IRA Contribution Limits for 2017 – Unchanged at $5,500 and $6,500; 401(k) Limits Unchanged Also

Posted by James M. Carlson
Oct 31 2016

Inflation was approximately .3% for the fiscal quarter ending September 30, 2016, so many of the IRA and pension limits as adjusted by the cost of living factor have not changed or the changes have been quite small.

The maximum IRA contribution limits for 2017 for traditional and Roth IRAs did not change – $5,500/$6,500.

The 2017 maximum contribution limit for SEP-IRAs is increased to $54,000 (or,25% of compensation, if lesser) up from $53,000. The minimum SEP contribution limit used to determine if an employer must make a contribution for a part-time employee remains the same at $600.

The 2017 maximum contribution limits for SIMPLE-IRAs is unchanged at $12,500 if the individual is under age 50 and$15,500 if age 50 or older.

The 2017 maximum elective deferral limit for 401(k) participants is unchanged at $18,000 for participants under age 50 and $24,000 for participants age 50 and older.

  

 

 

Categories: Pension Alerts, Roth IRAs, SIMPLE IRAs, Traditional IRAs

Financial Institution Must Notify DOL It Will Use BICE And Must Comply With Record Keeping Requirements

Posted by James M. Carlson
Sep 28 2016

In order to use the BICE a financial institution must notify the DOL by providing an email to e-bice@dol.gov that it will to use the BICE. The notice can be generic. That is, it need not mention any specific IRA or any specific plan. If the notice requirement has been met, then the financial may receive compensation. The notice remains in effect until it would be revoked by the financial institution.

The financial institution must maintain for six years the records necessary for certain persons to determine whether the conditions of the BICE have been met with respect to each specific transaction. Upon request the following individuals must have the right to exam these records during normal business hours:

  1. Any authorized employee or representative of the IRS
  2. Any plan fiduciary which has participated in an investment transaction pursuant to the BICE
  3. Any authorized employee or representative of a plan fiduciary which has participated in an investment transaction pursuant to the BICE
  4. Any contributing employer and any employee organization whose employees or members are covered by the plan
  5. Any authorized employee or representative of a contributing employer and any employee organization which has participated in an investment transaction pursuant to the BICE

Any IRA owner or plan participant or inheriting beneficiary or an authorized representative of such persons.

None of the non-IRS individuals are authorized to examine records regarding a recommended transaction of another retirement investor, privileged trade secrets or privileged commercial or financial information of the financial institution or information identifying other information.

When a financial institution refuses to furnish requested information for a reason state above, it has 30 days in which to inform the requester of the reasons for denying the request and that the DOL if requested could request such information.

If the required records are not maintained, there is a loss of the exemption only for that transaction or transactions for which the records are missing or have not been maintained. Other transactions will still qualify for the BICE if those records are maintained. If the records are lost or destroyed, due to circumstances beyond the control of the financial institutions, then no prohibited transaction will be considered to have occurred solely on the basis of the unavailability of those records.

The financial institution is the party who is responsible to pay the ERISA civil penalty under section 502 or the taxes under section 502 or the taxes under section 4975 if the required records are not maintained

Categories: Pension Alerts, Traditional IRAs

Election Day November 8th, 2016 and the Politics of IRAs.

Posted by James M. Carlson
Sep 21 2016

You and other voters will go the voting booth on November 8th, 2016.

IRAs are political because they are created by the federal income tax laws. IRA owners receive tax preferences for making various types of IRA contributions or because the IRA has received a direct rollover or rollover contribution from a 401(k) plan or another employer sponsored retirement plan.

The federal deficit is a political issue waiting to be addressed. More and more politicians are starting to seriously look at IRAs and 401(k) plans as sources of tax revenues. Money in traditional, SEP and SIMPLE IRAs is tax deferred, it is not tax-free. When distributed or withdrawn, the distribution amount must be included in the recipient's income and tax paid at the person's applicable marginal income tax rate.

There is approximately 7.2 trillion dollars in traditional IRAs. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.4 trillion dollars from future IRA distributions. There is approximately 6.8 trillion dollars in 401(k) and other defined contribution plans. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.3 trillion dollars from future 401(k) distributions. The federal debt is estimated to be 19.5 trillion dollars as of September 30, 2016. IRAs and 401(k) plans cover 13.8% of the federal debt.

The question is, when will these tax revenues be collected?

Some politicians are starting to suggest the IRA rules need to be changed so the federal government starts to collect tax revenues sooner than under existing law.

Senator Ron Wyden represents the State of Oregon. He is a Democrat. There is a 50% chance he will become the chairman of the Senate Finance Committee in 2017 after the November 8th elections. He recently communicated that he and other Democrats will be pursuing the following IRA law changes.

  1. With respect to inherited IRAs, the 5-year rule would apply once an IRA owner dies. This would be a monumental change. A traditional IRA beneficiary would have 5-6 years to take distributions, include such amounts in income and pay tax. The ability to stretch out distributions over the beneficiary's life expectancy would be repealed. A Roth IRA beneficiary would lose the right to have the Roth IRA earn tax-free income for a period equal to his or her life expectancy. The beneficiary would be given only 5-6 years of tax-free income
  2. It is unclear if everyone would lose the right to make Roth IRA conversion contributions or if a person with traditional IRA funds could make a conversion contribution but only to the extent the IRA funds are taxable. That is, a person with basis in his/her IRA or pension plan could not convert any basis. The Obama administration has previously proposed not allowing basis within an IRA to be converted. A total repeal of the right to make a Roth IRA conversion contribution would be radical.

    At least on a short term basis, the federal government likes it when individuals make Roth IRA conversion contributions as tax revenues are collected.

  3. There would be a new tax rule stipulating that the maximum value of a person's Roth IRAs would be limited to $5,000,000 and if this limit was exceeded then the excess would have to be withdrawn. This also would be a radical change.
  4. A non-IRA change would be to change the law governing 401(k) plans. Somehow a person making student loan payments would be given credit under their 401(k)plan so that the loan payments would be treated as an elective deferral contributions so that an employer would have to make a matching contribution.

In summary, IRAs are political. As with other political subjects, each person will need to make their own voting decisions. Taking away IRA tax preferences is in essence a tax increase and individuals will need to decide the degree it will influence how they will vote. We at CWF believe switching to the 5-year rule for an inherited IRA beneficiary should be unacceptable.

Categories: Pension Alerts, Traditional IRAs

IRS Issues Additional Procedure For Waiver of 60-Day Rollover Requirement and Additional Self-Certification Procedure

Posted by James M. Carlson
Aug 15 2016

The IRS issued Revenue Procedure 2016-47 on August 24, 2016. It modifies Revenue Procedure 2003-16. The IRS now in the course of a examining a taxpayer’s individual tax return may determine that the person qualifies for a waiver of the 60-dayrollover requirement.

The IRS has created a third waiver method. The new waiver method is effective on August 24, 2016. The first waiver method set forth in Revenue Procedure 2003-16 requires the taxpayer to file an application requesting a waiver of the 60-day rule and the IRS must grant the waiver. The second waiver method authorizes an automatic waiver of the 60-day rule if four requirements are met.

Why this new IRS procedure?
In January of 2016 the IRS changed the filing fees that a taxpayer must pay when submitting his or her waiver application. In 2015, the filing fee was $500 if the purported rollover was less than $50,000, $1,500 if the rollover amount was less than $100,000 but equal to or more than $50,000 and $3,000 if the rollover amount was $100,000 or more.

The IRS increased the fee to $10,000 for all such waiver applications. Apparently the IRS concluded that it no longer could afford to assign the personnel it had assigned to process these waiver requests. Presumably, many taxpayers and tax professionals have expressed their dissatisfaction to the IRS. The $10,000 filing fee means many taxpayers are no longer able to have the IRS process their application and receive a concrete ruling that they were or were not entitled to a waiver of the 60-day rule. The application process provided a taxpayer with tax certainty.

In Revenue Procedure 2016-47 the IRS authorizes a self-certification procedure that a taxpayer may use to request the waiver of the 60-day requirement rather than using the application procedure.The IRS tentatively grants the waiver upon the making of the self-certification and the taxpayer is permitted to prepare his or her tax return to reflect that he or she made a complying rollover so the distribution amount is not required to be included in his or her taxable income. However, the IRS retains the right to examine the individual’s tax return for such year (i.e. Audit) and determine if the requirements for a waiver of the 60-day rule were or were not met. If the IRS determines the individual was not entitled to a waiver of the 60-day rule, the individual will have to include such distribution in his or her income and will have an excess IRA contribution situation needing to be corrected. The IRS explanation gives a limited discussion of the adverse consequences. If the IRS does not grant the waiver then the person may be subject to income and excise taxes, interest and penalties. One of the penalties which might apply would be the 25% tax for understating one’s income.

This self-certification procedure applies to distributions from any type of IRA and also from a 401(k) plan or other qualified plan and certain 403(b) and 457 plans.

The IRS has stated that it will be modifying the Form 5498 so that an IRA custodian which accepts a rollover contribution pursuant to this self-certification procedure after the 60-day deadline will complete such person’s Form 5498 to report that the rollover contribution was accepted after the 60-day deadline. The IRS will then be able to examine the tax returns of these taxpayers and the purported rollovers.

How does this self-certification procedure work?
The IRA owner will furnish the IRA custodian/trustee with a written certification meeting the following requirements. The IRA owner may use the IRS’ model letter set forth in the appendix of Revenue Procedure 2016-47 on a word-for-word basis or by using a form or letter that is substantially similar in all material respects.

The requirements:

  1. The IRS must not have previously denied a waiver with respect to a rollover of all or part of the distribution involved in the late rollover
  2. The IRA owner must make his or her rollover contribution as soon as practicable once the reason(s) for missing the 60-day deadline no longer apply. This requirement is deemed satisfied if the rollover contribution is made within 30 days after the reason or reasons no longer prevent the IRA owner from making the rollover contribution.
  3. The taxpayer must have missed the 60-day deadline for one or more of the following reasons:
  • An error was committed by the financial institution making the distribution or receiving the contribution
  • The distribution was in the form of a check and the check was misplaced and never cashed
  • The distribution was deposited into and remained in an account that you mistakenly thought was a retirement plan or IRA
  • Your principal residence was severely damaged
  • One of your family members died
  • You or one of your family members were seriously injure
  • You were incarcerated
  • Restrictions were imposed by a foreign country
  • A postal error occurred
  • The distribution was made on account of an IRS levy and the proceeds of the levy have been returned to you
  • The party making the distribution delayed providing information that the receiving plan or IRA required to complete the rollover despite my reasonable efforts to obtain the information.

A person whose reason for missing the 60-day requirement is not included in the list of reasons is unable to use this self-certification procedure. The IRA custodian is authorized to rely on the IRA owner’s self-certification for purposes of accepting the rollover and reporting it unless it has actual knowledge contrary to the self-certification.

The IRS has created this self-certification method because it had to have some alternative procedure to allow taxpayers to seek a waiver of the 60-day rule as discussed in Revenue Procedure 2003-16 as the increased filing fee meant most taxpayers no longer would be using the application process.

This new procedure will help some taxpayers, but it would not have been needed if the IRS would not have imposed the $10,000 filing fee. One can hope the IRS will see reason and will reduce the fees for 2017. Most likely the IRS will not. Although the 11 reasons the IRS lists as warranting the waiver of the 60-day rule are certainly welcomed by taxpayers, there are certainly other reasons for which the IRS should grant relief

Categories: Pension Alerts, Traditional IRAs

Planning Suggestion for an IRA Beneficiary Designation-Consider the Primary Beneficiary Might Want to Disclaim

Posted by James M. Carlson
Jul 11 2016

An IRA accountholder should almost always designate a primary beneficiaryand also designate one or more contingent beneficiary(ies). In some older IRA files the IRA accountholder has not designated a contingent beneficiary. In such situation, almost all IRA plan agreement forms provide that the IRA funds will then be paid to the decedent's estate. Tax options are not as many or as beneficial when an estate is the inheriting IRA beneficiary.

Be nice to your IRA clients and remind them periodically they should review and update their beneficiary designations, if appropriate. Of course, your IRA accountholders should be seeking the guidance of their legal and tax advisers.

Situation. John and Mary are now intheir 80's. Mary has $115,000 in her IRA. John has his own IRA with a balance approximating $75,000. Each has designated the other as their IRA beneficiary, but they did not designate any contingent beneficiaries. They have two daughters and a son. Mary died on July 8, 2016.

John has come into the bank because he wants these funds to go to the three children rather than himself. He believes this is what Mary wanted. That is, he wants three inherited IRAs set up for the three children.

The IRA custodian must not accommodate him. It would be tax fraud. It cannot be done since Mary had not designated the children as her contingent beneficiaries. If she would have designated the three children as her contingent beneficiaries and then John would have executed a valid disclaimer, then the desired result of having these IRA funds be inherited by the three children could have been realized. But this was not done.

If John executes the disclaimer now, Mary's estate will inherit her IRA and would have to comply with the RMD' rules applying to an estate beneficiary. John most likely would be making the situation worse. He will be better-off if he elects to treat Mary's IRA as his own and then withdraws only the RMD each year. He will, of course, name his three chi-dren as his IRA beneficiaries.

In summary, be nice to your IRA clients and remind them periodically they should review and update their beneficiary designations. In order to retain the flexibility of a primary beneficiary disclaiming his or her interest, one or more contingent beneficiaries need to have been designated by the deceased IRA accountholder. If so, additional planning options are then available

Categories: Pension Alerts, Traditional IRAs

More Wealthier Individuals Should Be Making Nondeductible Traditional IRA Contributions - They Just Need Some Help and You Can Provide It

Posted by James M. Carlson
Jun 07 2016

Wealthier individuals should be rushing to their bank to make a non-deductible IRA contribution. This is certainly true if they are a 401(k) participant.

This author admits his bias, many individuals should be making non-deductible traditional IRA contributions and they don’t do so because they (and their advisors) many times don’t understand the benefits, including how the related tax rules apply.

Every person should contribute as much as possible to a Roth IRA. Why? There are very few times under US income tax laws where INCOME is not taxed. That is, no taxes are owed with respect to Roth IRA funds if the Roth owner has met a 5-year rule and is age 59½ or older or the Roth owner is a beneficiary who has inherited the Roth IRA and the 5-year rule has been met.

The federal tax laws have been expressly written to make it impossible for a person with a high income to make an annual Roth IRA contribution. Some people (i.e. many Democrats) don’t want “wealthier” individuals to gain the benefit of contributing funds to a Roth IRA and earning tax-free income. They want them to pay more income taxes. A person who had tax filing status of single was ineligible to make a 2015 Roth IRA contribution if his or her MAGI (modified adjusted gross income) was $132,000 or more. A person who had filing status of married filing jointly was ineligible to make a 2015 Roth IRA contribution if the couple’s MAGI (modified adjusted gross income) was $193,000 or more. A person who had filing status of married filing separately was ineligible to make a 2016 Roth IRA contribution if his or her MAGI (modified adjusted gross income was $10,000 or more.

For discussion and illustration purposes, we will assume that Jane Doe has the following situation. She is age 54. She is married. Her husband, Mark Doe, is a bank president. He is age 57. Their joint income is sufficiently high that neither one of them is eligible to make an annual Roth IRA contribution. Their joint income is sufficiently high that neither one of them is eligible to made a deductible traditional IRA annual contribution.

This article is going to discuss the question, “should these two each make a non-deductible traditional IRA contribution?” The primary concern is Jane’s situation, but we will also discuss Mark’s situation.

For the reasons discussed below, both should make a maximum non-deductible traditional IRA contribution until each is no longer eligible to make a traditional IRA contribution (i.e. the year a person attains age 70½).

On March 15, 2016, Jane contributed $6,500 to a traditional IRA she had established in 1984. She designated her contribution as being for 2015. The IRA balance at the time of contribution was $8,500. With the addition of her $6,500 contribution the IRA balance became $15,000. Since then the account has earned $40 of interest.

It is now assumed that Jane has no other IRA funds in any traditional, SEP or SIMPLE IRAs. The IRA taxation rules require in applying the taxation rules that all non-Roth IRA funds be aggregated. One cannot avoid the pro-rata taxation rule by setting up separate IRAs or having separate time deposits.

The couple’s tax preparer has recently informed Jane that her contribution is non-deductible as her husband participates in a 401(k) plan and their MAGI is sufficiently high that they are not permitted to claim any tax deduction for her $6,500 contribution. What tax options are available to her? What options are unavailable to her?

  1. She may not use the recharacterization rules to make her traditional IRA contribution a Roth IRA contribution as their 2015 MAGI is too high
  2. There is no IRS guidance allowing the IRA custodian to switch the year for which the IRA contribution was made from 2015 to 2016
  3. The IRS has issued rules allowing her to withdraw her 2015 IRA contribution with no adverse tax consequences as long as she does so by 10-15-16, no deduction is claimed on the 2015 tax return and the related income is withdrawn. If she withdraws her $6,500 contribution she is required to withdraw the related income and it is taxable for 2016 since the contribution was made in 2016. The related income is a pro-rata amount of the $40 determined as follows: 6500.15000 x $40 = $17.33. Since she is younger than age 59½ she does owe the 10% additional tax on this $17.33. The bank as the IRA custodian will prepare a 2016 Form 1099-R inserting the codes (81) in box 7, box 1 would show $6,517.33 and box 2a would show $17.33
  4. In 2016 she is eligible to make a Roth IRA conversion of any amount in the range of $.01 to $15,040. If she would convert $15,040 into her Roth IRA she/they would include in income on their 2016 tax return the amount of $8,540. She as many taxpayers does not want to include the $8,540 in her/their income and pay tax on it.

Jane as many taxpayers would like to convert only her non-deductible contribution of $6,500. This would allow her to pay no taxes since she would not be converting any of the $8,540.

The tax rules require use of the standard pro-rata taxation rule when an IRA has taxable funds and non-taxable funds. If she converts $6,500, a portion would be taxable and a portion would not be. The taxable portion is: $6,500 x $8,540/$15,040 ($3,690.82) and the non-taxable portion is $6,500 x $65,00/15,040 ($2809.18) . Jane made a nondeductible IRA contribution for 2015. She is required to file Form 8606 and attach to the couple’s Form 1040. If it was not filed with the original return, an amended tax return should be filed and the 2015 Form 8606 attached. She is not relieved of this duty because she withdraws the $6,500 or converts it. A $50 penalty applies to a person who fails to file Form 8606 unless she could show a reasonable cause why she did not file it. A person must pay a $100 penalty if a person overstates the amount of nondeductible contributions.

Note that Jane will also be required to file a 2016 Form 8606 regardless if she withdraws a portion or all of the $6,500.

Having to include in income the amount of $8540 and pay tax on this amount should not influence Jane or any other wealthy person to not make non-deductible contributions. But it does. Tax on $8540 should not be that material to a couple who are ineligible to make annual Roth IRA contributions.

From a practical standpoint, Jane could convert her traditional IRA over a 2-4 year time period to lessen the amount of income which would be taxed each year.

The best of all “planning” situations would be if Jane would either work for an employer that had a 401(k) plan written to accept rollovers from traditional IRAs or if she could work for the bank and become eligible under the bank’s 401(k) plan. Why? If Jane was a participant of a 401(k) plan, the tax rules have been so written that if she wants to make a rollover contribution, the amount rolled over “first” is the taxable portion. The prorate rule does not apply in this situation.

If Jane only rolls over $8,540, this means that the $6,500 remaining in the IRA are non-taxable. She may then convert such amount to a Roth IRA. This is her goal, this any person’s goal.

In summary, Jane wants to make as make non-deductible IRA contributions (currently $6,500 but his amount which change as it is indexed for inflation) as she can between ages 54-701/2 because she should convert all such funds into a Roth IRA.

What about her husband, Mark? He too wants to make the maximum amount of nondeductible IRA contributions from ages 57-70½ and at some point convert such contributions to a Roth IRA. The sooner the conversion can be completed the better as the earnings realized after the conversion will be tax-free if the qualified distribution rules are met.

Most likely Mark participates in a 40(k) plan which will allow him to move “taxable” IRA money into his 401(k) account. If not, he probably has the ability to rewrite the plan so he would have this right.

The 401(k) plan in which he participates may allow him to make Designated Roth deferrals and he exercises that right to the maximum. This would be $24,000 for 2016 ($18,000 + $6,000). Good for him. But why not contribute an additional $6,500 to his traditional IRA as a non-deductible contribution and convert it? Contributing $6500 for 12 years would result in an additional $78,000 in a Roth IRA.

In summary, Mark too should want to make as many non-deductible traditional IRA contributions as he is eligible for until he is no longer eligible to make traditional IRA contribution.

Categories: Pension Alerts, Traditional IRAs

Warning – Determine if Your IRA Processor Has Prepared Some of Your Institution’s 5498 Forms Incorrectly

Posted by James M. Carlson
Jun 07 2016

An IRA custodian called CWF with the following situation/question. Jane Doe has her own personal traditional IRA and she has an inherited traditional IRA arising from her mom. The IRA processor prepared just one combined 2015 Form 5498. Is this correct or permissible?

It is incorrect. Two 5498 forms must be prepared. It is understandable why a software engineer would think that it is better and simpler if just one form 5498 record is prepared rather than multiple forms. It is not simpler. The IRS rules do not permit aggregation of the data when there are multiple IRA plan agreements. The IRS has had the rule for a long time that contributions, distributions and fair market value statements are prepared and reported on a per plan agreement basis.

IRA tax data may be aggregated on a per IRA plan agreement basis, but it is not permissible to aggregate data from multiple IRA plan agreements. For example, Jane Doe age 53 has IRA Plan #1 and makes three $2,000 contributions for tax year 2015 on 3/10/15, 9/10/15 and 3/1/16 and she made a rollover contribution from a 401(k) plan to IRA Plan #1 of $12,000 on 6/10/15 and another rollover contribution from her 401(k) plan of $23,000 on 10/10/15. Box 1 will be completed with $6,000 and box 2 will be completed with $35,000.

As the discussion below illustrates, there is tax logic to the rule that there must be a separate IRA reporting form prepared on a per IRA plan agreement basis rather than allowing the reporting entity to aggregate the information and then furnish one form.

For example, Jane Doe has her own traditional IRA and she has has also inherited her mom’s traditional IRA. There must be two also separate 5498 forms prepared for her. For income taxation purposes she does not aggregate her IRA with the inherited IRA from her mother.

Preparation of a combined Form 5498 is a violation of IRS requirements. The IRS has the authority to assess a fine of $50 for each incorrect form and $50 for each missed form. Remember, the fines are doubled in the sense that one form goes to the IRS and one copy to the individual. Most likely the processor in its contract tries to have the IRA custodian be liable for this type of mistake. It’s CWF opinion that if the processor has written its software to not comply, it should be liable for any IRS fines.

What tax harm is being caused by such impermissible aggregation?

A person must do separate tax calculations for distributions from personal IRAs and inherited IRAs. This capability is lost if the data is aggregated.

If two 5498 forms both show a rollover contribution, most likely the IRS will determine that only one of them qualifies to be a rollover contribution because of the once per year rule and the other would be a taxable distribution. This audit capability is lost if there is just one combined Form 5498 prepared. The IRS prepares many statistical studies based on the info set forth on the 5498 forms. Many analytic capabilities are lost if there is not one Form 5498 prepared for each plan agreement.

Categories: Governmental Reporting, Pension Alerts, Traditional IRAs

CWF's Guidance on Transfers and Direct Rollovers

Posted by James M. Carlson
Jun 02 2016

Direct rollovers from 401(k) plans into traditional IRAs average more than $75,000.

The tax rules applying to a transfer contribution are very different from those applying to rollover contribution (direct or indirect).

Procedures must exist to minimize IRA custodian errors. Errors arise because IRA personnel do not understand that the tax rules differ from transfers and direct rollovers. They are not the same and IRA staff sometimes fail to know this.

For example, a check for $65,000 is sent to First State Bank (FSB) fbo Jane Doe's traditional IRA. The personnel of First State Bank process the contribution as a transfer as they forget to ask the question, "what type of plan issued the check?". The problem is, the check was issued because Jane Doe had instructed her former employer's 401(k) plan to directly roll over her 401(k) funds to a traditional IRA. Since the check was processed as a transfer, FSB did not report this contribution on the Form 5498 as a rollover as it is required to do. No doubt the IRS will contact your customer who will contact you and the IRS will be interested in learning why FSB did not report this rollover on the Form 5498.

Solution. Determine that you and your IRA staff know what is needed to be known regarding transfers, direct rollovers and rollovers. We at CWF can assist. Call us at 800.346.3961 or visit our website for information on webinars, IRA Tests, IRA Procedure Manual and IRA Rollover Certification Forms.

If your IRA rollover form has a print or revision date prior to 2015, it is obsolete and should be discarded.

Categories: Pension Alerts, Traditional IRAs

Inheriting HSA Beneficiary - Duty to Prepare Form 8889

Posted by James M. Carlson
May 25 2016

If the HSA owner's surviving spouse is the designated beneficiary, the surviving spouse becomes the HSA owner. Consequently, he or she completes Form 8889 for transactions occurring after the HSA owner's death.

If the HSA owner has designated a non-spouse beneficiary and dies, the HSA ceases being an HSA. If the inheriting beneficiary is not the HSA owner's estate, the beneficiary completes Form 8889 as follows.

  1. Across the top of the form write, “Death of HSA Owner.
  2. At the top the beneficiary will insert his/her name and social security number. Part I (Contributions) is not to be completed. It is to be skipped as no additional HSA contributions may be made by a beneficiary
  3. On line 14a the HSA’s fair market value as of the date of death is inserted. The beneficiary includes this amount in his or her taxable income for the year during the HSA owner died. This is true even if the beneficiary withdraws the funds in a following year. The 20% penalty for non-medical use does not apply. Any earnings realized after the death of the HSA owner are included in the beneficiary's income for the withdrawal year. The HSA Custodian/trustee prepares the Form 1099-SA to report the distribution to the beneficiary for the year during which the withdrawal occurs
  4. The remainder of Part II (Distributions) is to be completed
  5. If the beneficiary pays within one year of the date of death medical expenses incurred by the HSA owner prior to his or her death, then such amount is to be listed on line 15. At times the beneficiary may need to file an amended tax return.

If the inheriting beneficiary is the HSA owner's estate, the final tax return and Form 8889 for the HSA owner as follows.

  1. Across the top of the form write, “Death of HSA Owner.
  2. Part I is to be completed, if applicable. That is, if the HSA owner made contributions prior to his death, they are reported
  3. On line 14a the HSA fair market value as of the date of death is inserted. This amount is included on the deceased HSA owner's final tax return for the year he or she died. This is true even if the personal representative withdraws the funds in a following year.
  4. The remainder of Part II (Distributions) is to be completed
  5. If the estate pays within one year of the date of death medical expenses incurred by the HSA owner prior to his or her death, then such amount is to be listed on line 15. At times the final tax return for the deceased HSA owner may need to file an amended tax return.

There are two times when a person is apparently required to file a paper tax return (versus an electronic filing) and file multiple 8889 forms.

The first situation is the person has his or her own personal HSA and then inherits an HSA. The person must prepare a Form 8889 for each HSA and a summary Form 8889. “Statement is to be written at the top of each of the non-summary 8889 forms. These statements are to be attached to the summary Form 8889. The IRS instructions use the term “controlling 8889”, we prefer “summary 8889.”

Categories: Health Savings Accounts, Pension Alerts

CWF Discusses - Non-Deductible Traditional IRA Contributions by Bank Presidents and other High Income Individuals

Posted by James M. Carlson
May 24 2016

More Wealthier Individuals Should Be Making Non-deductible Traditional IRA Contributions - They Just Need Some Help and You Can Provide It.

Wealthier individuals should be rushing to their IRA custodian/trustee to make a non-deductible IRA contribution. This is certainly true if they are a 401(k) participant.

Many individuals should be making non-deductible traditional IRA contributions and they don’t do so because they (and their advisors) many times don’t understand the benefits, including how the related tax rules apply. Every person should contribute as much as possible to a Roth IRA. Why? There are very few times under US income tax laws where Income is not taxed. That is, no taxes are owed with respect to Roth IRA funds if the Roth owner has met a 5-year rule and is age 59½ or older or the Roth owner is a beneficiary who has inherited the Roth IRA and the 5-year rule has been met.

The federal tax laws have been expressly written to make it impossible for a person with a high income to make an annual Roth IRA contribution. Some people (i.e. many Democrats) don’t want “wealthier” individuals to gain the benefit of contributing funds to a Roth IRA and earning tax free income. They want them to pay more income taxes. A person who had tax filing status of single was ineligible to make a 2015 Roth IRA contribution if his or her MAGI (modified adjusted gross income) was $132,000 or more. A person who had filing status of married filing jointly was ineligible to make a 2016 Roth IRA contribution if the couple’s MAGI was $193,000 or more. A person who had filing status of married filing separately was ineligible to make a 2016 Roth IRA contribution if his or her MAGI was $10,000 or more.

For discussion and illustration purposes, we will assume that Jane Doe has the following situation. She is age 54. She is married. Her husband, Mark Doe, is a bank president. He is age 57. Their joint income is sufficiently high that neither one of them is eligible to make an annual Roth IRA contribution. Their joint income is sufficiently high that neither one of them is eligible to made a deductible traditional IRA annual contribution.

This article is going to discuss the question, “should these two each make a non-deductible traditional IRA contribution?” For the reasons discussed below, both should make a maximum non-deductible traditional IRA contribution until each is no longer eligible to make a traditional IRA contribution (i.e. the year a person attains age 70½).

On March 15, 2016, Jane contributed $6,500 to a traditional IRA she had established in 1984. She designated her contribution as being for 2015. The IRA balance at the time of contribution was $8,500. With the addition of her $6,500 contribution the IRA balance became $15,000. Since then the account has earned $40 of interest. It is now assumed that Jane has no other IRA funds in any traditional, SEP or SIMPLE IRAs. The IRA taxation rules require in applying the taxation rules that all non-Roth IRA funds be aggregated. One cannot avoid the pro-rata taxation rule by setting up separate IRAs or having separate time deposits.

The couple’s tax preparer has recently informed Jane that her contribution is non-deductible as her husband participates in a 401(k) plan and their MAGI is sufficiently high that they are not permitted to claim any tax deduction for her $6,500 contribution. What tax options are available to her? What options are unavailable to her?

She may not use the recharacterization rules to make her traditional IRA contribution a Roth IRA contribution as their 2015 MAGI is too high.

There is no IRS guidance allowing the IRA custodian to switch the year for which the IRA contribution was made from 2015 to 2016.

The IRS has issued rules allowing her to withdraw her 2015 IRA contribution with no adverse tax consequences as long as she does so by 10-15-16, no deduction is claimed on the 2015 tax return and the related income is withdrawn. If she withdraws her $6,500 contribution she is required to withdraw the related income and it is taxable for 2016 since the contribution was made in 2016. The related income is a pro-rata amount of the $40 determined as follows: 6500.15000 x $40 = $17.33. Since she is younger than age 59½ she does owe the 10% additional tax on this $17.33. The bank as the IRA custodian will prepare a 2016 Form 1099-R inserting the codes (81) in box 7, box 1 would show $6,517.33 and box 2a would show $17.33.

In 2016 she is eligible to make a Roth IRA conversion of any amount in the range of $.01 to $15,040. If she would convert $15,040 into her Roth IRA she/they would include in income on their 2016 tax return the amount of $8,540. She as many taxpayers does not want to include the $8,540 in her/their income and pay tax on it. Jane as many taxpayers would like to convert only her non-deductible contribution of $6,500. This would allow her to pay no taxes since she would not be converting any of the $8,540. The tax rules require use of the standard pro-rata taxation rule when an IRA has taxable funds and nontaxable funds. If she converts $6,500, a portion would be taxable and a portion would not be. The taxable portion is: $6,500 x $8,540/$15,040 ($3,690.82) and the non-taxable portion is $6,500 x $65,00/15,040 ($2,809.18) . Jane made a non-deductible IRA contribution for 2015. She is required to file Form 8606 and attach to the couple’s Form 1040. If it was not filed with the original return, an amended tax return should be filed and the 2015 Form 8606 attached. She is not relieved of this duty because she withdraws the $6,500 or converts it. A $50 penalty applies to a person who fails to file Form 8606 unless she could show a reasonable cause why she did not file it. A person must pay a $100 penalty if a person overstates the amount of non-deductible contributions. Note that Jane will also be required to file a 2016 Form 8606 regardless if she withdraws a portion or all of the $6,500.

Having to include in income the amount of $8,540 and pay tax on this amount should not influence Jane or any other wealthy person to not make non-deductible contributions. But it does. Tax on $8,540 should not be that material to a couple who are ineligible to make annual Roth IRA contributions. From a practical standpoint, Jane could convert her traditional IRA over a 2-4 year time period to lessen the amount of income which would be taxed each year.

The best of all “planning” situations would be if Jane would either work for an employer that had a 401(k) plan written to accept rollovers from traditional IRAs or if she could work for the bank and become eligible under the bank’s 401(k) plan. Why? If Jane was a participant of a 401(k) plan, the tax rules have been so written that if she would rollover a portion of the $15,040, the amount rolled over “first” is the taxable portion. The prorate rule does not apply in this situation. If Jane only rolls over $8,540, this means that the $6,500 remaining in the IRA are non-taxable. She may then convert such amount to a Roth IRA. This is her goal, this any person’s goal.

Jane wants to make as many non-deductible IRA contributions (currently $6,500 but his amount which change as it is indexed for inflation) as she can between ages 54-70½ because she should convert all such funds into a Roth IRA. What about her husband, Mark? He too wants to make the maximum amount of non-deductible IRA contributions from ages 57-70½ and at some point convert such contributions to a Roth IRA. The sooner the conversion can be completed the better as the earnings realized after the conversion will be tax free if the qualified distribution rules are met.

Most likely Mark participates in a 40(k) plan which will allow him to move ‘taxable IRA money into his 401(k) account. If not, he probably has the ability to rewrite the plan so he would have this right. The 401(k) plan in which he participates may allow him to make Designated Roth deferrals and he exercises that right to the maximum. This would be $24,000 for 2016 ($18,000 + $6,000). Good for him. But why not contribute an additional $6,500 to his traditional IRA and convert it? Contributing $6500 for 13 or 14 years would result in an additional $84,500 or $91,000 in a Roth IRA. Those individuals attaining age 70 between July and December 31st are eligible to make a contribution for their "70" year whereas those who attain age 70 and 70½ are ineligible.

Be aware that under existing laws Roth IRA funds are ineligible to be rolled over into a 401(k) plan. This is true even for 401(k) plans having Designated Roth features.

Mark too should want to make as many non-deductible traditional IRA contributions as he is eligible for until his 70½ year.

In summary, a bank president and his/her spouse want to make as many non-deductible traditional IRA contributions as possible prior to his/her 70½ year. With some pre-planning, it will be possible to convert these to be Roth IRA conversion contributions.

Categories: Pension Alerts, Traditional IRAs