2010 ira & pension update presented by: robert s. keebler, cpa, mst, aep © 2010 robert s....

2010 IRA & Pension Update

PRESENTED BY:

Robert S. Keebler, CPA, MST, AEP

© 2010 Robert S. Keebler, CPA, MST, AEPAll rights reserved.

• Bankruptcy & IRAs

• Recent Developments

• Prohibited Transactions

• PLR 201021038 (Reformation of IRA Trust)

• New 3.8% Medicare Surtax

• APPENDIX: Analyzing Roth IRA Conversions


Outline

2

Bankruptcy & IRAs


3

• Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

• Signed by President on April 20, 2005

• Main Purpose – to stop perceived abuses in the bankruptcy system

Bankruptcy & IRAs

2005 Bankruptcy Act


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• 11 U.S.C. §522

– Retirement Asset Protections

o IRA and Roth IRA Limitations

o $1 Million

– Rollover IRA Protections

o Separate Accounts

– Protection for Business Owners

• 11 U.S.C. §541

– Coverdell Accounts and 529 Plans

Bankruptcy & IRAs


2005 Bankruptcy Act

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• Several states have “opt out” provisions that replace the U.S.C. with state law protection

− It is important to assess the level of protection each state law provides IRA owners to determine which set of laws (federal vs. state) to apply in a particular case

Bankruptcy & IRAs


2005 Bankruptcy Act

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• (2010, Bktcy Ct MN) 105 AFTR 2d 2010-609, 01/11/2010

• The United States Bankruptcy Court for the District of Minnesota held that funds in an inherited IRA account are exempt from the debtor’s bankruptcy estate.

• Although the IRA funds were subject of a post-death trustee-to-trustee transfer, such transfer did not affect their character as retirement funds or qualification as such for exemption.

• Court found that under the plain language of 11 U.S.C. § 522(d)(12), the funds qualify for exemption under that provision and have been properly claimed exempt.

Bankruptcy & IRAs

In re Nessa


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• (Bktcy Ct TX) 105 AFTR 2d 2010-XXXX, 03/5/2010

• United States Bankruptcy Court for the Eastern District of Texas held that a debtor’s inherited IRA is not exempt from her bankruptcy estate.

• Court looked at the meaning of “retirement funds” under § 522(d)(12), a term which is not defined in the Bankruptcy Code. Viewing the words “retirement funds” in their entire context, the Court felt that it could not reasonably be understood to authorize an exemption of an inherited IRA. The Court concluded that “the funds contained in an inherited IRA are not funds intended for retirement purposes but, instead, are distributed to the beneficiary of the account without regard to age or retirement status.”

• Court concluded that an inherited IRA is not equivalent to an IRA for purposes of determining whether the account contains “retirement funds” that may be exempted from the estate under § 522(d)(12).

Bankruptcy & IRAs

In re Chilton


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Recent Developments


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• No. CV-06-0119-PHX-FJM, 105 AFTR 2d 2010-690

• ERISA’s applicability (including surviving spouse statutory claim provisions) terminate once plan is rolled over to IRA

• See also Charles Schwab v. Debickero, 105 AFTR 2d 2010-XXXX, 01/22/2010

Recent Developments

Charles Schwab & Company v. Chandler


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• IRS ruled that the 10 percent additional income tax contained in IRC Sec. 72(t)(1) (the early distribution penalty) did not apply to our client’s withdrawals from his IRA because of his disability.

• Taxpayer diagnosed with multiple sclerosis which forced him to leave his job and apply for Social Security disability benefits. He was granted disability benefits from the Social Security Administration.

Recent Developments

PLR 201011036


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• An individual convicted of and imprisoned for the murder of the decedent will still be treated as the designated beneficiary of the decedent's IRAs despite the state law slayer statute treating him as predeceased for purposes of inheriting property from the decedent.

• The individual convicted of murdering the decedent, is the designated beneficiary of the IRAs held by the IRA owner on the date of her death, as well as on September 30 of the calendar year immediately following the calendar year of her death.

Recent Developments

PLR 201008049


12

• 133 T.C. No. 9 (2009)• In a case of first impression, the Tax Court sustained the Internal

Revenue Service’s determination that a Roth IRA is not an eligible S corporation shareholder. Accordingly, the taxpayer was taxable as a C corporation for the year involved.

• An IRA or Roth IRA can be an S-corporation shareholder in the case of a corporation which is a bank (as defined in IRC Sec. 581) or a depository institution holding company (as defined in section 3(w)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(w)(1)), but only to the extent of the stock held by such IRA or Roth IRA in such bank or company as of Oct. 22, 2004. IRC Sec. 1361(c)(2)(A)(vi). In such a case, the individual for whose benefit the IRA or Roth IRA was created is treated as a shareholder. IRC Sec. 1361(c)(2)(B)(vi).

Recent Developments

Taproot Administrative Services, Inc. v. Commissioner


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• Notice confirms the accepted notion that, if the employee says "no" to a direct rollover, and instead takes an outright distribution from the plan, and then rolls over only part of the distribution within 60 days, the part rolled over comes out of the pretax money first.

• However, the IRS says a partial direct rollover is treated differently: If the participant chooses a direct rollover to an IRA for part of his distribution, and takes outright distribution of the rest, both the portion directly rolled over and the portion paid to the employee will consist of proportionate amounts of the pre- and after-tax money in the employee's account.


Notice 2009-68

Recent Developments

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• The Tax Court found that the proper value of a life insurance contract was the "entire cash value" of the contract not taking into account a reduction for the surrender charges. Accordingly, the Tax Court held Mr. Matthies was required to recognize additional income of $1,053,304 on the bargain purchase of the policy.

• The IRS assessment of a $58,985 accuracy-related penalty was denied.

• The pension rescue strategy utilized in Matthies has been a common strategy for many years and is still marketed today in a manner designed to comply with the amended regulations.


Matthies v. Commissioner

Recent Developments

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• 134 TC No. 14

• A section 6321 lien attached to all of Wadleigh’s property, including an ERISA pension he had from Honeywell. Although the pension was fully vested, it would not be in payout status until November 2007.

• In 2005, Wadleigh and his wife filed a voluntary Chapter 7 bankruptcy petition, listing the pension as an excluded asset. They received a discharge in bankruptcy that included the 2001 federal income tax liability. Notwithstanding the discharge, in 2006 the IRS issued a notice of intent to levy on the pension income.

• Wadleigh made three core arguments: (1) that his liability for the unpaid tax was discharged

in bankruptcy, (2) that the levy was invalid because it was made before he was in payout status and (3) that the proposed levy was invalid because a previous levy on his pension was released.

• The Tax Court rejected all three arguments-IRS lien was not discharged in bankruptcy because the pension plan was an excluded asset under 26 U.S.C. 541(c)(2) and the trustee in bankruptcy had no power over it


Wadleigh v. Commissioner

Recent Developments

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• TC Memo 2010-146

• Taxpayer was found to be liable for 10% early distribution from IRA she inherited from her husband because she performed a spousal rollover of such inherited IRA before taking the distribution.

• When a spouse inherits an IRA, it is generally desirable to perform a spousal rollover. This allows the spouse to defer required minimum distributions until he/she reaches his/her required beginning date and also allows for further deferral to after the surviving spouse’s death if the spouse does proper beneficiary planning. However, as this case highlights, if a spouse is younger than age 59 ½, a spousal rollover should not be automatic. If there is a possibility that the spouse will need to access the IRA funds before age 59 ½, a rollover should not be performed. Instead, the IRA should remain titled in the name of the deceased spouse for the benefit of the surviving spouse. Distributions can then be taken from this inherited IRA without imposition of the 10% early distribution penalty because of the IRC Sec. 72(t)(2)(A)(ii) exception. Once the surviving spouse reaches age 59 ½, a rollover can be performed as there is no time limit imposed on a spousal rollover.


Sears v. Commissioner

Recent Developments

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• No. 10-10393 11th Circuit Court of Appeals.

• The 11th Circuit Court of Appeals upheld the U.S. Tax Court ruling that Eugene and Glenda Dollander were responsible for the 10% excise tax on their withdrawal from a qualified retirement plan. The petitioners had claimed that IRC section 72 (t) provided a hardship exception. The court, in reviewing the flush language of section 72(t), confirmed a financial hardship was not one of the enumerated exceptions.


Dollander v. IRS

Recent Developments

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• TC memo. 2010-140, N.o. 7181-08L.

• Judith and Robert Swanston operated a corporation that eventually filed for Chapter 7. The IRS issued a Letter 1153 notice of proposed trust fund recovery penalty assessment. The IRS eventually proposed penalties totaling over $289,000. In 2004, the IRS seized $289,017 from Mr. Swanston's IRA. In 2005, the Swanston's filed their income tax return for the 2004 tax year. In preparing this return they included the seized funds in gross income as a taxable distribution from the IRA. Although they paid $1,461 via withholding, they failed to pay the remaining balance of approximately $75,000 to the IRS.

• This case was truly more of a trust fund case than a case regarding IRAs, however the court was very clear that the payment of federal taxes by way of a levy constitutes an involuntary assignment of income and may be included in gross income in the year of levy pursuant to the doctrine of constructive receipt.

© 2010 Robert S. Keebler, CPAAll rights reserved.

Swanston v. Commissioner

Recent Developments

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Prohibited Transactions


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Any direct or indirect sale or exchange, or leasing, of any property between a plan and a “disqualified person”

• Residence or cottage

• Business interest

• Investment real estate


Prohibited Transaction - Defined


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IRC §4975(a)• 15 percent tax on prohibited transactions

IRC §4975(b) • Tax equal to 100 percent of the amount involved on a prohibited

transaction

IRAs - If individual or his beneficiary engages in any prohibited transaction, then:

• Disqualification of IRA

• Immediate income taxation


Prohibited Transaction – Applicable Law


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• IRA owner's pledge of his personal account as security for the IRA's debts to the broker would be a prohibited transaction.


Advisory Opinion 2009-03A


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• No fee

• Website: http://www.dol.gov/ebsa/publications/exemption_procedures.html


Department of Labor Requests


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PLR 201021038(Reformation of IRA Trust)

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• Service ruled that the retroactive reformation of a trust would not be respected for purposes of section 401(a)(9) and the related regulations

• The trustee reformed the trust pursuant to a state court order to remove charities under a limited power of appointment granted to first tier beneficiaries

• The adverse ruling means the trust was not treated as a “designated beneficiary trust” (“DBT”): the trust beneficiary’s life expectancy could not be used for required minimum distributions.

PLR 201021038


26

• Husband and wife create a straightforward revocable trust with a Survivors trust, Marital trust and a Bypass trust

• Upon the death of the surviving spouse the trust further divides among various family members

• The trust creates “protective” trusts for the benefit of “C” and “D” (children)

• Prior to death, the taxpayer’s counsel revised the trust adding the following language to allow for post-mortem trust reformations

(emphasis added):With respect to any IRA, 401 K or other retirement plan payable to the trust on the death of either Trust Creator, it is the Trust Creators’ desire that the Trustee utilize the minimum distribution rules described in the Internal Revenue Code (“IRC”) and applicable regulations when making withdrawals from said retirement account … In particular, the trustee should be guided by the following;

PLR 201021038


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(a) The Trustee should first determine whether the custodian allows for long-term deferral of income taxes by the Trustee; … (c) the Trustee should determine what requirements exist, if any, in order to elect the longest tax-deferral period; (d) Having made the appropriate election in order to elect the longest tax-deferral period of time, the Trustee should withdraw funds from the retirement plan in the minimum amounts required under IRC and applicable regulations without penalty; additional amounts should be withdrawn only if the Trustee determines that a need exists; … (f) … The provisions of this instrument are intended to inform the Trustee of the Trust Creator’s desire that the rules commonly known as the “stretch IRA” rules should be applied to all retirement plans. … It is the Trust Creator’s hope that the Trustee will use his or her best efforts to minimize income taxes on these assets for the maximum duration permitted by law … For purposes of qualifying as a Designated Beneficiary under IRC and applicable regulations, each Beneficiary may amend the terms of the trust which govern the distribution of his or her trust at death in the absence of a complete and effective exercise of any applicable power of appointment;…”

PLR 201021038


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• In earlier PLRs the Service allowed a trust that was reformed after the IRA owner’s death to qualify as a DBT

• See PLRs 200235038 and 200620026 (the authors represented the taxpayers in these rulings).

• Now the message seems to have changed and if the Service’s position is eventfully sustained by the Tax Court the burden on drafting lawyers is high

PLR 201021038


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• The moral of this ruling is that counsel and other advisors must exercise great care when drafting IRA trusts.

• Given the difficulty of drafting an accumulation trust that qualifies as a designated beneficiary, it may be advisable to first draft the trust as a conduit trust (i.e. any and all IRA distributions must be paid outright to the trust beneficiary) and give the Trust Protector a one-time option to switch the trust to an accumulation trust after the death of the IRA owner but before September 30 of the year following the year of death. This technique was approved in PLR 200537044.

•Visit www.ultimateestateplanner.com/robertkeebler.html for the podcast

PLR 201021038


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http://www.ultimateestateplanner.com/robertkeebler.html

New 3.8% Medicare Surtax


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• Beginning with the 2013 tax year, a new 3.8% Medicare “surtax” will apply to taxpayers who have “net investment income” and whose gross income exceeds a certain “threshold amount”

• This “surtax” will be in addition to the ordinary income tax



32

Taxable Income 2010 2011 - 2012

Top Ratewith Surtax

2013[1]

$ 0 – 16,750 10% 15% 15%

$ 16,750 – 68,000 15% 15% 15%

$ 68,000 – 137,300 25% 28% 28%

$ 137,300 – 209,250 28% 31% 34.8%

$ 209,250 – 373,650 33% 36% 39.8%

Over $373,650 35% 39.6% 43.4%

[1] The top rate with surtax in 2013 is simply the rate shown for 2011 in addition to the surtax rate of 3.8%.

Married Filing Jointly Table



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APPLICATION TO INDIVIDUALS – the new “surtax” is equal to 3.8% times the lesser of:

1. “Net investment income” for such taxable year, OR

2. The excess (if any) of –A. the “modified adjusted gross income” (“MAGI”) for such taxable

year, over

B. the “threshold amount”



34



APPLICATION TO ESTATES AND TRUSTS – the new “surtax” is equal to 3.8% times the lesser of:

1. The undistributed “net investment income” for such taxable year, OR

2. The excess if any of –A. the adjusted gross income (as defined in section 67(e) for such

taxable year, over

B. the dollar amount at which the highest tax bracket in section 1(e) begins for such taxable year ($11,200 in 2010).

35

“NET INVESTMENT INCOME” means:• Interest, dividends, rents and royalties (other than income derived in

the ordinary course of a trade or business)

• Capital gains attributable to the disposition of property (other than property held in a trade or business)



36

EXCEPTION FOR DISTRIBUTIONS FROM QUALIFIED PLANS - • The term “net investment income” does not include any distribution

from a plan or arrangement described in section 401(a), 403(a), 403(b), 408, 408A, or 457(b).

• Specific examples of excluded items:− Roth IRAs

− Traditional IRAs

− 401(k)

− ESOP

− Profit sharing plans



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“THRESHOLD AMOUNT” means:• Single taxpayers - $200,000

• Married taxpayers - $250,000

• Trusts - $11,200 (i.e. the “floor” of the top tax bracket in 2010)



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Example 1 - John, a single taxpayer, has $100,000 of salary and $50,000 of net investment income for MAGI of $150,000. The 3.8% surtax would not apply because his MAGI is less than $200,000.

Example 2 - Mary, another single taxpayer, has $225,000 of net investment income and no other source of income. The 3.8% surtax would apply to $25,000 of income (the lesser of investment income of $225,000 or the excess of $225,000 MAGI over $200,000 “threshold amount”).

Example 3 - Terry & Tina, married filing jointly, have $300,000 of salaries and no net investment income. The tax 3.8% surtax will not apply because they have no investment income.


New 3.8% Medicare SurtaxExamples

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New 3.8% Medicare SurtaxExamples

Example 4 - Peter & Paula, married filing jointly, have $400,000 of salaries and $50,000 of net investment income. They will pay the 3.8% surtax on $50,000.

Example 5 - Sarah & Scott, married filing jointly, have $200,000 of salaries and $150,000 of net investment income for total MAGI of $350,000. The 3.8% surtax would apply to $100,000 of income (excess of $350,000 MAGI over $250,000 “threshold amount”).

Example 6 - Randy, a single taxpayer, age 69, has investment income of $200,000 and is not subject to the surtax. In the following year, Randy has an RMD from his IRA of $125,000. In this case $325,000 of MAGI exceeds the $200,000 threshold and $125,000 is subject to the 3.8% surtax. This is called the surtax “bubble”.

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REDUCING “NET INVESTMENT INCOME”• Municipal bonds

• IRA and qualified plans

• Tax deferred annuities – (during deferral)

• Life insurance

• Depreciation on real estate

• 15% depletion allowance on oil and gas

• IDC deductions on passive oil and gas



41



REDUCING “MAGI”• Reduce investment income (above)

• Roth conversions in 2010, 2011 and 2012

• Non-grantor charitable lead trusts

• Charitable remainder trusts

• Installment sales

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OTHER PLANNING CONSIDERATIONS

• The 3.8% surtax does not apply to distributions from IRAs and other qualified retirement plans. Thus, taxpayers may wish to increase contributions to IRAs and 401(k), 403(b) and 457 plans

• The 3.8% surtax does not apply to distributions from Roth IRAs

43


The benefit of a conversion of a $500,000 IRA at the 39.6% rate for a client that will be at the 43.4% rate.

Roth Conversion with Inside Funding (tax due to conversion paid with IRA funds) 1

Year After Conversion No Conversion Roth IRA

Conversion Difference Percentage Difference

Investment Balance - 10 Years $ 826,436 $ 860,463 $ 34,026 4.12% Investment Balance - 15 Years $ 1,078,170 $ 1,127,824 $ 49,654 4.61% Investment Balance - 20 Years $ 1,398,741 $ 1,479,361 $ 80,619 5.76% Investment Balance - 25 Years $ 1,804,561 $ 1,941,891 $ 137,331 7.61% Investment Balance - 30 Years $ 2,315,507 $ 2,550,869 $ 235,363 10.16% Investment Balance - 35 Years $ 2,956,149 $ 3,353,187 $ 397,038 13.43%

Outside Funding (tax due to conversion paid with funds outside the IRA)

Year After Conversion No Conversion

Roth IRA Conversion Difference

Percentage Difference


1 The assumptions used for this calculation were as follows: A sixty year-old IRA owner; a beginning Traditional IRA balance of $500,000; a taxable investment account beginning balance of $200,000; six percent pre-tax growth rate; and a 4.8% after tax growth rate. These assumptions are the same for each of the charts.

New 3.8% Medicare SurtaxRoth IRA Conversion Illustration #1

44

The benefit of a conversion of a $500,000 IRA at the 35% rate for a client that will be at the 43.4% rate.

Roth Conversion with Inside Funding (tax due to conversion paid with IRA funds) 1

Year After Conversion No Conversion Roth IRA

Conversion Difference Percentage Difference


Outside Funding (tax due to conversion paid with funds outside the IRA)

Year After Conversion No Conversion

Roth IRA Conversion Difference

Percentage Difference

Investment Balance - 10 Years $ 826,436 $ 935,377 $ 108,941 13.18% Investment Balance - 15 Years $ 1,078,170 $ 1,248,787 $ 170,617 15.82% Investment Balance - 20 Years $ 1,398,741 $ 1,667,418 $ 268,677 19.21% Investment Balance - 25 Years $ 1,804,561 $ 2,226,654 $ 422,093 23.39% Investment Balance - 30 Years $ 2,315,507 $ 2,973,787 $ 658,281 28.43% Investment Balance - 35 Years $ 2,956,149 $ 3,972,042 $ 1,015,893 34.37%

1 The assumptions used for this calculation were as follows: A sixty year-old IRA owner; a beginning Traditional IRA balance of $500,000; a taxable investment account beginning balance of $200,000; six percent pre-tax growth rate; and a 4.8% after tax growth rate. These assumptions are the same for each of the charts.


New 3.8% Medicare SurtaxRoth IRA Conversion Illustration #2

45

Randy, a single taxpayer, age 69, has investment income of $200,000 and is not subject to the surtax. In the following year, Randy has an RMD from his IRA of $125,000 of investment income. In this case $325,000 of MAGI exceeds the $200,000 threshold and $125,000 is subject to the 3.8% surtax. This is called the surtax “bubble”. However, if the distributions were from a Roth IRA rather than from a Traditional IRA, MAGI would be unchanged and the surtax would not apply. Note the chart below:

Regular IRA Roth IRA

Investment Income $200,000 $200,000

IRA Income $125,000 $0

MAGI $325,000 $200,000

Less Threshold Amount ($200,000) ($200,000)

Amount Subject to Surtax $125,000 $0

Surtax @ 3.8% $ 4,750 $0

Surtax over 10 years $ 47,500 $0© 2010 Robert S. Keebler, CPA, MST, AEPAll rights reserved.

New 3.8% Medicare SurtaxRoth IRA Conversion Example

46

APPENDIXAnalyzing Roth IRA

Conversions


47

GENERAL ASSUMPTIONS

Current Year 2010

IRA Owner's Age 60

ASSET ASSUMPTIONS

FMV of Traditional IRA 500,000$ Growth Rate 6.00%

FMV of Roth IRA -$ Growth Rate 6.00%

FMV of Taxable Investment Account 175,000$ Cost Basis of Taxable Investment Account 175,000$ Yield Rate 2.00%Growth Rate 4.00%Annual Asset Turnover 50.00%Distribute Yield? Yes

Real Estate -$ Growth Rate 0.00%

Other Assets -$


Analyzing Roth IRA Conversions

48

INCOME & CASH FLOW ASSUMPTIONS

Other Income -$ Annual Increase (%) 0.00%

After-Tax Cash Flow Needs -$ Annual Increase (%) 0.00%

TAX ASSUMPTIONS

Effective Ordinary Income Tax Rate - IRA Owner 25.00%Effective Ordinary Income Tax Rate - Beneficiaries 25.00%Effective Capital Gains Tax Rate 15.00%

Estate Tax Rate 45.00%Estate Tax Exemption 3,500,000$

ROTH IRA CONVERSION ASSUMPTIONSOption 2 Option 3 Option 4 Option 5 Option 6

Roth IRA Conversion Amount 100,000$ 200,000$ 300,000$ 400,000$ 500,000$ Number of Conversions (20 Maximum) 1 1 1 1 1

Ordinary Income Tax Rate on Roth IRA Conversions 25.00% 27.00% 29.00% 31.00% 33.00%

Spread Conversion Over 2011 & 2012 (2010 Conversion Only)? No No No No No

Pay Income Tax on Conversion With Roth IRA Funds Only? No No No No No



49

$956,060

$962,098 $961,939

$955,582

$943,003

$924,218

Net to FamilyYear 10

Option 1 - Do Nothing Option 2 - Roth IRA Conversion Option 3 - Roth IRA Conversion

Option 4 - Roth IRA Conversion Option 5 - Roth IRA Conversion Option 6 - Roth IRA Conversion



50

$1,646,170

$1,667,033

$1,677,872$1,678,685

$1,669,434

$1,650,145






51

$2,772,501

$2,839,881

$2,891,045

$2,925,992$2,944,659 $2,947,088






52

Acknowledgements:

The author gratefully acknowledges the assistance of Larry Kaminsky and

Eliot Becker with regard to the afore appendix.

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Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

Although effort was taken to ensure the accuracy of these materials, Robert S. Keebler and Baker Tilly Virchow Krause, LLP assume no responsibility or liability for an individual’s reliance on these materials. These materials are being provided for educational and informational purposes only and are in no way to be construed as accounting, financial, tax, legal or other advice. Individual readers must consult their own professional tax and legal advisors.

Circular 230 Notice

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2010 ira & pension update presented by: robert s. keebler, cpa, mst, aep © 2010 robert s....

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