Don’t let valuable tax deductions go down the drain. Attend our Dec. 11 webinar (or watch the recording) to discuss this content.
By Robert A. Green
Getting through your holiday “to-do” list — sending cards, gift buying, wrapping presents and baking cookies — is important for enjoying the holidays. The list may be long, but if you want gifts from Uncle Sam-ta, here are 6 items to add to it. Just be sure to execute them before year-end.
1. Make portfolio and business transactions for significant tax advantages.
Consider year-end transactions like selling winning or losing investment portfolio or business positions, invoicing clients and purchasing business items. If you are in the top tax bracket, defer income and accelerate expenses to reduce Obama-era tax hikes on income and net investment taxes (the combined federal tax rate is 44%). If you’re in lower tax brackets, accelerate income and defer expenses to utilize potentially wasted itemized deductions and take advantage of lower marginal tax brackets. A Roth IRA conversion is great for soaking up lower tax rates. Learn more in our year-end tax planning blog and webinar.
2. Don’t get caught paying taxes on phantom income. (Ouch! That would hurt.)
If you take a loss on a security toward year-end and buy back a substantially identical position in any of your taxable and/or IRA accounts within 30 days before or after, it’s considered a wash sale loss deferral (and permanently lost with an IRA). Break the chain on wash sales by not buying the position back in 30 days and get credit for the full tax loss in 2014. Business traders should consider a Section 475 MTM election in 2015 to convert year-end wash sale losses on trading positions into business ordinary losses on Jan. 1. Turn garbage into gold!
3. You’ve set up your entity, but unless you execute compensation and employer 401(k) plans before year-end, its employee-benefit plan tax deductions will go down the drain.
Watch our video about how to use Paychex. It takes up to two weeks to sign up and execute compensation and an employer 401(k) plan, so get going today. If you want to save thousands of dollars with retirement plan and health insurance tax deductions (employee-benefit plans) for 2014, you must act on time. Plan to pay the 401(k) elective deferral portion by year-end. You can wait to fund the 25% profit-sharing plan through the due date of your 2014 tax return (including extension).
4. Don’t miss the boat on 2015; set up your trading business and entity for Jan. 2.
If you’ve been waiting to set up your trading business entity, starting on Jan. 2, 2015 is more convenient and beneficial. It breaks the chain on wash sales with your individual taxable and IRA accounts at year-end, since the entity is a different taxpayer identification number. 2015 tax compliance is easier and lower in cost, since you’ll report the entire year’s trading business activity on the entity return and skip individual tax compliance for part of the year in connection with trading activities.
It’s a little tricky to time the entity formation to a Jan. 2 start date. We can form a single-member LLC disregarded entity in December so you can execute the legal paper work and open the bank and trading accounts before year-end. We’ll add your spouse and or file the S-Corp election effective Jan. 1, 2015. As a disregarded entity in 2014, the SMLLC doesn’t force a partnership or S-Corp tax filing for 2014, even for a simple inactive entity tax return. However, in some states like California, we should wait until Jan. 2 to form the LLC, since that state charges a $800 minimum tax on LLCs even for just a few days in 2014. Consider our entity formation service.
5. Don’t get slapped with an underestimated tax payment penalty.
Get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, viewing the underestimated tax penalty as a low-cost margin loan. Why prepay taxes when you aren’t sure how the year will wind up? The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit (state taxes are an AMT preference item).
6. The clock is ticking onRMDs, charitable contributions, gifts and FSAs.
Do your required minimum distributions (RMDs) from retirement plans, including Inheritor IRAs, and charitable contributions and gifts before year-end. If you have a flexible spending account (FSA) with an employer, you must “use it or lose it” before year-end.
Contact us ASAP: We are standing by to help our clients with these transactions.
Join or watch our Webinar: 11 tax breaks to start and grow a small business.
Among the most popular “American dreams” is starting your own business. Entrepreneurship is the bedrock of America’s thriving economy and Congress continues to favor small business with tax breaks. Uncle Sam is patient for income taxes, allowing: upfront and accelerated expensing; paying business taxes on individual tax returns where other business or investment losses and expenses can be applied; lower tax rates (graduated rates) for lower income; and averaging business income over several years with net operating losses (NOLs). Plus America has voluntary tax compliance. America’s tax system is the envy of the world, and it’s the best place to start a business.
Interested in starting your own business? Find a niche in the marketplace in which you can compete with an edge. It’s possible to open a virtual business within weeks. The incredible advances in ecommerce have made it possible to launch a website with an online store and outsource fulfillment and logistics to other entrepreneurs. Borrow money at record low interest rates and get a full tax deduction for interest expense.
GreenTraderTax has been servicing investors, traders and investment managers since 1983. Business traders and investment managers are classic small businesses. Business traders have trading gains and losses rather than revenues. Investment managers have advisory fee revenues. Both have operating expenses and no inventory of products. They share many of the same tax, accounting, entity and retirement plan strategies and solutions.
Small business also generates self-employment income (SEI) or earned income, which in many cases triggers FICA and Medicare taxes — payroll taxes on wages or self-employment (SE) taxes on sole proprietor net income or Schedule K-1 ordinary income from partnerships. Traders do not have SEI on trading gains, with the exception of a futures trader who is a full-scale member of a futures exchange. S-Corps also do not pass through SEI, so the IRS requires “reasonable compensation” for officer/owners of approximately 50% of net income.
If you’re thinking of starting up your own small business, consider these 11 important tax breaks:
1. Business expenses and NOLs
If you want to see what a country values most, study its tax code. In America, business enjoys the best tax breaks compared to investors and employees. Business expenses are deductible from gross income with few limitations and business losses comprise NOLs, which can be carried back two years and/or forward 20 years. You can choose between the cash or accrual method of accounting. Conversely, investment expenses and unreimbursed employee business expenses (Form 2106) are limited as miscellaneous itemized deductions on Schedule A.
Costs to develop, build or acquire a business or asset are capitalized as an asset. A taxpayer must check to see how the IRS allows expensing of that asset — depreciation or amortization —generally over a prescribed useful life. Obviously, the sooner you can write off an asset via a tax deduction, the more your net income will be reduced.
2. First-year expensing (100% depreciation) and bonus depreciation
Section 179 “Election to expense certain depreciable business assets” allows 100% depreciation in the acquisition year on qualified Section 179 property. The 2013 limit was $500,000, but “tax extender” legislation lapsed at the end of 2013, so the old limit of $25,000 returns for 2014 with an adjustment for inflation. Hopefully, the 2014 and 2015 Congress will renew a much higher limit for Section 179 retroactively to Jan. 1, 2014. (Postscript on 12/4: The House just renewed all tax extenders for 2014 and the Senate and White House will probably agree.) Learn more about the Section 179 Deduction on the IRS site, including What Property Qualifies?
3. Start-up expenditures
Section 195 “start-up expenditures” include costs for “investigating and inquiring” about a new business; they do not include acquisition costs, fixed assets (equipment) or intangible assets (software). Sometimes a larger business may try to disguise acquisition costs as start-up costs and the IRS says no. However, many small business start-ups do have costs for investigating and inquiring about a new business. Business traders take classes before trading and that squeezes into start-up costs. Section 195 rules: file an internal “expense election” to deduct $5,000, plus deduct the rest over 180 months beginning with the month in which the business begins. Tip: start your business activity ASAP so expenses after commencement are unlimited operating expenses. We think capitalizing start-up costs six months from inception is reasonable.
4. Organizational expenditures
Section 248 “organizational expenditures” are similar to start-up expenditures with an election for a $5,000 deduction and the rest over 180 months beginning with the first month. Organizational expenditures are for forming your business entity with attorneys, accountants and incorporation services. When an attorney provides various services to your company, it’s important to get an itemized breakdown of the fees between organization expenditures, operations, acquisition and personal.
5. Converting personal expenses to business use
The majority of taxpayer individuals are employees receiving W-2s. Employees don’t have deductions from gross income or adjusted gross income (AGI). They are stuck with restricted itemized deductions for state and property taxes, mortgage and investment interest, charitable contributions and miscellaneous itemized deductions (investment expenses, tax compliance expenses and unreimbursed employee business expenses). Employees get few tax breaks after wasting deductions to thresholds, AMT preferences, the Pease limitation and state restrictions. It’s the opposite for small business: They get deductions from gross income (business and home-office expenses) and adjusted gross income (retirement and health insurance premiums).
Many small business people have an office in their home and they coop one of the family automobiles for business use too. They arrange vacations that can also accomplish some business goals like attending a trade show or convention. They socialize with other entrepreneurs who can help them succeed in their business. They start to blur the lines between business and personal and the end result is a reduction of personal non-deductible expenses and an increase of business expenses. Be sure to follow IRS rules on compliance, documentation, autos, travel and entertainment. It’s wonderful to convert personal-use assets and expenses into business-use assets, unlocking business deduction treatment. Without spending additional money, you convert limited itemized deductions or non-deduction of personal expenses into business tax deductions. Tip: Use GTT Tracker to track expenses and comply with IRS rules for documentation on a contemporaneous basis.
6. Home-office deductions
The home-office deduction is one of the most powerful deductions for business owners. Since the IRS liberalized home office rules in 1999, taking the deduction is no longer a red flag. You don’t have to meet clients in your home, but you can only deduct home office expenses against business income. The amount not deducted is carried over to the subsequent tax year. Determine the home office percentage by either the square footage method or room’s method, and then deduct that percentage of all home expenses including depreciation or rent. Tip: Most taxpayers would love to write off a big chunk of their home expenses, so make sure you meet the exclusive use requirement to enjoy this juicy tax break.
7. Retirement plan deductions
Uncle Sam gives generous tax breaks to those saving for retirement. All income growth in retirement plans is tax free until ordinary income distributions are taken in retirement. Set up officer compensation in your S-Corp or C-Corp or guaranteed payments in a partnership, or look to sole proprietorship net income. Establish a high-deductible retirement plan.
We generally recommend an employer 401(k) plan for corporations and partnerships and an Individual 401(k) plan for sole proprietors. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. An Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer plan.
High income businesses should consider a defined benefit (DB) plan where much higher amounts can be contributed per year (up to $210,000 for 2014). DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction.
8. Health insurance deductions
Sole proprietors and partners in partnerships have SEI which unlocks a 100% AGI deduction for health insurance premiums on their individual tax return. S-Corps are tricky: Add the individual health insurance of the officer to officer’s compensation and take a 100% AGI deduction for health insurance premiums on the owner’s individual tax return.
For high-deductible ACA-compliant health insurance plans, consider a Health Savings Account plan. If you have significant unreimbursed health expenses, consider a medical reimburse plan. Only a C-Corp can have an MRP, not a partnership or S-Corp for more than 2% owners and attribution rules apply to spouses. If you have a C-Corp, consider other types of fringe benefit plans, too.
9. Hire family members
Shift income to children over the age of the kiddie tax rules. Hire a spouse to do the elective deferral for your spouse on an employer 401(k) plan.
10. Active Investors
If you join a small business as an active investor — providing capital and labor — you can navigate around the onerous Section 469 passive-activity loss rules by meeting the material participation standards. Although material participation is similar to “trader tax status” requiring “regular, continuous and substantial” work, there are important differences. Material participation standards provide bright-line tests, whereas trader tax status looks to case law instead. The material participation rules are complex; read them closely and consult an expert afterward. (Read more about our creation of the “Active Investor” tax strategy on our blog Private-Equity Active Investor Tax Breaks.)
Passive investors may only deduct passive activity losses – passed through on Schedule K-1s – against passive activity income. They may not take a net loss in a given tax year, unless they sell the investment fully realizing the loss. Otherwise, they have suspended tax losses. Passive activity net income from pass-through entities is also subject to Obamacare 3.8% Medicare surtax on unearned income (Net Investment Tax, NIT bucket 2). Active investor owners don’t have net investment income for NIT.
11. Ecommerce/virtual business in a tax-free state
Many taxpayers living in a high-tax state would like to operate their business from a tax-free state to avoid paying state taxes. If you operate a pass-through entity, it doesn’t make any sense since the income is passed to your individual state tax return anyway. To claim you do business in a foreign state rather than your resident state, you shouldn’t have employees, assets and sales in your resident state (known as “nexus” rules). Traders live, work and trade in their home state, so claiming an out-of-state business wouldn’t be feasible, and they use pass-through entities anyway. But it’s different for an ecommerce/virtual business set up in cyberspace.
One idea is to form a C-Corp in Delaware and operate an ecommerce/virtual business that is not landed with sales, employees, inventory or assets in your high-tax resident state. Arrange for the corporation to pay you fees as an agent (not employee). Those working in the corporation as independent contractors — along with the servers — must be located out of your home state.
Enjoy lower corporate tax rates of up to 15% on the first $50,000 of income and 25% on the next $25,000 of income. (The rate is 34% for $75,000 and up.) Avoid state corporate tax and individual tax for many years. After you accumulate large retained earnings, pay a qualifying dividend taxed at lower capital gains taxes up to 20% (federal plus state).
Be your own boss Most Americans prefer the “security” of a job over the perceived risks of starting and owning your own small business. Putting in a week’s work and get a weekly paycheck seems safer than working hard at a new small business and perhaps losing money.
But many of today’s jobs are not your grandfather’s jobs which often provided a lifetime of pension security. Today’s jobs are more prone to disappear in a flash with outsourcing, mergers, reorganizations, downsizing, productivity improvements (machines taking over), company or product obsolescence and disruptive technologies. Corporate America has grown harsher in its never-ending pursuit of productivity and profit often at the expense of the people. To save a buck, established businesses boot out aging employees just as they reach the pinnacle of individual success and compensation. Starting your own small business is not just a dream — it’s good business.
Green & Company and Green NFH helped thousands of traders and others launch new businesses, and we are ready to help you too. We have the expertise you need to assess new business opportunities, structure the business with the right entity and employee-benefit plans, reap small business tax breaks and grow your business with success. What’s your small business American Dream?
MLPs Can Generate Tax Bills In Retirement Accounts
It’s a surprise to many people that MLPs generate taxable income in retirement plans requiring a tax filing and payment of taxes.
Traders and investors are interested in using their IRA and other retirement plan accounts (collectively referred to as “retirement plans”) for making “alternative investments” in publicly traded Master Limited Partnerships (MLPs). Most MLPs conduct business in energy, pipelines, and natural resources. (Learn more about publicly traded partnerships at The National Association of Publicly Traded Partnerships, see its list of PTPs Currently Traded on U.S. Exchanges and read its warning about MLPs and Retirement Accounts.) Retirement plans also make alternative investments in hedge funds organized as domestic limited partnerships or offshore corporations.
Publicly traded partnerships (including MLPs) and hedge fund LPs use the partnership structure as opposed to a corporate structure. That allows organizers to pass through significant tax breaks on a Schedule K-1, including intangible drilling costs (IDC) and depreciation to individual investors. Taxes are paid on the investor/owner level, so the partnership structure avoids double taxation. Conversely, corporations owe taxes on the entity level and investor/owners pay taxes on dividends received from the corporation. (Real Estate Investment Trusts do not use a partnership structure.)
Tax problems for retirement plans investing in MLPs Most MLPs conduct business activities including energy, pipelines and natural resources. But hedge funds do not — they buy and sell securities, futures, options and forex, which are considered portfolio income activities. Private equity and venture capital funds using the partnership structure also may pass through business activity income.
When retirement plans conduct or invest in a business activity, they must file separate tax forms to report Unrelated Business Income (UBI) and often owe Unrelated Business Income Tax (UBIT). MLPs issue Schedule K-1s reporting business income, expense and loss to retirement plan investor/owners. That’s the problem! The retirement plan then has UBI, and it may owe UBIT. Instead of the MLP being a tax-advantaged investment as advertised, it turns into a potential tax nightmare investment.
Form 990-T According to Form 990-T and its instructions “Who Must File,” when a retirement plan has “gross income of $1,000 or more from a regularly conducted unrelated trade or business” it must file a Form 990-T (Exempt Organization Business Income Tax Return). While the retirement plan may deduct IDC and depreciation from net UBI, gross income will probably exceed $1,000 causing the need to file Form 990-T. UBIT tax brackets go up to 39.6%, which matches the top individual tax rate. (See the UBIT rates and brackets in the instructions.) File Form 990-T to report net UBI losses so there is a UBI loss carryforward to subsequent tax years.
Don’t overlook the need to file Form 990-T Noncompliance with Form 990-T rules can lead to back taxes, penalties and interest. It can lead to “blowing up” a retirement plan, which means all assets are deemed ordinary income. And if the beneficiary is under age 59½, it’s considered an “early withdrawal,” subject to a 10% excise tax penalty. Schedule K-1s are complex, and UBI reporting can be confusing especially if the retirement plan receives several Schedule K-1s from different investments. Don’t look to brokers for help; most have passed off this problem to retirement plan trustees and beneficial owners (and that is you!).
In our July 2013 blog and Webinar “The DOs and DON’Ts of using IRAs and other retirement plans in trading activities and alternative investments,” we cautioned investors on making alternative investments in their retirement plan accounts. We talked about UBIT, self-dealing and prohibited transactions. We explained that U.S. pension funds invest in offshore hedge funds organized as corporations since the offshore corporations are “UBIT blockers.”
If your retirement plan is invested in a publicly traded partnership, assess your tax situation immediately, catch up with Form 990-T filing compliance and consider selling those investments. It’s better to buy them in a taxable account.
The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees to comply with Obamacare on 2014 tax filings. In this post, I help clarify the details of the mandate.
There are three scenarios for dealing with the mandate on 2014 tax returns:
1. Off-exchange coverage: If you had ACA-compliant health insurance coverage for all of 2014 — either an individual plan purchased directly from an insurance company (off exchange), an employer plan or government-sponsored programs like Medicare or Medicaid — there’s little to do. You may receive a new IRS Form 1095-B reporting your health insurance coverage from an insurance company and, if applicable, a Form 1095-C from your employer. Both of these tax forms are not mandatory for 2014. Give the 1095s to your accountant and you’re finished. There won’t be any penalties, premium tax credits or return of exchange subsidies.
2. On-exchange coverage: If you purchased your 2014 health insurance on an exchange (marketplace), you will receive a mandatory Form 1095-A from the marketplace and you must file new tax Form 8962 (Premium Tax Credit). When you applied for your 2014 health insurance coverage, you submitted estimates of your 2014 income which the exchange relied on for pricing your plan, perhaps offering a subsidized plan with “advanced credits.” The purpose of Form 8962 is to determine your rightful premium tax credit based on income reported on your 2014 tax return and to reconcile advanced credits (if any) with the premium tax credit calculated on Form 8962. Estimates probably won’t match actual income, especially for traders who have fluctuations in trading gains and losses.Therefore, one of three things will happen on Form 8962:
i. You will have a tax liability caused by advanced credits being greater than the premium tax credit.
ii. You will have a tax credit caused by advanced credits being less than the premium tax credit.
iii. No tax liability or credit because you used an exchange but did not receive an advanced credit and there is no premium tax credit.
The Obamacare Website says individuals can use an exchange even without getting a subsidized plan, but we heard from taxpayers that they were not permitted to use some state exchanges unless they qualified for subsidies. Some individuals say they received a better quote off exchange compared to on exchange without subsidies. Expect to receive new tax information document IRS Form 1095-A from the exchange reporting your coverage and any advanced credits paid for a subsidized plan. Give the 1095s to your accountant and he or she will prepare Form 8962. Tax software should have an input area to enter Form 1095 information and calculate Form 8962 and the premium tax credit.
3. No health insurance coverage: If you did not have ACA-compliant health insurance coverage for 2014 — and that includes large gaps in coverage — and you don’t qualify for an exemption from Obamacare, then you will owe a shared-responsibility payment (tax penalty). Apply to an exchange to receive a Form 8965 exemption for certain types of exemptions, and for others types of exemption claim them on a self-prepared Form 8965. As of Oct. 29, the IRS had not yet released a draft tax form for calculating the shared responsibility payment.
The shared responsibility payment is whichever amount is larger of the following: For 2014, the payment is either $95 per adult and $47.50 per child (up to $285 for a family) or 1% of household income. For 2015, it’s either $325 per adult and $162.50 per child (up to $975 for a family) or 2% of household income. For 2016, it’s either $695 per adult and $347.50 per child (up to $2,085 for a family) or 2.5% of household income. Per the IRS Website, “the individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014.” As has been widely publicized, the shared responsibility payment is not enforceable by the IRS. That means the IRS will offset the payment against tax refunds due, but it can’t file liens, levy assets or start collection proceedings for this payment. The IRS may fully enforce claw-backs of advanced credits (subsidies) reported on Form 8962.
The 2014 Form 1040 has three lines dealing with the Obamacare health insurance mandate:
Payment (line 69): Net premium tax credit. Attach Form 8962.
Other Taxes (line 61): Health care: individual responsibility (see instructions). Full-year coverage (box to check).
Open enrollment through exchanges for 2015 coverage Traders should consider special strategies for purchasing 2015 health insurance coverage through exchanges. The open enrollment period runs from Nov. 15, 2014 to Feb. 15, 2015. Most individuals will purchase 2015 insurance before they deal with Obamacare tax compliance on 2014 tax returns.
If you want to receive a premium tax credit on Form 8962, you need to enroll through an exchange, not directly with an insurance provider or employer. You can’t receive premium tax credit if you are eligible for other “minimum essential coverage,” such as employer-sponsored coverage that’s considered adequate and affordable. Traders should use a reasonable basis for providing the exchange with an estimate of household income perhaps qualifying for a subsidized plan with advanced credits. Some exchanges ask for monthly household income for either 2014 or 2015. Remember, you will have to square up with the IRS on a 2015 Form 8962 but at least you’re in the game for filing a Form 8962 and receiving a premium tax credit. Many traders may have low income in 2015 and they should keep this opportunity open. High-income sole proprietors have confidence they won’t get a premium tax credit and they can skip the exchange all together if working directly with an insurance provider is more convenient.
The exchange system is inconvenient for traders who have fluctuating income Most individuals consider ACA-compliant non-subsidized health insurance plans expensive. If your household income is above 400% of the Federal Poverty Line, you or your family won’t qualify for a subsidized plan on the exchange. You may even face obstacles in using an exchange. No worries, you can purchase an individual or employer ACA-compliant health insurance plan directly through an insurance company. Just keep in mind that rules out the possibility of getting a premium tax credit if you wind up with household income under 400% of the Federal Poverty Line since the insurance must be purchased through an exchange to qualify for the credit.
Many traders have wide fluctuations in trading gains and losses from year-to-year. They could easily fall under 400% of the Federal Poverty Line in 2014 and qualify for an exchange-subsidized plan for the year of 2015. But these traders may wind up with large trading gains in 2015, thereby triggering an “excess advance premium tax credit repayment” (claw back of subsidies) on their 2015 Form 8962. The big problem is the exchange requires an estimate of income before the coverage year starts, and traders don’t know their income until the year ends. Tip: Traders can use an exchange but decline the subsidies up front and file for a premium tax credit if their income is under 400% of the federal poverty line.
There are five new Obamacare tax forms for 2014
1. Form 1095-A: Health Insurance Marketplace Statement. The exchange issues this form to individuals who purchased insurance through an exchange for 2014. (Similar to a bank or broker that issues a tax information Form 1099.) Its instructions state: “You received this Form 1095-A because you or a family member enrolled in health insurance coverage through the Health Insurance Marketplace. This Form 1095-A provides information you need to complete Form 8962, Premium Tax Credit (PTC). You must complete Form 8962 and file it with your tax return if you want to claim the premium tax credit or if you received premium assistance through advance credit payments (whether or not you otherwise are required to file a tax return). The Marketplace has also reported this information to the IRS. If you or your family members enrolled at the Marketplace in more than one qualified health plan policy, you will receive a Form 1095-A for each policy.” If the Form 1095-A does not list any advanced credits and you are confident your income will be well above 400% of the Federal Poverty Line, you don’t have to prepare Form 8962. Some taxpayers may easily generate the form with their tax software and choose to attach it with their return just in case IRS computers look for it.
2. Form 1095-B: Health Coverage. The insurance provider issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-B provides information needed to report on your income tax return that you, your spouse and individuals you claim as dependents had qualifying health coverage (referred to as “minimum essential coverage”) for some or all months during the year. Individuals who do not have minimum essential coverage and do not qualify for an exemption may be liable for the individual shared responsibility payment. Minimum essential coverage includes government-sponsored programs, eligible employer-sponsored plans, individual market plans and miscellaneous coverage designated by the Department of Health and Human Services. For more information on minimum essential coverage, see Pub. 974, Premium Tax Credit (PTC).”
3. Form 1095-C: Employer-Provided Health Insurance Offer and Coverage. The employer issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-C includes information about the health coverage offered to you by your employer. Form 1095-C, Part II, includes information about the coverage, if any, your employer offered to you and your spouse and dependent(s). If you purchased health insurance coverage through the Health Insurance Marketplace and wish to claim the premium tax credit, this information will assist you in determining whether you are eligible. For more information about the premium tax credit, see Pub. 974, Premium Tax Credit (PTC).” Some people used an exchange to receive subsidies even though their employer offered them a good health insurance plan as reported on Form 1095-C, so these individuals should be prepared for a claw back of subsidies on Form 8962.
4. Form 8962: Premium Tax Credit. This tax form is prepared by taxpayers and/or their tax preparers. Its instructions state: “Complete Form 8962 only for health insurance coverage in a qualified health plan (described later) purchased through a Health Insurance Marketplace (also known as an exchange). This includes a qualified health plan purchased on www.healthcare.gov.” Caution: An “excess advance premium tax credit repayment” increases estimated income taxes due, whereas a “net premium tax credit” (payment) does not reduce estimated taxes due since payments are listed below tax liability. (That’s inconsistent and unfair in our view.)
The Federal Poverty Line and household income Exchange subsidies and the Form 8962 premium tax credit are granted to individuals and families with household incomes between 100% and 400% of the “Federal Poverty Line.” Household income is also used for calculating the Obamacare shared responsibility payment for not having minimum essential coverage or an exemption from coverage (Form 8965). Household income is basically taxpayer’s adjusted gross income reported on the tax return plus: Social Security payments excluded from AGI, tax-exempt income (i.e. municipal bond interest), and Form 2555 exclusions for U.S. residents abroad (foreign earned income and housing allowance). Household income also includes the income of any dependents covered on the family insurance plan.
Tax planning tip: Try to defer income and accelerate losses and expenses for household income so you don’t go just a few dollars over 400% of the federal poverty line, as that would require a 100% claw-back of exchange subsidies on Form 8962.
An Obamacare website https://www.healthcare.gov/income-and-household-information/income/ confirms household income includes “Social Security payments, including disability payments — but not Supplemental Security Income (SSI).” According to Form 8962 instructions, social security benefits otherwise not subject to income tax are “added back” since you start with modified AGI rather than just AGI. Eighty-five percent of Social Security payments are included in AGI if the taxpayer exceeds the Social Security AGI threshold of $44,000 for married filing joint ($34,000 for all other taxpayers). Taxpayers under those thresholds exclude 100% of Social Security payments from AGI. Including all social security payments in household income pushes many seniors above the Federal Poverty Line and prevents them from getting a premium tax credit, but most seniors don’t use the exchange because they are covered under Medicare.
For a full description of household income, see Form 8962 instructions.
Federal Poverty Line Chart (based on Form 8962 instructions; these numbers are slightly different for Hawaii and Alaska residents)
According to Obamacare Mandate: Exemption and Tax Penalty, “The mandate’s exemptions cover a variety of people, including: members of certain religious groups and Native American tribes; undocumented immigrants (who are not eligible for health insurance subsidies under the law); incarcerated individuals; people whose incomes are so low they don’t have to file taxes (currently $9,500 for individuals and $19,000 for married couples); and people for whom health insurance is considered unaffordable (where insurance premiums after employer contributions and federal subsidies exceed 8% of family/household income); and those going without insurance for less than three months in a row … Hardship Exemption Update: If you had your plan canceled in 2014 due to the Affordable Care Act you now qualify for a hardship exemption in 2014. That means you won’t have to pay the shared responsibility payment if you decide to go without insurance and will qualify for low premium, high out-of-pocket catastrophic plans on your state’s health insurance marketplace.” U.S. residents abroad who qualify for Section 911 (foreign earned income exclusion) are deemed to have minimum essential coverage whether they do or not. That means they don’t apply for a Form 8965.
Obamacare is progressive taxation Obamacare is the epitome of progressive taxation and transfer payments using fiscal policy. Upper-income taxpayers pay more to subsidize lower-income folks, and middle-class taxpayers pay their fair share of more expensive coverage that can’t rider out pre-existing conditions. Like many new major social programs enacted before it, some Obamacare tax hikes started on upper-income taxpayers before the new benefits were even provided, including Obamacare Net Investment Income Tax, which started in 2013 even though Obamacare benefits didn’t start until 2014. (Read more about Net Investment Income Tax reported on Form 8960.)
Open question: Are federal exchange subsidies legal?
One court ruled that federal exchange subsidies are illegal and another court overruled it. The Supreme Court agreed to hear the case (WSJ Nov. 7). Obamacare law authorizes subsidies “through an exchange established by the state,” it does not mention a federal exchange. Obamacare law contemplated that all states would have a state exchange but many states balked and chose to participate in HealthCare.gov, the federal exchange just as some also balked at Obamacare’s Medicaid expansion. Did Obamacare purposely provide an incentive to states to create their own exchange, or was leaving out subsidies for the federal exchange an inadvertent oversight? (Read more: http://www.cnbc.com/id/102137279 and http://www.cnbc.com/id/102147639.)
Two Helpful IRS Fact Sheets on ACA
Per Thompson Reuters on Nov. 10 “Affordable Care Act Provisions Impacting Individuals and Employers: Two new IRS fact sheets provide details on key provisions of the ACA. The IRS notes the most important ACA tax provision for individuals and families is the premium tax credit and individuals without coverage and those who don’t maintain coverage throughout the year must have an exemption or make an individual shared responsibility payment. These provisions will affect 2014 income tax returns filed in 2015. For employers, the workforce size is significant because that’s what determines the applicable ACA provisions. Generally different rules apply to employers with fewer than 50 employees. IRS Fact Sheets FS-2014-09 and FS-2014-10 are available at http://www.irs.gov/uac/Newsroom/Fact-Sheets-2014.”
The employer mandate was delayed
Individuals have felt the brunt of Obamacare compliance over the individual mandate. President Obama issued an executive order to delay the employer mandate. But that delay is ending soon. See CNBC Nov. 11 Obamacare Cadillac plans? You’re gonna pay for that….
More changes Prior to Obamacare, S-Corps could reimburse employees for health insurance on a tax-free basis by not including health insurance reimbursements in employee taxable wages. But starting in 2014, S-Corps must include the health insurance reimbursements in taxable wages for income, FICA and Medicare taxes. Don’t skip over making this change as the Obamacare law includes a fine of $100 per employee, per day. An employer group health insurance plan still delivers tax-free benefits to employees. (Postscript 2/18/15: The IRS issued relief for the above draconian penalty. Read more.)
Bottom line Consult with your tax adviser to discuss how Obamacare taxes will affect your 2014 tax return and how it may be best for you to obtain coverage for 2015. There’s still plenty of confusion and new surprises will arise, so stay tuned for updates on our blog.
Postscript Nov. 24, 2014: The IRS published new guidance on ACA’s individual mandate, hardship exemption, and premium tax credit. Notice 2014-76, Rev Proc 2014-62 and final regs for Section 5000A on the individual mandate. Notice 2014-76 “Individual Shared Responsibility Payment Hardship Exemptions that May Be Claimed on a Federal Income Tax Return Without Obtaining a Hardship Exemption Certification from the Marketplace.” Rev Proc 2014-62 “This table is used to calculate an individual’s premium tax credit.” The Rev Proc “announces the indexed applicable percentage table in Code Sec. 36B(b)(3)(A), which is used to calculate an individual’s premium tax credit for tax years beginning after calendar year 2015.”
Darren Neuschwander, CPA and Star Johnson, CPA contributed to this article.
Join us for our Oct. 28 Webinar covering this blog, or watch the recording afterwards.
Traders should consider general year-end planning strategies like deferring income and accelerating expenses, but they should also be aware of some other special tactics. In this article, I touch upon 20+ ideas for tax savings on your 2014 tax return.
1. Avoid NIT if you can. As of Jan. 1, 2013, if you have adjusted gross income (AGI) over $250,000 (married) and $200,000 (single), then additional investment income will be subject to the 3.8% Net Investment Income Tax (NIT). (Read Net Investment Income Tax.)
2. Accelerate income to utilize lower tax brackets
There are some situations where it’s better to accelerate income and defer expenses, such as if you happen to be in a low tax bracket in 2014 due to trading losses and or other types of expenses and losses. Take advantage of ordinary tax rates up to 28%, a good regular tax rate and the highest alternative minimum tax (AMT) rate.
If you hold a security for 12 months before selling, it’s considered a long-term capital gain subject to rates that are lower than the ordinary rates for short-term capital gains. Look in your investment portfolio for positions with material unrealized capital gains. Consider selling some or all of the long-term winners before year-end. The long-term capital gain tax rate is graduated: 0%, 15% and 20%. The 0% rate applies up to $73,800 of taxable income for married filing joint and $36,900 for single filers. The long-term rate applies to qualified dividends, too.
3. Accelerate more income with a Roth IRA conversion
Another good way to accelerate income to utilize lower tax brackets is by executing a Roth IRA conversion before year-end. You can break up an IRA into pieces in order to convert a certain amount. You can always recharacterize the conversion in 2015 if it doesn’t work well — for example, if you lose the money in the Roth account and prefer a do over or if your tax rates in 2015 are far lower than 2014. (Read my Oct. 7 blog Last chance to reverse 2013 Roth IRA conversion by Oct. 15, 2014.)
4. Get a handle on wash sale loss deferrals Wash sale loss deferrals accelerate income if you don’t have a capital loss limitation. Many taxpayers hate wash sales because they cause tax liability on phantom income, with the IRS deferring losses into the next tax year.
Smart investors, business traders and investment managers spend November and December identifying and avoiding potential wash sale losses on “substantially identical positions” (i.e., between Apple stock and Apple options at different strike prices). Don’t wait until you receive broker-issued Form 1099-Bs in February to find out you have a huge tax problem with wash sale loss deferrals which might increase your 2014 tax bill significantly. (Read Cost-Basis Reporting and Form 8949.)
5. Use trade accounting software to better manage wash sales
Run trade accounting software before year-end to calculate and avoid wash sales, handle cost-basis reporting correctly and generate Form 8949 for tax filings. Keep running it through the end of January for wash sale loss calculations since they are triggered 30 days before and 30 days after taking a loss (if you re-enter that position). Once you spot a potential wash sale, sell all open positions before year-end and don’t buy them back for 31 days. (Read Accounting Solutions.)
6. Break the chain on wash sales with an entity Consider trading in a separate entity in Q4 or on Jan. 1 to disconnect your individual trades under a different taxpayer ID number for the entity. A single-member LLC (SMLLC) disregarded entity doesn’t work here; you need a partnership or S-Corp return. (Read Entity Solutions.)
7. Avoid wash sales in IRAs Don’t forget to run trade accounting software on your individual IRA accounts too. Avoid permanent wash sale losses between individual taxable accounts and IRAs. Don’t trade substantially identical positions between taxable and IRA accounts.
8. Take advantage of tax loss selling Most financial media recommend “tax loss selling” as part of year-end tax planning. If you have capital gains year-to-date, sell a few losing positions to reduce capital gains taxes. Remember, don’t rush to buy back that losing position within 30 days (in January) as that can cause a wash sale loss deferral at year-end 2014, thereby defeating the purpose of tax loss selling.
9. Hold winning positions at year-end
Investors, business traders and hedge fund managers often hold open winning positions in securities with unrealized gains at year-end in order to defer taxes and perhaps achieve lower long-term capital gains rates in 2015 or subsequent years.
10. Utilize capital losses to maximum advantage
If you have significant capital losses and carryovers in 2014, consider selling open winning positions before year-end to utilize those capital losses. There’s no sense holding a winning position open for 12 months to achieve a long-term capital gain if that gain is offset with a capital loss carryover.
Per tax publisher Thompson Reuters, “Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses must be used to offset short-term capital gains before they are used to offset long-term capital gains. A taxpayer should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income.”
11. Section 475 traders are exempt from wash sale rules
Business traders should learn about Section 475 MTM business ordinary gain or loss treatment. While short-term capital gains on securities are taxed at ordinary rates, short-term capital losses are subject to the $3,000 capital loss limitation and problematic wash sale loss rules. The main tax benefit of Section 475 is that 475 trading losses are business ordinary losses without any limitation, and are included in net operating loss (NOL) calculations. Section 475 trades are exempt from the wash sale rules, too. New taxpayers (entities) are entitled to elect Section 475 within 75 days of inception, so this is a good solution for traders late in the year. (Read Section 475 MTM Accounting.)
12. Turn 2014 unrealized capital losses into 2015 ordinary losses
If business traders qualifying for trader tax status don’t have Section 475 in 2014, they can elect it for 2015 by April 15, 2015. That 2015 election converts unrealized business trading gains and losses at the end of 2014 into ordinary gains or losses on Jan. 1, 2015 — that’s the required Section 481(a) adjustment. A negative Section 481(a) adjustment on Jan. 1 from unrealized losses on Dec. 31, 2014 is far better than a capital loss carried over from 2014 to 2015. In this case, wash sales are good because they are part of a Section 481(a) adjustment, rather than being a capital loss carryover. Traders generally have a hard time using up large capital loss carryovers. In this case, the business trader wants to skip tax loss selling and it’s beneficial to have an unrealized capital loss at year-end.
13. Learn the rules for segregation of investments Some business traders and many hedge fund managers skip Section 475 MTM elections because they have a hard time following the rules for “contemporaneous” segregation of investments from business trading positions. The IRS is increasingly challenging traders over the segregation of investment rules. Hedge fund managers also don’t want investors paying taxes on open positions, as investors would request redemptions to pay the tax bill while managers have cash funds tied up in those open positions. (Read my Aug. 13 blog IRS warns Section 475 traders.)
14. Assess your qualification for trader tax status
Section 475 hinges on trader tax status (TTS), so active retail traders and hedge fund managers should assess their qualification before year-end. Sole proprietors and hedge funds can claim TTS after they assess the facts and circumstances, but Section 475 MTM is not allowed after the fact. It had to be elected with the IRS by April 15, 2014 for 2014 or within 75 days of a “new taxpayer” (i.e., a new entity) filed in the entity books and records (an internal election). (Read Trader Tax Status: How to Qualify.)
15. Forex can be ordinary or capital treatment
By default forex receives Section 988 ordinary gain or loss treatment. Forex traders may file an internal contemporaneous election (known as a forex “capital gains” election) to opt out of this treatment. Major forex forward contracts for which regulated futures contracts trade on U.S. futures exchanges are labeled “foreign currency contracts” under Section 1256(g). Section 1256 has the tax benefit of lower 60/40 tax rates: 60% is subject to lower long-term capital gains rates and the other 40% is taxed at ordinary rates. Section 1256 is mark-to-market at year-end, whereas Section 988 is realized transactions only. We make a case for treating forex spot like forex forwards in Section 1256(g). (Read Forex tax treatment.)
16. Decide whether to accelerate or defer expenses. Currently, 2015 tax rates match 2014 rates. This means if you are in a high tax bracket it’s a good idea to defer income and accelerate business expenses and itemized deductions. (Using credit cards on the last days of the year counts.) You may not qualify for TTS in 2015, so get business deductions while you still can. Investment expenses exclude home office, education, and startup costs. (Business expenses allow them.) If you don’t qualify for TTS at year-end but will in 2015, then defer business expenses to 2015.
17. Get employee-benefit plan deductions with entities
Trading gains are not considered earned income, so traders need an entity to pay the owner/trader compensation to unlock valuable employee-benefit-plan tax deductions, including retirement and health insurance premiums. (Traders generally save thousands of dollars with these strategies.) S-corps and C-corps should execute payroll and partnerships administration fees before year-end. To avoid under-estimated tax penalties, increase tax withholding through year-end payroll. (Read Entity Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)
18. Establish retirement plans before year-end
Business traders should open an employer 401(k) plan before year-end in an S-Corp trading entity or C-Corp management company — otherwise, they will miss the boat on the best retirement plan choice for most traders. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. For sole proprietors, an Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer 401(k) plan.
Make sure to pay compensation before year-end to execute these employee-benefit plan deduction strategies. High income traders should consider a defined benefit (DB) plan where you can contribute much higher amounts per year (up to $210,000 for 2014). DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction. Can you afford a Roth contribution too? See 2014 retirement plan limits on the IRS site (click here for DB plans). Don’t overlook required minimum distributions (RMD) rules for traditional retirement plans. (Read Retirement Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)
19. Get a handle on accounting first Focus on accounting before year-end to get a proper handle on tax planning. Accounting for securities trading is complex with cost-basis reporting, wash sales and reporting realized gains and losses only. We recommend trade accounting software to download your trades and handle this accounting.
20. GTT Tracker app for expense accounting
For expenses and asset purchases, we recommend our GTT Tracker accounting solution and app. Account for expenses and assets, including fixed assets (equipment), intangible assets (software), Section 195 startup costs and Section 248 organization costs. GTT Tracker prepares a full accounting and it properly documents your trading expenses and other business expenses. It’s a single-entry accounting system that is extremely effective and easy to use. The software allows you to download bank account and credit card transactions and follow IRS rules for compliance and documentation on a daily basis. Don’t be stuck trying to remember who you had dinner with and what the business purpose was at year-end. The IRS is tough on these issues in exams.
21. Expenses must be in order by year-end Execute expense reimbursements before year-end — a requirement in S-Corps and suggested in partnerships. Learn how to handle the health insurance premium deduction, which is tricky with S-Corps. Employee-benefit plan deductions determine the amount of compensation needed to unlock those deductions. S-Corps should consider using salaries in December and engaging a payroll processing firm — we recommend paychex.com.
22. Get your Obamacare matters in order The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees on 2014 tax filings. In this Webinar, we will clarify the details of the mandate to avoid confusion. 2014 is the second year for the Net Investment Income Tax (NIT). (Read my blog Obamacare ushers in several new tax forms for 2014.)
23. Consider a C-Corp A C-Corp is taxed separately from individuals and the top C-Corp tax rate (35%) is lower than the top individual tax rate (up to 44% with NIT). But there’s also double taxation with C-Corps: once on the entity level and again when qualified dividends are paid on the individual level. Double taxation is less of an issue in states with no individual income tax.
There are a number of ways to get income into the C-Corp. House intellectual property there, charging your trading entity royalties. Have the C-Corp get a profit allocation from the trading entity. Have the C-Corp charge the trading entity administration fees. C-Corps can have a medical reimbursement plan, which is a good way to pay for high deductible Affordable Care Act-compliant health insurance plans.
24. Catch up with estimated taxes at year-end Don’t forget to get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, considering the underestimated tax penalty like a low-cost margin loan. The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state(s) before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit.
The IRS commissioner recently told Congress that further delay on anticipated renewal of “tax extenders” will delay the 2014 tax-filing season and 2014 tax refunds. Many taxpayers are hoping Congress renews tax extenders retroactively to all of 2014 so it increases their 2014 tax refunds. I can see a case for non-renewal of tax extenders.
The IRS needs a long lead time
Each year, the IRS and tax publishers need to finalize tax forms and software on a timely basis. Last minute tax law changes often throw a monkey wrench into that process. When Congress passes new tax law, the IRS has to codify those laws with proposed regulations and final regulations. The last step is drafting and finalizing tax forms and related instructions. Factor in government bureaucracy and this entire process can take a lot of time. Congress passed the Affordable Care Act (ObamaCare) in March 2010, yet it took the IRS several years to finalize regulations and 2013 Net Investment Income Tax Form 8960. Form 8960 was released late for the 2013 tax filing season – delaying last year’s tax season. The IRS just released 2014 ObamaCare insurance-mandate tax forms, which is early in this case (see upcoming blog).
Renewal of tax extenders is not certain
Congress allowed the entire list of “tax extenders” to expire at the end of 2013. Unlike in prior years, Congress did not renew the tax extenders during its annual game of political brinksmanship. If Congress permanently passed tax extenders, it would blow a huge hole in the budget deficit forecast and that’s a political problem.
My latest thoughts about tax extenders and tax reform
Why pass tax extenders just before the major election in November 2014? Congressmen campaign on tax policy raising money from the tax-benefit lobby. Pundits currently predict that Republicans may win narrow control of the Senate, but not filibuster-proof. Republicans could press for their vision of tax reform with the mantle in both houses of Congress. With ongoing public controversy over corporate tax inversions and U.S. companies moving abroad, a Republican Congress can probably exert pressure on the White House to pass corporate tax reform. Most small businesses uses pass-through entities like LLCs and S-Corps, which means they pay their business taxes on individual tax returns. For this reason, Congress should include individual tax reform in the tax reform bill, too. You can’t leave a large gap between individual and corporate tax rates.
The 2015 Congress sits in late January 2015, which means the 2014 lame-duck Congress will deal with year-end calls for renewing tax extenders. It’s highly unlikely the latter will deal with tax reform.
Is the IRS Commissioner weighing in to politics by pressuring Congress on tax extenders before the November election? Tax extenders lapsed at the end of 2013. Shouldn’t the IRS create tax forms based on current tax law? It’s certainly not easy with a last-minute Congress.
I vote for tax reform over just renewing tax extenders. For those that cry wolf, I question if corporations will reduce their research and development, or investments in new technology and equipment simply because the U.S. Treasury won’t subsidize them. American big and small businesses need to innovate and stay technologically advanced or they will lose their worldwide competitive edge.
As we approach the year-end holidays, many lobbyists, corporations and individuals will write letters to their Congressmen crying foul over tax extenders, Congress may cave and renew tax extenders. It’s tough to do tax planning with this routine.
In the past, many Canadians living in the U.S. were surprised and dismayed to learn they owed U.S. taxes, penalties and interest on income accumulating inside their Canadian retirement plans. These U.S. residents figured their Canadian retirement plans were automatically afforded the same tax-deferral treatment as U.S. retirement plans, with income only being taxable when distributed from the plan. They were unaware they had to file an IRS election for deferral treatment.
That wasn’t the only surprise — many Canadians didn’t realize they had to report Canadian retirement plans on U.S. Treasury FBAR filings (foreign bank account reports).
We’re happy to see the IRS acknowledged the tax-deferral problem and it now provides relief. In Revenue Procedure 2014-55, the IRS repeals the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral. The new rules are retroactive, so it abates back taxes, interest and penalties and that spells “relief.”
This relief applies to U.S. taxpayers with Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). The IRS altered regulations governing annual reporting requirements, mostly doing away with the election requirement and there is no longer a need to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans).
Foreign retirement accounts must still be reported on FinCEN Form 114, Report of Foreign Bank and Financial Account. (Read more on International Tax Matters in our Trader Tax Center.)
If you converted a traditional IRA to a Roth IRA in 2013, the IRS allows you to “recharacterize” the conversion if necessary. (See IRS law on this at Reg. 1.408A-5.) But the due date of Oct. 15, 2014 is quickly approaching. You can reverse a 2013 Roth conversion by executing a direct transfer of funds from it back into a traditional IRA. If you already filed your 2013 individual tax return reporting the Roth conversion amount in gross income, you’ll need to file an amended tax return to reduce the income accordingly. Generally, when financial markets rise, there are fewer recharacterizations, but if your account dropped in value, it may be a good idea.
When an estate is under the estate tax return filing threshold ($5 million for 2011, $5.12 million for 2012, and $5.25 million for 2013), trustees should still consider filing a Form 706 estate tax return. Trustees can make a “portability election” allowing the surviving spouse to use the decedent spouse’s unused exclusion amount. The IRS allows late elections for estates created after 2011 and before 2014; the due date is Dec. 31, 2014. After that date, it’s too late. See Rev. Proc. 2014-18.
Non-resident alien traders often ask us these two tax questions:
• “If I open an individual brokerage account in the U.S. to trade securities, futures and forex, will I be liable for U.S. taxes on my trading gains?”
• “If I become a partner in a U.S. proprietary trading firm filing a partnership tax return, do I owe U.S. taxes on my Schedule K-1 income?”
The answer to the first question is no. Trading gains are considered portfolio income which is not effectively connected income (ECI) in the U.S. Generally, non-resident aliens are liable for U.S. tax on income from business and real property in the U.S. There is tax withholding on dividend payments and sales of master limited partnerships (MLPs). There is no withholding in connection with futures or forex trading.
The answer to the second question is more complex. Typically, foreign partners in U.S. partnerships are considered to have U.S. ECI on their Schedule K-1 income. But if the partnership is a trading company — in financial markets, not goods — the income is considered portfolio income, including the partner’s share. Typically, U.S. partnerships withhold taxes on foreign partners, but that is not required if the foreign partner only has portfolio income not subject to U.S. tax. It gets more complicated with dividends in the partnership, since there was no withholding of dividends tax for the share owned by the foreign partner.
864(b) Trading Safe Harbor
According to research by tax attorney Mark Feldman, if the partnership is doing just forex trading (or other types of trading in stock, securities or futures), then it is probable that a foreign partner will not be subject to U.S. tax based on the following:
Generally, under Section 875(1), if a partnership is engaged in a trade or business in the U.S. (“ETB”), a nonresident alien partner of the partnership is automatically ETB. However, Section 864(b)(2)(A)(ii)&(B)(ii), provides an exception to ETB if a nonresident alien trades for his own account—even if through a principal office located in the US. It seems that this exception overrides the general rule of Section 875(1); after all, a deemed presence under 875(1) should be no worse than an actual presence in a principal office.
See FSA 199909004: Section 1.864-2(c)(2)(iii) provides rules for determining whether the taxpayer’s principal office is in the United States. . . . However, we note that the Taxpayer Relief Act of 1997, P.L. 105-34, section 1162(a), removed the requirement that the partnership have its principal office outside the United States. Therefore, for taxable years beginning after December 31, 1997, even if it was determined that USP [US partnership, with its principal office in the US] was a trader rather than investor in stocks and securities, FC [foreign corp, which was a partner in USP] nevertheless would not be subject to tax on its distributive share of USP’s capital gains due to the section 864(b)(2)(A)(ii) safe harbor. After December 31, 1997, FC would fail the trading safe harbor in section 864(b)(2)(A)(ii) only if either FC or USP was also a dealer in stocks or securities.
The FSA is presumably basing itself on this language in Treas. Reg. 1.864-2(c)(2)(ii) (which was not yet amended to reflect the repeal of the principal office requirement, otherwise known as the Ten Commandments, in 1997):
Partnerships. A nonresident alien individual, foreign partnership, foreign estate, foreign trust, or foreign corporation shall not be considered to be engaged in trade or business within the United States solely because such person is a member of a partnership (whether domestic or foreign) which, pursuant to discretionary authority granted to such partnership by such person, effects transactions in the United States in stocks or securities for the partnership’s own account or solely because an employee of such partnership, or a broker, commission agent, custodian, or other agent, pursuant to discretionary authority granted by such partnership, effects transactions in the United States in stocks or securities for the account of such partnership. This subdivision shall not apply, however, to any member of (a) a partnership which is a dealer in stocks or securities or (b) a partnership (other than a partnership in which, at any time during the last half of its taxable year, more than 50 percent of either the capital interest or the profits interest is owned, directly or indirectly, by five or fewer partners who are individuals) the principal business of which is trading in stocks or securities for its own account, if the principal office of such partnership is in the United States at any time during the taxable year.
Presumably, after the regulation is amended, part (b) of the last quoted sentence will be removed. Also, PLR 8850041 (not reliable for precedent) says that Section 864(b)(2)(B) “commodities” include forex.
“It’s my understanding that a non-U.S. person that is a member of a prop trading firm is subject to the exemption in 864 for trading for your own account provided that the prop trading firm is not a dealer,” tax attorney Roger Lorence says. “In some cases, a prop trading firm is a member of a commodities exchange or a securities exchange, but this is as a customer member. The prop trader receives better fees and commissions, but is not actually making a market or otherwise trading. So long as the prop trading firm is a customer member, then there’s no ETB issue. However, there can be state issues where the state diverges from the federal rules of 864.”