Jan 11

What You Should Know About Taxation Of Cryptocurrencies

Here’s a recent article, from Forbes.com, talking about the taxation of Bitcoin and other cryptocurrencies –

If you spend or invest in virtual currencies, it is crucial to understand how virtual currency transactions are treated for tax purposes.

IRS Notice 2014-21

The IRS addressed the taxation of virtual currency transactions in Notice 2014-21. According to the Notice, virtual currency is treated as property for federal tax purposes. This means that, depending on the taxpayer’s circumstances, cryptocurrencies, such as Bitcoin, can be classified as business property, investment property, or personal property. General tax principles applicable to property transactions must be applied to exchanges of cryptocurrencies. Hence, Notice 2014-21 holds that taxpayers recognize gain or loss on the exchange of cryptocurrency for other property.  Accordingly, gain or loss is recognized every time that Bitcoin is used to purchase goods or services.

Determining Basis & Gain

When it comes to determining the taxation of cryptocurrency transactions, it is important for cryptocurrency owners to properly track basis. Basis is generally defined as the price the taxpayer paid for the cryptocurrency asset.

For example, on June 1 2017, Jane purchased five Bitcoins for $6,000 ($1,200 each Bitcoin). On November 1, 2017, she used one Bitcoin to purchase $2,000 worth of merchandise via an online retailer. Jane recognized an $800 gain on the transaction ($2,000 amount realized – $1,200 basis in one Bitcoin).

What You Should Know About Taxation Of CryptocurrenciesTreating cryptocurrency, such as Bitcoin, as property creates a potential accounting challenge for taxpayers who use it for everyday purchases because a taxable transaction occurs every time that a cryptocurrency is exchanged for goods or services. For example, if Jane purchased a slice of pizza with one Bitcoin that she purchased on June 1 2017, she would have to determine the basis of the Bitcoin and then subtract that by the cost of the slice of pizza to determine if any gain was recognized. There is currently no “de minimis” exception to this gain or loss recognition. Taxpayers must track their cryptocurrency basis continuously to report the gain or loss recognized on each crypto transaction properly. It is easy to see how this treatment can cause accounting issues with respect to everyday cryptocurrency transactions.

On the other hand, the loss recognition on cryptocurrency transactions is equally complex. A deduction is allowed only for losses incurred in a trade or business or on a transaction entered into for profit. If Jane had recognized a $100 loss on her purchase of merchandise from the online retailer, the loss may not be deductible. If Jane uses Bitcoin for everyday transactions and does not hold it for investment, her loss is a nondeductible personal loss. However, if she holds Bitcoin for investment and cashes out of her investment by using Bitcoin to purchase merchandise, her loss is a deductible investment loss. Whether Bitcoin is held for investment or personal purposes may be difficult to determine, and further guidance by the IRS on this topic is needed.

Cryptocurrency values have been extremely volatile since its inception. As illustrated below, this volatility makes a significant difference in gain or loss recognition.

Jane purchased four Bitcoins on February 2, 2017 for $1,120 per Bitcoin, ten Ethereum coins on March 10, 2017 for $320 per coin, and 65 Litecoins on July 5, 2017 for $65 per coin.  Jane would need to keep track of the basis and sales price for each cryptocurrency transaction in order to properly calculate the gain or loss for each transaction.  In addition, if Jane purchased Bitcoins at different dates and at different prices, at sale, Jane would have to determine whether she would be selling a specific Bitcoin or use the first-in, first-out (FIFO) method to determine any potential gain or loss. The default rule for tracking basis in securities is FIFO. Taxpayers can also determine basis in securities by using the last-in, first out (LIFO), average cost, or specific identification methods. The prevalent thought is that these methods should be available for property that does not qualify as a security, and that taxpayers investing in cryptocurrency should use the method that is most beneficial to them. However, no direct IRS authority supports this position.

In sum, taxpayers must track their cryptocurrency purchases carefully. Each cryptocurrency purchase should be kept in a separate online wallet and appropriate records should be maintained to document when the wallet was established. If a taxpayer uses an account with several different wallet addresses and that account is later combined into a single wallet, it may become difficult to determine the original basis of each cryptocurrency that is used in a subsequent transaction.

The details of all cryptocurrency transactions in a network are stored in a public ledger called a “Blockchain,” which permanently records all transactions to and from online wallet addresses, including date and time. Taxpayers can use this information to determine their basis and holding period. Technology to assist taxpayers in this process is being developed currently and some helpful online tools are now available.

Characterization of Gain or Loss for Cryptocurrency Transactions

The character of gain or loss on a cryptocurrency transaction depends on whether the cryptocurrency is a capital asset in the taxpayer’s hands. Gain on the sale of a cryptocurrency that qualifies as a capital asset is netted with other capital gains and losses. A net long-term capital gain that includes gain on crypto transactions is eligible for the preferential tax rates on long-term capital gains, which is 15% or 20% for high net-worth taxpayers. Cryptocurrency gain constitutes unearned income for purposes of the unearned income Medicare contributions tax introduced as part of the Affordable Care Act. As a result, taxpayers with modified adjusted gross incomes over $200,000 ($250,000 for married taxpayers filing jointly) are subject to an additional 3.8% tax on cryptocurrency gain.

For example, on August 1, 2017, Jen, a sole proprietor, digitally accepts two Bitcoins from Steve as payment for services. On that date, Bitcoins are worth $10,000 each, as listed by Coinbase. Therefore, Jen recognizes $20,000 ($10,000 x 2) of business income. A month later, when Bitcoins are trading for $11,500 on the Coinbase exchange, Jen uses two Bitcoins to purchase supplies for her business. At that time, Jen will recognize $23,000 ($11,500 x 2) in business expense and $3,000 [($11,500 – $10,000) x 2] of gain due to the Bitcoin exchange. Since Jen isn’t in the trade or business of selling Bitcoins, the $3,000 gain is capital in nature.

Now let’s assume the same facts as above, except that Jen uses the two Bitcoins to purchase a new car for her personal use. According to the Coinbase exchange, Bitcoins are now trading at $8000. Jen will realize a loss of $4000 [($8000 – $10,000) x 2]. However, this loss is considered a nondeductible capital loss because Jen didn’t use the Bitcoins for investment or business purposes.  It is important to note that a payment using cryptocurrencies are subject to information reporting to the same extent as any other payment made in property. Thus, a person who, in the course of a trade or business, makes a payment using cryptocurrency with a fair market value of $600 or more is required to report the payment to the IRS and the payee’s cryptocurrency payments are subject to backup withholding. This means that persons making reportable payments with cryptocurrency must solicit a Taxpayer Identification Number (TIN) from the payee. If a TIN isn’t obtained prior to payment, or if a notification is received from the IRS that backup withholding is required, the payer must backup withhold from the virtual currency payment.

In summary, if a taxpayer acquires cryptocurrency as an investment and chooses to dispose of it by purchasing merchandise or services, any loss realized will be treated as a deductible investment loss. However, at times, it may be difficult to determine whether cryptocurrency is held for investment or personal purposes.

Employment Taxes and Information Reporting – Cryptocurrency Mining

According to Notice 2014-21, if a taxpayer’s mining of cryptocurrency is a trade or business, and the taxpayer isn’t classified as an employee, the net earnings from self-employment resulting from the activity will be subject to self-employment tax. Cryptocurrency mining is defined as a computationally intensive process that computers comprising a cryptocurrency network complete to verify the transaction record, called the “Blockchain”, and receive digital coins in return.  Cryptocurrency mining is considered a trade or business for tax purposes, in contrast to investing in cryptocurrencies which is considered an investment.  This is a crucial distinction since the taxation of investment gains or losses are subject to the capital gain/loss tax regime, whereas, business income is subject to a different tax regime.  A taxpayer generally realizes ordinary income on the sale or exchange of a cryptocurrency that is not a capital asset in his hands.

Inventory and property held for sale to customers are not capital assets, so income recognized by a miner of, or broker in, cryptocurrency is generally considered ordinary. If a taxpayer’s mining of cryptocurrency constitutes a trade or business, the net earnings from mining (gross income less allowable deductions) are subject to self-employment tax. Similarly, if an independent contractor receives virtual currency for performing services, the fair market value of such currency will be subject to self-employment tax. If cryptocurrency is paid by an employer to an employee as wages, the fair market value of the currency will be subject to federal income tax withholding, FICA and FUTA taxes, and must be reported on Form W-2 (Wage and Tax Statement).

Questions Remain

The IRS’s guidance in Notice 2014-21 clarifies various aspects of the tax treatment of cryptocurrency transactions. However, many questions remain unanswered, such as how cryptocurrencies should be treated for international tax reporting (FBAR & FATCA reporting) and whether cryptocurrencies should be subject to the like-kind exchange rules.

To learn more about using your retirement funds, including a Solo 401(k) Plan, to invest in cryptocurrencies, please contact a retirement expert from the IRA Financial Group @ 800.472.0646.

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Sep 09

401(k) Loans Are Viable Last Resort For Hurricane Victims

This article originally appeared on Forbes.com

Hurricane Harvey has set a record for rainfall in the continental United States. It is estimated that some 100,000 homes have been affected by Harvey all with differing degrees of insurance coverage.  In addition, at least 37 people have died from the storm.

Over the coming weeks we will be hearing news about payout projections by insurers, but chances are those dollars will flow to the commercial sector, not homeowners. If the 2012 Hurricane Sandy is a predictor, households are facing a severely diminished quality of life, financial frustration, a long process for applying for grants and aid, and way too little insurance funding in relation to the premiums they’ve been paying. Many insurance experts estimate that only a relatively small percentage of the Harvey-impacted homes and businesses will have adequate flood insurance. For those without it, there is a short list of possible bases for coverage under a home policy.  However, for Harvey storm victims who are participating in an employer 401(k) plan or who are self-employed, an unorthodox financing option exists that can help storm victims borrow up to $50,000 tax-free and penalty free from their 401(k) plan.

Internal Revenue Code Section 72(p) allows a Solo 401(k) plan participant to take a loan from his or her 401(k) plan so as long as it is permitted pursuant to the business’s 401(k) plan documents. The loan proceeds can be used for any purpose.  In order to be eligible to take a loan from a 401(k) plan, the solo 401(k) plan documents must specifically provide for a loan program

In general, to avoid having a 401(k) plan loan treated as a taxable distribution to the recipient, the following conditions must be satisfied (IRC Sec. 72(p)(2)).

  • The loan must have level amortization, with payments made at least quarterly.
  • The recipient generally must repay the loan within five years, although a fifteen year period can be used for the purchase of a primary residence.
  • The loan must not exceed statutory limits.

401(k) Loans Are Viable Last Resort For Hurricane VictimsGenerally, the maximum amount that an employee may borrow at any time is one-half the present value of his vested account balance, not to exceed $50,000. The maximum amount, however, is calculated differently if an individual has more than one outstanding loan from the plan.  A 401k loan is permitted at any time using the accumulated balance of the solo 401k as collateral for the loan. In other words, a Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value, whichever is less. This loan has to be repaid over an amortization schedule of five years or less with payment frequency no less than quarterly.  The lowest interest rate that can be used is prime as per the Wall Street Journal, which as of September 1, 2017 is currently 4.25%. However, if a loan fails to satisfy the statutory requirements regarding the loan amount, the loan term, and the repayment schedule, the loan is in default and is considered a deemed distribution. In addition, another potential disadvantage of taking a 401(k) plan loan is that the borrowed funds are removed from investment in the market, forfeiting potential tax-exempt gains.

For Harvey storm victims participating in an employer 401(k) plan, taking a 401(k) loan can be done generally by contacting the 401(k) plan administrator.  Whereas, for individuals who are self-employed or have a business with no full-time employees, other than a spouse or partner(s), a Solo 401(k) plan with a loan option can be adopted quite easily, which will allow such individuals to borrow up to $50,000 and use the proceeds for any purpose, including paying for home repairs, purchasing a car, paying living expenses, paying credit card debt, or other expenses.

In the case of Harvey storm victims, the primary advantage of using a 401(k) loan feature is that the individual will gain the ability to use up to $50,000 of retirement funds without tax or penalty.  In addition, the loan payments of principal and interest are paid back by the individual to his/her plan account, thus, increasing the overall value of the 401(k) plan assets over the loan period. Drawbacks of taking a retirement plan loan include the loss of compounding for assets in the plan, as well as the fact that loans are repaid with after-tax dollars, resulting in a loss of tax-free or tax-deferred advantages of such an account.

For more information about using a loan from your 401(k) plan, please contact us @ 800.472.0646.

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Jul 31

What The Law Says About UBTI In Non-Real Estate Investments

This article, written by Adam Bergman, about the UBTI rules when making non-real estate investments, first appeared on Forbes.com

For many retirement account investors, understanding how the Unrelated Business Taxable Income Rules work, also known as UBTI, UBIT, or debt-financed income rules, and how they may potentially apply to one’s retirement account investment has been a challenge.  The main reason is that the majority of IRA or 401(k) plan investors invest in traditional types of investments, such as equities, mutual funds, and ETFs, which do not trigger the application of the UBTI tax rules since most passive investments that a retirement account might invest in are exempt from the UBTI rules, such as interest, dividends, and capital gains.

Understanding the potential impact of the UBTI rules is crucial for retirement account investors Understanding the potential impact of the UBTI rules is crucial for retirement account investors seeking to make non-real estate alternative investments in their retirement accounts, including options, stock short sales, and commodity futures contracts.  In general, the UBTI tax rules are triggered in three instances: (i) use of margin to buy stock, (ii) use of a nonrecourse loan to buy real estate, and (iii) investment in a business operated through a flow-through entity, such as an LLC or partnership.  The tax imposed by triggering the UBTI rules is quite steep and can go as high as 40 percent.

When it comes to non-real estate transactions, such as securities and other financial products involving retirement funds, understanding the application of the UBTI or debt-financed income rules have been somewhat difficult. Neither the Code nor the Treasury regulations define “indebtedness” for purposes of the debt-financed income rules. Generally, when a retirement account borrows funds and has a clear obligation to repay the funds, the debt-financed income rules are applicable. However, many financial product type investments that involve “leverage” but not a direct borrowing are not considered debt-financed property and are not subject to UBIT.

Below is a summary of how the UBTI/debt-financed income rules apply to some of the more common type of financial product investments involving retirement funds:

Purchase of Stock or Securities on Margin:  It is well established that the purchase of securities on margin gives rise to unrelated debt-financed income (Elliott Knitwear Profit Sharing Plan v. Commissioner, 614 F.2d 347 (3d Cir. 1980).

Repurchase Agreements:  In a repurchase agreement, one party (usually a bank) purchases securities from another party (the bank’s customer) and agrees to sell the securities back to the customer at an agreed price. Such transactions are treated as a loan of money secured by the securities and give rise to unrelated debt financed income (Rev. Rul. 74-27, 1974-1)

Securities Lending Transactions: IRC Section 514(c)(8) provides that payments with respect to securities loans are deemed to be derived from the securities loaned, not from collateral security or the investment of collateral security from such loans.

Short Sales of Stock: The IRS has ruled that neither the gain attributable to the decline in the price of the stock sold short nor the income earned on the proceeds of the short sale held as collateral by the broker constituted debt-financed income (Rev. Rul. 95-8, 1995-1)

Options: IRC Section 512(b)(5) excludes from UBTI all gains or losses recognized, in connection with an organization’s investment activities, from the lapse or termination of options to buy or sell securities.

Commodities Futures Transactions: The IRS has concluded that gains and losses from commodity futures contracts are excluded from UBTI under Code section 512(b)(5). The IRS has rules that the purchase of a long futures contract entailed no borrowing of money in the traditional sense.  Likewise, the IRS found a short contract was merely an executory contract because there was no property held by the short seller that produced income and thus there could be no acquisition indebtedness.

Notional Principal Contracts: The IRS has issued regulations providing that all income and gain from notional principal contracts is excluded from UBTI. (Treas. Reg. § 1.512(b)-1(a)(1).)

The Internal Revenue Code permits retirement account investors to make a wide range of financial product investments using retirement funds. While the majority of financial product type investments would not trigger the UBTI or debt-financed income rules, (including mutual funds and options) transactions involving margin, however, would likely trigger the tax.  The burden falls on the retirement account holder to make the determination of whether the financial product type transaction triggered the UBTI rules and, if so, file the IRS Form 990-T. Therefore, it is important to work with a tax professional who can help one evaluate the financial product transaction to determine whether the transaction will trigger the UBTI or debt-financed income rules tax.

For more information, please contact the IRA Financial Group @ 800.472.0646!

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May 11

Pass-Through Tax Cut May Impact Small Business Owner Retirement Savings Strategies

This article originally appeared on Forbes.com

President Donald Trump’s plan to cut the tax rate to 15 percent for so called pass-through businesses, such as partnerships, LLCs and S Corporations, will help many small business owners reinvest in their business by saving on taxes.  President Trump also plans to cut the corporate tax rate to 15 percent.  While many applaud the President’s plan to cut taxes on businesses, which they believe will help stimulate the U.S economy as well as make American businesses more competitive globally, the discrepancy in tax rates between businesses and individuals could prove problematic, especially for retirement savings.

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President Trump has announced that he plans to cut personal income tax rates by reducing the number of individual income tax brackets from seven to three — 10, 25 and 35 percent.  Individual tax rates currently have a ceiling of 39.6 percent and a floor of 10 percent. Most Americans pay taxes somewhere between the two.  With corporate and business pass through tax rates at 15 percent compared with generally higher individual income tax rates for most Americans, various tax planning opportunities will present themselves, including the ability to structure business payments at a 15 percent tax rate versus taking compensation at a generally higher income tax rate.  For example, under the Trump tax plan, if an LLC owner has $100,000 of net income currently taxed at 35 percent, the allocated portion that is compensation would be taxed at 35 percent while the portion that is allocated as business income would be taxed at a 15 percent tax rate. Thus, taking compensation of $20,000 versus $60,000 could save a significant amount of taxes.  Furthermore, since retirement savings is based on the amount of compensation one receives and not on the amount of profits the business generates, the less compensation one receives will directly impact the amount of retirement savings that may be available.  For example, a husband and wife business partnership would be incentivized to take less compensation and allocate more of the available income to business income in order to reduce their tax liability.  If the partnership has established a 401(k) plan or SEP IRA, the maximum amount they would be able to contribute would likely be reduced since their maximum plan contribution amount is directly based on the amount of compensation they earned from the business in a year.

In general, many economists believe that cutting taxes for small businesses is a positive plan by the president.  However, sizable tax rate discrepancies between different forms and categories of income could create decisions that are more tax than business based and run counter to the principles of tax neutrality.  In addition, such circumstances will likely invite abusive tax schemes, as well as some unanticipated results, such as a potential cut in retirement savings for small business owners.

For more information, please contact the IRA Financial Group @ 800.472.0646.

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Mar 28

Avoiding Required Minimum Distribution Rules With A Roth 401(k) Plan

Here’s another article from Forbes by our own Adam Bergman –

In the case of a 401(k) qualified retirement plan, when one reaches the age of 70 1/2, a 401(k) plan participant generally is required to start taking taxable withdrawals, also known as required minimum distributions (“RMDs”) from their 401(k) plan.  The same RMD rules apply to pre-tax IRAs, SIMPLE IRAs and SEP IRAs.  However, Roth IRAs, which consists of after-tax contributions and which can generate tax-free returns, do not require RMDs until after the death of the owner or his/her spouse. This exception to the RMD rules for Roth IRAs allow for some tax planning opportunities.

Avoiding Required Minimum Distribution Rules With A Roth 401(k) PlanNot all employer sponsored 401(k) plans offer a Roth component.  For employer sponsored 401(k) plans that offer a Roth option, eligible employees generally have the option to make pre-tax as well as Roth employee deferral contributions. Under 401(k) plan rules, a plan participant who reached the age of 70 1/2 would be required to take RMDs on both the pre-tax and Roth amounts. RMDs are the minimum amount one must withdraw from the retirement account each year.  RMD withdrawals will be included in the plan participant’s taxable income except for any part that was taxed before (basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).

The RMD amount for any given year is the total account balance in the retirement account as of the end of the immediately preceding calendar year (12/31) divided by a distribution period as set forth by the IRS each year. Accordingly, if a plan participant nearing or over the age of 70 1/2 has a Roth 401(k) account in a 401(k) plan, the individual can directly rollover the Roth funds to a Roth IRA tax-free prior to 12/31 leaving the Roth 401(k) account with a zero balance and, thus, avoiding the RMD rules since a Roth IRA is not subject to the RMD rules.

For example, Jen is sixty-nine years old and has $185,000 in her employer sponsored Roth 401(k) plan.  If Jen left the Roth 401(k) funds in the 401(k) plan she would become subject to the RMD rules at 70 1/2.  However, if Jen elected to directly rollover the Roth 401(k) plan funds tax-free into a Roth IRA prior to 12/31, she would be able to avoid the RMD rules and, thus, gain the opportunity to continue increasing the value of the Roth account without having to take yearly withdrawals.

For a participant in an employer sponsored 401(k) plan who has a Roth account and is nearing or over the age of 70 1/2, understanding the Roth 401(k) and Roth IRA RMD rules and exceptions could help further advance the overall value of the Roth account as well as offer some potentially valuable estate planning opportunities.

For more information about the Roth 401(k), please contact us @ 800.472.0646.

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Dec 06

Trump Tax Plan May Boost Attractiveness Of Rollover Business Start-Up Solution (ROBS)

This article originally appeared on Forbes.com

The subject of business taxes was a popular theme during President-elect Trump’s election campaign and will surely become a hot topic during his first year as president.  President-elect Trump has stated that he favors a 15% corporate rate as part of his tax plan as well as eliminate the corporate alternative minimum tax. This rate would be available to all businesses, both small and large, that want to retain the profits within the business.

When it comes to using retirement funds to invest in a business involving the retirement account holder or any of his or her lineal descendants (“disqualified persons”) there is generally only one legal way to do it and it involves the purchase of “C” corporation stock (qualifying employer securities) by a 401(k) qualified retirement plan.  The structure is known as a “rollover business start-up” or “ROBS”.

Trump Tax Plan May Boost Attractiveness Of Rollover Business Start-Up Solution (ROBS)The Internal revenue Code explicitly permits the purchase of corporate stock by a 401(k) qualified plan.  Nevertheless, the ROBS structure remains somewhat controversial. Although the Internal Revenue Service (“IRS”) has repeatedly confirmed its legality, it continues to be on the radar of the IRS and Department of Labor (DOL) due to a lack of compliance in some cases.

The ROBS arrangement typically involves rolling over a pre-tax IRA or 401(k) plan account into a newly established 401(k) plan, which is sponsored by a “C” corporation and then investing the rollover funds in the stock of the “C” corporation.  The individual retirement account holder can then earn a reasonable salary as an employee of the business.

The advantage of the ROBS solution is that it does allow one to use all their pre-tax IRA or 401(k) funds to buy a business that they will be involved in personally as an employee without tax or penalty.

The primary downside of the ROBS structure is the use of a C corporation as the business entity, an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs. Corporations are known to have double tax, first, when the company makes a profit, and then to the shareholder on their personal return when dividends are paid. The highest corporate income tax rate is currently at 35%. A sole proprietorship, LLC, or “S” Corporation is treated as a pass-through entity for tax purposes.  In other words, a “C” Corporation would impose two taxes on corporate earnings: a corporate level tax and a shareholder tax on the dividends received.

In comparison, for a pass-through entity, such as an LLC, the profits bypass taxation at the corporate level and are distributed and taxed at the owner’s level.  For example, assuming a corporate and personal income tax rate of 25%, a C Corporation earning $100 would be subject to a tax of 25% ($25) at the corporate level and then the individual shareholder would be subject to a tax of $18.75 on the dividend received ($75 dividend multiplied by a 25% tax rate) for an overall tax of  $43.75. In the case of an LLC, there would be no corporate tax rate and the individual member would be required to pay just $25 in taxes ($100 of allocated profits multiplied by a tax rate of 25%).  Therefore, clearly the use of a C Corporation has been a big reason why many individuals have walked away from using a ROBS solution to buy a business with retirement funds and have instead opted for a taxable distribution.  However, that may all change in 2017 and beyond.

A reduction in the corporate tax rate to 15% as President-elect Trump has promised would certainly make C Corporations a more attractive form of doing business from a tax standpoint than before and should make the ROBS solution a far more attractive option for people looking to use retirement funds to buy a business in 2017 and beyond.

For more information about using your retirement funds to start a business, please contact us @ 8900.472.0646.

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Sep 30

Forbes.com Publishes Article on Rollover Business Start-up (ROBS) Written By Adam Bergman

Adam Bergman is a contributor to Forbes.com on the topic of retirement taxation, contributes articles on using retirement funds to buy a business

Adam Bergman, partner with the IRA Financial Group, has just written an article published on Forbes.com that addresses the legality of the Rollover Business Startup (ROBS) solution. The article titled, “Robbing Your Retirement Account To Fund Your Business Invites IRS Scrutiny” discusses some of the problem areas and compliance issues the Internal Revenue Service has addresses regarding using the ROBS structure to buy a business or franchise.

Adam Bergman is a senior tax partner with the IRA Financial Group, LLC, the markets leading provider of Self-Directed IRA LLC and Solo 401(k) plans. Mr. Bergman is also the managing partner of the law firm The Bergman Law Group, LLC. In addition, Mr. Bergman is a recognized expert on IRAs and 401(k) Plans and is the founder of the BergmanIRAReport.com and the Bergman401KReport.com. Mr. Bergman is the author of the book titled, “Going Solo: America’s Best Kept Retirement Secret For the Self-Employed,” available on Amazon, and is a frequent contributor to Forbes. Mr. Bergman has advised over 12,000 clients on the Self-Directed IRA LLC and Solo 401(k) Plan solutions.

Forbes.com Publishes Article on Rollover Business Start-up (ROBS) Written By Adam BergmanMr. Bergman has been quoted in a number of major publications on the area of self-directed retirement plans. Mr. Bergman has been interviewed on CBS News and has been quoted in Businessweek, CNN Money, Forbes, Dallas Morning News, Daily Business Review, Law.com, San Francisco Chronicle, U.S. Tax News, the Miami Herald, Bloomberg, Arizona Republic, San Antonio Express, Findlaw, Smart Money, USA Today, Houston Chronicle, Morningstar, and American Lawyer on the area of retirement tax planning.

Prior to joining the IRA Financial Group, LLC, Mr. Bergman worked as a tax and ERISA attorney at White & Case LLP, Dewey LeBoeuf LLP, and Thelen LLP, three of the most prominent corporate law firms in the world. Throughout his career, Mr. Bergman has advised thousands of clients on a wide range of tax and ERISA matters involving limited liability companies and retirement plans. Mr. Bergman received his B.A. (with distinction) from McGill University and his law degree (cum laude) from Syracuse University College of Law. Mr. Bergman also received his Masters of Taxation (LL.M.) from New York University School of Law.

Mr. Bergman is recognized as a leading retirement tax-planning expert and has lectured attorneys on the legal and tax aspects of Self-Directed IRA LLC and Solo 401(k) Plans. Mr. Bergman has also been retained by several leading IRA custodians, including Entrust, to offer expertise on the Self-Directed IRA structure. Mr. Bergman is a member of the Tax Division of the American Bar Association and New York State Bar Association.

The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP.

IRA Financial Group is the market’s leading “checkbook control” Self Directed IRA and Solo 401(k) Plan provider. IRA Financial Group has helped thousands of clients take back control over their retirement funds while gaining the ability to invest in almost any type of investment, including real estate without custodian consent.

To learn more about the IRA Financial Group please visit our website at http://www.irafinancialgroup.com or call 800-472-0646.

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Jul 13

What You Need To Know About Using Retirement Money For Business Funding

For most would-be entrepreneurs, the hardest part is not coming up with a business idea or a potential business to buy, but finding the cash needed to start or buy a business. After taking an inventory of their personal finances, the next step on the financing train is usually family and friends. If the train needs to keep moving, the next stop for potential financing is typically a bank or hard money lender that can provide a small business loan. Often this is where the financing train runs out of track.

The good news for many entrepreneurs is that there are a number of legal ways to use retirement funds to buy a business or franchise, although these opportunities do come with substantial downside that must be well examined. Buying or starting a business is not without risk. The Small Business Administration (SBA) keeps the statistics on business failures and claims that more than half of new businesses will disappear in the first five years.

Here is a look at the most common ways to use retirement funds to buy or start a business:

Take a Taxable Distribution: If the funds are in a individual retirement account (IRA) the funds can always be taken as a taxable distribution. The downside is that a pre-tax IRA would trigger an ordinary income tax on the amount of the distribution and a 10% early distribution penalty if the individual taking the distribution is under the age of 59½. In the case of a Roth IRA (after-tax), the funds can be distributed tax-free if the Roth IRA holder is over the age of 59½ and the Roth IRA has been opened for at least five years. If the Roth IRA holder is under the age of 59½, the 10% early distribution penalty would apply on the Roth earnings. Taking an IRA distribution is certainly not the most tax efficient way to use retirement funds to buy a business, but, based on the amount of funds needed for the business and the age of the IRA holder, it could end up being the wisest decision.

401(k) Loan Option: Many 401(k) qualified retirement plans offer a loan feature, which allows a plan participant to borrow the lesser of 50% of their plan account value or $50,000. The loan does have to be paid back over a five year period, at least quarterly and at an interest rate of at least Prime as per the Wall Street Journal, which as of June 30, 2015 is 3.25%. The advantage of using the 401(k) loan feature is that the plan participant would be able to get tax-free and penalty-free use of up to $50,000 of retirement funds, which can be used for any purpose including for the purchase of a business. The downside is that the loan is capped at $50,000 or 50% of the plan account value and the loan need to be paid back over a five-year period. The 401(k) plan loan feature can work well if one is in need of a small amount of money for the purchase of a business, but for many entrepreneurs, the maximum loan amount available would not be sufficient which makes the loan option an unviable option.

ROBS: The Rollover Business Startup Solution (“ROBS”) is a controversial retirement structure that allows one to use rollover retirement funds to purchase a business tax-free. The controversy stems from the fact that although the structure is based off a provision in the Internal Revenue Code (IRC 4975(d)(13)) and has been confirmed to be legal by the Internal Revenue Service (IRS), it continues to be on the radar of the IRS and Department of Labor (DOL).

The ROBS arrangement typically involves rolling over a pre-tax IRA or 401(k) plan account into a newly established 401(k) plan, which is sponsored by a “C” Corporation and then investing the rollover funds in the stock of the “C” Corporation. The individual retirement account holder can then earn a reasonable salary as an employee of the business. The advantage of the ROBS solution is that it does allow one to use all their pre-tax IRA or 401(k) funds to buy a business that they will be involved in personally as an employee without tax or penalty.

The downsides are numerous. First, the ROBS solution requires the use of a “C” Corporation, which is treated as a completely separate taxpayer from its owners, whereas, a sole proprietorship, LLC, or “S” Corporation are treated as pass-through entities for tax purposes. In other words, a “C” Corporation would impose two taxes on corporate earnings: a corporate level tax and a shareholder tax on the dividends received. In comparison, for a pass-through entity, such as an LLC, the profits bypass taxation at the corporate level and are distributed and taxed at the owner’s level. It is important to note that it can be argued that the double taxation handicap does not impact retirement accounts (i.e. 401(k) plans) as much as individuals, since the dividend from the “C” Corporation to the 401(k) plan shareholder would be exempt from tax since a 401(k) plan is a tax-exempt retirement account. However, the double taxation is not eliminated but simply deferred until the 401(k) plan participant elects to take a 401(k) plan distribution, which would generally be subject to a second tax.

The ROBS solution also requires the use of a 401(k) plan, which brings with it some additional costs and compliance issues. Even though 401(k) plan administration costs have come down significantly over the years, there is still the cost of offering a 401(k) plan to employees, which needs to be balanced with the advantage of offering 401(k) plan benefits to employees. In addition to having to potentially make a minimum 3% safe harbor contribution, as many small business 401(k) plans opt to become safe harbor plans, 401(k) plans cost money to administer because there are many compliance issues that have to be monitored, as well as many ongoing service and administration functions that must be provided. It is not uncommon for a small business 401(k) plan to cost anywhere from $750-$1500 annually for plan testing and recordkeeping.

Third, establishing a ROBS solution could lead to an IRS audit. We know that the IRS and DOL have been looking at the promoters of ROBS plans as far back as 2005 because of some of the abuses they perceived were occurring. The IRS outlined their concerns in a October 31, 2008 memorandum titled, “Guidelines regarding rollovers as business start-ups.” The IRS stated that while this type of structure is legal and not considered an abusive tax avoidance transaction, the execution of these types of transactions, in many cases, have not been found to be in full compliance with IRS and The Employee Retirement Income Security Act of 1974 (ERISA) rules and procedures. In the “Memorandum,” the IRS highlighted two compliance areas that they felt were not being adequately followed. The first area of concern the IRS highlighted was the lack of disclosure of the adopted 401(k) Plan to the company’s employees, and the second area was establishing an independent appraisal to determine the fair market value of the business being purchased. In sum, the IRS was concerned that people were using their retirement funds to buy a business and that ultimately the business was not being purchased and the individual then used the funds for personal purposes, thus avoiding tax and potential penalties. Additionally, the business that was purchased closed, and the retirement account liquidated, thus leaving the IRS without the potential to tax the retirement account in the future.

The IRS did not publicly comment on the ROBS solution again until August 27, 2010, almost two years after publishing the “Memorandum,” when the IRS held a phone forum open to the public which covered transactions involving using retirement funds to purchase a business. Monika Templeman, Director of Employee Plans Examinations, and Colleen Patton, Area Manager of Employee Plans Examinations for the Pacific Coast, spent considerable time discussing the IRS position on this subject. The IRS again aired their concerns about the ROBS solution and the potential for abuse, but did confirm that the structure was not considered illegal or prohibited if done correctly. That being said, the IRS’ primary concern with the ROBS solution is directly tied into the SBA statistics on new business failures. Most people don’t think of the IRS as their partner in their retirement accounts, but that is the reality. For pre-tax retirement funds, the IRS permitted the IRA holder to receive a tax deduction for the amounts contributed, but will force the IRA holder to take a required minimum distribution (RMD) beginning at age 70½ and pay tax on the RMD amount. Imagine how the IRS feels when the IRA holder takes the majority of his/her pre-tax retirement funds and invests it in a business that untimely fails. The IRS has now lost any potential tax revenues resulting from RMDs because the funds were lost. In contrast, if the IRA holder purchased stocks, mutual funds, or even real estate, the account would fluctuate in value, but would likely not be lost.

This article originally appeared in Forbes by IRA Financial Group tax partner Adam Bergman.  For more information, please contact us @ 800.472.0646.

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Jun 30

Choosing The Right Solo 401(k) Plan For Your Business

The Solo 401(k) plan, also known as an individual 401(k) or self-employed 401(k) plan, is an IRS-approved retirement plan which is suited for business owners who do not have any full-time employees, other than themselves and perhaps their spouse. The Solo 401(k) plan is not a new type of plan; It is a traditional 401(k) plan covering only one employee. However, not all Solo 401(k) plans are the same.

When it comes to deciding what type of Solo 401(k) plan is best for your business, it is important to look at all the options the plan provides to make sure it will satisfy your retirement planning, tax, and investment goals.

Most financial institutions, such as Charles Schwab or E-Trade, offer Solo 401(k) Plans, often called individual 401(k) Plans. However, these plan documents, which are often free of charge, will restrict your plan investment options and typically only allow you to buy traditional equities or mutual funds, financial products that generate commissions and fees for the institution. For example, a 401(k) retirement plan established using E-Trade plan documents would not allow you to make any alternative asset investments, such as real estate.

Choosing The Right Solo 401(k) Plan For Your BusinessThe reason behind this is simple – traditional financial institutions and banks make money when you buy stocks and mutual funds, not when you buy real estate. That being said, if the only investments you want to do with your Solo 401(k) plan are stocks or mutual funds, then selecting a financial institutional would likely be a wise and cost-effective choice. However, if you were considering making alternative asset investments, such as real estate, in your Solo 401(k), you would likely want to consider the self-directed Solo 401(k) Plan.

In general, the determination of which of the features addressed below are available in a Solo 401(k) Plan depend on the plan documents. Below is a summary of the most popular features available in a Solo 401(k) plan, which may help you decide between a financial institution-directed Solo 401(k) or an open architecture self-directed Solo 401(k) plan.

High Annual Tax-Deductible Contributions: For all Solo 401(k) Plans, under the 2015 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000. That amount can be made pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $53,000, an increase of $1,000 from 2014. For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can be made pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $59,000, an increase of $1,500 from 2014.

Tax-Free Loan: Most financial institution and bank adopted Solo 401(k) Plan documents offer no loan feature, while the majority of self-directed Solo 401(k) plan documents offer a loan feature. Thanks to the 2001 Economic Growth Tax Relief and Reconciliation Act (“EGTRRA”), a Solo 401(k) plan is able to offer a plan participant the ability to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose, including paying credit card bills, mortgage payments, personal or business investments, a car, vacation, or anything else. The loan has to be paid back over a five-year period at least quarterly at a minimum interest rate, which as of June, 1 2015 is 3.25%, the Prime interest rate as per the Wall Street Journal (you have the option of selecting a higher interest rate)

Investment Diversification: The most notable benefit of establishing a self-directed Solo 401(k) Plan is that it offers a wide array of investment opportunities, such as real estate, precious metals, hard money loans, private business investments, tax liens, and much more. One lesson of the 2008 financial crisis has been the importance of having some investment diversification in your retirement portfolio.

While I am a tax attorney and not a financial advisor, I think it is safe to say that when one diversifies their retirement assets into other asset classes, any potential investment risk is spread around. The more places one invests their retirement assets, the less chance that the overall retirement portfolio will take a big hit when any single asset class slumps. Furthermore, many alternative assets have an underlying physical value. For example, when you buy stocks and bonds, you ultimately own pieces of paper. Buying real estate or IRS approved precious metals or coins gives you an intrinsically valuable asset that has a use above and beyond its investment value. Of course, one should discuss any investment opportunity with a financial advisor or attorney, but establishing a self-directed Solo 401(k) plan does at least offer an individual investor that ability to make traditional as well as alternative assets with their retirement funds.

Roth Contributions & In-Plan Conversions: Most financial institution adopted Solo 401(k) Plans do not allow for Roth (after-tax) contributions or in-plan Roth conversions for fear of complicating plan recordkeeping. The concern is that offering a Roth feature would cause added complexity for purposes of managing pre-tax and Roth account funds in the plan. However, almost all self-directed Solo 401(k) plan documents offer a built in Roth sub-account which can be contributed to without any income restrictions.

For 2015, a plan participant can make a Roth 401(k) plan employee deferral contribution of up to $18,000, or $24,000 if over the age of 50. Any employer profit sharing contributions made can then be converted to Roth. Most self-directed Solo 401(k) plan document providers recommend that the plan participant open two separate plan bank accounts, one for the pre-tax funds and one for the Roth funds. In addition, the majority of Solo 401(k) plans that offer Roth contributions will also provide for in-plan Roth conversions, which allows a plan participant to convert pre-tax 401(k) funds to Roth without any plan-triggering event. However, the Solo 401(k) Plan participant must pay income tax on the amount converted.

“EZ” Administration: One of the primary reasons the Solo 401(k) Plan has become the most popular plan for the self-employed is that they are so easy to operate. There is generally no annual filing requirement unless your solo 401(k) Plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).

No Tax On Real Estate Financing: Since a financial institution or bank established Solo 401(k) Plan does not allow for real estate investments, you would not be able to benefit from the ability to use non-recourse financing tax-free when making real estate investments with Solo 401(k) retirement funds. A non-recourse loan is a loan that is not personally guaranteed by the borrower and is secured by the underlying asset. A non-recourse loan is the only type of loan that can be used to purchase real estate with retirement funds as using a traditional recourse mortgage would trigger the IRS prohibited transaction rules. In general, a 401(k) plan that uses a non-recourse loan to purchase real estate will not be required to pay any tax on the leverage used. This is in contrast to an IRA that would be subject to the Unrelated Debt Financed Income (“UDFI”) rules – a type of Unrelated Business Taxable Income (also known as “UBTI or UBIT”) on which taxes must be paid. The UBTI tax is approximately 40% for 2015. But, with a Solo 401(k) plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax and investment advantages for using a Solo 401(k) Plan versus an IRA to purchase real estate.

The Solo 401(k) plan is designed explicitly for small, owner only business. Whatever type of Solo 401(k) plan you elect to establish, a Solo 401(k) plan offers self-employed individuals and small business owners with no third-party employees significantly greater retirement benefits than an IRA or even a SEP IRA.

For more information, please contact a 401(k) Expert @ 800.472.0646!

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