Fiduciary Is Fun!
(a.k.a. I heart taxes)
(a.k.a. I heart taxes)
The recently passed CARES Act is designed to provide stimulus and economic support during the COVID-19 pandemic. The largest such relief of its kind in history, it’s not surprising that there is much to the legislation. The law itself runs for 880 pages. And like all big pieces of legislation, there are provisions affecting your retirement plan. Let’s take a look at one.
One of the provisions getting the most press permits eligible employees to take hardship distributions from their qualified accounts penalty free up to $100,000. Normally, a Hardship Distribution that occurs before 59 ½ is subject to both income taxes as well as a 10% early withdrawal penalty. Waiving the withdrawal penalty seems like a humanitarian gesture in this time of need. But as with most things like this, the initial gesture can get complicated quickly.
For one thing, the law permits the income tax on the distribution to be paid over a period of 3 years, but it does not require this. Presumably an employee would make some kind of election as to how to pay this tax – all at once, evenly spread, some here/some there, etc. But because the amount is treated as ordinary income, it would get lumped in with all other earned income and considered part of your Modified Adjusted Gross Income (“MAGI”). This by itself is going to require some real planning. But wait, it gets better.
On the top of page 159 of the CARES Act there is a specific provision that allows, but does not require, someone who has taken a distribution to repay the amount of the distribution into the same qualified account from which it came or another qualified account if the repayment occurs within 3 years. If the amounts taken, or some of the amounts taken are repaid, those amounts are not considered taxable income. It would sort of be like the distribution never actually occurred, and no tax would be owed on those amounts repaid.
What if an employee chose to pay all the tax this year, and in 2 ½ years when this whole crisis is in the rear-view mirror decides to repay some of the original distribution? It would seem as though the employee should receive credit for the taxes paid originally, right? Double taxing the same dollars would be inappropriate. I’m sure we will get guidance on this, but the law is silent.
And on top of all this, if the distribution is from an employer qualified retirement plan versus an IRA, this whole thing has to be approved by an employer. The employer is not required to permit hardship distributions. And what type of reporting might the employer need to consider if these distributions, repayments, and taxes all need to be tracked and monitored? What if the distribution comes from your plan but the employee repays the amount to an IRA? Or another plan?
If you are an employer looking for good counsel during these times, I would encourage you to give me a call. This is not the time to try to figure this stuff out on your own.
Pete Welsh a/k/a 401kGuy
Apparently, Required Minimum Distributions (“RMDs”) are a lot harder than you would think. A new survey from TD Ameritrade finds that only 38% of Americans actually know that RMDs are required from tax advantaged qualified retirement accounts, e.g. IRAs, 401ks. And if we are to believe that the Baby Boomers are retiring at the rate of 10,000/day, it’s safe to say that this could become an issue in the not too distant future.
Not taking RMDs is a problem because the penalty for missing one is 50% of the amount that should have been with withdrawn, in addition to the income tax due! If that seems like a pretty steep penalty, that’s because it is! The good news is that these accounts are generally at financial institutions that are aware of the need to make the RMDs and notify the individual of the amount that needs to be withdrawn. Nevertheless, this doesn’t necessarily always mean things go well
For example, do you know when you MUST begin your first RMD? The first one is due by April 1st of the year FOLLOWING the year in which you turn 70 1/2. That’s all well and good, and many people (or at least some people) actually know this. A problem can surface, however, if you wait until April 1st because delaying doesn’t mean you don’t need to take another distribution by December 31st of that same year. Consequently, you could get two distributions in one year which could do some things to your tax bill that you would rather not happen.
Another common challenge folks face is when they have multiple tax advantaged accounts – IRAs, old 401k balances, etc. Any idea how to calculate what is required there? The math isn’t necessarily that hard, but the actual distributions can be tricky. For instance, if you have multiple IRAs, you can take the total required distribution from 1 IRA or mix it up. No problem as long as the total for the IRAs is distributed. Does it work the same for 401ks? Nope, it does not. Each 401k account stands on its own. How about 403b balances left with old employers. Seems like they should be treated like 401ks, right? Wrong. Now we are back to the IRA method. Don’t worry, if you get it wrong the penalty is only 50%!
There is some legislation that will be changing the RMD rules again if it gets passed this year, which seems like a real possibility. Will the new rules make things less complicated? Maybe…maybe not. You should probably talk to a professional about this. You should probably talk to me.
Give me a call and let’s have conversation.
Pete Welsh aka 401kGuy
There are many ways for a small business owner to fund retirement. Although according to US News in a survey done in 2018, 34% of all small business owners had saved nothing for retirement. That’s not good. And interestingly, 42% of small business owners, according to The Motley Fool, June 2018, are counting on the sale of their business to constitute a major source of retirement income. That’s seems like a pretty big bet to me. Who is going to buy those businesses again?
So what might a small business owner do with respect to planning for retirement? In most pass-through tax entities – S-Corps, Partnerships, and LLCs – the most viable, tax advantaged way to plan for retirement is through a qualified retirement plan. The amount that can be contributed to a defined contribution plan is dependent, in large part, on the owners earned income, but can be as high, for 2019, as $56,000 or 25% of wages, whichever is less.
In working with smaller companies, I often see an owner trying to maximize the contribution at $56,000. Simple math says that $56,000 is 25% of $224,000. In other words, if an owner pays himself anything more than $224,000 in wages, he is not getting any benefit as far as his defined contribution plan is concerned. He would be better off taking amounts above $224,000 as passive income, if that is an option, and paying taxes at a lower rate.
However, if there is a spouse gainfully employed, or a spouse that could be so employed, there could be an argument that we should pay the spouse some of the income that might have otherwise gone to the owner above $224,000. Why would we do this? Those additional wages going to the spouse are now earnings that can be considered for our 25% limitation. We can’t give our owner any more contribution, but if we pay the spouse $100,000, for example, we could make a contribution of up to $25,000 into her account
As you might expect, there are many considerations that must be factored in before we rush to take the action noted above. The additional payroll taxes for the spouse might be steep. But then again, getting a benefit from Social Security might be good. Who knows? The additional $25,000 deduction good, right? Lots to consider. Make sure you work with someone qualified and experienced to walk you through the pros and cons around these scenarios.
In fact, work with me.
The 2018 tax filing year is over for most, but many owners, partners, and members of pass through tax entities are still on extension as they try to make sense of all the tax changes that went into effect for 2018. Many partners and LLC members are still trying to understand what the Tax Cut and Jobs Act of 2017 has done to their net income and taxes. While there were a number of positive changes for high income earners there were also some caps, particularly in the areas of State and Local Taxes (“SALT”).
For those individuals who might be looking at a tax bill that is larger than what was expected, the question could be asked “what can we do now?” The general answer is “not much”, but there is one area of planning that is still available post the close of the year, assuming you are on extension, and that includes making profit sharing contributions to your retirement plan. Such contributions can have a meaningful impact, potentially, on Qualified Business Income (“QBI”) and the available 20% income deduction. These situations are extremely fact dependent, obviously, and everyone’s situation does vary.
There are many ways to make contributions, but for partners and LLC members, the calculation is more than a little complex to say the least. The IRS did create a 21 Step Process for calculating your earnings and your deduction in Publication 560 to help make it a little easier for you. Suffice to say, however, it’s not that easy. But given the importance in getting this tax deduction contribution correct, you should consult an expert.
For those of you looking to explore your tax planning options with your retirement plan and to understand how those changes will impact your personal situation, please reach out to us for a free consultation. We work collaboratively with your tax and legal advisors to get you the maximum deduction.
Pete Welsh aka 401kGuy