IRA ROLLOVER ROLLER-COASTER: HOW TO ROLLOVER AN IRA FOLLOWING BOBROW AND IRS ANNOUNCEMENT 2014-15

by | May 6, 2014 | Uncategorized

In a recent case known as Bobrow v. Commissioner,  the U.S. Tax Court held that an IRA owner may only conduct one 60-day IRA rollover within a one year period for all of their IRAs. This holding from the Tax Court, was in opposition to the customs of many IRA custodians, financial advisors, and to IRS Publication 590. For more on Bobrow, and the rationale from the Tax Court please check out my prior blog article here.

Following Bobrow, the IRS issued Announcement 2014-15 and stated that the IRS was going to amend its guidance to taxpayers in Publication 590 and was going to adopt the Tax Court’s position of one 60-day Rollover per IRA per year

As a result of Bobrow and IRS Announcement 2014-15, taxpayers should consider the following issues when rolling over an IRA.

  1. Trustee to Trustee Transfers – If you want to change IRA custodians, the best way is via a trustee to trustee transfer whereby your old custodian transfers your IRA funds to your new custodian. Funds are sent directly from your old IRA to your new IRA and you as the IRA owner never touch the funds. IRA owners can still do as many trustee-to-trustee transfers as they want.
  2. New Rule to be Enforced in 2015 – The One 60-Day Rollover Per One Year Period rule won’t be enforced by the IRS until 2015. So don’t stress if you’ve already conducted multiple 60-Day rollovers over multiple accounts within a one year period. That is, unless your last name isn’t Bobrow.
  3. One 60-Day Rollover per 1-Year Period, Not Per Tax Year- The new rule has been explained as One 60-Day Rollover Per Year, however, the actual code (IRC 408(d)(3)(B) states per “1-year period” from the date of the last 60 Day Rollover. As a result, don’t think of one per tax year but rather think one can be done 1-year following the last 60 Day Rollover conducted by the IRA owner.
  4. One 60-Day Rollover Per Roth IRA and One Per Traditional IRA Per 1-Year Period – Based on my analysis of the Code, individuals would be allowed one 60-Day Rollover per Traditional IRA and one per Roth IRA.  The analysis is certainly complex but I’ve tried to summarize it below. Traditional IRAs are governed by IRC 408. IRC 408(d)(3)(B) is the section which limits 60 day rollovers to one per 1 year period and this was the section the Tax Court relied on in Bobrow. Roth IRAs are governed by IRC 408A, and IRC 408A(e) is the section that enables 60-Day rollover contributions for Roth IRAs. Under, IRC 408A(e) the code allows Roth IRA qualified rollover contributions that meet the requirements of IRC 408(d)(3) [the traditional IRA code section] but specifically states that, “For purposes of IRC 408(d)(3)(B), there shall be disregarded any qualified rollover contribution from an individual retirement plan (other than a Roth IRA) to a Roth IRA.” In other words, the section enabling Roth IRA rollovers states that you only count the number of Roth IRA rollovers when considering the one-year rollover rule for a Roth IRA Rollover. As a result, even if the taxpayer had conducted a rollover of a traditional IRA in the prior twelve-month period, this rollover would not be counted in applying the one 60-Day rollover per year rule for the Roth IRA. This application of a separate One-Rollover-Per-Year  for Roth and Traditional IRAs is also the position the IRS appears to be taking. In the IRS summary of the IRA One-Rollover-Per Year Rule, the IRS explained the One-60 Day Rollover per IRA rule for traditional IRAs and then stated that, “A similar limitation would apply to Roth IRAs.” Rather than lumping the Roth IRAs into Traditional IRAs for purposes of the rule, the IRS seems to be treating them separately. It would be nice though if they could be more clear on this issue before 2015 “rolls” around.

So, in sum, always opt for trustee-to-trustee transfers of IRA funds (where possible) and avoid taking a 60-Day Rollover from an IRA unless you are certain you have not conducted one in the prior 1-year period.

When is a Business Partner a Disqualified Person to My Self-Directed IRA?

by | Apr 29, 2014 | Uncategorized

Most self directed IRA owners know that their self directed IRA cannot conduct transactions with themselves or certain family members (e.g. spouse, kids, parents, etc.). Most self directed IRA owners also know that their self directed IRA cannot do business with a company they own or that their disqualified family members own 50% or more of. However, one of the most confusing areas of the prohibited transaction rules are the prohibited transaction rules which apply to business partners or officers, directors, and/or highly compensated employees of companies the IRA owner or family members are personally involved in. For example, what if I own a business with a partner? Can my IRA enter into a transaction with that business partner if we aren’t family? Well, it depends.

Disqualified Person Analysis

To analyze the rules you first need to determine whether the company in which the business partner (or officer, or director) is involved in is a company that is owned 50% or more by the IRA owner or their disqualified family members. IRC 4975 (e)(2)(E),(H), (I). So, for example, if my wife and I owned 60% of the business and our partner owned 40% of the business, then this company would be owned 50% or more by disqualified persons.

Once we know that the company is owned 50% or more by disqualified persons, we need to identify all of the officers, directors, highly compensated employees, and 10 % or more owners of that company. In sum, all of these persons are disqualified to the IRAs of the 50% or more owners. In the example above, since my business partner owned 40% of the company, he is a 10% or more owner and as a result he is a disqualified person to my IRA (since my wife and I own 50% or more of the company).

Let’s look at another example. Say that I am a 35% owner of a business with a few other partners who are not disqualified family members to me.  Since I do not own 50% or more of this company, it doesn’t matter who the other partners, officers, or directors, are, as they are not disqualified to my IRA as part of this rule since my ownership (and that of my disqualified family members) is below 50%.

As a final example, let’s say that I own 70% of a company and that I have a partner who owns 5%. Under the rule, my partner or fellow shareholder does not have 10% or greater ownership and as a result they are not disqualified to my IRA. However, if that 5% owner was the President of my company then they would be a disqualified person.

These rules can be tough to understand when you read the code, but if you take the two step analysis you can easily determine what partners, officer, directors, or highly compensated employees are disqualified to your IRA.

Here’s also a quick summary of the rule from my book where I took the text of the tax code and put it into plain language.

Key Persons in Company Owned 50% or More by Disqualified Persons

An officer, director, or 10% or more shareholder, or highly compensated employee (earns 10% or more of the company’s wages) of a company owned by the IRA owner or other disqualified persons. IRC § 4975 (e)(2)(H).

Before investing with someone who is an officer, director, highly compensated employee, or a shareholder/owner in a company you are involved in, please consult these rules and where you are un-clear, seek the advice of competent counsel.

60 DAY IRA ROLLOVERS: TAX COURT SAYS DON’T FOLLOW IRS GUIDANCE

by | Mar 18, 2014 | Uncategorized

A recent U.S. Tax Court case, Bobrow v. Commisioner, T.C. Memo 2014-21, held that a taxpayer may only conduct one 60-day rollover of retirement plan funds per 1-year period. The Court’s opinion was a drastic change from what most taxpayers and professionals understood and from what the IRS has explained in its own publications.

The relevant facts of Bobrow are as follows. Mr. Bobrow conducted two 60-day rollovers in a 1-year period with two separate IRA accounts. He received both sums of money personally and paid them back into his two respective IRAs each within 60 days. Mr. Bobrow, presumably, believed that since he had two different IRAs that he could do two separate 60-day rollovers with those accounts without having either account subject to withdrawal. While Mr. Bobrow relied on a commonly accepted practice that was supported clearly by IRS guidance, the Tax Court disagreed based on the language of IRC 408 (d)(3)(B).

A 60-day rollover is often used by retirement account owners who temporarily roll-over money to themselves personally from their existing retirement account and re-deposit the funds into a new custodian’s retirement account within 60 days.  A 60-day rollover, however, is not to be confused with a trustee to trustee transfer or even a direct rollover, whereby retirement account funds are sent from the prior custodian or trustee of the retirement account funds to the new custodian or trustee. These types of transactions can be done as many times as an account owner desires and do not result in a retirement account owner’s personal receipt of retirement account funds or withdrawal under the tax rules. A 60-day rollover, on the other hand, is sent to the retirement account owner in their own name and can be deposited and used by the retirement account owner during the 60-day period so long as the funds are returned to the retirement account or to a new account within 60-days. A 60-day rollover is sometimes used by retirement account owners who, for example, withdraw funds from their IRA for short-term personal use or investment and then return the withdrawn funds to their IRA within 60-days.

Under IRC 408 (d)(3)(A), an IRA owner’s withdrawal from an IRA is not taxable when returned or deposited into a new IRA within 60 days. However, the question posed in the Bobrow case was how many 60-day rollovers can an individual do in a 1-year period. The 60-day rollover exception is limited in the Code when an individual has already received one 60-day roll-over from an IRA in the past 12 months. The Code specifically states that the 60-day rollover exception cannot be used if the individual has already completed and relied on the exception for a 60-day rollover in the prior 1-year period. IRC 408(d)(3)(B). It has been unclear, however, whether the one 60-day rollover per year applied on a per IRA basis or whether it applied to the individual for all of their accounts.

The IRS had clarified that questions and has previously explained that an individual can conduct one 60-day rollover per 1-year period per IRA and thus interpreted IRC 408(d)(3)(b) to apply on a per IRA basis. This one 60-day rollover per IRA rule is explained by way of example in the current version of IRS Publication 590, page 25, as follows.

You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2

Based on this explanation, it is clear that the guidance from the IRS is that an individual can make one 60-day rollover per account per 1-year period. Yet, despite this publication, the IRS sought to make Mr. Bodrow’s second 60-day rollover from a separate IRA taxable as it was his second 60-day rollover in a one-year period. The IRS did not give any consideration to the fact that the second 60-day rollover was from a separate IRA (as it clearly explained in IRS Publication 590 to be acceptable).

The U.S. Tax Court agreed with the IRS and held that the limitations of IRC 408 (d)(3)(B) means that an individual can only conduct one 60-day rollover per 1-year period. After my own analysis of IRC 408 (d)(3)(B), I have to say that I agree with the Court’s opinion as the statutory language does not make a distinction between accounts but instead refers to 60-day rollovers taken per individual. Consequently, the intent of the statute is that a taxpayer can only conduct one 60-day rollover per 1-year period for all of their IRAs. Unfortunately, the error of the IRS in providing incorrect guidance does not go in favor of the taxpayer.

Based on the Court’s opinion, retirement account owners are well advised to only conduct one 60-day rollover per 1-year period. Keep in mind that you can conduct as many trustee to trustee or direct rollovers per year as you want as those transfers or rollovers result in money being sent directly to a new retirement account custodian or trustee and are not governed under the 60-day rollover rules.

As of March 18, 2014, the Bobrow case is still somewhat in limbo as there is currently a motion to reconsider filed by the taxpayer pending with the Court. Once the Court decides the motion to reconsider, the Judge will issue a final decision and after the decision is entered the taxpayer will have 90 days to appeal the Court’s ruling to the U.S. Court of Appeals for the Third Circuit. Given the significance of the Court’s ruling, I presume that the case will likely be appealed and heard by the U.S. Court of Appeals for the Third Circuit.

By: Mat Sorensen, attorney and author of The Self Directed IRA Handbook.

ARE YOU CONSIDERING MOVING YOURSELF OR YOUR MONEY OUTSIDE THE U.S.?

by | Mar 4, 2014 | Uncategorized

Are you a U.S. citizen considering moving yourself or your money outside the U.S.? Before you or money leave the USA, first consider the tax and legal consequences as they are often misunderstood.

U.S. Citizens have numerous tax and reporting obligations that arise from their foreign assets, investments, and accounts. In essence, if you have foreign assets, investments, or bank accounts, then you have two obligations to the United States Government.

First, you must disclose any foreign bank account whose value is over $10,000 (all foreign accounts are combined to reach the $10,000 threshold) and you must report any foreign asset (e.g. foreign stock, company ownership, etc.) whose value is $50,000 or greater.  The form required to be filed annually to disclose foreign bank accounts in excess of $10,000 is known as FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). The form filed annually to disclose foreign assets with a value in excess of $50,000, is IRS Form 8938, Statement of Specified Financial Assets. In sum, the first obligation U.S. citizens have to their home country is the disclosure of foreign bank accounts and foreign assets.

Second, as a U.S. citizen you are required to pay U.S. federal income tax on the foreign income you receive as the U.S. taxes its citizens on income no matter whether it was earned in the U.S. or abroad. In other words, even if you make money outside the U.S., as a U.S. citizen, you are still required to pay federal tax on that income. If you paid foreign income taxes to the country where the income was derived and if that country has a tax treaty with the U.S., then you’ll typically receive a credit in the U.S. for the foreign taxes paid, which thereby reduces the amount of federal taxes owed in the U.S. Click here to see the list of countries with a foreign tax treaty with the U.S.

Some U.S. citizens presume that if they leave the U.S. that they are no longer subject to federal income tax in the U.S. but this is not the case. Even if you relocate to a foreign country and no longer earn income from the U.S. you are still subject to U.S. tax and on your foreign income (and potential state income tax depending on your state of residence). The only way to entirely escape the tax jurisdiction of the United States is to renounce U.S. citizenship but this is a costly and expensive process with numerous tax repercussions. See the Expatriation Tax rules from the IRS for more information here.

Let’s run through a common example that demonstrates how the disclosure and income tax reporting requirements work. A U.S. citizen has a bank account in Switzerland with a balance of $100,000. That account generates income of $5,000 for the year. For example purposes, let’s say that the $5,000 in income resulted in taxes owed to Switzerland of $500 and that the U.S. citizen reported and paid the tax to Switzerland. In addition to compliance with Switzerland law, the U.S. citizen would need to file FinCEN Form 114 (FBAR) to disclose the foreign bank account. The FBAR form filing is due by June 30th for the prior year’s accounts. The U.S. Citizen would also need to file IRS Form 8938, since the account was over $50,000. Form 8938 is due with the filing of the U.S. citizen’s federal tax return. In addition to the two disclosure forms that are filed in the U.S., the $5,000 of income from the Switzerland account must be reported as taxable income on the income tax return (form 1040) of the U.S. citizen. The $500 paid in tax to Switzerland will be credited to the taxpayer in computing the tax owed to the U.S. because the U.S. and Switzerland have a tax treaty. In sum, a $100,000 foreign bank account resulted in two disclosure form filings to the U.S. and inclusion of the income on the U.S. citizen’s federal tax return.

These are just the basics and every country has their own nuances. In addition there are many special rules and there are numerous exceptions to the filing discussed herein and as a result a U.S. citizen leaving the U.S. or sending money outside the U.S. should seek out experienced professionals to assist them in their U.S. tax reporting obligations.

401(k) Contributions from S-Corp Income

by | Feb 18, 2014 | Uncategorized

A properly structured s-corporation is utilized best when business owners adopt and contribute to a 401(k) plan. Whether the business has only one owner/employee (or spouses only) or whether the business has dozens or even hundreds of employees. Simply put, a 401(k) plan can be used as a tool for putting the income of the business owner (any applicable employees) away for retirement with the added benefit of a tax deduction for every dollar that can be contributed. There are so many neat things about 401(k) plans and there are so many options.  For example, you can do Roth 401(k) plans, you can self direct a 401(k) plan, and you can even loan money to yourself from your 401(k) account. While books have been written about all of these options and benefits, one of the most misunderstood concepts of 401(k) plans is how s-corporation owners can contribute their income to the plan. That is the focus of this article.

Rules for 401(k) Contribution

In order to understand how s-corporations income can be contributed to a 401(k) plan, you need to understand the following three basic rules:

  1. Only W-2 Salary Income can be Contributed to a 401(k). You cannot make 401(k) contributions from dividend or net profit income that goes on your K-1. See IRS.gov for more details. Since many s-corporation owners seek to minimize their W-2 salary for self-employment tax purposes, you must carefully plan your W-2 and annual salary taking into account your annual planned 401(k) contributions. In other words, if you cut the salary too low you wont be able to contribute the maximum amounts. On the other hand, even with a low W-2 Salary from the s-corporation you’ll still be able to make excellent annual contributions to the 401(k) (up to $17,500 if you have at least that much in annual W-2 salary).
  2. Easy Elective Salary Deferral Limit of $17,500 or 100% of Your W-2, whichever is less. If you have at least $17,500 of salary income from the s-corporation, you can contribute $17,500 to your 401(k) account.  Every employee under the plan is allowed to make this same contribution amount. As a result, many spouses are added to the s-corporation’s payroll (where permissible) to make an additional $17,500 contribution for the spouse’s account. If you are 50 or older, you can make an additional $5,500 annual contribution.  Follow this link for the details from the IRS on the elective salary deferral limits. The elective salary deferral can be traditional dollars or Roth dollars.
  3. Non-Elective Deferral of 25% of Income Up to a $52,000 total Annual 401(k) Contribution. In addition to the $17,500 annual elective salary contribution, an s-corporation owner can contribute 25% of their salary compensation to their 401(k) account up to a maximum of a $52,000 total annual contribution.  This non-elective deferral is always made with traditional dollars and cannot be Roth dollars. So, for example, if you have an annual W-2 of $100,000, you’ll be able to contribute a maximum of $25,000 as a non-elective salary deferral to your 401(k) account. If you have employees who participate in the plan besides you (the business owner) and your spouse, then the non-elective deferral calculation gets much more complicated. But for now, let’s assume there are no other employees and run through the examples.

Examples

Lets run through two examples. The first is an s-corporation business owner looking to contribute around $30,000 per year. The second is a business owner looking to contribute the maximum of $52,000 a year.

Example 1: Seeking a $30,000 Annual Contribution.

  • S-Corporation Owner W-2 Salary = $50,00
  • Elective Salary Deferral = $17,500
  • 25% of Salary Non-Elective Deferral = $12,500 (25% of $50,00)
  • Total Possible 401(k) Contribution = $30,000

Example 2: Seeking Maximum $52,000 Annual Contribution

  • S-Corporation Owner W-2 Salary = $138,000
  • Elective Salary Deferral = $17,500
  • 25% of Salary Non-Elective Deferral = $34,500 (25% of  $138,000)
  • Total Possible 401(k) Contribution  (maximum) = $52,000

As a result of the calculations above, in order to contribute the maximum of $52,000, you need a W-2 salary from the s-corporation of $138,000. Keep in mind that if you have other employees in your business (other than owner and spouse) that you are required to do comparable matching on the 25% non-elective deferral and as a result such maximization is often difficult to accomplish in 401(k)s with employees other than the owner and their spouse. Consequently, the additional 25% non-elective salary deferral is best used in owner only 401(k) plans.