One of the drawbacks to garden variety IRA’s is that you are limited in your choice of investments to financial assets such as certificates of deposit, stocks, bonds, and mutual funds. In the current market, cd’s don’t earn anything and the volatility in the public equity and fixed income market scares many off.
In a self directed IRA, the account owner is able to invest in a broader range of alternative asset categories, including private equity and corporations, real estate, and partnerships. This is appealing to some IRA owners. Opening a self directed IRA is as easy as filling out some forms and arranging a trustee to trustee transfer from an existing IRA.
But as is usually the case, there are traps to be avoided. Let’s run through them.
First is the matter of fees. Your plain vanilla IRA is essentially free these days, but you will pay up to several hundred dollars a year for the administration of a self directed IRA, and possibly considerably more.
Second, there are restrictions on prohibited assets and prohibited transactions that apply to all IRAs. IRS regulations specifically prohibit IRA investments in life insurance and collectibles. The purpose of the prohibited transaction rules is to prevent self-dealing, i.e., improper use of the assets in the account by the account owner, the account owner’s beneficiary, or any other disqualified person. The penalties for violating these provisions are severe.
Third, there are two basic flavors of self directed IRA’s, and not everyone agrees on the validity of the second type. The more conservative type requires the trustee/custodian to approve all investments made by the IRA. While safe, this can prove cumbersome if there are numerous or tricky investments. It can also be expensive if there is a separate transaction fee charged by the custodian. The second type of self directed IRA, sometimes referred to as a “checkbook” IRA, involves two entities: the IRA itself and a newly formed limited liability company (LLC), which the IRA invests in. The LLC is controlled by the IRA owner and makes the investment purchases without having to gain approval of the trustee/custodian. While convenient to the client, there are IRA administrators who believe that this second type of self directed IRA doesn’t work, and will eventually run into IRS problems.
Finally, regardless of which type of structure is selected, there are two taxes that can pop up to complicate matters: unrelated business income tax (UBIT) and unrelated debt financed income (UDFI). The important thing to know about these taxes is that if they apply, they will cause the IRA itself to owe income tax. Investments made in operating businesses by the IRA can throw off UBIT. Even if the income is exempted from the tax ordinarily, it might be taxed if it is generated by debt.
For example, take an investment by an IRA in a limited partnership where the business of the limited partnership is to acquire and lease apartments. If either the funds to buy the interest by the IRA or the acquisition of the apartments by the partnership are made with debt, taxes may be due, thereby reducing the investor’s after tax rate of return.
Self directed IRA’s might be the ticket for certain taxpayers in certain situations, but be aware of potential traps before you dive.
October 27th, 2011 in
Investments |
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The Congressional Budget Office recently issued the government’s latest revenue and spending figures for the fiscal year ended September 30, 2011. They are summarized below in billions of dollars:
Year Receipts Outlays Deficit
2008 $2,524 $2,983 $ 459
2009 $2,104 $3,520 $1,416
2010 $2,162 $3,456 $1,294
2011 $2,303 $3,600 $1,298
Taxpayers are regularly reminded that the U.S. government is not like private enterprise, since the government can create its own financing.
I was curious to see, however, what would happen to the balance sheet of a private corporation if its managers generated the same results as the government did for the above period. The results are horrifying.
I created a balance sheet as of September 30, 2008 under the following assumptions: (a) current assets were fixed at 120 days of fiscal year 2008 revenues; this consisted of cash and inventories at 30 days each and accounts receivable at 60 days; (c) fixed assets were $500,000; (c) the debt to equity ratio was set at a conservative 1:3 ratio in order for the starting balance sheet to be healthy. My private company generated revenues in 2008 of $2,524,000 and reflected the same annual revenues and expenses as the government, except that the above amounts were in thousands, not billions.
At September 30, 2008, the balance sheet looked like this:
This is the balance sheet of a nice little company – well capitalized, acceptable balance sheet ratios and equity book value in excess of a million dollars.
The next step was to roll the losses through the three fiscal years ending in 2009-2011 in order to generate a September 30, 2011 balance sheet. To do this I assumed: (a) all asset balances remained constant; and (b) that losses were financed entirely by debt. This is the resulting balance sheet:
This is the balance sheet of a disaster. The company is well beyond bankrupt and it would be impossible to overstate the fiscal incompetence which led it to this point. What do you suspect are the odds of the lender being able to get his $4,342,333 back from the borrower?
So I guess the moral of the story is that we had better hope that government is different!!
Permit us Aggies to be excited about Friday’s Cotton Bowl game against LSU. It’s been a while.
I caught this story in Monday’s Chronicle that brought back some memories. Several years ago I penned a piece for the family in which Hugh McElroy played a prominent point:
“There was another trip to Austin and a visit to Aunt Ethel’s house. Aunt Ethel was married to Uncle Claude, A&M Class of 1912, the sole relative of his generation to attend A&M. He had suffered hearing loss as a result of an artillery blast in the First World War. I always wondered what he thought about as the Aggie Band would break into the war hymn – the opening words depicting the sounds of artillery: “Hullabaloo, Kaneck! Kaneck! Hullabaloo, Kaneck! Kaneck!”
We sat in their parlor in Tarrytown and listened to the Aggies play LSU in Baton Rouge. Late in the game, A&M trailing, an Aggie wide receiver named Hugh McElroy got loose in the LSU secondary, caught a pass from Lex James and ran 70 yards for the winning touchdown.
Uncle Claude had this old fashioned contraption that allowed him to hear, but it was no match for the bedlam in that room. I did my best to explain what had just happened. I also explained that Hugh was an African American – the first to play at A&M. He gave me a long look and a wry smile, and then remarked that was okay because he was our African American.
In 1971 the Longhorns came to Kyle Field to play the Aggies on Thanksgiving Day. We planned a family reunion around the game, meeting in my dorm room and having lunch.
Unfortunately, our Hugh fumbled away a punt early on while trying to make a shoe top catch. Texas recovered, moved in for a touchdown, and the rout was on.
A few years ago, I happened to be seated next to Hugh McElroy at a business lunch. I introduced myself and asked him if he was the guy that had caught the pass that beat LSU. He beamed. I said that was nice to know because then that made him the guy that fumbled the punt against Texas. He remarked that sometimes people remember too much.
I told this story to someone who thought I was being mean – I don’t think so. I’ll bet he liked it.”
January 4th, 2011 in
Sports |
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Mitch McConnell
John Boerner
Eric Cantor
This is really getting interesting folks. Yesterday the Obama Administration and Republican Congressional leaders agreed on the elements of a tax package. Today’s New York Times story is here.
Key elements of the plan, which has yet to be brought before either house of Congress include:
- Current income tax rates will stay in effect for two more years – no end to the Bush era tax cuts for the wealthy. Dividends and capital gains rates remain at 15%.
- Estate tax is reinstated at 35% with first $5 million of estate excluded from estate tax (first $10 million for married couple.
- Jobless benefits are extended an additional 13 months for the long-term unemployed.
- Middle class Americans would obtain protection from alternative minimum tax.
- Research & Development credits extended.
- 100% deduction in 2011 for fixed asset purchases.
- Employee’s portion of Social Security tax is cut from 6.2% to 4.2%.
Details are yet to be worked out, but with the exception of the extension of unemployment benefits, this pretty much looks like Obama’s total capitulation to the Republicans, and Congressional Democrats are furious. I wonder what Paul Krugman’s blood pressure is today?
Other unhappy campers include Tea Partiers on the Republican side who have focused on the unemployment benefit extension, and indicated that they might vote against any bill that includes it.
To reiterate yesterday’s point, there is not an ounce of deficit reduction anywhere to be found in any of this. So the boys and girls in Washington are at each other’s throats even before asking anybody to sacrifice in the name of reducing deficits and saving the country. Geez!!
It now looks as if a deal is in the works that will extend the Bush-era income tax cuts for a two year period for all taxpayers (including those nasty “rich” ones that make more than $250,000 per year). Congressional Republicans have advocated for nobody’s taxes to be increased, while Democrats have wanted an end to the Bush tax rate reductions for the rich. Apparently, the compromise will extend all tax cuts for two years and will also extend unemployment benefits for a year. For the New York Times, Washington Post, and USA Today reporting on the subject click here, here, and here.
For what the insufferable Paul Krugman, who in mho ceased being an economist and started being a lackey for his partisan beliefs some time ago, thinks the Democrats should do, click here.
This is certainly not Congress and the Obama Administration demonstrating focus in support of budget deficit solutions: the R’s and the D’s have their constituencies here whose interests are being protected. The hard work of solving our continuing fiscal profligacy remains to be done. If you are not convinced, read this.
Congress has reconvened. The lame-duck assembly now in session is controlled by Democrats, but this will change in January. The current session promises to be one of the most entertaining, if not necessarily one of the most productive sessions in recent history. In the next few weeks which include Thanksgiving and Christmas recesses, there are three separate groups of tax issues to be addressed: estate and gift taxes, income taxes, and extenders. I will address them in separate posts. Today we’ll tackle estate taxes.
Since my earlier post (Estate Tax in the Horse Latitudes) not much has happened. As a result, here we are on November 24, 2010, and estates of those dying in 2010 are still in limbo. For an abstract of a piece written in October by Donald Marron for the New York Times Freakonomics blog click here. I agree with everything he says and believe his views pretty much sum up the views of most practitioners.
As things stand now for 2010 there is (a) no estate tax for deaths in 2010. The IRS has indicated that they will not accept estate tax returns; (b) no asset step up. Assets transferred at death will obtain a “modified carryover basis” which is essentially the cost basis to the decedent plus upward adjustments of up to $3 million for transfers to surviving spouse and $1.3 to others; (c) lifetime gift allowance of $1 million, not including annual exclusion present interest gifts currently $13,000 per donee per year, then taxed at 35%; and (d) no generation skipping tax.
As things stand now for 2011 (a) estates over $1 million will be taxed at rates that go as high as 55%; (b) assets will be stepped up to their fair market value at date of death; (c) lifetime gift allowance of $1 million, not including annual exclusion present interest gifts currently $13,000 per donee per year, then taxed at 45%; and (d) generation skipping tax returns with a maximum rate of 55% and $1 million exemption.
To repeat a point made earlier and by many: this is obscene. A billionaire’s heirs are free from estate tax in 2010, but the estate of a person with $250,000 in home equity, $250,000 in savings, and $500,000 in an IRA is subject to the estate tax if the death is in 2011. We might argue about many things, but it is unlikely that many are in favor of estate taxes being levied on the estates of those whose assets were insufficient to provide for the decedent while he or she was alive. But that is the reality of our current tax regime and investment markets, most notably interest rates.
Several things can happen from here. If the lame duck session gets feisty, it could pass a law which would retroactively reinstate the estate tax for 2010 deaths. There are both political and constitutional issues that make this problematic, but it could happen. However, the odds are against this, and in any event are much lower than before the elections.
A few experts have indicated the possibility of lame duck legislation retroactive to the beginning of 2010 that would give to executors the option of either paying no estate tax or not obtaining a basis step up. This probably doesn’t do a whole lot (at least in the case of large estates) since few executors would pay large amounts of current estate tax to avoid higher future income taxes on sales of assets transferred to the beneficiaries by the estates, but it would provide some political cover. There is no possibility of retroactive reinstate of the estate tax to 2010 by the new Congress if the lame duck group fails to do so.
Once the new Congress is seated, it’s hard to tell what will happen going forward. For some time those of us who work in the area believed that the grand compromise would include a lifetime allowance of $3.5 – $5.0 million per person with a top rate around 45%. This was rejected for political reasons by both parties when they were in power, so it’s hard to say for sure that it won’t be rejected again. It shouldn’t, but it could. Stay tuned.
The next post will discuss what is going on concerning income taxes, particularly extension of the Bush income tax cuts.
The baby-boomer generation, of which I am a member, has a love/hate relationship with technology. Many of those at the older end decided mid-career that learning about it was more trouble than it was worth, while the younger boomers (now in their mid 40’s) tend to be pretty savvy. Many of them visit websites such as www.40tech.com whose tag line is “over forty but not over the hill.” That’s annoying, but it’s a good read and source.
In my particular case, I practiced for years with no staff, so I decided early on that I had to know how to use the tools to produce the work product. I learned to do that even though I didn’t understand much of it. We’re not talking about anything fancy here – letters, spreadsheets, and tax returns and windows based filing systems so they could be found.
Recently several of us from Null Lairson attended a CCH (www.cch.com) User Conference in Orlando. The conference was truly over the top, and I mean in a good way – great sessions, wine and food. CCH is a vendor to the accounting industry. I thought that what they do is sell tax preparation software, but what I learned they really do is much more interesting.
The theme of the conference was collaboration and assisting firms achieve client satisfaction through leveraging of technology platforms including something called “full service through self service”. The idea here is that the second generation of internet sites, the Web 2.0 applications, has created an environment in which many of our clients can get answers for themselves. And here’s the really interesting part – CCH has commissioned studies that show that they enjoy doing it. Think about this in the context of a client waiting three days for a return call from a partner who then assigns the project to staff who takes three days to complete it. The alternative to a client might be to google the word.
The challenge to accounting firms is to organize work flow and to communicate results in a manner that benefits the client. The ultimate objective is to provide them information wherever and whenever they want it. Internet based applications and data stored in the “clouds” will make information available 24/7 to the client.
It seems like the pure techie stuff is being pushed out to the internet. We will spend less time hooking up printers and scanners, dealing with internal network issues, and buying powerful laptops. Our vendors will provide products and services that will facilitate collaboration and communication with clients – we can focus on what our clients want and need and take care to timely deliver it. This seems to represent a functional merging of technology with client service. We collaborate with clients through the use of technology, instead of using technology to prepare a work product in the back office which we then mail on to the client.
So I have finally decided to get serious about technology, because now it really is more about client service and less about computers. And this baby-boomer can understand that!!
November 23rd, 2010 in
Technology |
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Robert Rubin
Former secretary of the U.S. Treasury Robert Rubin has co-authored a piece in today’s Wall Street Journal in which he urges Congress to enact legislation which would permanently tax estates over $3.5 million at a top rate of 45%.
Something clearly needs to be done. The law currently is so convoluted that it makes sense to nobody – if a billionaire dies during calendar year 2010, no estate tax is due, but if an individual with an estate of more than $1.0 million dies in 2011, an estate tax of up to 55% is due on the extra amount. At today’s low interest rates, it is conceivable that a person who does not earn enough interest to comfortably support his or her lifestyle while alive would nevertheless leave a taxable estate to his heirs. Incredible.
Our leaders in Washington get to take full credit for this. The whole issue of estate (“death” if you are a Republican) taxes has been a political football for years. Though Rubin can be applauded for a suggestion that will at least clear up the mess (the exemption amount and the top rate suggested more or less fall in line with what estate tax planners and practitioners have been thinking would eventually come out of all this) the reasoning behind his suggestions will cause teeth to gnash.
Perhaps unintentionally, perhaps not, his arguments are partisan and political in nature. They start with the idea that public investment (i.e. government spending) is more efficient than private sector savings and debt repayments, and that maintaining our view of ourselves as a meritocracy and land of opportunity is enhanced by having the government collect and spend tax dollars in order to avoid the private accumulation of excessive economic and political power. Is there anything that we are arguing about more these days? Try convincing someone with even a smidgen of traditional liberal belief that somehow it is more meritorious for the government to accumulate (and spend) privately owned and previously taxed wealth, than it is for private citizens to keep it themselves. You won’t win that argument.
The argument for retroactivity – that it is justified because public officials have been talking about it and that no one died earlier as a result – is flat bizarre. Public officials talk all the time about things best ignored and I’m thinking that the timing of death under the circumstances could depend on the answers to two questions: how rich and how sick?
So here’s the argument I would make instead. We need to clear up the mess. The uncertainty associated with estate and gift taxes is yet another in the quiver full of uncertainty arrows that continues as a drag on economic recovery and mounting fiscal problems. We have a responsibility to the public to be clear and transparent. An exemption of $3.5 million and a top tax rate of 45% represent a compromise between those who believe that taxing estates is immoral and those “progressive” thinkers who would tax at a much higher rate in the interest of redistributing wealth. Maybe the numbers should be $5.0 million and 35%, but no matter. Get it done.
I don’t ever forward chain letters. The suggestion (always at the end) that unless you send it on to your contacts you will lose your patriotism, health or money is silly.
Recently, however, there has been an email about tax law changes that several clients have asked me about. It says that health insurance benefits provided by your employer will begin to be taxed in 2011. This is not true.
The text of the email follows:
Now, your insurance will be INCOME on your W2′s!
One of the surprises we’ll find come next year, is what follows – - a little “surprise” that 99% of us had no idea was included in the “new and improved” health care legislation . . . the dupes, er, dopes, who backed this administration will be astonished!
Starting in 2011, (next year folks), your W-2 tax form sent by your employer will be increased to show the value of whatever health insurance you are given by the company. It does not matter if that’s a private concern or governmental body of some sort.
If you’re retired? So what… your gross will go up by the amount of insurance you get.
You will be required to pay taxes on a large sum of money that you have never seen. Take your tax form you just finished and see what $15,000 or $20,000 additional gross does to your tax debt. That’s what you’ll pay next year.
For many, it also puts you into a new higher bracket so it’s even worse.
This is how the government is going to buy insurance for the15% that don’t have insurance and it’s only part of the tax increases.
Not believing this??? Here is a research of the summaries…..
On page 25 of 29: TITLE IX REVENUE PROVISIONS- SUBTITLE A: REVENUE OFFSET PROVISIONS-(sec. 9001,
as modified by sec. 10901) Sec.9002 ”requires employers to include in the W-2 form of each employee the aggregate cost of applicable employer sponsored group health coverage that is excludable from the employees gross income.”
- Joan Pryde is the senior tax editor for the Kiplinger letters.
- Go to Kiplingers and read about 13 tax changes that could affect you. Number 3 is what is above.
What is interesting and a little bit different about this email is that it actually includes statutory language, however the writer reaches the wrong conclusion – the law does not say that the health coverage is taxable, it only says that the employer will be required to let the IRS know how much it is beginning in 2011.
Kiplinger in their June 11, 2010 letter had the following to say about the matter: “[t]he email is a hoax. We’ve always said that the new law doesn’t tax employees on employer provided coverage. Presumably, the reason Congress required the value to be shown on W-2’s is to give workers a better appreciation of the amount spent to cover them. But lawmakers definitely did not vote to tax workers on the coverage.”
So, at least for now, you’re okay on this.
August 26th, 2010 in
Taxes |
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Tiger Woods may be on the verge of a comeback if his golf this week is as good as his responses to sportswriter’s silly questions. At a press conference prior to the start of this year’s final major, the PGA Championship, Tiger was asked how he felt since he was, in the opinion of the questioner, currently one of the “planets worst golfers.” His response was a beauty – “Well, I’m pretty sure that I can beat you and I feel good about that.”
August 12th, 2010 in
Sports |
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