DDK & Company is dedicated to being more than a CPA firm that focuses solely on minimizing taxes, avoiding penalties, and preparing financial statements. We are committed to helping you build and manage your business, as well as take care of your personal financial concerns. We balance our hand holding approach with our promise that you will receive honest, quality and useful advice, which will lead to results worthy of your time and money.
By William Prue, Director of Accounting and Auditing
What's a physician practice worth? In reality, whatever someone is willing to pay for it.
There's no strict rule of thumb for pricing, because so many factors have influence, not the least of which is the nature of services performed since certain specialties are more unique than others and nature of client base. (Private pay versus managed care). But the nexus of pricing generally falls into a couple of broad categories:
There are two types of earnings, based on the size of the practice. Practices earning less than $1 million usually use a metric based on Seller's Discretionary Earnings, or SDE. You take net profit and add your salary back to it to show the prospective purchaser the profit of the business. Your sale price is typically one to three times SDE.
Larger practices, including both specialists and primary care physicians, typically base valuations on earnings before interest, taxes, depreciation and amortization, or EBITDA. In those cases, selling price could be as high as three - to five-times EBITDA.
Past performance is only part of the equation. Make sure you're factoring in the future. What do you think is going to happen in the future? If you can say that you have a great product or service with increasing demand and solid client base (aging population), then you can conclude that there's little risk and potentially unlimited growth. While on the other hand, if you have customers that have limited means to pay and your reimbursements are shrinking, you're high risk.
Deal Structure & Buyers
You can also structure deals to influence price. Different types of buyers influence the price obtained. As a seller you don't have to sell out at 100%. You can agree to stay on and consult and also sign a non-compete agreement. Your willingness to do this as a seller can be worth something to the buyer and add extra dollars to your value.
A synergistic buy usually reaps the highest price. it can be said that good marriages are ones in which you get the right buyer and seller together. These transactions are made in heaven and can reap rewards for both the buyer and seller.
The New York State 2009-10 budget package includes a number of provisions that were recently enacted by the legislature. These provisions will affect personal and business income, as well as sales tax for New York State taxpayers. A summary of the most relevant tax changes is as follows:
Business Tax Provisions
New Partnership Filing Fee
The annual filing fee previously imposed on limited liability companies and limited liability partnerships will now apply to both general and limited partnerships. Partnerships with New York source gross income under $1 million are exempt from the fee. The new fee is based on gross income from New York sources, and ranges from $500 to $4,500 depending on gross income.
Mandatory First Installment of Estimated Tax
Effective January 1, 2010, the mandatory first installment of estimated tax will increase from 30% to 40% of the prior year's tax. This will apply to businesses with tax of $100,000 or more in the previous year.
Changes to the Empire Zone Program
Under the new law, businesses participating in the Empire Zone (EZ) Program will become decertified if it is determined that:
They have received greater tax benefits than was invested in employment and facilities within the Empire Zone (the one-to-one test), or
Its employment and investment gains are merely transfers from other related New York entities (applicable to businesses certified before August 1, 2002), or
It moved out of the Empire Zone or changed ownership
Empire State Development will review all certified businesses to confirm that they pass the one-to-one test. New applicants for certification must now provide projections showing that they meet a new twenty-to-one test over their first three years of certification – i.e., they expect to make capital investments of at least twenty times the benefits they will receive (ten times for manufacturers). Other changes limit EZ real estate tax and sales tax benefits for certain businesses.
New MCTD Payroll Tax
In March 2009, the new Metropolitan Commuter Transportation Mobility Tax became effective for both employers and self-employed individuals working in the 12-county downstate Metropolitan Commuter Transportation District (MCTD). Employers paying a minimum of $2,500 of wages in any quarter and self-employed individuals with income in excess of $10,000 are subject to this tax. The tax rate is 0.34%. Self-employed individuals include partners and limited liability company members that receive self-employment income from their entities under federal rules. The tax is imposed on the full wages of employees who work predominantly in the MCTD, and cannot be withheld from wages. Self-employed taxpayers who work both within and outside of the MCTD will pay the tax on the portion of their income allocated to the MCTD. The first estimated payments for both employers and individuals are due on November 2, 2009.
Personal Tax Provisions
Increased Personal Income Tax Rates
For tax years beginning after 2008 and before 2012, the top personal income tax rate is increased from 6.85% to 8.97%. This applies to filers with taxable income in excess of $500,000. A 7.85% bracket is added for filers with taxable incomes less than $500,000 but above:
$300,000 – for joint filers
$250,000 – for heads of household
$200,000 – for single filers
The benefits of the lower brackets continue to be phased out. Taxpayers who are subject to the phaseout will pay a flat 8.97% on all their taxable income.
Additional Reduction in Itemized Deduction of High Income Filers
For tax years beginning after 2008, the legislation limits the use of itemized deductions by individuals having NYS adjusted gross income over $1 million. The amount of itemized deductions that can be claimed is limited to 50% of their charitable contributions. All other deductions are lost.
Taxpayers can avoid 2009 estimated tax penalties by recalculating their 2008 tax using the new tax rates and reduction in itemized deductions. This is known as a "protect" estimate.
Expanded Definition of Resident Individuals
For tax years beginning on or after January 1, 2009, an individual is defined as a NYS resident for certain taxpayers who are present in a foreign country and his/her spouse or minor children are present anywhere in NYS for more than 90 days, not just at the taxpayer’s permanent place of abode.
Sale of Entity Interest & Expanded Definition of Real Property
Gains from sale of an interest in certain partnerships and other entities are included in a nonresidents’ NYS source income. It is included to the extent attributable to the entity’s ownership of NYS real property. According to the new law, “real property located in the state” includes an interest in a partnership, LLC, S-Corporation, or C-Corporation with 100 or fewer shareholders that owns real property located in NYS. Additionally, the fair market value of that real property must be more than 50% of all of the entity’s assets on the date of the sale of the interest. Only those assets that the entity owned for at least 2 years before the date of the sale or exchange are used in determining the fair market value of all of the entity’s assets on that date.
Middle Class STAR
The Middle Class STAR rebate program is repealed.
Sales and Use Tax Provisions
Expanded Definition of Vendor
The new law expands the definition of “vendor” to include an entity affiliated with a vendor and either: (1) uses the trademarks, service marks, or trade names in NY that are the same as those used by the seller; or (2) engages in activities that are advantageous to the benefit of the seller, then he is a vendor.
A new sales tax is imposed on personal transportation services provided by a limousine, “black car” or similar vehicle with a driver. Medallion taxi cabs, buses, scheduled public transport services, and transportation in connection with funerals are excluded. Special rules apply when the vehicle is leased from its owner by an unrelated party (generally the driver), providing that the owner (not the driver) is considered to have provided the transportation services at a fee deemed to be two times the amount he was paid to lease the vehicle. If a trip crosses from one sales tax jurisdiction to another, the applicable sales tax rate is the one in effect where the trip begins.
Commercial Aircraft Exemption
Commercial aircraft are no longer exempt from sales tax if they are primarily used to transport persons related to entities that are affiliated with more than a 5% common ownership with the aircraft company.
New Compliance Provisions
The New York State Tax Commissioner can now compel taxpayers to make electronic records available (if they exist), whether or not they were required to keep those records electronically. Even if taxpayers make hard copy records available to the state, a penalty of up to $5,000 can be imposed if the taxpayer maintains electronic records and does not allow the state access to them. Failing to maintain required sales tax records can also subject taxpayers are subject to new penalties of up to $5,000. A penalty of $1,000 per quarterly return period will be levied on persons required to make or maintain sales tax records but fail to present such records.
Other provisions include:
Interest rates applicable to underpayments of tax have been increased by 1.5%, with most changing from 6% to 7.5%.
The deadline for filing the annual quarterly combined withholding, wage reporting and unemployment insurance return has been moved from February 28th to January 31st.
The Commissioner can now share with the IRS any information received as a result of the Voluntary Disclosure and Compliance Program.
Regarding sales tax refunds and credits, the State is permitted to avoid payment of any interest, if the payment of the refund is made within 3 months after the return on which the refund claim was filed.
Any person aiding or assisting in the giving of fraudulent sales tax returns or other documents with the intent to evade tax will now be subject to a civil penalty not to exceed $5,000.
By William Prue, Director of Accounting and Auditing
Private companies have received a temporary reprieve on an accounting rule that changes the way they will be required to account for income taxes on financial statements. The Financial Accounting Standards Board (FASB) voted to defer the effective date of FASB FIN No. 48, Accounting for Uncertainty in Income Taxes, for all private companies to periods beginning after Dec. 15, 2008. This means calendar year companies will be required to adopt FIN 48 on their 2009 financial statements, rather than 2008.
FIN 48 has already gone into effect for public companies for fiscal years beginning after Dec. 15, 2007. The standard establishes a "more likely than not" threshold for the reporting of uncertain tax positions on financial statements, but has already run into high costs and difficulties at public companies.
FIN 48 Background:
The requirements of computing and reporting uncertain income tax positions under the guidelines of FIN 48 add to the already complex standards of FAS 109 “Accounting for Income Taxes”. The purpose of FAS 109 is to recognize (a) the amount of taxes payable or refundable for the current year and (b) the deferred tax liabilities and assets of future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. FIN 48 takes the principles of FAS 109 further by requiring additional computations, documentation, and disclosures of a company’s individual tax exposures in the financial statements. FIN 48 is intended to reduce inconsistencies and increase the relevance and comparability in the application of the accounting rules related to income tax contingencies.
FIN 48 applies to all entities that prepare financial statements in accordance with GAAP with the potential to be subject to income tax. This includes both pass-through and not-for-profit entities that may be subject to state and local taxation or not-for profits subject to unrelated business income as well as the possibility of having done something to jeopardize their tax-exempt status.
The delay is viewed as a positive relief for most private companies because it affords more time to prepare. The adoption of FIN 48 by a private company will allow for a fresh look at its tax exposures and to evaluate tax planning implemented in the past so that a company can execute the appropriate steps to minimize risk in the future.
Private companies can benefit from the experiences of public companies that were required to implement FIN 48. The process can be cumbersome and some public companies are still struggling with the implementation. It is important to start the process early. FIN 48 allows for any initial adjustments to be reflected in the opening balance sheet without an adjustment to the income statement. However, for all subsequent years beyond the initial year of adoption, adjustments as a result of the FIN 48 analysis must be reflected in the income statement. Per-forming a thorough analysis in the initial year may minimize unwanted outcomes affecting earnings in future years.
The implementation of FIN 48 for private companies has only been delayed and will not go away. Under the guidelines of FIN 48, companies are required to inventory all previous and current tax positions that are still subject to audit within the statute of limitations. The next step is to evaluate each position on the uncertainty and whether each position individually satisfies a more-likely than not threshold (greater than 50%) of sustainability at the full amount during an examination. After the level of uncertainty is determined, a rather complex subjective computation is required to determine the materiality of the uncertainty, financial statement impact, and potential disclosure within the financial statements presented under GAAP.
The ideal next step for a private company is to coordinate a plan of action with their tax advisors to implement FIN 48. Planning early may enable changes to be made in the filing of 2008 tax returns thereby minimizing the amount of uncertainty of income tax positions required to be disclosed. The best way for a private company to take advantage of the delay is to be proactive and start the FIN 48 process early.
Examples of uncertain tax positions are:
Decision to not file a tax return (it is important to note that the statute never closes on a return not filed).
Credits (such as foreign tax credit or research & development credit)
State and local nexus issues
International issues (such as transfer pricing)
Revenue recognition policies
Timing of deductions
Complications inherent in mergers & acquisitions or restructuring
Poor documentation to support positions
The initial disclosures under FIN 48 for most private companies will be reported in the 2009 financial statements. However, in most cases, we recommend that the planning of FIN 48 engagements should be done much earlier. The timing and fees of a FIN 48 engagement will greatly depend on the history of the company, the complexity of the issues, and the documentation already in place.
There are concerns regarding the amount of disclosure in the financial statements and the use of the disclosures by the IRS to provide a roadmap for examinations. Currently, the IRS is taking the position of not requesting the workpapers that support the FIN 48 analysis during an examination. However, the IRS’s position is subject to change in the future.
Employer & Employee Tax Refund claims resulting from Windsor descision
During June 2013, the Supreme Court held, inU.S. v. Windsor, that a federal law that defined marriage as a union between one man and one woman was unconstitutional.
The Court's decision allowed the federal marital deduction for estate tax purposes for bequests to a decedent's same sex spouse. The decision also impacted certain employee benefits that previously had been taxable when provided to same sex spouses. For example, pursuant to an employer's flexible spending or cafeteria plan, an employee's federal taxable wages can now be reduced by payments for health insurance premiums with respect to his or her same sex spouse. Before, the employee would be required to pay these premiums with after-tax dollars.
The Court's decision was retroactive. As a result, employers and employees have been overpaying FICA employment and federal withholding taxes with respect to spousal health insurance for the benefit of same sex spouses. The IRS recently issuedNotice 2013-61that explains how employers and employees may make claims for refunds for overpayment of FICA taxes and Federal income tax withholding.
Claims may be made for taxes paid on returns filed within the past three years. Normally, employers are required to file Form 941-X for each calendar quarter for which a claim is made. However, the Notice provides for a special procedure that allows employers to claim the adjustments for all four quarters of a calendar year on one Form 941-X filed with respect to the fourth quarter of that year, provided that employees are reimbursed or repaid for the over withheld taxes. The Notice also provides detailed rules for reflecting the changes in the third and fourth quarter 2013 filings.
Please consult with your DDK advisor if you would like more information regarding this refund opportunity.
On June 28, 2013, a New York Appellate Court reversed the ruling of the Supreme Court of New York State (Nassau County Court) in Mangano V. Silver. The lower court ruled that the Metropolitan Commuter Transportation Mobility Tax (MCTMT) was unconstitutional. The appellate court concluded that the MCTMT is in fact constitutional.
New York enacted the MCTMT on May 6, 2009. The tax as it was initially enacted applied to all payroll paid to employees for work performed within the 12 counties serviced by the MTA. The tax was levied at a rate of .34% for employers with taxable payroll in excess of $2,500 per quarter or self-employed individuals with the self-employment income in excess of $10,000 per year.
Effective April 1, 2012, legislation was passed which raised the thresholds to $312,500 in payroll for any calendar quarter and $50,000 of self-employed income per year. This legislation also created graduated MCTMT tax rates for taxable payroll under under $437,500, thus providing additional relief to smaller businesses.
The Supreme Court of New York State (Nassau County Court), on August 22, 2012, held that the tax as enacted is unconstitutional on a number of technical grounds. The court found that the tax is a special law that does not serve as a substantial state interest. Therefore, under the New York State Constitution, the law should have been passed either with a home rule message or by message of necessity with two thirds vote in each house. Because these procedural requirements were not met, the lower court held that the tax is unconstitutional.
Appellate Court's Conclusion:
The appellate court concluded that the MCTMT law, which provides a funding source for the preservation, operation, and improvement of essential transit and transportation services in the Metropolitan Commuter Transportation District, does serve a substantial state concern. Therefore, the passage of the MCTMT did not necessitate a home rule message. Accordingly, the Appellate Court reversed the lower court and held that the MCTMT in infact constitutional.
This discussion is for your general knowledge and is not meant for specific tax advice. Therefore, please consult with your DDK advisor in order to obtain advice that is specifically tailored to you.
Important FBAR Reminder: Annual deadline is June 30, 2013
Taxpayers with either a financial interest or signature authority over foreign bank or financial accounts that, in total, are valued at U.S. $10,000 at any time during calendar year 2012 have to file Report of Foreign Bank and Financial Accounts (Form TD F 90-22.1, commonly known as the "FBAR"). This Report must be received by the Department of the Treasury by June 30, 2013. If the FBAR is not received timely, then the penalties could be onerous. read more...
The New York State 2013-2014 budget was passed on March 28, 2013. Following is a summary of the major tax provisions.
Business Franchise and Income Tax Provisions
Metropolitan Business Tax (MTA) Surcharge
The 17 percent MTA Surcharge was extended for an additional five (5) years for taxable years ending before December 31, 2018. The MTA Surcharge applies to NYS corporate franchise, bank franchise, insurance franchise, and Article 9 corporation taxes. read more...
NYS Court of Appeal Upholds "Amazon" click-through Nexus Law
In 2008, New York State enacted legislation requiring Amazon.com and other Internet retailers with gross receipts in New York in excess of $10,000 to collect New York sales tax on purchases by New York residents. The 2008 legislation applies to Internet retailers whose only connection to New York was through New York-based "affiliates" which enable New York residents to reach the Amazon.com website by clicking on a link posted on the websites of the "affiliates." Amazon and Overstock.com, a smaller competitor, both challenged this law in court. read more...
As previously reported, a New York Supreme Court judge in Nassau County recently held that the Metropolitan Commuter Transportation Mobility Tax ("MTA payroll tax") was unconstitutional, based in part on the limited applicability read more...
A New York Supreme Court judge in Nassau county recently held that the Metropolitan Commuter Transportation Mobility Tax ("MTA payroll tax") was unconstitutional, based in part on the the limited applicability of the MTA read more...
After much negotiation, Congress has extended the two-percent payroll tax cut for employees through the end of 2012. The Temporary Tax Cut Continuation Act through the end of February. However, the Middle Class Tax Relief and Job Creation Act of 2012 (2012 Job Act) now extends read more...
The IRS Finalizes Form 8938, Statement of Specified Foreign Financial Assets
As part of its ongoing efforts to identify the foreign assets of U.S. citizens and other persons with federal tax reporting obligations ["subject taxpayers"], and to tax the income of those assets, the IRS created Form 8938, Statement of Financial Assets. Form 8938 must be filed read more...
The state of Texas recently announced a limited amnesty program aimed at collecting delinquent taxes and fees. The program will run from June 12, 2012 to August 17, 2012, during which time taxpayers read more....
For our clients and friends affected by Hurricane Sandy, we hope for a speedy and complete recovery. To aid with this recovery, the Internal Revenue Service has granted relief. In adddtion, the federal tax law als provides
New York City, including the Department of Small Business Services (SBS) an the New York City Economic Development Corporation (NYCEDC), and the U.S. Small Business Administration (SBA), are providing a set of services to assist NYC small businesses in recovering from Hurricane Sandy. A summary of available programs and relevant contact information is outlined below.
If you are interested in taking an equity position in a small business, do so before Dec. 31. The shares will not be subject to federal capital gains tax when you sell them (after owning for five years). If you dally and purchase next year, the maximum tax rate is slated to be 14 percent when you sell (after the mandatory five years). This provision applies only to stock of qualified small business corporations. Certain sectors – including, but not limited to, financing, oil and gas extraction and hospitality ventures (hotels, motels and restaurants) – do not qualify for this type of tax break. Be sure to get expert tax and investment advice before you buy small business stocks.
You can claim 100 percent first-year bonus depreciation on new assets that are put to use in your business before Dec. 31. There are no dollar limits on this tax break and businesses small and large are eligible. If your depreciations lead to an overall tax loss for 2011, it may be carried back to 2010 and 2009 and could generate refunds for taxes you paid during this time period. Again the key phrases here are new and purchased and put to use before Dec. 31, 2011. Assets must be considered qualified property; most equipment, software and some lease hold improvements fit in this category.
If you buy a new van or SUV for business purposes (with a gross vehicle-weight rating of more than 6,000 pounds), you can deduct the entire business-usage percentage of the vehicle’s cost on your 2011 tax return, up to a maximum deduction of $25,000. The business usage of the vehicle must be more than 50 percent, and this percentage is based on overall mileage. In 2012, the depreciation break is expected to be cut to 50 percent.
New light trucks and passenger cars are eligible for a maximum deduction of $11,260 and $11,060, respectively. To qualify, the vehicle must be new and be used 100 percent for business purposes.
Also due to expire at the year-end are provisions that permit you to claim deductions of as much as $250,000 for qualified real estate improvements. In most instances, the improvements must have been put to use more than three years after the business opened for business. The deductions cover only nonresidential building interior costs for qualified leasehold property. Elevator construction and some other interior structural costs do not qualify. Restaurant property deductions include both building and improvement costs. To be eligible, more than 50 percent of the building’s square footage must be devoted to preparing meals and to customer seating. Qualifying retail building improvements cover nonresidential buildings that are open for customers to visit and whose products involve sales of tangible, personal property.
The above are concise summaries. Your tax professional can provide more information on these and other tax exemptions that are due to disappear by year’s end.
Under a provision of the Tax Increase and Reconciliation Act of 2005 that becomes effective in 2010, anyone (regardless of income) may now convert traditional IRA accounts into Roth IRA accounts. Previously, conversions were only permitted for taxpayers whose income (not including the Roth conversion itself, which adds to income) was not more than $100,000. The new law also includes a one-time special rule that allows taxpayers to delay for up to two years the tax due on Roth conversions that occur in 2010.
Many middle- and higher-income taxpayers who were unable to take advantage of traditional-to-Roth IRA conversions in the past now have a new choice. The elimination of the income threshold to Roth conversions presents a variety of opportunities and risks.
In order to understand this change in the tax law, it is necessary to understand what a Roth IRA is, how it differs from a traditional IRA, and advantages and disadvantages of each type of account. Unlike a traditional IRA, contributions to a Roth IRA cannot be deducted from taxable income. However, the Roth IRA has many positive features not found in traditional IRAs. Foremost among these is that the income earned in the Roth IRA is never taxed. In a traditional IRA, taxation is merely deferred – tax must be paid on all distributions eventually taken. (Even if you die before the account is fully distributed, your heirs will owe income tax when they receive it). By contrast, once you have owned any Roth IRA account for at least five years and are at least 59½ years old you (and your heirs) will never pay tax on distributions from your Roth IRAs, no matter how large they have grown.
The second major benefit is the ability to leave the money in the Roth IRA, earning tax-free income, after you retire. When a taxpayer turns age 70½, he must begin taking required minimum distributions (RMDs) from a traditional IRA based on his life expectancy. There are no RMDs from a Roth IRA, so if the money is not needed for living expenses, the entire balance may continue to compound tax-free in the Roth.
Another difference from traditional IRAs is the ability to continue contributions even past age 70½. This may be a consideration as depleted retirement portfolios cause some individuals to defer retirement. For younger people, Roth IRAs allow withdrawal of original contributions (but not earnings), even before age 59½, with no tax consequences. Since the funds in the Roth IRA will continue to compound tax-free as long they remain there, removing them in this manner should be considered last, and only after all other sources of funds are considered. But if it must be done, at least it will not result in a tax bill when you can likely least afford it.
Whether a Roth or traditional IRA is the better choice depends on many factors. The younger you are, the longer the income of a Roth IRA will compound tax-free, which can dramatically increase the benefits. An older taxpayer may not receive sufficient years of tax-free income to offset the loss of the tax deduction that a traditional IRA can provide. Your expectation of future changes in tax rates may also affect the decision. By forgoing the tax deduction, you effectively choose to pay tax at the current rate. If tax rates increase in the future, you may be locking in a beneficial rate. Conversely, if you will be in a lower tax bracket after you retire than you are now, a traditional IRA may make more sense. A low-income year can also make a Roth IRA advantageous. For example, if you have a net operating loss, or if your deductions and exemptions exceed your income in a particular year, the deduction provided by a traditional IRA may not save any tax. Contributing instead to a Roth IRA can provide the valuable Roth tax benefits at little or no cost.
For 2009 and 2010, individuals under 50 may contribute up to $5,000 of their compensation each year to an IRA (older taxpayers may contribute $6,000). This contribution can be made to either a traditional or a Roth IRA, or split between both types (as long as the total does not exceed the maximum). Contributions may be made during the year and up until April 15th of the following year (so 2009 contributions can still be made until April 15, 2010). Certain income limits prevent higher-earning taxpayers from contributing to Roth IRAs. The allowable Roth contribution limit is reduced for joint filers with modified adjusted gross income from $167,000 to $177,000 and single taxpayers from $105,000 to $120,000. Taxpayers with higher incomes cannot make annual Roth IRA contributions.
Besides annual contributions, another way to fund a Roth IRA is to convert all or any portion of your existing traditional IRA accounts to Roth IRAs. Your IRA custodian can do this quite easily, but it has tax consequences. The amount converted is includible in taxable income in the calendar year the conversion takes place. For example, a taxpayer who lives in New York City may pay a combined tax rate (federal, state, and city) of 45%. Converting a $100,000 traditional IRA to Roth will cost a tax outlay of $45,000. But after the conversion, neither the original $100,000 nor the future earnings on it will ever be taxed. If the taxpayer is 40 when he converts the account, and it returns an average 5%, he will have over $335,000 at age 65 – all of it completely tax-free. If the funds had remained in a traditional IRA, he would have to pay more than $150,000 of tax (assuming rates remain the same) on a distribution of those funds.
The tax on the conversion is usually paid from funds outside the IRA, and this creates two additional tax advantages. First, it in effect allows the taxpayer to make an extra contribution to his retirement. The taxpayer in the example above will have a $100,000 IRA balance whether or not he converts – but in a traditional IRA, the account is really only worth $55,000 to him since he must pay $45,000 of tax to access it. The Roth IRA is worth the full $100,000, since there is no tax – so by converting he has essentially contributed an extra $45,000 to his IRA. Second, by paying the $45,000 tax to the government it is removed from the taxpayer’s estate for estate tax purposes. If the $100,000 account remained a traditional IRA, the taxpayer would have $145,000 in his taxable estate – the IRA and the $45,000 outside the IRA that he could have used to pay the tax on the conversion. By converting to Roth, the taxpayer owns essentially the same after-tax asset, but his taxable estate contains only the $100,000 Roth IRA. Thus, $45,000 has been removed from his estate, potentially saving $20,000 or more of estate tax.
Up until the end of 2009, a conversion was not permitted if the taxpayer’s modified adjusted gross income (generally his income before the Roth conversion itself is considered) exceeded $100,000 (this applied to both single and joint filers). Thus, many middle- and upper-income taxpayers could not take advantage of a conversion. Starting in 2010, this restriction is permanently removed. On or after January 1, 2010, all taxpayers may convert any amount of traditional IRA accounts to Roth, as long as they are willing to pay the tax on the conversion. As a result of this change, higher-income taxpayers may also bypass the income limit for annual contributions to Roth IRAs (discussed earlier) by contributing to a traditional IRA and immediately converting it into a Roth IRA. This achieves the same result as an annual contribution, but may be done at any income level.
The law change also provides that for 2010 conversions only, the resulting income is taxable half in 2011 and half in 2012, not all in 2010 as under the normal conversion rules. A taxpayer may, however, choose to pay tax on the conversion in 2010. This may be desirable if he has excess deductions in 2010, or if he expects to be in a much higher tax bracket (or expects Congress to increase tax rates significantly) in 2011 and/or 2012.
Traditional IRA contributions are not always deductible. Taxpayers who participate (or whose spouses participate) in employer-sponsored pension plans cannot deduct IRA contributions if their income exceeds certain limits. Such taxpayers may still contribute to traditional IRAs; however, they will not get a tax deduction for this contribution. Such after-tax contributions create "basis" in the IRA – since no deduction was taken at the time of contribution, no tax is due when the amounts are later distributed. Taxpayers that have made non-deductible contributions to a traditional IRA keep track of their basis on Form 8606 in their annual income tax returns.
Unlike a Roth IRA, earnings in a nondeductible traditional IRA are taxable upon distribution. A taxpayer with a non-deductible IRA may also own a separate IRA funded with deductible contributions, fully taxable when distributed. When taking traditional IRA distributions, a taxpayer cannot choose to withdraw her non-taxable basis first – any distribution is considered to come proportionately from taxable and non-taxable funds in all traditional IRA accounts. Only the original non-deductible contributions are tax-free. For example, assume a taxpayer owns two traditional IRA accounts. One is $60,000 IRA that was funded with only pre-tax (deductible) contributions. The other is a $40,000 nondeductible IRA which contains $30,000 of after-tax contributions (basis) and $10,000 of earnings. Her total IRA balance is $100,000, in which she has basis of $30,000. Thirty percent of any distribution from either (or any combination of) these IRAs is nontaxable and 70% is taxable. It does not matter which IRA provides the funds.
When a taxpayer owns a nondeductible traditional IRA, the same pro-rata rules that apply to distributions also apply to conversions. If the taxpayer in the above example were to convert any part of either traditional IRA to a Roth IRA, 70% of the conversion would be taxable and 30% would be nontaxable.
There is a method that can be used in certain circumstances to convert (or distribute) only the non-taxable portion. Since 2002, qualified pension plans may accept rollover contributions from IRA accounts, if the plan’s terms permit it. If a taxpayer belongs to a qualified pension plan, and that plan accepts IRA rollovers, a special rule treats the rollover as coming first from taxable funds (in fact it is impermissible to roll nontaxable amounts into a qualified plan). Thus you can "siphon off" some or all of the taxable portion to a qualified plan and then convert (or distribute) only the remaining portion, which will be nontaxable either in full or to a larger degree.
If the taxpayer in the above example belonged to such a plan, and rolled over the $60,000 taxable IRA to her plan, she could then convert the $40,000 IRA and pay tax on only $10,000. If she also rolled $10,000 of the $40,000 IRA into her plan, the remaining $30,000 would consist of entirely non-taxable funds (basis) and could be converted to Roth (or distributed) with no tax consequences.
Many tax and financial considerations come into play when determining whether to convert your traditional IRA to a Roth IRA. If you have any questions about these conversions and the new 2010 planning opportunity, please contact our office.
By William Prue, Director of Accounting and Auditing
In 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 - Accounting for Uncertainty in Income Taxes. FIN 48 requires U.S. companies to recognize and measure tax positions they have taken or expect to take. FIN 48’s effective date for privately-owned entities was deferred but the standard now covers all entities – public, privately-owned, and not-for-profit, including pass-through entities - for years beginning after December 15, 2008 (generally, calendar 2009). Its impact is significant and requires additional tracking and documentation from every entity and location.
What is a tax position?
A tax position is a position in a previously filed tax return or a position to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities in an entity’s financial statements. This analysis requires a review of an entity's tax positions taken on all of its income tax returns. If a position is uncertain, a related liability (if material) is recorded for the potential tax, plus penalties and interest. The term "tax position" also encompasses, but is not limited to:
A decision not to file a tax return
Allocation of income between jurisdictions
A decision to classify a transaction, entity, or other position in a tax return as tax exempt
An entity’s status, including its status as a pass-through entity (S-Corp, LLC, etc.) or a tax exempt not-for-profit entity
What is an uncertain tax position?
All companies seek to legitimately reduce their overall tax burden and minimize or delay cash outflows for taxes. Positions taken in tax returns may be well-grounded and in good faith, but with the complexities and varying interpretations of the tax law, these positions may not ultimately prevail. Complexity creates uncertainty regarding the actual benefit a company will receive from a position taken on its tax return. Newly issued standards establish uniform accounting for uncertain tax positions. Common examples of uncertain tax positions include characterizing gains or losses as capital gains or losses, claiming a tax credit, allocating income between jurisdictions (or not filing a return when a company believes it does not have nexus in a state or country), excluding income the company believes is tax-exempt, and taking a tax deduction.
Entities that prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) must review all of their federal and state tax positions — including decisions not to file in a particular state — and to determine whether the positions would "more likely than not" withstand a challenge by the IRS or a state tax authority. More likely than not means that there is a more than 50% possibility that the position would be sustained upon examination by taxing authorities.
If a position fails the more-likely-than-not test, the corresponding tax benefit isn’t recognized in the company’s financial statements. Entities must establish reserves for the portion of the tax benefit that isn’t recognized (or if applicable, record a liability) and make financial statement disclosures about uncertain tax positions.
Private companies would be required to disclose the following:
The total amount of interest and penalties recognized in the financial statements.
The nature of uncertainties that could significantly change within 12 months.
A description of tax years that remain subject to examination by major jurisdictions.
IRS Proposes FIN 48 Disclosure in Tax Returns
On January 26, 2010, the IRS issued Announcement 2010-9, Uncertain Tax Positions. In a speech on that day, Commissioner Douglas Schulman said this proposal would apply to businesses with assets over $10 million that prepare financial statements under FIN 48. These companies will have to file a new schedule, currently under development, with their tax returns. The form will require a brief description of all uncertain tax positions taken by the taxpayer, along with the maximum dollar amount of tax exposure for the issue. It will not require the taxpayer to reveal its risk assessment or tax reserve amount (which the IRS can still seek by summons). No effective date for the new filing requirement has been determined, but Mr. Schulman told reporters it will not be in effect for the current tax season. He also mentioned penalties if, upon audit, it is found that a company did not file the required information.
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