Category Archives: Financial Planning Tips

401(K) HARDSHIP WITHDRAWAL RULES RELAXED

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The Bipartisan Budget Act of 2018 (BBA) mandated changes to the 401(k) hardship distribution rules. Generally, these changes relax certain restrictions on taking a hardship distribution. For 2019, the changes are optional, but effective January 1, 2020, following issuance of final regulations, certain changes will be mandatory.

An employer may, but is not required to, provide for hardship distributions in their retirement plans. Many plans such as 401(k) plans, 403(b) plans, and 457(b) plans permit hardship distributions.

If a 401(k) plan provides for hardship distributions, it must provide the specific criteria used to make the determination of hardship. Thus, for example, a plan may provide that a distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and education expenses. In determining the existence of a need and of the amount necessary to meet the need, the plan must specify and apply nondiscriminatory and objective standards.

The rules for hardship distributions from 403(b) plans are similar to those for hardship distributions from 401(k) plans.  If a 457(b) plan provides for hardship distributions, it must contain specific language defining what constitutes a distribution on account of an “unforeseeable emergency.”

Effective for hardship withdrawals made on or after December 31, 2018, IRS proposed regulations eliminate the mandatory requirement that a participant obtain all loans available under the plan and all other plans maintained by the employer. Such a restriction is now an optional provision that may be adopted by the employer. The requirement that a participant must first obtain available distributions under all other plans maintained by the employer, (whether qualified or nonqualified) before receiving a hardship withdrawal remains in place.

Hardship distributions from a 401(k) plan were previously limited to the amount of the employee’s elective deferrals and generally did not include any income earned on the deferred amounts. The proposed regulations permit, but do not require, 401(k) plans to allow hardship distributions of elective contributions, QNECS, QMACS, and safe harbor contributions and earnings on these amounts regardless when contributed or earned. The change can be made as of January 1, 2019.

The proposed regulations also make it optional for 2019 to prohibit an employee from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution. Under the proposed regulations effective January 1, 2020, the 6-month suspension from making elective contributions is no longer allowed.

Prior to the issuance of the proposed regulations there were no special rules for hardship distributions on account of hurricanes or other natural disasters. The proposed regulations modify the safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need by adding a new type of expense to the list, relating to expenses incurred as a result of certain disasters.

Finally, the proposed regulations incorporate guidance provided under the Pension Protection Act of 2006 by providing that qualifying medical, educational, and funeral expenses relating to a participant’s primary beneficiary may qualify as expenses eligible for a hardship withdrawal.

A review of these changes would indicate that employers should not wait until 2020 to make these changes because they represent opportunities for employers to simplify plan administration in areas where administrative mistakes often occur.

Plan participants should ask their employers about the implementation and timing of these changes so they can adjust their financial plans accordingly.

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Why Do Stocks Split?

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Why do stocks split?  According to Wells Fargo Advisors, when a company feels its stock price is getting too expensive to appeal to individual investors, it can decide to do a stock split to lower its per-share price.  When this occurs, you now own more shares, yet the amount of equity you own in the company remains the same.

The stock split may not directly affect your portfolio. However, the lower-priced shares may eventually attract more buyers, eventually driving the stock price up over time. If that happens, you could benefit from the split and from the resulting share-price increase.  Unfortunately, stock splits are occurring less frequently than in prior years.

Here’s what you need to consider:

    • Don’t wait for a split. If you’re putting off buying stock in a particular company because you hope the stock will split and the per-share price will drop, don’t hold your breath. Buy stocks according to ongoing purchasing strategies upon which you and your Financial Advisor agree and that make sense for your portfolio.
    • Revisit your individual stock-buying strategy. It can be very satisfying to invest in certain companies you really like. However, individual stocks tend to be more volatile investments than aggregated funds such as an investment designed to track performance of the S&P 500® Index or Russell 2000 index. Be sure you have a well-diversified portfolio before and after you consider adding individual stocks.
    • Consider gifting differently to kids and grandkids. In the past, you may have enjoyed giving younger family members individual stocks — maybe in companies that made their favorite cereals or digital devices, for example. You can still do that, but with fewer splits happening over time, the per-share price could limit how many shares you can give. The 2017 annual gift tax exclusion of $14,000 will increase to $15,000 beginning in 2018.

If you have any questions regarding stock splits or gifts to family members, contact Steve Siesser at ssiesser@verizon.net

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Bad Debt-Business or Personal Deduction?

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You loan someone money and they don’t pay you back.  What’s the proper tax treatment for deducting the debt?

A business bad debt is deductible on the business tax return of the taxpayer (i.e. Schedule C) as an ordinary loss and can generate a net operating loss (NOL). A non-business bad debt is deductible as a short-term capital loss (Schedule D), subject to the $3,000 per year net capital loss limitation.

The taxpayer in this case made a career out of lending money for profit, both through business entities and out of his personal funds. One of his personal loans to a commercial laundry wound up going bad. He deducted the loss as a business bad debt which in turn created NOL carrybacks and carryforwards. The IRS claimed it was a personal bad debt because the taxpayer’s private lending was not a trade or business.

According to IRC section 166, for a money lending activity to be considered a trade or business, the taxpayer must have been involved in the activity with continuity and regularity, with the primary purpose of earning income or making a profit. The courts have developed a non-exhaustive list of facts and circumstances to consider in deciding whether a taxpayer is in the business of lending money.

The IRS argued that even if the taxpayer had made enough loans over the years, his source of funds was a family limited partnership (FLP) he managed with his two sisters. Out of 89 loans made over a 14 year period, only 8 listed the taxpayer as the lender. The rest listed the FLP as the lender.

The court disagreed with the IRS based on the fact that the majority of those alleged to be FLP loans were in fact made from the taxpayer’s personal trust. The taxpayer made at least 66 loans over this period of time (either alone, or acting as trustee of his trust) to a multitude of borrowers, easily exceeding $24 million. These figures were more than sufficient to support the finding that the taxpayer’s personal lending activities were continuous and regular by themselves.  Unless motivated by some hidden whimsy or charitable purpose, the number of personal loans made and the money he tied up in them proves he spent a sufficient amount of time on them.

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Son Sells House To Parents To Avoid Foreclosure. What’s Taxable?

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The son was unable to make his mortgage payments that became due on his house. In order to avoid foreclosure, he sold his house to his parents. His parents financed the purchase by taking out a loan that was used to pay off $664,048 of the taxpayer’s outstanding mortgage debt. The closing statement showed that “Total Consideration” for the sale and purchase was $975,000. The IRS claimed that the amount realized on the transaction was $975,000. The son argued that the amount realized should be his $664,048 liability relief.

IRC section 1001(b) states that the amount realized from the sale of property is the sum of any money received plus the fair market value of property other than money that is received. The regulations for this code section state that the amount realized includes the amount of liabilities from which the transferor is discharged as a result of the sale.

The son argued that the amount realized should be the $664,048 of liability relief because the transaction was in part a sale and in part a gift to his parents. The IRS argued the total consideration of $975,000 shown on the closing statement controls the determination of the amount realized.

The tax court rejected the IRS argument saying that the son received no cash and no other property from his parents as a result of the sale other than the mortgage debt that was discharged. The court said the IRS failed to understand that the transaction was in part a sale and in part a gift. [Reg. §1.1001-1(e)(1)]

The tax court ruled that the amount realized on the sale was the $664,048 of mortgage debt relief, minus the son’s settlement costs at closing.  (Son must report the gift on Form 709)

If you’re in a similar bind and need tax help, contact Steve Siesser for advice.  ssiesser@verizon.net

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IRS Announces New Simplified Portability Election Method

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For purposes of the Federal Estate and Gift tax, a portability election allows a surviving spouse to add the decedent’s unused estate and gift tax exclusion amount to the surviving spouse’s own exclusion amount.

Generally, since December 31, 2014, executors needed to apply via a private letter ruling to request the IRS to grant an extension of time to make the election. However, as a result of numerous requests for relief, the IRS has issued a new revenue procedure for a new simplified method to make the election, effective June 9, 2017.

For decedent’s dying in 2017, the inflation adjusted exclusion amount is $5,490,000. This means that for decedent’s dying in 2017, lifetime gifts plus the value of assets included in the gross estate up to $5,490,000 are excluded from the Federal Estate tax. For example, if a decedent dies in 2017 with total lifetime gifts and a gross estate of $3 million, the surviving spouse can elect to add $2,490,000 ($5,490,000 minus $3,000,000) to his or her own exclusion amount.

The executor of the estate of the deceased spouse must elect portability of the unused estate and gift tax exclusion amount by filing an estate tax return for the decedent within nine months of the decedent’s date of death (plus extensions) and include a calculation of the unused exclusion amount on that return.  A return must be filed by the executor to elect portability even if the decedent was not otherwise required to file a Federal Estate tax return. Regulation section 301.9100-3 provides relief for executors who fail to make the election by the due date of the return by allowing an extension of time to make the election under certain circumstances.

The new simplified method is available to the executor of the estate of a decedent if:

1) The decedent:

a) Was survived by a spouse,

b) Died after December 31, 2010, and

c) Was a citizen or resident of the United States on the date of death.

2) The executor is not required to file an estate tax return based on the value of the gross estate and adjusted taxable gifts and without regard to the need to file for portability purposes,

3) The executor did not file an estate tax return by the due date of the estate tax return, and

4) The executor satisfies the following requirements:

a) The executor must file a complete and properly prepared Form 706 on or before the later of January 2, 2018, or the second annual anniversary of the decedent’s date of death.

b) The executor filing the Form 706 states at the top of the Form 706 that the return is “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER Sec. 2010(c)(5)(A).”

If the executor does not satisfy the above requirements, the executor can still request relief by requesting a private letter ruling under the provisions of Regulation section 301.9100-3.

This simplified method does not extend the period during which the surviving spouse or the surviving spouse’s estate may make a claim for credit or refund as a result of making the portability election under this revenue procedure.

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