generating new business during tax season

Presented byRobert S. Keebler, CPA, MST, DEPVirchow, Krause & Company, LLP

Phone: (920) 739-3345Fax: (920) 733-6022

[email protected]

Generating New Business During Tax Season

Key Developments • Status of estate and gift tax legislation• New preparer penalties• Family Limited Partnership issues• Recent IRA Private Letter Rulings• Non-spousal post-mortem IRA rollovers• Charitable IRA contributions• Roth IRAs• Non-Qualified Deferred Compensation• Retirement plan planning for the small business

owner

2

Gift/Estate Tax Status

3

New Preparer Penalties

4

• Preparer penalties are now extended to the preparation of estate, gift, excise, exempt organizations and employment tax returns.

• Under prior law, a preparer penalty could only be imposed when the position did not have a "realistic probability of success" (i.e. one-third or greater chance of winning). However, under the new tax act, this standard now requires a "more-likely-than-not" chance of success (i.e. greater than fifty-percent chance of winning).– Notwithstanding the above, the new tax act states that the preparer

penalty will not be imposed if the position is disclosed on the return (using either IRS Form 8275 or IRS Form 8275-R) and there is a "reasonable basis" for the position taken (i.e. one-third or greater chance of winning).

• A new twenty-percent additional penalty is imposed on the excess of the amount of a claim for refund or credit over the amount allowable, except if the claim had a reasonable basis.

New Preparer PenaltiesKey Highlights

5

• The "first-tier" penalty (relating to an understatement of tax from taking a "unrealistic" position) is increased from $250 to the greater of: (a) $1,000 or (b) 50-percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty is imposed.

• The "second-tier" penalty (relating to an understatement of tax due to a willful attempt to understate tax or a reckless or intentional disregard of the rules or regulations) is increased from $1,000 to the greater of: (a) $5,000 or (b) 50-percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty is imposed.

New Preparer PenaltiesKey Highlights

6

New Preparer PenaltiesStandards Matrix

STANDARD % STANDARDIRC §6694

(PRIOR RULE)IRC §6694

(NEW RULE)

More Likely Than Not

> 50% No Disclosure Required

No Disclosure Required

Realistic Possibility

(Old Standard)

331/3-50% No Disclosure Required

Disclosure Required

ReasonableBasis

(New Standard)

20-331/3% Disclosure Required

Disclosure Required

FrivolousReturn

<20% Cannot Sign

Cannot Sign

7

Family Limited Partnership Issues

8

Adjustments available Typical discount ranges

Lack of Control

Lack of Marketability

15% - 20%

15% - 20%

Particular types of unit’s value are adjusted based on partnership agreement terms

FLP IssuesValuation - Adjustments

9

• Gifts– Values determined

based on actual asset transferred, not other assets owned by donor or donee

– Tax exclusive - value of gift is not reduced by amount needed to pay tax

• Estate– Values determined as

a lump sum - not as individual assets passing to multiple people

– Tax inclusive - value of estate is reduced by the amount needed to pay tax

FLP IssuesValuation – Gifts vs. Estate

10

• Gift tax returns need to be filed for year of gift• Valuation reports must be completed to

substantiate value of gifts• Subject to three-year statute of limitation, if

properly disclosed• Subject to adjustments indefinitely, if not

adequately disclosed

FLP IssuesGift Tax Reporting

11

• Description of the property transferred

• Identity of and relationship between donor and donee

• If to trust - trust’s EIN and description of terms of trust

• CUSIP number for transfers of securities

• Method to determine fair market value - or - appraisal by a qualified appraiser

FLP IssuesGift Tax Reporting – Adequate Disclosure

12

• Holds self out to the public as an appraiser or performs appraisals on a regular basis

• The appraiser qualifications, that are in an attached description, the appraiser is qualified to make appraisals of the property transferred

• The appraiser is not the donor, donee or a family member

FLP IssuesGift Tax Reporting – Qualified Appraiser

13

IRS Position

Gift-on-formation

Difference between the gross and discounted values of partnership units gifted is an additional gift from the transferor to the transferee

Valuation issues

• Valuation discounts greater than 30% are not valid

• Combined discount: 15 – 20% range (typical)

Retained life estate

Includes all of the partnership in the transferor’s taxable estate if:

• Transferor has too much control

• Disproportionate distributions are made to the grantor

FLP IssuesIRS Audit Issues

14

• Set up separate bank accounts and/or other financial accounts in the partnership’s name

• Ensure that there is not a commingling of business and personal assets in the partnership

• Establish a formal accounting system whereby all income, expenses, receipts and disbursements are timely recorded

• Ensure that all distributions made to partners are pro-rata with their ownership interests

FLP IssuesMitigating IRS Audit Risk

15

• Ensure that all loans to partners are evidenced by a formal loan agreement that is strictly adhered to

• Establish a protocol as to how business affairs should be handled and ensure that this protocol is adhered to

• Ensure that all income and expenses are of a business nature and do not have any kind of personal nature

• Establish a formal procedure for determining when and how income should be retained and/or disbursed

FLP IssuesMitigating IRS Audit Risk

16

Recent IRA Private Letter Rulings

17

• PLR 200742026 - Because decedent failed to designate an IRA beneficiary who was a living person at time of his death, his daughter/sole representative of his estate cannot be treated as Code Sec. 401(a)(9) “designated beneficiary” of his IRA. Therefore, the minimum required distributions for the stated year and all subsequent calendar years cannot be calculated based on the daughter's remaining life expectancy and instead must be calculated on the remaining life expectancy of the decedent.

• PLR 200707158 -Taxpayer/ IRA Beneficiary will not be subject to gift tax under Code Section 2501, upon entering into a settlement agreement which reformed the beneficiary designation or the IRA account so that his sibling was the sole beneficiary of account at the decedent's death.

Recent IRA PLRs

18

• PLR 200719017 - For purposes of determining how much of net settlement proceeds payable to married taxpayers should be treated as representing IRA losses incurred by taxpayers, the amount should be allocated between taxpayers' IRAs and non-IRA account in proportion to losses incurred in each account. If allocations which represent recoveries of IRA losses are contributed to stated IRAs, allocations will be considered restorative payments not subject to limitations on contributions.

• PLR 200720023 - Trustee-to-trustee transfers between IRAs (one of which was a SEPP IRA) constituted a modification to a series of substantially equal periodic payments. As a result, such modification resulted in the imposition of the 10% additional income tax.

Recent IRA PLRs

19

• PLR 200736036 - IRS declined to waive the 60-day rollover requirement where the taxpayer, despite a misunderstanding of how to create an IRA online, did not show that his failure to timely accomplish a rollover was attributable to any factors outlined in Rev. Proc. 2003-16.

Recent IRA PLRs

20

Non-Spousal Post-Mortem IRA Rollovers

21

• Non-spouse beneficiaries are permitted to roll over a qualified retirement plan (e.g. 401(k) plan), via trustee-to-trustee transfer, into an inherited IRA.

• “Designated beneficiary” trusts are also permitted to roll over qualified retirement plans into inherited IRAs.

• Effective for tax years beginning after December 31, 2006

CAUTION: The inherited IRA must be set up under the decedent qualified plan owner’s name (e.g. “John Smith, Deceased, IRA f/b/o Jane Smith, beneficiary)

Non-Spousal IRA RolloversPension Protection Act of 2006

22

EXAMPLE 1 – Inherited IRA Held by Beneficiary

On March 15, 2007, Betty Smith passes away, naming her son Dave as sole beneficiary of her 401(k). On August 3, 2007, Dave transfers his mother's 401(k) to an inherited IRA for his benefit via a trustee-to-trustee transfer. Under the new tax law, Dave is permitted to make this post-mortem transfer to an inherited IRA for his benefit, thereby allowing him to stretch the IRA withdrawals over his life expectancy.

Non-Spousal IRA RolloversPension Protection Act of 2006

23

Pension Protection Act of 2006

EXAMPLE 2 – Inherited IRA Held by Qualified Trust

Assume the same facts as Example 1, except that Betty named a trust, for the benefit of Dave, as beneficiary of her 401(k). In this case, the trustee would be permitted to make a post-mortem trustee-to-trustee transfer of the 401(k) into an inherited IRA for Dave's trust’s benefit.

Non-Spousal IRA Rollovers

24

Notice 2007-7• Non-Spouse rollovers only allowed if

plan allows for such rollovers.

• If under the five-year rule because of optional plan provision or beneficiary election, must perform rollover by December 31st of year following year of death to switch to life expectancy method under IRA.

Non-Spousal IRA Rollovers

25

Year of

Death

Applicable Payout under the Plan

Amount Allowed to be Rolled Over

Applicable Payout under the IRA

2002 and earlier

5-year rule None (Notice 2007-7, A-17(b)) NA – No Rollover Permitted

2003 - 2005

5-year rule Amount not already distributed from Plan as long as rollover completed before year containing fifth anniversary of death (Notice 2007-7, A-17(b))

5-year rule (Notice 2007-7, A-19)

All Life Expectancy All, minus prior and current year RMDs (Notice 2007-7, A-17(c)(1))

Life Expectancy (Notice 2007-7, A-19)

2006 and later

5-year rule under Treas. Reg. § 1.401(a)(9)-3, Q&A 4(b) or (c) (optional plan provision or election by beneficiary)

All, minus prior and current year RMDs (Notice 2007-7, A-17(c)(2))

Life Expectancy of Beneficiary if rollover occurs prior to the end of the year following the year of death (Notice 2007-7, A-17(c)(2)). Otherwise 5-year rule.

Non-Spousal IRA RolloversNotice 2007-7

26

• Example 1– John dies in 2002. George inherits John’s

qualified plan. Under the plan, the five-year applies. George cannot perform a rollover to an inherited IRA. 2002 = No Rollover

• Example 2– John dies in 2004. George inherits John’s

qualified plan. Under the plan, the five-year rule applies. George can perform a rollover to an inherited IRA, but must still use the 5-year rule. 2003-2005 = Rollover + Five Year Rule


27

• Example 3– John dies in 2004. George inherits John’s qualified

plan. Under the plan, George can utilize his life expectancy. George can perform a rollover to an inherited IRA and continue to utilize his life expectancy.

• Example 4– John dies in 2007. George inherits John’s qualified

plan. Under the plan, the 5-year applies. If George performs a rollover to an inherited IRA by December 31, 2008, he can utilize his life expectancy for RMDs from the IRA.


28

Charitable IRA Contributions

29

• Effective for distributions made after 12/31/2005 but before 1/1/2008, taxpayers may choose to exclude from gross income, on an annual basis, “qualified charitable distributions” from IRAs to the extent that the aggregate amount of such distributions does not exceed $100,000 in any given tax year.

CAUTION: This provision only applies to distributions from traditional IRAs (not SEPs or SIMPLE IRAs) and taxable distributions (i.e. non-qualified distributions) from Roth IRAs.

Charitable IRA ContributionsPension Protection Act of 2006

30

• A “qualified charitable distribution” is an otherwise taxable distribution from a traditional IRA or Roth IRA which is:– Made directly by the IRA trustee to an IRC §170(b)

(1)(A) charitable organization (other than a IRC §509(a)(3) private foundation or a IRC §4966(d)(2) donor advised fund)

AND– Made on or after the date in which the IRA owner

has attained 70½

Charitable IRA ContributionsPension Protection Act of 2006

31

Roth IRAs

32

• 100% of growth is tax-exempt• No required minimum distributions at age

70½– NOTE: Distributions from Roth IRAs cannot be

used to fulfill the RMD from a traditional IRA

• $100,000 Modified Adjusted Gross Income (MAGI) limitation

• RMDs on Inherited Roth IRAs• Roth 401(k) plans

Roth IRAs

33

• Starting in 2010, the $100,000 Adjusted Gross Income (AGI) limitation no longer applies– The taxable income recognized on a Roth IRA

conversion in 2010 may be spread over the following two tax years (i.e. 2011 and 2012)

• Married Filing Separately taxpayers can convert to a Roth IRA

Roth IRAs

34

• Critical decision factors– Tax rate differential

• Year of conversion vs. withdrawal years

– Use of “outside funds” (i.e. non-qualified retirement accounts) to pay the

income tax liability– Time horizon– IRC §691(c) “effect”

Roth IRAsMathematics of Roth IRA Conversions

35

Conversion Period Recharacterization Period

1/1/2007 – First day conversion can

take place

2007

12/31/2007 – Last day conversion can

take place

4/15/2008 – Normal filing date for 2007 tax return

/ last day to recharacterize 2007 Roth IRA

conversion

10/15/2008 – Latest filing date

for 2007 tax return / last day to

recharacterize 2007 Roth IRA

conversion

12/31/2008

2008

Roth IRAs

36

Roth IRA Conversion Timeline

Non-Qualified Deferred

Compensation

37

• Advantages – Company– Can be discriminatory– Generally non-regulated by ERISA, DOL and IRS– Customized and unlimited benefits– Can be forfeited

• Disadvantages – Company– No current income tax deduction for accrued liability and

expense of benefits

NQDCAdvantages & Disadvantages

38

• Advantages - Employee– Deferral of tax until benefits are received

• Disadvantages - Employee– Security of future benefits– Risk of forfeiture– Subject to Social Security and Medicare payroll taxes– No rollovers available

NQDCAdvantages & Disadvantages

39

• All plan deferrals are included in gross income as soon as they are no longer subject to a substantial risk of forfeiture

• Deferrals subject to 20% additional tax, plus interest equal to the IRS underpayment rate plus 1%

• Form defects may affect all plan participants• Operational defects affect only those that benefit

NQDCConsequences of Improper Deferral

40

• Restrictions on distributions• Timing of deferral elections

– Initial– Subsequent

• No acceleration of benefits• Rules related to funding

NQDCDeferral Requirements

41

• Employee’s separation from service• Death • Disability• Specified time or fixed schedule established at

deferral – Occurrence of an event is not considered specific

time (e.g., child enters college)

• Change in control• Unforeseeable emergency

NQDCPermitted Distributions

42

• Election must be made in preceding tax year– Election is prior to services being performed– Exception: 30 days after date of initial eligibility

• Performance-based compensation– Election must be made 6 months before service

period ends– Service period must be at least 12 months

• Distribution timing and form specified at deferral

NQDCTiming of Initial Election

43

• Offshore trusts– Assets in offshore rabbi trust are taxable immediately

− Exception for assets in foreign jurisdiction if substantially all services were performed in such jurisdiction

• Financial health triggers

NQDCFunding Restrictions

44

• Effective for amounts deferred in tax years after 2004• An amount is considered deferred before 2005 if:

– Service provider has legal binding right to payment and

– Amount is earned and vested before that date

• Grandfather rule• Effective if plan materially modified after 10/03/04• Effective date for earnings the same as the deferrals

NQDCIRC §409A Effective Dates

45

Retirement Plan Planning for the Small Business

Owner

46

401(k) maximum elective deferral - $15,500Maximum catch-up 401(k) deferral (taxpayers > age 49) - $5,000

Roth 401(k) maximum elective deferral - $15,500Maximum catch-up Roth 401(k) deferral (taxpayers > age 49) - $5,000

Compensation cap - $225,000Defined benefit maximum - $180,000Defined contribution maximum - $45,000

SEP compensation limit - $225,000

Maximum SIMPLE contribution - $10,500Maximum SIMPLE catch-up contribution - $2,500

“Highly compensated employee” earnings threshold - $100,000“Key employee” earnings threshold - $145,000

Retirement Plan Planning2007 Contribution Limits

47

Maximum traditional IRA contribution - $4,000

Maximum traditional IRA catch-up contribution (owner > 49) - $1,000

Deductible traditional IRA AGI phase-out amounts:

Single/Head of Household: $52,000 - $62,000

Married filing jointly*: $83,000 - $103,000

Married filing jointly**: $156,000 - $166,000

Married filing separately: $0 - $10,000

Maximum Roth IRA contribution - $4,000

Maximum Roth IRA catch-up contribution (owner > 49) - $1,000

Roth IRA AGI phase-out amounts:

Single/Head of Household: $99,000 - $114,000

Married filing jointly: $156,000 - $166,000

Married filing separately: $0 - $10,000

* Applies when both taxpayers are considered “active participants” in an eligible employer retirement plan** Applies when one spouse is not considered to be an “active participant” in an eligible employer

retirement plan

Retirement Plan Planning2007 Contribution Limits

48

SEP SIMPLE IRA

DESIGN-BASED SAFE HARBOR 401 (k) PLAN

Eligible Employers

No limit on number of employees.

100 or fewer employees with at least $5,000 of compensation for the prior calendar year.

No limit on the number of employees.

Plan Year Must be calendar year or fiscal year of employer. Can be established after end of employer’s fiscal year.

Must be calendar year. Any 12 month period.

Document Form 5305-SEP Form 5305-SIMPLE or Form 5304-SIMPLE, prototype or individually drafted.

Qualified plan document.

Retirement Plan PlanningComparison of Plan Types

49

SEP SIMPLE IRA


Other Qualified Plans?

Yes, if using prototype SEP document.

No-Must be the only plan-covering employees.

Yes

Related Employer Rules Apply?

Yes Yes Yes

Eligible Employees

May impose age 21 requirement, but must contribute for any employee who earned at least $500 in 3 of last 5 years. May exclude union employees

Any employee who received $5,000 of compensation in any prior 2 years and is expected to receive $5,000 in current plan year. No age limit permitted. May exclude union employees.

Qualified plan rules apply. Can require age 21 and one year of service. May exclude union employees.


50

SEP SIMPLE IRA


Coverage testing

Does not apply.

Does not apply. Applies.

Elective Contributions

N/A 2007 limited to $10,500 per calendar year, then indexed. 60-day election period required prior to beginning of plan year.

Limited $15,500 per calendar year; notice must be provided within “reasonable” period prior to beginning of plan year.

Catch up contributions for individuals age 50 and over.

N/A $2,500 in 2007 Indexed for inflation.

Over and above 402(g) limit the lesser of 1) $5,000 in 2007. Indexed for inflation. 2) participants compensation for the year reduced by other elective deferrals for the year. (Not subject to ADP/ACP)


51

SEP SIMPLE IRA


Matching Contributions

N/A Dollar for dollar match, up to 3% of compensation. May be reduced down to 1% cap in 2 of 5 years.

Dollar for dollar match, up to 3% of compensation plus $0.50 on the dollar from 3 – 5% of compensation. (May not impose a last-day rule or 1,000 hours of service rule for active or terminated participants.) 100% immediate vesting.

Non-elective contribution

Lesser of 25% compensation or $45,000 gross.

In lieu of match, 2% of compensation for all participants with at least $5,000 of compensation.

In lieu of match, 3% of compensation for all participants. (May not impose a last-day rule or 1,000 hours of service rule for active or terminated participants.) 100% immediate vesting.


52

SEP SIMPLE IRA


Subject to ADP/ACP testing

N/A NO No, if matching or non-elective safe harbor contributions are made.

Other Employer Contributions Permitted?

N/A No-only deferrals and required match or non-elective contribution may be made.

Yes, contributions such as profit sharing may be made and may be subject to 1,000 hour/last day requirements and a vesting schedule.

Vesting Allowed?

NO NO Yes, except for safe harbor contributions.


53

SEP SIMPLE IRA


Top Heavy Rules

YES NO Yes, but both 3% non-elective & match contribution made to satisfy safe harbor may be used to satisfy the top-heavy minimum contribution.

Loans No No Yes

Rollovers May be rolled to qualified plan, §403(b) plan or a governmental §457 plan.

Accepts SIMPLE IRA rollovers only. May be rolled to a qualified plan, §403(b) plan or a governmental §457 plan.

Qualified plan rules apply.


54

SEP SIMPLE IRA


Withdrawals Permitted anytime, subject to 10% penalty if under age 59 ½.

Permitted anytime, but 10% penalty increased to 25% if employee is under age 59 ½ and withdrawal is in first 2 years of plan.

Terms of plan control. Section 401(k) deferral restrictions apply.

Minimum Distributions

Must start by April 1 of the year following calendar year in which age 70 ½ is attained.

Same as SEP. Must start by April of year following later of 1)calendar year age 70 ½ is attained or 2) calendar year retires, if employee is not a 5 % owner, the rule is same as for SEP and SIMPLE IRA

Form 5500 NO NO YES


55

SEP SIMPLE IRA


Trust Accounting

NO NO YES

Transmittal of Elective Contributions

N/A Earlier of: 1) 30 days after close of month or 2) earliest date employer is able to segregate from its assets.

Earlier of: 1) 15th business day of the following month or 2) earliest able to segregate.


56

Conclusion

57

generating new business during tax season

Documents

tax return preparer

preparer penalty

understatement of tax

gift tax returns

new tax act states

giftestate tax status

employment tax returns

tier penalty