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By Editor, May 4, 2011

IRA owners and beneficiaries who have reached age 70 1/2 are permitted to make cash donations to IRS-approved public charities directly out of their IRAs. These so-called qualified charitable distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on Form 1040. That’s OK because the tax-free treatment of QCDs equates to an immediate 100% deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages too. Here is what you need to know.

QCD Basics

A QCD is a cash payment of an otherwise taxable distribution, by your IRA trustee, directly to a qualified public charity. The funds must be transferred directly from your IRA trustee to the charity. You cannot receive the funds yourself and then make the contribution to the charity. However, the IRA trustee can give you a check made out to the charity that you then deliver to the charity.

You cannot arrange for more than $100,000 of QCDs in any one year. If your spouse has IRAs, he or she has a separate $100,000 limitation. If you are the beneficiary of an IRA (as opposed to an account owner), you too are eligible for the QCD deal if you are at least age 70 1/2.

You must get and keep substantiation of the contribution from the charity. Also, you must not have received any benefit in return for making the contribution.

The QCD privilege is scheduled to expire at the end of this year, so if you want to take advantage of the idea, it is not too soon to start thinking about it.

Income Tax Benefits

QCDs are not included in your Adjusted Gross Income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based phase-out rules. In addition, you don’t have to worry about the 50%-of-AGI limitation that can delay itemized deductions for garden-variety cash donations to public charities.

QCDs count as a payouts for purposes of the Required Minimum Distribution (RMD) rules. Therefore, you can donate all or part of your 2011 RMD amount (up to the $100,000 limit on QCDs) and thereby convert taxable RMDs into tax-free QCDs.

Does the QCD Deal Work for You?

The QCD privilege is beneficial for seniors in the following circumstances:

• You don’t itemize deductions. Under the “normal” rules, only itemizers get any income tax benefit from charitable donations. Making QCDs will save taxes whether you itemize or not because neither you nor your heirs will ever have to pay income taxes on the donated amounts.
• Your itemized charitable donations would be delayed by the 50%-of-AGI limitation. Making QCDs will avoid this unfavorable limitation.
• You want to avoid being taxed on RMDs that you are forced to take from your IRAs. The QCD strategy does the trick while also allowing you to satisfy your charitable inclinations.

Conclusion

If you’re interested in taking advantage of the tax-saving QCD strategy for 2011, you will need to arrange with your IRA trustee for money to be paid out to one or more qualifying charities by year-end.

If you have questions about QCDs or want more information, your Wilson Price accountant.

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By Editor, January 6, 2011

Background

Before 2010, there was an often-unavoidable stumbling block for higher-income individuals who wanted to implement the Roth IRA conversion strategy. In those years, conversions were prohibited for folks with Modified Adjusted Gross Income (MAGI) in excess of $100,000. For 2010 and beyond, the MAGI restriction is history. The rule that made individuals who use married filing separate status ineligible for Roth IRA conversions is also history for 2010 and beyond. Thanks to the demise of these restrictions, 2010 was “the year of the Roth IRA conversion”. For taxpayers that made the conversion, the story is not over. In fact, 2011 is when the rubber meets the road for 2010 conversions.

2010 Converters Must Decide When Conversion Income Will Be Recognized

2010 converters can spread the taxable income triggered by 2010 conversions evenly over 2011 and 2012 (50% in each year) for federal income tax purposes and thereby defer the tax hit. In fact, this defer-and-spread deal happens automatically unless the taxpayer makes the alternative election to recognize all the conversion income in 2010. [See IRC Sec. 408A(d)(3)(A)(iii) .]

Going with the defer-and-spread deal is not a no-brainer. For example, if you believe you will pay a lower marginal tax rate in 2010, it might make sense to recognize all the conversion income in 2010 by reporting it on that year’s Form 1040. As we just explained, making that choice will require an election with the 2010 return.  As this was written, we did not have any details about how to make the election. We will tell you as soon as we know more.

No general rule of thumb can be offered for whether to recognize the income for 2010, or spread it over 2011 and 2012. Each taxpayer’s situation must be considered individually.

2010 Converters Have until 10/17/11 to Reverse Ill-fated Conversions

Another “safety valve” for Roth IRA conversions is the fact that converters are allowed to change their minds well after doing the deed. Any 2010 converter has until the extended due date for filing his 2010 Form 1040 to recharacterize the converted amount back to traditional IRA status. The extended due date for 2010 returns is 10/17/11 (for calendar-year taxpayers). A recharacterization reverses the earlier conversion and eliminates the related tax liability. The 10/17/11 deadline for reversing 2010 conversions applies whether or not the converter actually extends his 2010 Form 1040. [See IRC Sec. 408A(d)(6) and (7) and Reg. 301.9100-2(b) .]

Example: Fred converted two traditional IRAs into two Roth IRAs in 2010. In 2011, the values of the converted accounts plummet due to poor investment performance. In this bleak scenario, Fred would have to pay income tax on value that later disappeared. Bad idea! Thankfully, he has until 10/17/11 to reverse the 2010 conversions by recharacterizing the two Roth IRAs back to traditional IRA status. After the reversal, it’s as if the ill-fated conversions never happened. So, Fred won’t owe any tax on the now-reversed conversions.

Side Note: Regardless of whether taxpayers are 2010 converters, doing any 2011 conversions early in the year makes some sense because clients will have until 10/15/12 to reverse any ill-fated 2011 conversions. That’s almost two years to see how things go. Of course, if 2010 converters also do 2011 conversions, it puts extra variables in play regarding the best time to recognize income from the 2010 conversions.

Why 2010 Converters Should Extend Their Returns

There are two big reasons for 2010 converters to extend their 2010 returns to 10/17/11.

• First, it creates extra time for converters to decide if they are better served by: (1) going with the defer-and-spread deal that results in spreading the conversion income evenly between 2011 and 2012, or (2) making the election to report all the conversion income in 2010. Converters should have a better handle by next October on how much income they expect to have in 2011 and 2012. We hope and trust that the IRS will provide timely guidance not only on how to make this election, but also allowing it to be made on a timely filed extended return.
• Second, extending their 2010 returns will make it much easier for converters to handle any reversals of 2010 conversions. If the converter’s return is extended, the reversal is reported by simply showing no income from the now-reversed conversion on the original 2010 Form 1040. Simple! If the 2010 return is not extended and a 2010 conversion is reversed after the filing date, an amended 2010 return will have to be filed to report the reversal. Not so simple!

Conclusions

Doing Roth IRA conversions in 2010 made lots of sense for certain taxpayers, but the book is still open because decisions about 2010 conversions must be made in 2011. First and foremost, 2010 converters should consider to extending their returns to create extra time to make those decisions.

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By Editor, November 10, 2010

If your traditional IRA has dropped in value and you expect to pay higher federal income tax rates in future years, now might be a very good time to consider converting all or part of your traditional IRA balance into a Roth IRA. Here’s why. If you convert, it will trigger a current tax hit on the amount you convert. But, with your traditional IRA balance at a depressed level (and possibly your overall income too), the tax hit will be less. After the conversion, all the income and gains that accumulate in your Roth IRA, and all withdrawals after you reach age 59¹/₂, will be totally free of any federal taxes—assuming you meet the tax-free withdrawal rules. In contrast, future withdrawals from a traditional IRA could be hit with tax rates that are higher than today’s rates (maybe much higher depending on how things go).

Before this year, there were two big restrictions on the Roth IRA conversion privilege. First, your Modified Adjusted Gross Income (MAGI) could not exceed $100,000. Second, you were completely ineligible if you used married filing separate status. For 2010, both restrictions are eliminated. Now, virtually anyone who owns a traditional IRA can do a Roth IRA conversion.

Of course, conversion is not a no-brainer. You have to be satisfied that paying the upfront conversion tax bill makes sense in your circumstances. In particular, converting a big account all at once could push you into higher tax brackets, which would not be good. However, for 2010 conversions only, you can elect for federal income tax purposes to spread the income triggered by conversions evenly over 2011 and 2012 and thereby defer the related federal income taxes. You must also make assumptions about future tax rates, how long you will leave the account untouched, the rate of return earned on your Roth IRA investments, and so forth. If the Roth IRA conversion idea intrigues you, please contact us for a full analysis of all the relevant variables.

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By Editor, November 5, 2010

At some point, every owner exits his business and, in many cases, the business represents a significant portion of the family wealth.  While most business owners recognize the importance of an exit strategy, few actually have a plan in place.  The longer an owner has to implement a plan, the greater the opportunity to maximize the value of the business, minimize taxes and achieve estate planning goals.

Exit planning should be viewed as a process rather than a one-time event.  Though there are many key steps involved in developing a plan, the following exercise will help you initiate the process:

Determine your exit objectives

Many times, an owner does not address their objectives until they are ready to exit the business.  They generally have an idea of the value they want from their business, but don’t necessarily know if this will meet their needs in retirement.  Identifying your objectives early on will allow plenty of time to provide for your objectives.  Objectives will include:

• A retirement timetable – when do you want to retire?
• Income needs during retirement – what is the annual after-tax amount you will need to pay for a lifestyle you are comfortable with?
• To whom would you like to transfer your business? – a family member, co-owner, key-employee, or outside party.
• Additional objectives might include creating a legacy, rewarding employees, providing charitable gifts, shifting wealth to children, or receiving desired value for your business.

Common misstep: Stopping the process of exit planning with a buy-sell agreement, and not taking into consideration other long term goals and objectives.

Determine your business and personal resources

Once you know your objectives, it is important to measure your resources.  Perhaps you have a retirement plan or other personal assets that will provide for some of your income needs in retirement. Determining resources will include:

• What is your business actually worth?
• What are the key drivers of your business’s value?
• What personal resources are available?
• How will the taxes consequences affect your resources?

Common misstep: Overestimating the value of the business and not giving enough time or planning to achieve value needed.

By analyzing your objectives (what you want) versus your resources (what you have), a gap between the two is now more apparent.  The next step will be to develop a plan that will intersect your wants and needs.  All exit planning strategies will begin with these two steps, the answers to which will establish a foundation for timing of the plan, involvement of other advisors, estate planning, business continuity and protecting the value of your business.

Please contact us if we can help you get started in this process.

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By Editor, August 3, 2010

As your parents age, pay close attention to their mental health, as well as their physical health. Advanced age or illness can impair their intellectual ability to manage day-to-day activities, making the need for an incapacity determination a possibility.

The issue of incapacity can bring about gut-wrenching decisions that are worthy of some advanced planning and thought.

If you observe a parent’s declining mental condition, you may have to make the difficult decision to have him declared incompetent. A guardian or conservator will then be appointed by a judge to manage his affairs.

What is “capacity?”

“Capacity,” generally means the mental ability to adequately function and live in the manner to which one is accustomed, but the legal definition can vary from state to state. If a person is unable to adequately care for their own health or financial needs, an adjudication process to determine their competency may be necessary.

What is a guardian or conservator?

If incapacity has been determined by a judge and a guardian or conservator has been appointed, the guardianship or conservatorship will specify the extent of duties.  They may be responsible for managing all aspects of your parent’s life or a narrower scope, such as financial matters.  They will owe a duty of care to your parents and will be held accountable by the court to demonstrate appropriate actions. The guardian or conservator is often a child or adult grandchild, but doesn’t have to be a family member.

Asking for assistance

Ideally, an elderly parent knows he needs assistance and asks for help.  In this circumstance, the expense and emotional charge of a guardianship proceeding can be avoided. There are various ways to assist your parents, such as:

Power of attorney

Your parents may still be legally competent to make decisions, but consent to give you or another trusted individual the legal right to act on his behalf for financial and health care matters.  This is similar to a guardianship or conservatorship.

Paying bills

If you are unable to write checks and pay your parent’s bills, you can hire a professional firm to provide the service.  Delegating the work could free up time and energy for you to focus on other things, while still maintaining a sense of control.

If you face decisions involving the capacity of your parents, understanding the roles of a guardian or conservator makes it somewhat easier.  Advance communication with your parents and family members is also key.

Contact Wilson Price Family Office  for more information about how to plan for a parent’s incapacity, guardianship or conservatorship.

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By Editor, August 3, 2010

You can typically name beneficiaries for a variety of assets, including retirement plans, annuities and life insurance policies.  But naming a beneficiary is not as simple as putting a name on a form; it should involve careful consideration, as the repercussions for your loved ones could be significant.

Out-of-date

If you haven’t reviewed your beneficiary designations recently, it’s possible the designations are no longer appropriate.  Review your designations on a regular basis, ideally annually, and when major life events occur, such as marriage, divorce, birth or death.  The assets are passed outside of legal proceedings and the designation is absolutely binding.  The assignment of assets cannot be superseded, not even by a Will. 

Be Specific

Most beneficiary designation forms allow you to name more than one primary and contingent beneficiary with specified percentage of assets.  Be specific and name each versus naming one trusted relative or friend to distribute the assets for you.  If no beneficiary is named, the assets will be distributed through the probate process, which in the case of a retirement plan, can create adverse tax consequences.

Tax Consequences

With life insurance, the goal is to keep the proceeds out of your estate.  If your spouse doesn’t need the money after you are gone, policies (existing or new) can be structured in various ways to keep life insurance from increasing the value of your estate.  This will be even more apparent next year if the estate tax exemption falls to $1 million.  Life insurance may play a major role in creating taxable estates for those who wouldn’t normally have the issue. This estate tax issue can be avoided in many cases if structured properly. 

Regardless of the beneficiary designation, retirement plans, however, will be includable in the value of the estate.  It is important, though, to make sure the designation is not left blank or that “the estate” is not named as the beneficiary.  In these cases, the retirement assets must be distributed within 5 years or at least as fast as the decedent was receiving required minimum distributions (RMDs), thus triggering a quicker income taxability of the assets in addition to the estate taxability. If your family does not need the funds for living expenses, the goal here is to defer distributions as long as possible, “stretching” the assets over longer life expectancies.  This can be accomplished by naming an individual as beneficiary.

Other considerations

To avoid taxable distributions altogether, you could donate your retirement plan to a charity if other assets are available to provide for your family.  Not only will the organization receive the assets tax-free, but your estate will also be eligible for a charitable deduction.

You can name almost anyone as your beneficiary, including individuals, charities and trusts, but minor children, however, cannot be named beneficiaries of life insurance policies, retirement plans or annuities. Additionally, if you are considering designating a special-needs person as your beneficiary, it may hinder the individual’s eligibility for government provided benefits.

There are various ways to still provide for those you want to benefit after you are gone, but with careful planning with an accredited estate planner.