overall tax liability prior to year-end allows families to adjust deductions and employers to make needed capital purchases before year-end.

Actions based on next year’s rules …

Since we don’t yet know the tax rules that will apply in 2018, it will be especially difficult to fulfill the second part the year-end tax planning (where we either act or defer actions this year based on comparing the tax code in both the current and coming years).
Based on the two tax proposals (House and Senate versions) we consider acting prior to year-end if there is a high probability that a tax advantage will be lost in the new year and it plays a significant role in the person’s finances.

Though neither proposal appears to “simplify” taxes, both bills make significant changes to current tax rules and may, in fact, make it ideal to take some actions before the end of 2017 (taking advantage of current rules), while delaying those that benefit from the rules in the new year.

It will now be the job of the legislative committee to reconcile the differences without inserting any new provisions which will then need to go to the House and Senate for final approval. It is still too early to take action according to one or the other proposal but exploring the impact in light of individual tax circumstances makes sense.

  1. It may be worth considering accelerating itemized deductions into 2017 that are targeted for elimination. For example State income tax is scheduled to disappear in both proposals. Nevertheless, consideration must be given to unique situations, particularly regarding AMT (Alternative Minimum Tax).
  2. Consider recognizing tax losses prior to year-end (which is a normal annual year-end tax action) but the ability to select tax lots may disappear in 2018. The new rules may require that sales “first-in-first-out” (FIFO) which results in higher tax liability as it recognize higher gains on the sale of a security. We are hoping FIFO will not survive the reconciliation process but if it does we’ll have to act quickly before Dec 31.
  3. If you are planning to transfer very large assets between family members you would be well advised to wait until 2018 when there is an increased tax exemption. This doesn’t change the annual gifting which is currently at $14K in 2017 (and will be $15K in 2018).

Though we all want to contribute our share of taxes to sustain our communities and our way of life, it is always prudent to annually evaluate and implement the best way to handle tax liability considering current and future implications.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Converting Sweat Equity to Personal Wealth

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If you are a small business owner, you’re probably familiar with the term “sweat equity.” Essentially, sweat equity is a measure of the added interest or increased value that you’ve created in your business through plain hard work (that is to say, through physical labor and intellectual effort). Typically, business owners just starting out don’t have the necessary capital or don’t want to hire a large staff to run the business or to purchase high-tech, so they put in untold extra hours, do much of the work themselves and try to “think smart” in terms of marketing or production. They often use this opportunity to develop a clientele and a business process they enjoy. If well designed it can be profitable, but at some point the owner must put in place strategies that can convert business profit into personal wealth.

In other words, to be considered a truly viable business, at least two things must happen (there are others, but for the purposes of this article we’ll just focus on two). One, you must evolve the business to the point where it is sustainable with only the amount of personal labor you want to dedicate and in a way that allows you to maximally build Owner Wealth while covering business cash flow needs. Moreover, the goal is a process that gives you a sense of accomplishment and satisfaction. This is what we call a “life-style” business. Or two, you must organize and prepare the business to a degree or footing that it can be sold for a profit, at least enough and in a manner that will allow you to retain the profit as personal or “Owner Wealth.”

I should note, for those who are not self-employed, that employees can also generate sweat equity for their firm by creating additional ways to increase the bottom line. For startups, you may defer your vacation and even put off earnings. All these things add value to the company, but employees will expect to receive some form of compensation either in the form of existing benefits (bonus, parental leave, or nonqualified plans) or in shares of company value.
As a business owner, the first question you must ask yourself is “What do I want my life to look like while I’m creating this equity, and what do I want to accomplish in the long term?” Once you answer this question, and only then, can we come up with a proper plan to support your direction.

It is our experience that business owners without such a plan likely encounter challenges that can undermine their ability to convert their equity to personal wealth. These challenges come either in terms of selling the business or ensuring that the life-style business is sustainable. For instance, there is a good chance that instead of generating wealth to your maximum potential, you’ll be funding Uncle Sam (and the California Franchise Tax Board) and coping with cash flow problems.

Presupposing your business is already generating profits, a well-tailored plan can (at least potentially) make a big difference in terms of retaining or accumulating Owner Wealth. Aside from using earnings to support current lifestyle, your business can create benefits that permit the owner to retain earnings for future use and reduce current tax liability, particularly important in California, where the tax liability on business owners with profitable business can exceed 50% of their business profit.

For example, a business owner with sweat equity from their start-up or life-style business that yields around $500K per year (after business expenses) might have a tax liability of $110K (IRS only) or $155K in California (see table below). Using available benefit tools/strategy an owner can (in this scenario) build wealth annually of about $230K. Much of their wealth is built from deferring taxable income and lowering their tax liability to $45K (or $70K within California).

table

Allowed to grow over 5, 10, or 20 years this strategy could (at a conservative 5% annual return) yield wealth of $1.3M, $2.9M and $7M respectively for the business owner. On its own, tax and benefit planning can yield a high conversion of sweat equity to Owner Wealth.

When starting a business, the last thing we ever think about is how we’ll exit from it and collect on all the hard-earned sweat equity we’ve invested. We’re usually focused on creating value and determining how we can generate sufficient earnings. Yet for some businesses it is only from a well-designed and planned sale that the owner will realize any personal wealth from their risk and hard work. For the owner of a life-style business, selling your firm may seem akin to selling off your first-born, but there comes a time in all our lives when such decisions are unavoidable, even advantageous. At the very least, it may be worth considering selling part interest in the business as a way of reducing workload and simultaneously augmenting Owner Wealth.

As an owner ready to sell you will want to be confident that you are choosing the right time, securing the best price, and structuring the transaction wisely. You’d be well advised to seek expertise in selling your business (particularly new entrepreneurs), and give plenty of thought to how it will impact Owner Wealth, which is all too often overlooked.

When considering how to exit from their business, entrepreneurs need to at least follow these 7 steps to maximize Owner Wealth.

  1. Plan your exit well in advance since the best fit team and solution may take time to identify and develop.
  2. Understand and acknowledge your emotional connection to the business. It can be deeply personal and leave you unsatisfied if not fully addressed – regardless of profit.
  3. Prepare the business for the sale so that it is financially attractive to the financial advisors of potential buyers.
  4. Choose experienced individuals in your specific type of business to guide you through the process of selling your business BUT include your personal advisor to ensure that the best exit also meets with your personal financial goals. Again, building a team that is right for you.
  5. Think clearly about family succession – don’t make assumptions on how your family or key employees feel about the business.
  6. Gauge the interest for a friendly buyer from co-owners, family, employees, vendors, and even customers.
  7. Develop a thorough wealth strategy plan. The wealth strategy plan should NOT be just about the business but should address how your efforts will be used to build your personal wealth and meet your personal goals.

Take the time to know yourself, know your goals and make absolutely sure your financial advisor has a clear picture of your objectives. Together, your plan will convert all that valuable sweat equity into wealth to fuel your dreams.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Building Wealth: Your Real Estate Asset

Real estate is often purchased as a lifestyle asset (to live in) or as a commercial investment (to generate rental income). It’s also quite common for people to think of their home as both lifestyle and an investment. Certainly, the most common near-term goal for families is home ownership – many think it amounts to a “no brainer” investment (meaning they think their home is a great investment) when it actually costs them much more than they realize.

In our examination of annual return rates on residential and commercial real estate we find that real estate is by no means a no brainer investment. Real estate assets can indeed contribute to wealth creation if the purchaser buys for value, carefully manages maintenance/renovation costs, and the sale is handled with an eye to minimizing taxes on gain from the sale.

Your residence has the potential to be a large part of your wealth, particularly in the Bay Area, but it can also be your largest liability.

Lending institutions have different requirements when lending for an owner occupied residence than for commercial real estate. A primary residence can often be purchased with lower down payments and lower mortgage rates than non-owner occupied real estate. In addition, on the sale of the owner occupied residence the gain will often fall under the capital gain exclusion rules which allow couples to exclude $500K from their income, tax free. This is one of the few opportunities to realize gain completely tax free. Couples who want their residence to be an investment rather than a lifestyle asset should consider selling their home once the gain (market value above basis) in their home approaches the $500K cap gain exclusion. This doesn’t mean you have to buy bigger or smaller or move away from your neighborhood but it does mean that you must sell a property to capture this tax free gain.

If a couple bought a home for $600K, made no renovations and 5-10 years later it is worth $1M they could choose to sell their home and retain the $400K gain tax free. They could repeat this process several times in a couple’s lives and each time a sale is completed the gain can be retained tax free. At the end of 3 rounds (there are residence requirements for each exclusion to be allowed) this couple could have managed to clear (net) well over $1M tax free. Despite this unparalleled opportunity to build tax free wealth, most home owners will buy one home and live in it until retirement. A well purchased property will still yield gain but much of it will be taxed. A home purchased at $600K that sells for $1.8M in retirement will have $500K of the gain tax free but $700K will be taxed at capital gain rates federally and at regular income rates by the state.

A residence can turn into a large liability when the debt burden is too high, when the home renovations do not yield increased value for resale, when the home requires a lot of maintenance, and when the location is no longer appealing (loss of home value appreciation).

Unlike residential home purchases, real estate purchased for investment is first valued on its ability to generate sufficient income and not as much on its appreciation. Before buying an investment property the property is thoroughly analyzed from various perspectives. An APOD (Annual Property Operating Data) is the principal tool to understand the cash flow, return rate, and profitability that can be expected from a prospective property. Once a property passes the APOD test (primarily for risk assessment) then the tax shelter provided by such an investment and the impact of the time value can be used to determine if this is an appropriate investment. Not surprisingly, much of the success of these investments stem from proper usage of tax rules. The value of the annual depreciation (using Schedule E) is well known. An equally important tax tool is a 1031 exchange. In a 1031 exchange the value of the investment property you own can be used to buy a second investment property of the same or greater market value while deferring tax payments on the gain.

In short, both residential and non-owner occupied real estate can be part of your investment plan. Unlike market investments it is more difficult to identify and protect against unexpected events and the illiquid nature of ‘real’ assets. Managing real estate to attain investment value requires thoughtful deliberate actions that may not always be aligned with your personal wishes (far from being a “no brainer”). Investing in real estate can reap big rewards, but entails doing a lot of meticulous research, taking only risks that are necessary, covering for contingencies, working with an experienced team, and then allowing time to do the work.

If you need help deciding whether a real estate purchase fits with your long term goals, give Aikapa a call.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax Penalty/Bonus? – Single, Married, Domestic Partnerships

After nearly thirty years of marriage, I would be the last person to suggest that
tax consequences are a reason for making a lifelong personal commitment. On
the other hand, I am often the first to point out that marriage is not always a
tax neutral activity. Some people work on the expectation that a “married
filing jointly” (or MFJ) tax filing will always result in a lower combined tax
liability and a marriage tax bonus (meaning taxes are reduced solely due to
filing as MFJ). They are surprised when this joint filing actually creates a
marriage tax penalty (meaning filing MFJ results in higher taxes).

So when should we expect a penalty or bonus? The literature describes that ‘in
general’ we see a tax bonus when two partners have disparate incomes and a
tax penalty when they have similar or equal income. Based on the literature I
expected that income splitting (as occurs in a domestic partnership tax filing)
could provide an additional tax bonus over MFJ since disparate incomes can
be split evenly between partners.

While exploring the new 2013 tax rules we examined some tax scenarios and
want to share some highlights with you. We found that starting at a combined
AGI (Adjusted Gross Income–the number at the very bottom of the 1040
form) of $230K filing as MFJ resulted in a tax bonus of about $2K IF the two
people had disparate incomes ($200K and $30K respectively) but a penalty of
$2K for those with similar incomes ($115K each). Therefore at this level of
AGI couples with disparate incomes do slightly better under MFJ and those
with similar AGI do slightly better filing as individuals.

With a joint AGI of $330K the single disparate earners ($300K and $30K)
receive a marriage tax bonus of about $3K. If the same joint income was
earned evenly ($165K each) they would pay $4K more filing as MFJ than as
two individuals (a $4K tax marriage penalty). Looking at these scenarios, it
became clear that those with similar incomes would annually save thousands
of dollars if they filed as individuals rather than MFJ (Note: this is not the
same as married filing separately but rather unmarried individuals). As a
corollary, those in a domestic partnership may want to verify that they will not
have a large tax increase if they marry and file as MFJ.

Finally we looked at a couple with a $530K AGI who will pay $143K in taxes if
they file as two individuals with disparate incomes ($500K and $30K) and
taxes will be about the same if they file under MFJ (there is about a $1K tax
bonus). We do see a large tax penalty if this income was earned evenly by two
individual filers ($265K each) and they file MFJ. As two individuals the tax
burden would drop by at least $15K.

Marriage does provide non-income tax related advantages for spouses and
the family which are not discussed here.

Once you consider tax consequences of marriage, domestic partnership or
single tax filings any decision you make will work as long as you make plans to
cover the marriage tax penalty or find ways to spend the marriage bonus.
The above analysis assumed that ‘itemized deductions’ were kept constant and
that there was no AMT. These were modeled tax estimates – please consult
your tax preparers for the specific tax impact in your situation.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax Season and the Retiree

Tax Season and the Retiree

There are a lot to contemplate when considering the state in which to retire. Most want to be close to family and friends, the weather to be suitable for them, and what they hope to do in terms of activities.  A consideration this time of year are taxes — one of life’s two certainties and, one often a large expense in retirement.  It is never a good idea to seek out a retirement state based solely on tax burden but it is good to be aware which states fit your plans best for retiement.

So, find out how each state taxes your income and plan accordingly. Also consider how the state taxes your property and your consumption and you might want to consider how it taxes your estate.  That should give you a state tax burden that you’ll need to cover during retirement.

Older Americans who planned for retirement often generate income from several sources during retirement, including income from wages or self-employment; Social Security; pensions; and personal assets, including taxable and tax-deferred accounts. Taxes on those sources of income, mean less money for your care and enjoyment.  But don’t forget state and local property taxes, state and local sales and use taxes. You might pay plenty in property taxes and sales taxes.

Remember, what you save on income taxes in one state you might pay in property taxes or sales taxes. And vice versa. What you save on property and sales taxes in one state you might pay in income taxes – so calculate for your specific retirement situation.

One more note, for those who itemize deductions, there are five types of deductible non-business taxes, including state, local and foreign income taxes; state, local and foreign real estate taxes; state, and local personal property taxes; state and local sales taxes, and qualified motor vehicle taxes.

Your specific tax burden, will depend on whether you can take advantage of these deductions.

The states are listed in order of tax friendliness from an overall tax burden point of view:

1. Alaska:  Alaska doesn’t tax personal income, including Social Security benefits and pension income. And, there’s no state-imposed sales tax. This is not to say that you won’t pay any taxes in Alaska – You’ll pay other types of taxes, such as property taxes.

2. Nevada: This state doesn’t tax income, Social Security benefits or pension income. And its property taxes are reasonable, too. Its sales tax, however, is higher than the national average.

3. South Dakota: The state doesn’t tax individual income, Social Security benefits or pension income. And the overall tax burden is among the lowest in the nation.

4. Wyoming: There’s no individual income tax on Social Security benefits or pension income in Wyoming but property taxes and sales taxes tend to be higher than the national average.

5. Texas: In Texas, there’s no individual income tax. But property and sales taxes tend to be higher than the rest of the nation.

6. Florida: There are plenty of reasons why people choose to retire to the Sunshine state, the low tax burden being among those reasons. There’s no individual income tax on Social Security benefits or pension income with high property and sales taxes.

7. Washington: There’s no individual income tax on Social Security benefits or pension income. But if you plan on spending lots money while in retirement watch out for the high sales tax.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Estate Planning – Don’t forget to prepare the heirs

Estate Planning should include Coaching Heirs

Estates fail at a rate of 70 percent following their transition to heirs. Why?  Attorneys and financial planners do a good enough job on the assets and the estate but seldom have the mandate or interest to prepare the heirs for the assets they will receive.  Preparing heirs dramatically increases the ability to retain investmented portfolios through the tramatic transition and beyond.

The failure of estates following transition to heirs For many years, estate planning has routinely focused on the “Big Four” issues of taxation, preservation, control and philanthropy. Estate planners do a great job in these four areas, as fewer than 3 percent of estate failures (post-transition) can be attributed to errors by professional advisors, according to research conducted by The Williams Group.

What is missing from the traditional focus on the “Big Four” planning objectives?

. Research clearly shows that the missing element is preparing the heirs for the assets. In fact, the losses that occur during the estate’s post-transition period are driven by unprepared heirs, the lack of a family agreement on the mission of the estate, and the family’s fundamental inability to trust and communicate internally. It is not the scapegoat of estate taxes or the federal government, or even the litigious mentality of the modern day. It is frequently the result of an unprepared generation whose parents have not committed to preparing their heirs to receive and manage wealth in a responsible and competent manner. Lacking both preparation (skills, practice and team support) and motivation (commitment to a mission greater than that of satisfying self), heirs and their bequeathed estates are failing badly, at an astonishing 70 percent rate.

Family coaches that interact with the complete multigenerational family. Their objective is to ready the entire family to work with the advisory professionals by having the family meet and agree upon a mission for the family’s wealth. This is not only mom’s or dad’s mission, but also a multigenerational mission.

Once a mission is agreed upon, the family can move on to work with the family’s advisors to determine the roles that need to be filled (in the post-transition estate), to agree on the qualifications for those roles, and finally to set the observable and measurable standards that must be met to be allowed to continue operating (on behalf of the family) in those roles.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

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(1) Family Coaches: The “Missing” Link in Estate Planning By Vic Preisser and Roy Williams. Institute for Preparing Heirs.  http://www.cegworldwide.com/expert-team/001-family-coaches-estate-planning

IRS Audit rates for the wealthy

The Internal Revenue Service in 2011 (2010 tax year filings) overall audit rate stayed constant for individual taxpayers at 1.1%. For those earning between $200-500K it is at 2.66%. Of note since 2009 has been the significant increase in audits for the following groups:

–> an increase in audits of 29.9% for taxpayers with $10 million in income (in 2010 it was 18.3% and 10.6% in 2009).This is a group that consists of 0.01 percent of taxpayers. In addition, the IRS has implemented a more a more intense IRS task force audit that is more time consuming and costly.

–> an increase of 20.75% (from 11.55%) for those with Adjusted Gross Incomes (AGI) of $5-10 million.

Interestingly many tax prepares claim that the IRS is quicker to audit individual returns than in the past, sometimes contacting people within months of their return being filed. In some cases, “correspondence audits” are the norm, where the IRS will send a letter asking a taxpayer to verify a specific item on the return such as charitable deductions.

This change started in 2009 when the IRS created a special unit to examine the tax returns of high-wealth individuals. “We will take a unified look at the entire web of business entities controlled by a high-wealth individual, which will enable us to better assess the risk such arrangements pose to tax compliance and the integrity of our tax system,” IRS Commissioner Douglas Shulman said in a December 2009 speech. “We want to better understand the entire economic picture of the enterprise controlled by the wealthy individual and to assess the tax compliance of that overall enterprise.”

=============== March 23, 2012 – Credit: Bloomberg News online