Friday, March 18, 2016

Death and Taxes


Two things are inevitable: death and taxes. The occurrence is certain; only the timing is unknown. The tax portion has some implications that may affect future planning. Mr. Obama, in his 2017 budget proposal, included items that would effectively increase the taxes Americans will pay. While these items have not been implemented (yet), it does provide information for guidance in the future. The proposals include the following:

Excess Accumulations

Under Mr. Obama’s proposal, an individual would not be allowed to make tax deferred contributions to an IRA or defined contribution (i.e. 401(k), etc.) plan if the amount in the plan could produce an annual benefit in excess of $210,000. A Treasury Department document explaining the tax proposals in the budget stated “Such accumulations can be…in excess of amounts needed to fund reasonable levels of consumption in retirement…” and thus do not justify tax deferred treatment.

Inherited IRAs

Under current rules, an heir of an IRA can elect to receive distributions from the IRA over the lifetime of that heir, effectively “stretching” the distributions from the IRA over many years. This stretching allows the IRA to continue earning tax deferred for (potentially) many years and limiting tax payments to only taxes required on the amount withdrawn. The White House proposal would require an IRA inherited by anyone other than the surviving spouse to withdraw all proceeds from the IRA over a maximum of 5 years (and pay taxes on the withdrawals, of course).

Mandatory Roth IRA Distributions

Roth IRA contributions are made with after tax dollars; earnings accumulate tax free and there is no required minimum distribution under current rules. Two changes are proposed here: 1) minimum distributions beginning at age 70 ½ would be required (just as with regular IRAs), and 2) no additional contributions would be allowed after age 70 ½.

“Back Door” Roth IRA Contributions

Currently, Roth IRA contributions are not allowed for individuals making more than $132,000 annually for singles ($194,000 for couples) in 2016. However, individuals can open a regular IRA with non-deductible contributions and immediately roll the funds into a Roth IRA. That process effectively allows high income individuals to contribute to a Roth IRA regardless of the income level. The budget proposal effectively prohibits this practice in the future.

Net Unrealized Appreciation on Employer Stock

Retiring employees currently have the option of taking employer stock from a company plan at retirement. Their tax liability (as ordinary income) is based on the original cost of the stock to the employer plan. If the stock is held for a year or longer, the excess of the sale price above the plan cost (the net unrealized appreciation) is taxed at the more favorable long term capital gains rate. The budget proposal eliminates that option for employees under age 50 as of 12-31-16.

Other Items

While not included in the budget plan, there have been other tax measures discussed which affect investors. One is a “transfer fee” on securities transactions i.e. a tax on each security purchase and sale. I imagine the rhetoric will be couched in terms of affecting the only the wealthy and “hedge fund managers,” however; such a tax would also affect mutual funds. Those funds are the investment vehicle of most middle class investors and are the bulk of investments for 401(k), 403(b), etc. plans. It thus appears that such a tax would have a much wider impact on more Americans.

Income taxes have long been a favorite vehicle for raising revenue. Another item has been discussed—a wealth tax. Such a tax would be applied to the assets the investor owns. The amount and the frequency of collection (annually??) have yet to be determined. It will be interesting to see if such a proposal again appears.

In this political climate of “fair share” and “income inequality,” one can anticipate some tax changes will be forthcoming. We, at Paragon Financial Advisors, assist our clients in managing their financial assets in a changing tax world.  Specific actions should be discussed with your CPA to ensure appropriateness in your individual circumstances, but let’s try to delay both death and taxes. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
There was an error in this gadget