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Inherited IRAs Are Not Protected in Bankruptcy

The June 2014 unanimous Supreme Court decision in Clark v. Rameker determined that inherited IRAs do not qualify for the bankruptcy protection given to retirement funds.  The Court determined that amounts held in inherited IRA accounts are not set aside for the purpose of retirement because they do not meet the three legal criteria to be characterized as retirement funds.  First, the beneficiary of an inherited IRA account cannot put additional funds into the inherited IRA account in the same method that they can add additional funds to a regular IRA or Roth IRA account.  Second, the owner of the inherited IRA must begin withdrawals within a specific amount of time without regard to how many years remain until retirement.  Finally, the owner of an inherited IRA can withdraw money at any time without incurring a 10% early withdrawal penalty that would generally apply to distributions from a regular IRA or Roth IRA if the withdrawals are made prior to age 59 ½. 

Some tax planning can be performed to avoid an inherited IRA being subject to creditor claims in a bankruptcy proceeding if someone is concerned about the beneficiary’s situation.  For example, instead of listing an individual as a beneficiary of an IRA, a trust for the benefit of that individual can be the IRA beneficiary. 

Changes to the Offshore Voluntary Disclosure Program

The IRS has made changes to the offshore voluntary disclosure program which is intended to allow more taxpayers to participate.  The taxpayers who may be eligible are those who have previously failed to disclose foreign accounts but didn’t willfully evade their tax obligations.  U.S. citizens and resident aliens are required to report worldwide income, including income from foreign accounts, and pay taxes on that income.  Failure to report the existence of foreign accounts or failure to pay tax on the income from the foreign accounts can lead to civil and criminal penalties. 

The streamlined procedures are available to taxpayers living outside the U.S. and certain taxpayers living within the United States.  If you or someone you know may be eligible to become compliant under the new streamlined procedures, please contact us to discuss further details.

Avoiding the 3.8% Net Investment Income Tax

The 3.8% net investment income tax became effective for tax years beginning on January 1, 2013.  This tax, passed as part of The Patient Protection and Affordable Care Act and amended by the Health Care and Education Reconciliation Act of 2010, created a tax on net investment income.  What is net investment income?  Generally, it includes interest, dividends, capital gains and losses, royalties and rental income and expenses from passive activities.  The income is offset by investment expenses such as investment advisory management fees and some of a taxpayer’s state and local income taxes.  Single filers are subject to the tax once their adjusted gross income exceeds $200,000, and married taxpayers are subject to the tax once their adjusted gross income exceeds $250,000.  During our tax season appointments this past winter, I often explained to our clients that this tax was created to pay for the Affordable Care Act, otherwise known as “Obamacare”.  But, did you realize that the revenue from this tax is expected to generate up to 50% of the total revenue needed to pay for Obamacare?  Once 2013 individual income tax returns were finalized, taxpayers were able to see how much this tax impacted them by reviewing the new Form 8960 and the total amount that was reported on line 60 of Form 1040.   You may have read articles or heard stories of the extreme lengths that some U.S. taxpayers have gone through to avoid the net investment income tax.  Even as far as getting a divorce!  There are less extreme measures that can help a taxpayer to save some or all of the net investment income tax.  Here are four of our favorites:

Charitable Donations

Rather than selling appreciated stocks, you can donate them to charity and obtain a tax deduction for the fair market value of the stock on the date of donation.  Had you sold the stock and then donated the cash proceeds, you would be subject to capital gains tax and potentially, the net investment income tax.  Donate the appreciated property and obtain the tax deduction without being subject to the taxes. 

Gifts of Appreciated Property

Are you planning to gift money to someone in a lower tax bracket this year?  If the answer is yes, consider gifting appreciated property and having the recipient sell the stock.  Depending on the adjusted gross income level of the recipient, they may not be subject to the net investment income tax on the gains from the sale.  We recommend discussing this with us before entering into the transaction so that we can advise you of any potential gift tax return requirement from your gift.

Harvest capital losses

Capital loss carryovers from prior tax years and current year capital losses can be utilized to offset capital gains that otherwise would subject to the net investment income tax.

Consider swapping investment properties

Are you considering selling an investment, such as a rental property, that has appreciated in value?  By investing the proceeds from the sale in a new, similar (termed ‘like-kind’) property, you can defer the capital gains until the sale of the second property and also defer the net investment income tax on the gain.    This is called a 1031 exchange, named after section 1031 of the Internal Revenue Code.  Contact us if this is something you are interested in learning more about, as IRC 1031 exchanges involve advance planning and the involvement of a third party intermediary to handle the proceeds and identification of the new investment.

If you have questions about any of the topics discussed in this newsletter, please feel free to call us.

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