Category Archives: Tax Planning

Cover topics of interest that will help keep you informed on tax issues that might be relevant to you – our clients.

Self Employed Individual 401K Plan Loans

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Who said you can’t have your cake and eat it too?

Self employed small business owners have an opportunity to not only save maximally through retirement plans but also build a safety-net through their ability to borrow from their individual 401K accounts.  Properly structured they can borrow from their retirement plan when the need arises without incurring the usual 10% penalty for early withdrawal.

In addition, 401k Loans for the Self employed business owners provides a loan, while allowing them to pay back interest to their own 401K rather than a financial institution.

An Individual 401k loan is permitted using the accumulated balance of the Individual 401k as collateral for the loan. Individual 401k loans are permitted up to 1/2 of the total balance of the 401k (but not exceed $50,000). A loan from an Individual 401k is received tax free and penalty free. There are no penalties or taxes if loan payments are paid on time.

Individual 401K Loans

  1. Can be used for any purpose.
  2. There are no income or credit qualifications to receive the loan.
  3. The monthly loan payments of principal and interest are repaid back into your own Individual 401k – you borrow and grow your retirement at the same time.

In addition, the assets can be from prior employer or IRA accounts that are rolled over to your individual 401K account.

Individual 401k are available to self employed individuals and small business owners with no full time employees other than a spouse. Your business can be a Sole proprietorships, LLC, S and C corporations,

The terms are set by the employer (yourself) but the 401k usually has a 5 year maximum repayment term for most loans, except it can be longer, for home purchase. There are no income or credit qualifications although you must charge yourself a competitive interest rate.

Although simple and fast to execute you  should remember that you are borrowing on your retirement nest egg.  It is only a valid action when you know you will have the ability to pay it back – default results in a withdrawal that can carry a 10% penalty.  The loan facilitates borrowing when it might be too difficult or too expensive to go through banks and lending institutions.

As good as it sounds consider that unlike a mortgage or a home-equity loan, if you use a 401(k) loan to buy or improve your home, you won’t get a tax deduction on the interest you pay. You may have to pay a one-time fee to the plan administrator for the cost of originating a loan; the fee is usually $50-100. Your retirement plan will also miss future targets if you don’t continue making annual contributions while you have this outstanding loan.  Though most self-employed who borrow from their 401K often pay their loans early it is important not to misuse your hard-earned retirement assets.

As can be seen the 401K Loan, like all tools, has advantages in disadvantages.  The advantages for the self employed should  encourage anyone who is or is planning to have their own business to begin saving in a tax deferred manner maximally.  By using an individual 401K account you can have your tax deferred savings and simultaneously build a safety net.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

IRS reports: Payroll Tax Extended into 2012

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Payroll Tax Cut Temporarily Extended into 2012
– reprinted from IRS Newswire IR-2011-124

The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2 percent to 4.2 percent of wages paid through Feb. 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.

Employers should implement the new payroll tax rate as soon as possible in 2012 but not later than Jan. 31, 2012. For any Social Security tax over-withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2012.

Employers and payroll companies will handle the withholding changes, so workers should not need to take any additional action.

Under the terms negotiated by Congress, the law also includes a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year amount). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2 percent of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100).

This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions. The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year. With the possibility of a full-year extension of the payroll tax cut being discussed for 2012, the IRS will closely monitor the situation in case future legislation changes the recapture provision.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Taxes – Unintended Consequence of Trust on Home Sale

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No Capital Gain Exclusion for Residence that is Held in Family Trust

IRS recent ruling shows unintended consequence of trusts used to hold personal assets. This ruling reminds us that tax rules change after a trust can’t be changed, making trusts sometimes inflexible in dealing with changing tax opportunities.

In this case the sale of a home, in which an individual resided for many years but to which title was legally held by a family trust, did not qualify for the Tax Code’s new capital gains exclusion on the sale of the house. The exclusion would for most home owners provide a $250K per person tax free gain.  The IRS concluded that the individual’s inability to control the assets of the trust prevented her from being deemed an owner of the trust for tax purposes.  The intention was that her largest asset held in a revocable trust would give her ultimate tax advantage while protecting her on the downside – the reality is that if her trust converts to a irrevocable trust she is no longer able to sell her property and obtain the $250K tax free gain.

Family trusts are a common estate planning tool and often place assets, such as a home, into a trust. The income beneficiary has rights to any income from the trust and may even have use of the assets but has no control to sell, mortgage or dispose of the assets of the trust. Since only the trust’s designated trustees have the power to make decisions related to the encumbrance or disposal of the trust’s assets then the IRS deems that the beneficiary has preferential estate tax treatment only if they have the ability to continue living in the home.

Planning for the smooth transition of your assets to your family upon death can be complicated and can have serious tax ramifications. ALWAYS review all tax documents with financial advisor, estate planner and tax advisor.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Social Security – Have a plan

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Maximize your inflation protected pension plan
– Couples must have a Social Security strategy

According to a recent survey (1) married couples nearing retirement do not maximize their social security benefits.  The vast majority of people are unaware of strategies that could increase their lifetime Social Security benefit by $40,000 or more. Only those with high net-worth or higher income appear aware that couples should have a social security implementation strategy.

Seventy-four percent of people with household income exceeding $200,000 expect to receive advice on Social Security benefit options from a financial planner, compared to only 48 percent of those with household incomes less than $50,000.

Most (77 percent) felt that the best advice to maximize their Social Security retirement benefits would be the Social Security Administration. Unfortunately, SSA personnel are not trained to provide more information than monthly benefit amounts at different election ages, and the SSA prohibits its representatives from dispensing advice.

If you are approaching your full retirement age or are planning on enrolling to receive social security make the investment to evaluate your social security implementation strategy with a qualified financial planner.

(1) survey source form socialsecuritytiming.com

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Where is Labuan?

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Financial Success during tough times … Labuan

Most of us probably don’t know Labuan, but amidst the major economic financial centers it is a shining star and part of what makes Malaysia such a power house. In an increasingly competitive and globalized world, international offshore financial centers rarely stop evolving and adapting to new circumstances and economic realities, and perhaps one of the most innovative, but lesser known, jurisdictions of recent times has been the Malaysian island of Labuan, which continues to go from strength to strength, despite the testing global economic conditions.

Labuan, situated a few miles off the northern coast of Borneo in Malaysia and tiny in size, is one of the newer additions to the list of the world’s offshore jurisdictions, but it is already attracting significant interest from businesses.

In 2010, Labuan maintained positive growth across all key business sectors, but particularly banking, leasing and insurance, despite the more challenging global environment, and new measures have been implemented recently to improve the flexibility and business-friendliness of its tax and legal framework, becoming effective as of 2009 and beyond.

Labuan has succeeded in not only attracting conventional business interest from all over the globe, it has its greatest potential in catering the growing demand for Islamic finance products.  Good or bad this is what appears to be in the future.

Labuan can now be said to be the new financial force to reckoned with, having built up a favorable reputation with international investors in a short space of time. Even so, they don’t appear content to rest on their laurels, and they’ve targeted several key strategies to advance Labuan as an international business and financial center of choice in the region. “In the pipeline are a number of initiatives under the Malaysian Financial Sector Blueprint, which aims to provide a holistic approach for the development of the Malaysian financial sector for the next 10 years“. Despite the gloomy world economic outlook and ongoing moves to force more regulation on offshore financial centers, with Malaysia’s backing it would seem that the sun is shining on Labuan’s future.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Who benefits most from our Tax Code?

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Business Corporations and Taxes

Warren E. Buffett and Bill Gates stated clearly that too many wealthy individuals pay unusually low taxes to the federal government. I’d like to share the information gathered so far on  Corporate America so that we might be able to understand our current tax code.

Recently a review showed that 280 of the biggest publicly traded American companies faced federal income tax bills equal to 18.5 percent of their profits during the last three years — just a bit over half the official corporate rate of 35 percent and lower than their competitors in many industrialized countries.

Mr. Buffett, said that the tax code is unfair, he paid just 17% in federal taxes last year, about half the percentage his secretary paid.  I want to know how much his secretary earns to pay 34% in effective federal taxes – this seems a bit high but his point is still valid.  Business owners are not treated the same by the tax code as employees – should they be?

This corporate review, examined the regulatory filings of these companies to compute each year’s current federal taxes. The study does understate tax payments because it omits deferred taxes that they may pay in future years. Since it did not analyze actual tax returns but used publicly available corporate regulatory filings many companies dispute it.

If 17-8% is the going Corporate average rate then we must look more closely at the 70 companies (a quarter of the 280 corporations) which owed less than 10 percent of profits in federal income taxes and the 30 companies that had no federal tax liability for the entire three-year period.

Why is this currently important?The Congressional super-committee will report on November 23rd how we’ll cut the budget deficit and is considering revamping our tax system.  The goal would be to simplify corporate structure and reduce corporate taxes. Corporations claim that the current system puts American companies at a disadvantage with competitors abroad and encourages them to shift jobs and investments overseas.  Is this real or a bargaining chip?

My view is that the current tax system rewards companies that aggressively avoid taxes. A quarter of the companies in the study had a federal tax bill of 35 percent of their profits, while a similar number had an effective rate of less than 10 percent.  Therefore not all corporations are equally sharing in the tax burden.  Maybe the solution is to close the loopholes & force a  minimum tax burden on profits for all corporations instead of lowering the rate.

Among the companies that the study said escaped a liability for all three years were Boeing and Ryder System, which benefited from the additional depreciation intended to stimulate the economy. Boeing officials countered that they had paid some federal taxes, but would not say how much. They said that their lower rate was from tax breaks intended to encourage hiring. Boeing claims to have hired 9,000 workers this year as a result of their tax credits.

Other companies include General Electric and Wells Fargo who claim respectively that new job creation and the Wachovia right downs where their reasons for reduced tax liability.

The fact is that corporations are paying a smaller share of taxes than in previous decades. According to the IRS they paid a total of $191 billion in federal income taxes in 2010, which is about 1.3 percent of the nation’s gross domestic product (GDP). That is down from about 6 percent during the 1950s.

Despite this decline the Americans for Tax Reform, said that the United States system was not competitive because it taxed income earned around the world, instead of just in this country. On the other hand Citizens for Tax Justice countered that about two-thirds of  the American companies with significant profits overseas actually paid more in taxes to foreign governments than they did in the United States.

But should we not consider the total tax?  The bottom line for a company is not how much they pay one country but how much they pay overall.

On the other hand, I can agree with the Citizens for Tax Justice’s request that the federal government end the subsidies and shelters that favor companies that game the system.

How can the supper-committee come up with real budget saving unless the loopholes are closed?

What do you think?

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

IRS: Banking transactions reported early 2012

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Banking Expenses are Going Up
Expect our fees to follow

The Internal Revenue Service just released this FAQ – that they are providing special transitional relief to banks and other payment settlement entities required to begin reporting payment card and third-party network transactions to the IRS on new Form 1099-K.  These are the fees that banks are trying to find a way to pass on to us, the consumer.

By law, reporting is scheduled to begin in early 2012 for payment card and third-party network transactions that occurred in 2011.

See details at:
http://www.irs.gov/newsroom/article/0,,id=249029,00.html

What is a third-party settlement organization?
A third-party settlement organization is a central organization that has the contractual obligation to make payments to participating payees (generally, a merchant) in a third party payment network. Characteristics of a third party payment network include: (i) the existence of a central organization with whom providers of goods and services have established accounts, (ii) an agreement between the central organization and providers to settle transactions between the providers of goods and services and purchasers, (iii) the establishment of standards and mechanisms for settling such transactions and (iv) the guarantee of payment in settlement of such transactions. The most common example of a third-party settlement organization is an online auction-payment facilitator, which operates merely as an intermediary between buyer and seller by transferring funds between accounts in settlement of an auction/purchase. Third-party settlement organizations charge sellers a fee for facilitating the transaction. Under the reporting requirements, these entities must report the gross reportable transactions of the businesses to which they make payments provided the payee satisfies certain transaction volume and dollar thresholds.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Government Policy To Watch

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Financial Policy in the news
Government policy that will impact our bottom line

1. Senate replaces Obama tax increases with millionaires’ tax

When President Barack Obama announced his jobs package in early September, he proposed paying for the measure with a series of tax increases on individuals making more than $200,000 and families making more than $250,000. Among them was a 28% cap on the tax exemption for municipal bond purchases and a hike in the tax on “carried interest” for private fund managers from the capital gains rate to the individual rate. In their version of the jobs plan, Senate Democrats replaced the Obama tax increases with a 5.6% surcharge on millionaires. The tax would apply to adjusted gross income less investment interest deduction above $1 million. Senate Democrats believe that the $1 million threshold more clearly delineates the difference between the middle class and the wealthy.

2. Obama’s jobs plan sliced, diced, stalled in Congress

In rallies around the country earlier this fall, Mr. Obama touted his jobs package and urged Congress to “pass this bill now.” By October, he was hoping that Congress would approve at least parts of it. It’s been slow going. The Senate blocked the entire $447 billion measure from getting to the floor. It was then diced up into smaller parts, and some blocked later on. The first portion of the package to get any traction was a provision to repeal a tax on government contractors that is set to go into effect in 2013. The bill’s prospects in the Senate are unclear.

3. Bills to promote crowd funding, raise SEC registration thresholds pass House Financial Services Committee

A bill that is similar to another piece of Mr. Obama’s jobs package was approved by the House Financial Services Committee on Oct. 26, would allow so-called crowd funding to finance startup companies by allowing the firms to pool small investments up to $5 million without having to register with the Securities and Exchange Commission. State regulators object, arguing that the bill would foster fraud.

4. What is the Buffett Rule? Capitol Hill steps into the definition vacuum

As he ramped up his re-election effort this fall, Mr. Obama proposed a so-called Buffett Rule. Named after Warren Buffett, the idea is that middle-class taxpayers should never fork over a higher percentage of their earnings to the federal government than the wealthy. The notion is based on Mr. Buffett’s suggestion that it is wrong for him to pay taxes at a lower rate than his secretary. A new bill, imposes an additional 5% tax on income from $350,000 to $500,000, 10% on $500,000 to $1 million, 15% from $1 million to $10 million and 20% on income exceeding $10 million. Another group has put forth a far different concept – taxpayers would be allowed to donate money to the Treasury Department to help pay down the national debt.  This last ‘concept’ has always been available BUT has yet to generate any income.

5. Republicans try to set rates on capital gains and dividends at 15% permanently and remove health care tax

House and Senate Republicans are attempting to bring some certainty to tax policy through a measure that would set capital gains and dividends rate permanently at 15%. If Congress does not extend the Bush tax cuts, the capital gains rate will rise to 20% and dividends will be taxed at individual rates beginning in 2013. In addition, the GOP is trying to get rid of a 3.8% Medicare tax that will be assessed on investment income starting in 2013 to help pay for the health care reform law.  Not sure how they plan to pay for it in a balanced budget BUT it may be a way to stop Obamacare by stopping its funding.

6. Legislation could allow retirement account borrowing to pay mortgages

Retirement savings advocates are wary of a bill that would allow penalty-free withdrawals from tax-exempt pension and retirement plans in order to pay mortgages.  It already allows it in 401K plans.  I would prefer that they borrow than withdraw BUT not for mortgage payments without a financial plan that helps them get ‘real’ to their current financial situation.

7. DOL on fiduciary-duty rule

The Labor Department is making clear to the financial industry that it is not abandoning a regulation that would significantly expand the definition of “fiduciary” for investment advisers to retirement plans. The agency withdrew a proposed rule in September which would increase regulatory and liability costs, and would drive brokers out of the individual retirement account market because it would subject them to fiduciary duty for the first time. But why would we want brokers who don’t follow fiduciary duty to be in the individual retirement market?

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Taxes prior to Debt Super Committee Vote

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2012-13 Tax Planning
– Prior to Debt Super Committee meeting deadline (Nov 23rd)

There are at least 60 income tax provisions scheduled to expire at the end of 2011 but even if they do the most significant income tax changes are expected in 2013.

The Bush tax cuts are set to expire and income tax rates rise in 2013. At that time, itemized deductions would once again be partially phased out, the estate tax exemption will drop precipitously and the estate tax rate will jump unless they are re-enacted.  At the same time we’ll begin the new healthcare surtax in 2013 that will result in 3.8% tax increase on
certain types of investment income and a tax of almost 1% on wages above a specified threshold.
Between now and 2013, we expect much talk about changes but the Congressional bipartisan ‘supercommittee’ is considering controversial revenue-raising measures, such as limiting itemized deductions for high income tax payers and other altered tax treatments. The vote & recommendations on November 23rd will play a large part in our confidence that our economy will begin to grow soon before the tax increases in 2013.

Our long term success still remain with business growth and ability to create and support well paying jobs.

What does this mean for investors? That we plan for what we know, not what might happen.  But we keep our eye on what changes are approved so that we can adjust and still reach your personal and professional goals.

This year and next year (are consistent with 2010) present us with tactical and strategic decisions that may require action before those rules expire.

Here are two lapsing provisions:
AMT Patch was extended from 2010 to 2011. If Congress
does not extend it, the AMT exemption for 2012 would
return to earlier, lower levels and will result in more tax owed.

The portion of the Federal Insurance Contributions Act (FICA) tax that goes to Social Security was reduced temporarily in
2011 from 6.2% to 4.2%. With no extension, the higher rate
returns in 2012.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Retirement Planning for Business Owners

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Retirement Planning for Business Owners: Compare 401K, SEP-IRA and Pension plans.

For self employed and small business owners to be personally successful they must contribute to their retirement savings at some point during their business development.  Some will do it a bit at a time while others will wait until they generate large profits.  Regardless, you should ensure that you minimize your tax liability while contributing towards your ideal retirement.

How do most self-employed select between available retirement savings plan?  Sometimes this is a decision based on ease of use, other times on a lack of understanding or incomplete or misleading information.  Here is a tiny overview of the major retirement plans available: SEP-IRA, 401K, Pension plans.

The most popular retirement saving vehicle for the self-employed is the SEP-IRA.

In many cases, the 401K should be considered since it exceeds the SEP-IRA limits and provides other benefits.  On the surface, 2011 limits for both SEP-IRA and 401K appear the same (at $49K), so what is the difference?  The way the contribution is calculated provides the key to why you can defer more with a properly designed 401K plan.

On a $100,000 W-2 earned income in 2011 a business (Corporation) owner (less than 50 years of age) can contribute $41.5K to a 401K or $25K to a SEP-IRA.  Yet so many self-employed use the SEP-IRA.  The lower contribution maximum of a SEP-IRA guarantees higher taxes and lower chance of attaining a reasonable retirement living standard. In many situations the 401K is a planning vehicle that not only provides more tax-deferred contributions but can be a resource in an emergency.

Even so, a 401K is not the best retirement saving tool for all self-employed.

For some, a better tool is a self-employed pension plan.  Although a pension plan does require a great deal more planning it is by far one of the best tools available to small business owners with high company earnings.

Make informed decisions about your tax and retirement options.  These decisions should be product neutral and planned to meet your specific situation.

If you have questions – let me know.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com