No Ls Roth Ira Conversions And Estate Planning In 2010

How to Benefit from Net Operating Losses, Roth IRA conversions and Estate Planning in 2011

January 15, 2011

Presented by: Glenn Rodney

Jeff Call Trey Webb

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Outline

What is a net operating loss?

What limits are placed on deducting business losses?

How is a net operating loss used?

What other rules need to be considered?

What planning can be done for the use of net operating losses?

Net Operating Losses

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Certain tax deductions exceed gross taxable income

Can be a trade or business loss

Or created by employee business expenses

Or created by a casualty or theft loss

Not by personal/non-business deductions


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Business vs. non-business deductions

Non-business deductions limited to non-business income


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Business income - examples

• Salary and wages

• Rental income

• Sole proprietorship income

• Income from a partnership or S corporation

• Gain on the sale of business property


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Business deductions - examples

• Rental losses

• Loss from a partnership or S corporation

• Loss on the sale of business property

• Employee business expense


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Non-business income - examples

• Dividend income

• Interest income

• Income from annuities

• Capital gains


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Non-business deductions - examples

• Personal exemptions

• Mortgage interest on personal residence

• Retirement plan contributions

• Charitable contributions

• Real estate taxes

• Investment interest


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Example – Joe Homebuilder has a tax loss of $2,000: Wages $10,000

Partnership loss $7,000

Mortgage interest of $5,000

What is his net operating loss?


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Answer - $0

The mortgage interest deduction is limited to his non-business income of $0 in computing the net operating loss. $10,000 wages less $7,000 partnership loss less $0 mortgage interest deduction leaves a positive amount for purposes of the NOL calculation. Note, Joe Homebuilder does not have taxable income for the year even though he does not have an NOL for the year.


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Basis limitations

At risk limitations

Passive activity losses


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Basis Limitations

Taxpayers cannot deduct losses from businesses in excess of their basis in the business


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S Corporations – basis is equal to the assets contributed in the form of capital or a loan plus income reported to the owner less losses and less assets distributed to the owner


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Partnerships – basis is same as S corporations plus the partners share of partnership debt


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At risk limitations

Losses deductible if you are at risk of suffering economically

Non-recourse debts

Related party loans


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Passive activity losses

Passive losses limited to passive income

Material participation key to avoiding passive losses

Special rules apply to rental activities


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Seven tests for material participation(1) The individual participates in the activity for more than 500 hours during

such year;(2) The individual's participation in the activity for the taxable year constitutes

substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

(3) The individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

(4) The activity is a significant participation activity (within the meaning of paragraph (c) of this section) for the taxable year, and the individual's aggregate participation in all significant participation activities during such year exceeds 500 hours;


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(5) The individual materially participated in the activity (determined without regard to this paragraph (a)(5)) for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;(6) The activity is a personal service activity (within the meaning of paragraph (d) of this section), and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; or(7) Based on all of the facts and circumstances (taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year.


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Carry losses back to prior years to recover taxes paid

Alternatively, elect to carry the loss forward only

Current law – 2010 losses can be carried back two years and forward twenty years

2008 & 2009 – 5 year elective carryback election


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File Form 1045 by the end of the year

Or file an amended return to claim the loss within three years


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What other rules should be considered?

Alternative minimum tax

Special rules apply when calculating the alternative minimum tax NOL


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Any claim for refund in excess of $2,000,000 is automatically selected for audit


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State rules can vary

Some states follow the federal net operating loss rules and other do not

Some states do not allow loss carrybacks or carry forwards

There can also be differences in calculation of the carryback or carryforward period

Georgia generally allows 2 year carryback and 20 year carryforward


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Material participation

Keep good records of time

Increase time to meet 500 hour threshold

Limit time where attempting to qualify as a significant participation activity


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Accelerating losses

Sell unused assets or inventory at a loss to increase NOL

Accelerate income

With loss carry forwards, liquidate appreciated assets to create cash flow without taxes

Match non-business deductions and non-business income


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Losses can offset capital gain income as well as ordinary income

Against capital gain income provides lower refund.

Consider foregoing carryback to a year with only capital gain income.

Accelerate ordinary income to utilize losses and pay tax on capital gain income


Estate Tax Planning in 2010/2011/2012 and ROTH IRA Conversions

Presented by:Jeff CallGlenn RodneyTrey Webb

Estate tax planning for 2010

Exclusion amount $5,000,000

Maximum tax rate 35%

Carryover basis Option to elect modified carryover basis regime and no estate tax instead of estate tax with $5 mm exemption

Exclusion amount $1,000,000 (no change)

Maximum tax rate 35% (no change)

Exclusion amount Tax repealed

Maximum tax rate 0%

2010 - Estate Tax

2010 - Gift Tax

2010 - Generation Skipping Tax

Estate tax planning for 2010

*Basic exclusion amount $5,000,000 (formerly called "applicable exclusion amount")

*Maximum tax rate 35%

*Step-up in basis Full step-up, unless estate elects out of estate tax

State death tax deduction Still available on line 3b (as it was in 2005-2009)

*Due date No earlier than nine months after date of enactment

*Carryover basis Applicable only if estate elects out of estate tax

*Max basis increase available $1.3M (plus $3M for property passing to spouse)

*Due date of new form (8939) No earlier than nine months after date of enactmentPenalties:1) Failure to report to the IRS: $10,000 per failure2) Intentional disregard: 5% of FMV of property3) Failure to report to beneficiaries:/donees: $50 per failure

Capital gains rate Proceeds in excess of adjusted tax basis subject to tax at the applicable capital gains rate when sold (currently 15%)

2010 Estate tax details

Estate tax planning for 2011-2012




Maximum tax rate 35% (no change)



2011/2012 - Estate Tax

2011-2012 - Gift Tax

2011-2012 - Generation Skipping Tax

Estate/Gift tax planning for 2011-2012

*DSUEA "Deceased spousal unused exclusion amount" (new in 2011)

Basic estate/gift exclusion amount $5,000,000 [2012: indexed for post-2010 inflation] now reunified

*Maximum tax rate 35%

State death tax deduction Still available on line 3b (as it was in 2005-2009)

Portability of exclusion DSUEA only from estate of spouse who dies in 2011 or 2012

Last deceased spouse DSUEA available only from last deceased spouse. Thus, DSUEA could be lost if

surviving spouse remarries, and is then "rewidowed.“ Unless it is used for gifting

during lifetime then you could benefit from the use of DSUEA’s from multiple deceased spouses during the donor’s lifetime.

*Applicable exclusion amount Basic Exclusion Amount + DSUEA

Step-up in basis Assets in first estate placed in bypass trust get no additional basis step-up at survivor’s (2nd) death, but are protected from tax on any appreciation at 2nd death. Same assets instead given directly to surviving spouse (and protected from tax in 2nd estate by DSUEA) do get step-up. But trade-off is that appreciation of these assets between 1st and 2nd deaths could be taxable if they exceed combined exclusions.

2011-2012 Estate/Gift tax details

Estate tax planning for 2010/2011/2012other notable changes and items

Decoupled State Estate Tax Returns

Currently there are 14 “decoupled” state estate tax returns. These states generally require that a Form706 be attached, either based on the 1999 or 2001 form, or on the form applicable to the year of death. Because there was no federal estate tax return for 2010 (until The Act of 2010), these states required a 2009 Form 706 to be attached. With the reinstatement of a federal estate tax for 2010, we might expect these states to change the requirement from a 2009 return to a 2010 (or 2011 or 2012) return.

Indexing the Basis Exclusion Amount for Inflation (applicable only in 2012)

The average cost-of-living adjustment (“COLA”) for the years 1975-2010 has been 4.2% (COLA for 2009 or 2010 has been 0%). Assuming that the post-2010 COLA is 4.2%, then the basic exclusion amount available in 2012 would be $5,210,000 (assuming no law change prior to that date).

Carryover Basis and Form 8939

Form 8939, “Allocation of Increase in Basis for Property Acquired From a Decedent”. Will be required for all estates with more than $1.3m of non-cash assets valued as of the date of death. This new form implements the allocation of up to $1.3m of basis increase per decedent (plus another $3m for property passing to a spouse).

There could be as few as 3,000 of these forms required to be filed for 2010. The only estates that would elect carryover basis treatment would be those over $5,000,000, and some of those (in the $5M - $7M range) might stay with the default estate tax treatment if it is less expensive than eventual capital gains tax on property that is greatly appreciated.

• 2010 Special Basis Rules only for individuals electing out of $5 mm exemption and Form 8939

• For deaths in 2010, we have a modified carry-over of basis system, unless they elect to utilize the $5 mm exemption rules enacted on Dec. 17, 2010

• A lack of information regarding the decedent’s basis in an asset presumably means a starting basis of -0- for that asset.

• The beneficiary’s (fiduciary’s) starting basis is the lesser of the decedent’s basis or fair market value at death. Under the new rules basis can “step down” but not up.

• The executor may/must allocate the “Special Basis Adjustment” of $1.3 million, as adjusted.

• The $1.3 million is increased by the decedent’s unused capital loss and operating loss carryovers, and by § 165 losses.

• The “Spousal Basis Adjustment” adds an additional $3 million of adjustment, but can only be allocated to assets passing outright to a surviving spouse or to a QTIP Trust – but not other marital trusts.

• Basis cannot be adjusted to more than the market value at death. Cannot “create” losses.

• The “executor” makes the allocations, asset by asset, on Form 8939, due at the same time as the final Form 1040 (now extended to 9 months from Dec. 17th). Failure to file can result in fines of $10,000 or more!

Estate tax planning for 2010 (Modified Carryover Basis)

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What is a Roth IRA?

Overview Non-deductible contributions 100% of growth is tax-free No required minimum distributions (RMD) at age 70½

NOTE: Distributions from Roth IRAs cannot be used to fulfill the RMD from a traditional IRA

Qualifying Distributions are tax-free Modified Adjusted Gross Income (MAGI) limitations on contributions

and conversions RMDs on inherited Roth IRAs Roth 401(k) plans

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Distributions from a Roth IRA

Qualified distributions are not subject to income tax Qualified Distributions

Distributions beginning 5 years after first contribution to Roth IRA or 5 years after conversion to a Roth IRA

AND: Distributions after age 59.5 Distributions due to the death of the original Roth IRA

owner Distributions due to the original Roth IRA owner’s disability Distributions up to $10,000 to acquire a first time home

Non-qualified distributions will be subject to income tax Basis can be withdrawn tax free Distributions are not subject to income tax if they do not exceed

aggregate contributions or conversions to the Roth IRA

What is new with the Roth IRA?

Starting in 2010, the $100,000 MAGI limitation on conversions no longer applies Taxable income recognized on a 2010 Roth IRA conversion may be

spread over the following two tax years (i.e., 2011 and 2012) Retirement plans eligible for conversion to a Roth IRA

Traditional IRA’s 401(k) plans (including in-service distributions) Profit-Sharing plans 403(b) annuity plans 457 plans “Inherited” 401(k) plans

Married Filing Separately taxpayers can convert to a Roth IRA

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Roth IRA Conversion Factors to Consider

Taxpayer’s ability to pay the income tax on the Roth IRA conversion from non- Roth IRA funds

Taxpayer’s expected future tax rate Taxpayer’s need to use IRA funds during retirement (no RMD’s for Roth

IRA)

Taxpayer’s time horizon Taxpayer with favorable tax attributes, such as net operating losses,

charitable contribution carry-forwards, investment tax credits, etc. Taxpayers benefit from paying income tax before estate tax (when a Roth

IRA conversion is made) compared to the income tax deduction for estate taxes paid on a traditional IRA, thus lowering overall taxes.

Taxpayers who need IRA assets to fund their credit shelter trust (estate exemption amount) should consider a Roth IRA election for that portion of their overall IRA funds.

Roth IRA Conversion Examples

The examples that follow illustrate some of the variables to evaluate in considering a Roth IRA conversion

The assumptions on the following slide will be applied to three different hypothetical taxpayers (currently age 40 and 60)

For each taxpayer, there will be three different illustrations of the conversion 1. With no change in tax rates 2. With tax rates lower in the future 3. With tax rates higher in the future

Assumptions

Taxpayer Age 40 60

FMV Traditional IRA $500,000 $500,000

Basis Traditional IRA - -

FMV Roth IRA - -

Traditional and Roth IRA Growth Rates 7% 7%

FMV Taxable Account $450,000 $450,000

Basis Taxable Account $400,000 $400,000

Taxable Account Yield 3% 3%

Taxable Account Growth Rate 4% 4%

Annual Asset Turnover 20% 20%

Distribute Yield No No

Tax Rate at conversion 35% 35%

Increased Tax Rate (5 years after conversion) 40% 40%

Decreased Tax Rate (5 years after conversion) 30% 30%

Capital Gains Tax Rate 20% 20%

Estate Tax Rate 35% 35%

Estate Tax Exemption $5,000,000 $5,000,000

Roth IRA Conversion Amount $500,000 $500,000

Premature Distribution Penalty 10% 10%

Taxpayer has other income to cover living expenses

Age 40 – Tax Rates Remain ConstantNet to Heirs

Age 40 – Tax Rates DecreasingNet to Heirs

Age 40 – Tax Rates IncreasingNet to Heirs

Age 60 – Tax Rates Remain ConstantNet to Heirs

Age 60 – Tax Rates DecreasingNet to Heirs

Age 60 – Tax Rates IncreasingNet to Heirs

Roth IRA Recharacterization

Taxpayers may “recharacterize” (i.e., undo) a Roth IRA conversion in current year or by the filing date of the current year’s tax return Recharacterization can take place as late as October 15 in the year

following year of conversion Reasons a taxpayer would recharacterize

Taxpayer originally planned on being able to pay income tax with non-Roth IRA funds, but now cannot

Roth IRA account value plummets after conversion Taxpayers cannot recharacterize a portion of a Roth conversion by

“cherry picking” only assets that decline in value All gains and losses to the entire Roth IRA must be pro-rated

Taxpayers may choose to “reconvert” Reconversion may only take place at the later of (1) Tax year

following the original conversion or (2) 30 days after the recharacterization

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Conversion Period Recharacterization Period

1/1/2010First day

conversion can take place

2010

12/31/2010Last day

conversion can take place

4/15/2011 Normal filing date for 2010

tax return 10/15/2011Latest filing date

for 2010 tax return/last day

to recharacterize 2010 Roth IRA

conversion

12/31/2011

2011

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Roth IRA Conversion Timeline

Roth IRA Segregation Conversion Strategy

STEP 1: Create separate IRAs for each asset, asset class or investment sector

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Roth IRA #1ABC Fund: $250,000

Roth IRA #2XYZ Fund: $250,000

Traditional IRAABC Fund: $250,000XYZ Fund: $250,000

Income tax liability due on $500,000 conversion amount

April 15, 2011*

* NOTE: Either a tax return or an extension must be filed by this date. In either case, the tax liability due on the Roth IRA conversion must be remitted by this date to avoid late payment penalties and interest.

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STEP 2: Pay income tax on Roth IRA conversion

IRSTaxpaye

r

Recharacterization of IRA using the value at the date of conversion

(e.g. $250,000)

October 15, 2011*

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STEP 3: Recharacterize Roth IRA conversion

Roth IRA #1ABC Fund: $100,000

(Current Value)

Roth IRA #2XYZ Fund: $300,000

(Current Value)

Traditional IRA #1

ABC Fund: $100,000 (Current

Value)

* NOTE: October 15, 2011, is the latest date for which a 2010 recharacterization can take place (either by filing extensions or by filing an amended return).

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Refund of overpayment on recharacterization of Roth IRA Conversion

October 15, 2011*IRS

Taxpayer


STEP 4: File (or amend) income tax return claiming refund for recharacterization

Conclusion

The decision to convert is based on an individual’s facts and circumstances. Taxpayers need to evaluate a variety of factors, including:

Risk tolerance Time horizon Need to use IRA funds in retirement Ability to pay income tax on conversion with taxable investment

account Prospective future tax rates Estate planning considerations

Questions?

Contact Information

Jeff Call Bennett Thrasher PC

Email: [email protected]

Phone: (678) 302-1456

Glenn Rodney Principal Financial

Email: [email protected] Phone: (770) 821-7872

Trey Webb Bennett Thrasher PC

Email: [email protected]

Phone: (678) 302-1457

mailto:[email protected]

mailto:[email protected]

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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.

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No Ls Roth Ira Conversions And Estate Planning In 2010