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Tax Tip of the Week | No. 269 | The Surprise IRA Tax September 24, 2014

Posted by bradstreetblogger in : General, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , 1 comment so far

Tax Tip of the Week | Sept 24, 2014 | No. 269 | The Surprise IRA Tax

While preparing 2012 individual tax returns in early 2013, we noticed a trickle of problems on Schedule K-1 from partnership investments in IRAs. That trickle became a flash flood this latest tax season. It is a problem which will erupt in an earthquake of tax and penalty if taxpayers receive an unexpected 1099-R for 2014 IRA distributions of which they were unaware!

What is this unexpected flow of taxable income from IRAs? In late 2012 and throughout 2013, investment advisers started advising clients to invest, or to rollover their IRAs in limited partnerships. These investments were sold as a way to increase returns, diversify the portfolio and increase liquidity (and were high commission products!). The culprit here is Internal Revenue Code Section 511 which applies the 39.6% unrelated business income tax (UBIT) on IRAs that earn income from a trade or business activity that generates more than $1,000 of income.

IRAs are exempt from UBIT on interest, dividends, royalties, rents and a few other items. The trap is that most limited partnerships operate businesses and borrow money, and most business and debt-financed income is considered UBIT when received by an IRA. Even if the IRA has exempt income the percentage attributed to debt financing may be subject to the UBIT tax at a flat 39.6% rate.

Look to the K-1 to see if it includes UBIT amounts, and if so, the trustee of the IRA is required to file IRS Form 990-T and pay the 39.6% tax. Even worse, the withdrawal from the IRA to pay the tax may be a taxable distribution, and if the taxpayer is under 59 and ½ it may be subject to the 10% early withdrawal penalty-all reported in January, 2015 on Form 1099-R!

Let’s see what happens here to the average taxpayer.

Assume the taxpayer rolled over $50,000 into a master limited partnership (MLP) in the oil and gas industry after being told they could earn as much as a 10% return. Assuming they did earn 10% this year that means they earned $5,000. This $5,000 is most assuredly subject to the UBIT tax, but they do receive a $1,000 exemption, so only $4,000 will be taxed at roughly 40% or $1,600 of tax. Because it is extremely unlikely that the IRA trustee paid quarterly required estimated tax payments, there might also be an underpayment penalty of say $100. If the IRA pays the tax and penalty, out of IRA funds this may be treated as an early withdrawal subject to tax at the individual level of ($1700 @ 30%) $510, plus a potential penalty of $170. So total tax would be (1600+100+510+170)=$2,380.   Plus, additional tax will be paid upon normal distributions. Even worse, any operating losses in the MLP are kept inside the IRA without benefit to the individual.

We do not want to go so far as to say that IRAs should not invest in MLP’s. That is clearly an investment decision. Our fear is that most taxpayers are not receiving the full picture of the tax aspect of an MLP investment in an IRA and that some brokers are motivated by commissions rather than suitability. Add in the complex reporting requirements that we fear IRA trustees are ignoring and we are looking at a perfect storm of potentially disqualified IRAs for non-compliance by trustees at worst, and dramatically reduced investment returns at best, particularly when compared to the risk of the investment.

You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.

Rick Prewitt – the guy behind TTW

…until next week.

Tax Tip of the Week | No. 268 | Taxpayers’ Income Hit $9.1T in 2012 September 17, 2014

Posted by bradstreetblogger in : Taxes, Uncategorized , add a comment

Tax Tip of the Week | Sept 17, 2014 | No. 268 | Taxpayers’ Income Hit $9.1T in 2012

Here is a recent article I read….

U.S. taxpayers reported $9.1 trillion in adjusted gross income (less deficit) for tax year 2012, according to the most recent IRS Statistics of Income Bulletin.

Statistics of Income – 2012, Individual Income Tax Returns, which was released on Friday, reported that taxpayers filed 144.9 million individual tax returns for 2012, down 0.3 percent from 2011. The AGI less deficit of $9.1 trillion represents an 8.7 percent increase from the previous year.

The SOI includes estimates on sources of income, AGI, exemptions, deductions, taxable income and more.

The report, Publication 1304, is available for download on the IRS Tax Stats page.

You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.

Rick Prewitt – the guy behind TTW

…until next week.

Tax Tip of the Week | No. 267 | Beware of Money Funds in 401(K)s September 10, 2014

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Planning Tips, Tax Tip, Taxes, Taxes , add a comment

Tax Tip of the Week | Sept 10, 2014 | No. 267 | Beware of Money Funds in 401(K)s

Here is a recent article from Bankrate.com…..

In July, the Securities and Exchange Commission, or SEC, issued new rules for money market funds.

After the rules go into effect in 2016, it will be possible for investors to lose money in money market funds -– mainly institutional investors. When the rules kick in, prime money market funds will post the real value of their investments with a floating net asset value, or NAV, as opposed to the fixed $1 NAV that has been the rule.

Money funds available to regular people, as opposed to institutions, were only partially hit by this regulation. If a crisis hits and money market funds impose redemption fees and gates (time delays on redemptions during crises), small investors run the risk of taking a hit to principal in the form of a fee if they want to pull their money out of the fund during a time of stress.

But small investors, particularly those in 401(k)s, may not be as safe from market vagaries as a safe investment would imply. A recent column on the website Marketwatch, “Your safe money-market fund may be at risk,” pointed out that some plan sponsors may offer money market funds that will feature floating NAVs.

Plus, all investors in money funds should investigate their funds’ plan for redemption fees and gates. There are plenty of other safe investment options including certificates of deposit and money market accounts.

For those with an investing time frame of five years or more, money market funds may be a waste of resources anyway. Most people need significantly higher returns on retirement portfolios to reach their goals.

Do money market funds play a role in your retirement portfolio?

You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.

Rick Prewitt – the guy behind TTW

…until next week.

Tax Tip of the Week | No. 266 | Home Office Deduction Not Precluded by Minor Personal Use September 3, 2014

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip , add a comment

Tax Tip of the Week | Sept 3, 2014 | No. 266 | Home Office Deduction Not Precluded by Minor Personal Use

A recent court case….

The Tax Court sided with the plaintiff in a recent case involving the rules surrounding the home office deduction. The deduction is allowed for the portion of a residence that is used exclusively and on a regular basis as the principal place of business for a taxpayer.

Setting aside an area of the dwelling for exclusive use is not always easy, however. In Lauren Miller’s case, the IRS challenged her deduction for the expenses allocable to one-third of her New York City studio apartment of 700 square feet.

Miller was employed by BrandingIron Worldwide (BIW), a company that provides public relations, advertising, and marketing services. BIW is headquartered in Los Angeles, while at the time she was hired; Miller was BIW’s only employee in New York.

Miller used part of her apartment as an office throughout 2009. BIW listed her apartment address and telephone number on its Web site as the address and phone number for its New York office.  Miller usually worked weekdays between 9 a.m. and 7 p.m., but was generally expected to be available at all times.

Miler’s studio apartment, a single room, was divided into three equal sections: an entryway, a bathroom, and a kitchen area; office space, including a desk, two shelving units, a bookcase, and a sofa; and a bedroom area including a platform bed and dressers. Miller has to pass through the office space to get to the bedroom area.

Miller frequently met with BIW clients in the office space, and she performed work for BIW using a computer on the desk. The bookcase and shelving units were used to store books, magazines, supplies and samples related to her work for BIW and its clients. Although she used the office space primarily for business purposes, she occasionally used the space for personal purposed. BIW did not reimburse Miller for any of the expenses related to her apartment.

The Tax Court, in Summary Opinion 2014-74, noted that if the taxpayer is an employee, the deduction for a home office is only allowable if the exclusive use of the office space is for the convenience of the taxpayer’s employer. In Miller’s case, BIW listed her apartment address on its Web site as its New York office address, and Miller “testified credibly that she regularly used one-third of her apartment space as an office to conduct BIW business, she met with clients there, and she was expected to be available to work well into the evening.”

The court agreed with Miller that her apartment was her principal place of business that she was obliged to use the space as an office for the convenience of her employer, and that BIW was not able or willing to reimburse her for any of her apartment-related expenses.

“Although Petitioner admitted that she used portions of the office space for nonbusiness purposes, we find that her personal use of the space was de minimis and wholly attributable to the practicalities of living in a studio apartment of such modest dimensions.”

Therefore, the court concluded that Miller was entitled to the home office deduction.

You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.

Rick Prewitt – the guy behind TTW

…until next week.