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Developments and planning ideas for Roth IRA and Regular IRA accounts

Congress enacts advance tax rebates and other tax breaks in the CARES Act

Congress passed and President Trump signed the Coronavirus Aid, Relief and Economic Security (CARES) Act (H.R. 748)  on March 28, 2020.  Here are some highlights of tax provisions of the Act.

Advance tax rebates

The provision that has received the most publicity is advance tax rebates of $1,200 for single persons and $2,400 for married couples who file joint income tax returns.  In addition to these amounts, $500 will be included in the advance tax rebate for each dependent child claimed by the taxpayer(s) who qualifies for the child tax credit under Internal Revenue Code Section 24.

The rebates will be mailed or electronically deposited as soon as possible by the IRS to provide relief to Americans who are suffering from the shutdown of our society to fight the coronavirus pandemic.

Not everyone will qualify.  The rebates are reduced to not below zero by 5% of the taxpayer’s adjusted gross income above $150,000 for married couples filing joint returns, $112,500 for heads of households, and $75,000 for other taxpayers.

Nonresident aliens, anyone who is claimed as a dependent, estates and trusts don’t qualify for the rebate.

The IRS will make a preliminary determination based on the last income tax return filed for 2018 or 2019, or for seniors who do not file an income tax return, their social security record.

When the taxpayer prepares his or her 2020 federal individual income tax return, the rebate will be recomputed based on the current year facts.  Any additional rebate will be allowed as a credit on the income tax return.  The taxpayer gets to keep any excess of the amount received over the computed amount.

The rebate reduces the federal income tax and any amount already received by the taxpayer and is treated as an refund received in amount.  The rebate isn’t taxable income.  The rebate can be more than the tax before the rebate and is refundable.

Waived early withdrawal penalty for certain retirement plan distributions

Taxpayers who receive a distribution from a qualified retirement plan or an IRA before they reach age 59 1/2 are normally subject to a 10% federal early distribution penalty.

The penalty will be waived for up to $100,000 of distributions during 2020 to an individual (1) who is diagnosed with coronavirus, (2) whose spouse or dependent is diagnosed with coronavirus, or (3) who experiences financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to the coronavirus crisis, being unable to work due to lack of child care due to the virus, closing or reducing hours of a business owned or operated by the individual due to the virus, or other factors as determined by the IRS.

Unless the taxpayer elects out, the income from a coronavirus-related distribution will be spread ratably over a 3-taxable year period, beginning with with the distribution year (2020.)

Although these distributions won’t be eligible under the usual rules for rollovers or trustee-to-trustee transfers, corona virus-related distributions from a qualified plan or an IRA may be repaid to the qualified plan or an IRA within 3 years beginning the day after the date the distribution was received.  The amount repaid will be treated as a direct trustee-to-trustee transfer within 60 days of the distribution.

It appears claiming the recharacterization of the distribution for any repayments will be reported on an amended 2020 income tax return.

Required minimum distributions aren’t required for 2020

The required minimum distributions that apply to defined contribution qualified retirement plans (401(k)s and profit sharing plans) and IRAs after a participant reaches age 72 (age 70 1/2 before the SECURE Act was enacted) is waived for 2020.

If an employee reached age 70 1/2 during 2019, so the employee has a required beginning date on April 1, 2020, the penalty is also waived for that payment.

For years after 2020, the required minimum distributions will be computed by the regular procedure (beginning balance divided by life expectancy) without regard to the 2020 required minimum distribution and the required beginning date will be unchanged for other income tax determination purposes.

Charitable contributions limits for individuals increased

Individuals who don’t itemize deductions on their federal income tax returns will be able to deduct on their 2020 federal income tax returns up to $300 of charitable contributions that would otherwise qualify, except for donations to a donor advised fund or a private foundation.

The limitation for itemized deductions of cash charitable contributions to public charities by individuals, normally 60% of adjusted gross income, is eliminated for 2020.

Charitable contributions limit for corporations increased

The limit for charitable contributions for C corporations is increased for charitable contributions paid in cash during calendar year 2020 to public charities from 10% of modified taxable income to 25% of modified taxable income.

Charitable contributions limit for food inventory

For noncorporate taxpayers, the limit for charitable contributions of food inventory is increased from 15% to 25% of the taxpayer’s aggregate net income for 2020 from all trades or businesses from which such contributions were made.

For C corporations, the limit for charitable contributions of food inventory is increased from 15% to 25% of modified taxable income.

Exclusion for employer payments on student loans

Effective for payments made after March 28, 2020 and before January 1, 2021, payments by an employer, whether paid to the employee or to a lender, of principal or interest on any qualified education loan incurred by the employee for education of the employee are excluded from the employee’s taxable income.  The employee won’t be eligible to claim an interest deduction for the excluded amount.

Payroll tax credit for certain employers

Employers who have their business operations fully or partially suspended during a calendar quarter due to orders from a government authority due to the coronavirus during the period beginning with the first calendar quarter beginning after December 31, 2019 for which gross receipts are less than 50% of gross receipts for the same calendar quarter in the prior year and ending with the calendar quarter for which gross receipts are greater than 80% of the gross receipts for the prior year and all tax-exempt organization during 2020 are eligible for an employee retention tax credit of 50% of qualified wages of up to $10,000 for each employee for all calendar quarters.

Note that employers who receive a small business interruption loan aren’t eligible for this credit.  (The loan may be eligible for forgiveness, and that would be double-dipping.)  If the employer claims the credit and receives a loan in a subsequent quarter, the credit will be recaptured.

The credit is effective for wages paid after March 12, 2020 and before January 1, 2021.

The credit is limited to the employment taxes (employer share of payroll taxes) for all employees during the calendar quarter, but any credit in excess of that amount is treated as an overpayment and is refundable to the employer.

The credit is reduced for credits allowed for employment of qualified veterans, research expenditures of qualified small businesses, and payroll tax credits for paid sick and paid family and medical leave provided in the Families First Coronavirus Response Act.

For employers having an average of more than 100 full-time employees during 2019, qualified wages means wages paid with respect to which an employee is not providing services due to a government-ordered suspension or a period of significant decline in gross receipts, but not in excess of the amount the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period.

For employers with an average of 100 or fewer full-time employees in 2019, qualified wages means wages paid with respect to an employee during any period of a government-ordered suspension or during a quarter that is within a period of significant decline in gross receipts.

Qualified wages don’t include any amounts taken in account for payroll tax credits provided in the Families First Coronavirus Response Act.

Qualified wages includes the employer’s qualified health plan expenses properly allocable to the wages that are excluded from the gross income of employees.

Wages of employees for which a work opportunity credit is claimed aren’t eligible for the credit.

Governmental employers aren’t eligible for the credit.

Deferred payment of employer payroll taxes

Deposits of the employer portion of payroll taxes due from March 28, 2020 through December 31, 2020 are deferred and payable 50% on December 31, 2021 and the balance on December 31, 2022.

Payments for one half of self-employment tax (the “employer” portion) for 2020 are also deferred and payable 50% on December 31, 2021 and the balance on December 31, 2022.

Employers that have a loan forgiven under Section 1106 of the CARES Act for a loan under Section 7(a)(36) of the Small Business Act aren’t eligible for deferring payment of employer payroll taxes.

Net operating loss deduction and carrybacks

The 80% of taxable income limitation for deducting net operating losses has retroactively been suspended for taxable years beginning after December 31, 2017 and before January 1, 2021.  For taxable years beginning after December 31, 2020, the 80% of taxable income limitation for deducting net operating losses will be restored.

For losses arising in a taxable year beginning after December 31, 2017 and before January 1, 2021, net operating losses may be carried back 5 taxable years. Previously, net operating loss carrybacks weren’t allowed for these years.

Taxpayers may elect to waive the carryback.  There is also a special election available to exclude carrybacks to one or more years that have income exclusion of offshore income under Internal Revenue Code Section 965.

Taxpayers may revoke a previous election to waive a net operating loss carryback by July 25, 2020.

Note many taxpayers should consider filing amended returns to claim net operating loss carrybacks from 2017, 2018. and 2019.

Excess business loss limitations suspended

The limitations on deductions for business losses in excess of business income have been suspended for taxable years beginning after December 31, 2017 and before January 1, 2021.

Since these losses will now be allowed, taxpayers who are entitled to them should file amended income tax returns to claim them.

Tax credit for prior year minimum tax liability of C corporations

The alternative minimum tax was repealed for C corporations by the Tax Cuts and Jobs Act of 2017.  Unused minimum tax credits were scheduled to be refundable with an annual 50% limitation for taxable years beginning in 2018, 2019, and 2020 until a 100% limitation would be applied for taxable years beginning in 2021.

Under the CARES Act, taxpayers may elect to claim a refundable credit for 100% of the balance for taxable years beginning in 2018 or 2019.

The election to claim the 100% limit for 2018 can be made using an application of tentative refund form (Form 1139.)  The form should be filed by December 31, 2020.  The IRS should issue the refund within 90 days after receiving the form.

Increased limit on deduction for business interest

Certain taxpayers that have more than $25 million of business income or are “tax shelters” are subject to a limitation for deducting business interest expenses.

Under the Tax Cuts and Jobs Act of 2017, the limit is the sum of (1) business interest income of the taxpayer for the tax year; (2) 30%  of the taxpayer’s adjusted taxable income for the year; and (3) floor plan financing interest of the taxpayer for tax year.

Under the CARES Act, the limitation of item (2) is increased to 50% for taxable years beginning in 2019 and 2020.

Technical correction for Qualified Improvement Property

Qualified improvement property is an improvement to an interior portion of a building that is nonresidential real property provided the improvement is placed in service after the date the building was first placed in service.  Improvements relating to the enlargement of a building, an elevator or escalator, or the internal structural framework of the building aren’t qualified improvement property.

This is the expanded definition of qualified improvement property adopted in the Tax Cuts and Jobs Act of 2017.

A drafting error in the Tax Cuts and Jobs Act of 2017 made the property subject to a 39 year depreciable life and not eligible for 100% bonus depreciation.

The CARES Act includes a technical correction defining qualified improvement property as 15 year property, qualifying for bonus depreciation.  This correction is retroactive to the date of enactment of the Tax Cuts and Jobs Act of 2017, which was December 20, 2017.

Taxpayers with commercial buildings that had qualified improvement property placed in service after 2017 should amend their 2017, 2018 and 2019 income tax returns to claim bonus depreciation for the year the property was placed in service.

Government loan guarantees for small businesses

In addition to the tax provisions discussed above and many other matters, the legislation includes a “Paycheck Protection Program.”  The Federal government will 100% guarantee SBA administered loans to businesses with not more than 500 employees.  Sole proprietors, independent contractors and other self-employed individuals are eligible for loans.  The covered loan period begins February 15, 2020 and ends on June 30, 2020.

The maximum loan amount is $10 million thorugh December 31, 2020.  The loan amount is based on payroll costs incurred by the business.

Uses of the loan include payroll support, such as employee salaries, paid sick or medical leave, insurance premiums and mortgage, rent, and utility payments.

Eligibility is based on whether a business was operational on February 15, 2020 and had employees for whom it paid salaries and payroll taxes, or a paid independent contractor.

The Act waives borrower and lender fees for particpaing in the Paycheck Protection Program, and waives collateral and personal guarantee requirements under the program.

The maximum interest rate for these loans is four percent.

No loan payments will be required for at least six months and not more than a year, and requires the SBA to issue guidance about the deferment process by April 27, 2020.

Although the stated maturity of the loans is 10 years, the principal amount of the loan is forgiven up to the amount of (1) payroll costs; (2) payments of interest on a covered mortgage obligation; (3) payments on any covered rent obligation; and (4) covered utility payments.

For details about how these changes affect your situation, consult with your tax advisor or write to me at mgray@taxtrimmers.com.

 

 

Urgent news if you have a retirement account with a Conduit Trust named beneficiary

Legislation called the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, enacted December 20, 2019, renders any estate plan involving a Conduit Trust beneficiary of a big retirement account (including 401(k) accounts and IRAs) obsolete.

A provision of the Act repeals “stretch” payments over the life expectancy of most successor beneficiaries for inherited retirement accounts of decedents who die after December 31, 2019.  The maximum time for distributions is 10 years after the death of the decedent/plan participant.

What is a Conduit Trust?  The purpose of a Conduit Trust was to control a retirement account, usually with a minor beneficiary, and still qualify for distribution of the account over the beneficiary’s life expectancy, called stretch distributions.  In order to qualify, the account had to be disregarded for income tax reporting with respect to the retirement account distributions.  The way this was accomplished was to require that any retirement account distributions received by the trust be immediately distributed to the beneficiary.

Since life expectancy distributions are usually very small, a huge distribution would be payable to the beneficiary 10 years after the death of the account owner, probably subject to very high federal income tax rates and possibly subject to mismanagement by the beneficiary.

There are some exceptions to the new rule, including (1) the surviving spouse of the employee/participant, (2) a child who is under age 21, (3) certain disabled persons, (4) certain chronically ill persons, and (4) an individual not previously described who is not more than 10 years younger than the employee/participant.

When a child of the decedent reaches age 21, the balance of the account must be distributed within 10 years.

If a beneficiary of a retirement account inherited from a person deceased before 2020 is deceased after 2019, the 10 year limit applies to that person’s successor beneficiaries.

Since the Conduit Trust no longer provides a tax benefit, employees/participants with retirement accounts should consult with their attorney and tax consultant about eliminating the Conduit Trust as a beneficiary and making alternative estate plans for their retirement accounts.

Major federal retirement changes enacted, Kiddie tax change repealed

As part of the domestic spending bill, H.R. 1865, Further Consolidated Appropriations Act, 2020, enacted on December 20, 2019, major federal retirement changes were enacted in Division O, the Setting Every Community Up for Retirement Enhancement Act of 2019, nicknamed the SECURE Act.  As part of the SECURE Act, Congress also repealed changes to the Kiddie tax enacted in the Tax Cuts and Jobs Act of 2017.  Taxpayers may elect to amend their 2017 and 2018 individual income tax returns to use this Kiddie tax change.

Here are highlights.  Please consult with your retirement plan consultant or tax consultant for more details.

  • Effective for plan years beginning after December 31, 2020, the rules for multiple employer plans have been relaxed so that if one employer violates the qualification rules, the entire plan won’t be disqualified.  (The “one bad apple rule.”)
  • Effective for plan years beginning after December 31, 2019, the maximum default contribution for a plan with automatic enrollment is increased from 10% to 15%.
  • Effective for taxable years beginning after December 31, 2019, the tax credit for retirement plan startup cost for small employers is increased from the lesser of (1) $500 or (2) 50% of qualified startup costs to the greater of (1) $500 or (2) the lesser of (a) $250 times the number of nonhighly compensated employees of the employer who are eligible to participate in the plan or (b) $5,000.  The credit applies for the first three years of the adoption of the plan.  It’s also available for employers that convert an existing plan to an automatic enrollment design.
  • Effective for taxable years beginning after December 31, 2019, amounts includable in an individual’s income paid to aid the individual in pursuing graduate or postdoctoral study, such as a fellowship, stipend, or similar amount, is treated as compensation for the limitation on IRA contributions.
  • Effective for taxable years beginning after December 31, 2019, the prohibition of contributions to an IRA by an individual who has reached age 70 ½ has been repealed.  The excludable amount for direct distributions to a charity after age 70 ½ is reduced by any contributions to an IRA after age 70 ½.
  • Effective for plan loans made after December 20, 2019, amounts loaned from a plan using a credit card or similar arrangement will be treated as deemed plan distributions and not as loans.
  • Effective for plan years beginning after December 31, 2019, when a plan will no longer accept a lifetime income option, such as an annuity, as a plan investment, employees will be able to make direct transfers of the lifetime income investment to an IRA or another retirement account within the 90-day period ending on the date when the lifetime income investment is no longer accepted by the plan.
  • Effective for plan years beginning after December 31, 2020, employers are required to permit employees to make elective deferrals if the employee has worked at least 500 hours per year with the employer for three consecutive years and has met the age requirement (age 21) by the end of the three-year period.  Each 12-month period for which the employee has at least 500 hours of service shall be treated as a year of service for vesting purposes.  This (500 hour) requirement will not apply for collectively-bargained plans.   Employers may elect to exclude these employees for the nondiscrimination and top-heavy requirements.  Employer contributions won’t be required for these individuals.
  • Effective for distributions made after December 31, 2019, distributions of up to $5,000 per birth or adoption can be made free of the 10% early distributions penalty during the one-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized.  (An eligible adoptee is any individual, other than a child of the taxpayer’s spouse, who has not reached age 18 or is physically or mentally incapable of self-support.)  Taxpayers must include the name, age, and taxpayer identification number of the child or adoptee on their tax return.  The distributions may be recontributed to an individuals eligible retirement plan, subject to certain requirements.
  • Effective for distributions after December 31, 2019, the age at which distributions are required to be made from an IRA or a qualified plan is increased from age 70 1/2 to age 72.  The age at which qualified charitable distributions of up to $100,000 per year from an IRA is unchanged at 70 1/2.
  • Retroactively effective for plan years beginning after December 31, 2017, the actuarial rules for defined benefit plans of privately-owned community newspapers are relaxed.  This is targeted relief benefiting this group.
  • Retroactively effective for defined contribution plan years beginning after December 31, 2015 and effective for IRA contributions after December 20, 2019 , difficulty of care payments that are excludable from gross income are treated as compensation for nondeductible IRA contribution limits.  These are payments by (1) a state or political subdivision of a state, or (2) a qualified foster care placement agency as compensation for providing additional care needed for qualified foster individuals.  The payments are provided when a qualified foster individual has a physical, mental or emotional disability for which the state has determined (1) there is a need for additional compensation to care for the individual; (2) The care is provided in the home of the foster care provider; and (3) the payments are designated by the payor as compensation for that purpose.
  • Effective for taxable years beginning after December 31, 2019, an employer may adopt a qualified retirement plan up to the extended due date of the employer’s federal income tax return and the plan can be retroactively effective for the taxable year.  Although employee contributions can’t be made after the year-end, employer contributions can be made up to the extended due date of the income tax return.  (This rule currently applies to SEP accounts.)
  • Effective for plan years beginning after December 31, 2021, the IRS is to issue procedures for employers who have similar individual account or defined contribution accounts to elect to file combined annual reports (Form 5500.)
  • The IRS is to issue model disclosures showing the estimated lifetime income based on the account balance of a plan participant, to be reported at least annually.  The IRS is also required to provide guidelines for how the income amount should be computed.
  • A fiduciary safe harbor is adopted so plan fiduciaries will satisfy the prudence requirement when selecting an insurer for a guaranteed retirement income (annuity) contract and will be protected from liability for losses that result to to participant or beneficiary due to an insurer’s inability to satisfy its financial obligations under the contract.  (A favorable provision for insurers, not so great for participants and beneficiaries.)
  • Effective on December 20, 2019, and electively retroactive to plan years beginning after December 31, 2013, the nondiscrimination rules are modified to protect older, longer service participation.  These rules are complex and beyond the scope of this explanation.  The rules will allow a closed or frozen plan to continue in existence.
  • Effective for distributions made after December 31, 2018, from Section 529 (educational savings) plans, registered apprenticeship expenses will be considered “qualified higher education expenses.”  Expenses for fees, books, supplies and equipment required for the designated beneficiary to participate in a registered apprenticeship program are qualified expenses for distributions from such a plan.
  • Effective for distributions made after December 31, 2018, up to $10,000 of qualified education loan repayments will be considered “qualified higher education expenses” for distributions from a Section 529 plan.  Student loan interest paid using distributions from a Section 529 plan won’t otherwise qualify for a tax deduction.
  • Effective for distributions made with respect to employees or plan participants who die after December 31, 2019, inherited retirement accounts must generally be distributed within 10 years after the employee or participant’s death.  There is an exception permitting “stretch” distributions based on life expectancy to (1) the surviving spouse of the employee/participant, (2) a child of the employee/participant who hasn’t reached majority, (3) certain disabled beneficiaries, (4) chronically ill beneficiaries, or (4) other beneficiaries who are not more than 10 years younger than the employee.  Once a child of the employee/participant reaches majority, the balance of the account must be distributed within 10 years after the date majority is reached.

The effective date for collective bargaining agreements and government plans will generally be for distributions with respect to employees or plan participants who die after December 31, 2021.

There is an exception for certain existing annuity contracts.

The ten-year distribution requirement also applies to successor beneficiaries of beneficiaries who inherited accounts before December 20, 2019.  (If an employee/participant was deceased during 2019, a surviving spouse might decide to disclaim IRA survivor benefits so that successor beneficiaries will be able to claim “stretch” distributions of benefits for which the election would otherwise be lost.)

Commenters have suggested  designating a charitable remainder trust as a beneficiary of a retirement account as a way to avoid the 10-year limit.  The plan distribution to the trust isn’t subject to current taxation.  Distributions are required to be made annually to the beneficiary(ies) of the CRT, which will probably carry taxable income.  Depending on how long the beneficiary(ies) live, some or all of the balance could go to a charity.  Seek tax and legal counsel when considering this alternative.

  • A provision of the Tax Cuts and Jobs Act of 2017 changed the Kiddie Tax that apples to the unearned income of certain individuals.  The rule applies to a child who (1) is required to file a tax return; (2) does not file a joint income tax return for the tax year; (3) the child’s investment income exceeds a threshold ($2,200 for 2019); (4) either of the child’s parents are alive at the end of the year; and (5) At the end of the tax year, the child is either (a) under age 18; (b) under age 19 and doesn’t provide more than half of his or her own support with earned income; or (c) under age 24, a full-time student, and does not provide more than half of his or her own support with earned income.  Under the Tax Cuts and Jobs Act, the child’s income tax is computed using the tax rate schedule that applies to estates and trusts.  This provision was causing a hardship, especially for survivors of military casualties.   Under the SECURE Act, this change is repealed, effective for tax years beginning after December 31, 2019.  Taxpayers may elect to retroactively apply the change for tax years 2018 and 2019.   This means children will generally be taxed on their unearned income at their parent’s marginal tax rate.  For 2019, the 37% marginal tax rate applies for single persons with taxable income over $510,300 and for estates and trusts with taxable income over $12,750.

IRS proposed regulations will keep more in retirement accounts

The IRS has issued proposed regulations relating to required minimum distributions from retirement accounts, including, 401(k), IRA and Roth IRA accounts.  (Proposed Regulations REG-132210-18, Proposed Regulations Section 1.401(a)(9)-9.)

The required minimum distribution is generally computed using a life expectancy table issued by the IRS, called the lifetime distribution table.  The life expectancy tables haven’t been updated for many years.  The proposed regulations include new life expectancy tables.

(If a taxpayer fails to take a required minimum distribution, the federal penalty is 50% of the undistributed amount.)

Since life expectancies have been increasing, required minimum distributions will be smaller using the proposed tables, potentially leaving larger balances to accumulate future earnings.  Bigger distributions can optionally be taken at the risk of exhausting the account before the employee or plan owner’s death.

The proposed regulations are proposed to be effective for retirement plan distributions for tax years beginning on or after January 1, 2021, provided they are adopted as final regulations by that date.

Required minimum distributions for a non-spouse beneficiary of a deceased employee or a deceased plan owner are based on the life expectancy determined using the Single Life Table of the beneficiary as of the date of death of the employee or plan owner, minus one for each subsequent year.  Under the proposed regulations, the beneficiary will be able to recompute his or her life expectancy as of the date of death of the employee or deceased plan owner using the new lifetime distribution table starting January 1, 2021.

 

What investments besides securities and bank accounts can you make with a Roth or IRA?

The interview on Financial Insider Weekly for this week is with Bill Neville, Certified IRA Services Professional of The Entrust Group. Our interview subject is "Making alternative investments with your IRA or Roth account."

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Tax and financial advice from the Silicon Valley expert.