Ready to Convert to a Roth IRA? |
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Even if converting your traditional IRA to a Roth IRA isn’t an option for you today, it will be next year. That’s because starting in 2010 the income and marital status restrictions that might otherwise restrict your ability to make that conversion will no longer apply.
Under current law, an individual with a modified adjusted gross income (MAGI) of more than $100,000 (not counting the conversion amount) isn’t allowed to convert a traditional IRA to a Roth IRA. Married individuals filing separate returns are also restricted from making traditional-to-Roth IRA conversions, except in certain circumstances.
So why should you convert? Because the pros may significantly outweigh the cons.
Let’s start with the cons. The conversion process causes the amount converted to be taxed. Essentially, you’re moving assets from an account funded with tax-deferred contributions (a traditional IRA) to one funded with after-tax dollars (a Roth IRA). If you converted a traditional IRA with $100,000 in assets to a Roth account and were otherwise in, for example, the 28% bracket, you’d likely be pushed into the higher 33% bracket for at least a portion of the amount. That extra 5% tax on, say, $50,000 would lead to an extra $2,500 in federal income tax.
To soften the blow, if you convert to a Roth IRA in 2010, you can report the income evenly over the following two years. Not only will you be able to defer recognition of the income, but you also may avoid being taxed at the higher rate. If you convert in later years, you’ll need to recognize income in the year of conversion. So, 2010 could be the best time to convert.
There are valid financial reasons for converting to a Roth IRA. First, required mandatory distribution (RMD) rules don’t apply to Roth IRAs, making them a good option if you won’t need the retirement income and want to grow your retirement plan assets for your heirs.
Also, in contrast to traditional IRA contributions, Roth IRA contributions — and the amount converted from traditional IRAs — can be withdrawn at any time, free of penalties and taxes. (Early withdrawals of earnings on contributions are subject to taxes and early withdrawal penalties, though there are exceptions.) Once you reach age 59˝, you can take tax-free distributions so long as you’ve had the Roth IRA for at least five years. Roth IRAs are also more flexible than traditional IRAs with regard to contributions — there’s no age limit, for example.
When deciding if a Roth is right for you, bear in mind that traditional IRAs boast tax-deductible contributions and may be advantageous for people who anticipate paying taxes at a significantly lower rate at retirement age. That said, there’s still the RMD rule that comes with a traditional IRA.
Roth-related tax law changes present some interesting planning opportunities. For example, if you’re restricted from making Roth IRA contributions because your income is too high, you can contribute to a nondeductible traditional IRA in 2009 and later years, converting it to a Roth when ready.
But be careful: Although this works well when you have no other traditional IRAs, it can be problematic if others do exist. That’s because you can’t choose to convert just the nontaxable portion of the traditional IRA. Any conversion will be done on a pro rata basis. So, if you have $100,000 in a traditional IRA and only $5,000 is from nondeductible contributions, 95% of the conversion amount will be taxable. If, however, you don’t have any other traditional IRAs, making a nondeductible contribution will allow you to convert next year, and you’ll only have to pay tax on any earnings.
Generally, if you can convert traditional IRA assets into a Roth with little or no tax cost, you should seriously consider it.
One caveat: When converting to a Roth IRA, do so via a custodian-to-custodian transfer, not by making a withdrawal from your traditional IRA and then opening a Roth account. You’ll need to complete the rollover within 60 days in order to avoid the negative tax consequences.
Now’s the time to consider whether converting your traditional IRA to a Roth version will benefit you, because 2010 isn’t that far away. And be sure to work with your tax advisor to determine which strategy is best for you before making any rollover moves.
Looking for other possible uses of your traditional IRA? Are you (or will you be) over 70˝ this year? Want to contribute to a favorite charity, but don’t know where to get the funds? Consider giving the charity money directly from your IRA. You can make a charitable distribution of up to $100,000 from an IRA to a qualified charity (or charities) by Dec. 31, 2009, and exclude the distribution amount from your income. Although you won’t get a charitable deduction for the amount distributed, the charity (or charities) will benefit and you’ll avoid any taxes you’d otherwise owe on the distribution.
Attract and Retain Top Talent |
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Even during this period of unprecedented layoffs, attracting and retaining top executive talent is still crucial. An appealing compensation package may be just the ticket, and deferred compensation can be an important part of that package.
In considering compensation, companies have two options: qualified deferred compensation (QDC) plans or nonqualified deferred compensation (NQDC) plans. Both can benefit your top employees; the major difference between the plans is how they affect your business:
QDC: These plans, such as 401(k)s, are standard retirement planning tools for most of a company’s workforce and provide a current tax deduction for the employer. Plan assets are secured from claims of the employer’s general creditors. There are some drawbacks, however: the employer must include, with some exceptions, all employees, and extensive government reporting is required.
NQDC: Only a select group of management or highly compensated employees may participate in these types of plans. If properly designed, employees don’t pay taxes on the contributions or earnings until received, and governmental reporting requirements are limited. On the other hand, employers can’t take a current tax deduction for NQDC contributions, and any assets set aside for informal financing of the “promise” must be subject to claims of the employer’s general creditors.
Although NQDC plans offer more flexibility in terms of tax-deferred executive compensation, they must also comply with Section 409A — a portion of the tax code designed to prevent Enron-type abuses of executive compensation.
Sec. 409A applies to all employers that provide an arrangement where an employee can defer income until a future year. Traditional NQDC arrangements, such as advance deferral elections of cash compensation and phantom stock plans, must abide by the strict compliance rules of Sec. 409A. In contrast, plans that provide no actual deferral of income — incentive stock options and restricted stock, for example — aren’t covered under the rules.
Under Sec. 409A rules, the election to defer compensation must, with limited exceptions, be made the year before the compensation is earned. Special rules apply to the timing of deferral elections applicable to certain performance-based compensation. (Consult your tax advisor for more information.) After an NQDC agreement is reached, Sec. 409A imposes substantial restrictions on a company’s ability to change the timing or form of payment.
Companies that fail to comply with these rules place their executives at risk of being taxed for all future benefits before the benefits are received. A stiff 20% penalty tax, plus interest, also applies. Each of these penalties falls on the executive (rather than the employer), placing the burden on those receiving plan benefits to ensure that that plan is in compliance.
With good planning, there are still ways to design compensation packages that will help you attract — and keep — top talent. The best strategy is to determine how you want your plan to operate, and then work with your tax and business advisors to design a plan that’s right for your company.
Risk Management: |
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If you think risk management involves only insurance, it’s time to reconsider your stance. During this era of financial uncertainty, globalization and technological change, companies are being called on to manage an assortment of daunting risks.
Many companies have turned to Enterprise Risk Management (ERM), an integrated, company-wide system of identifying and planning for risk. But though ERM sounds good on paper, some of the biggest dominoes in the 2008 financial collapse were recognized leaders in state-of-the-art ERM implementation. Bear Stearns, Lehman Brothers, Merrill Lynch and AIG, for example, all had ERM technology in place. Nevertheless, ERM still presents the most viable solution to the numerous and varied risks that companies face.
Risk management takes many forms, and the number of strategies available to deal with it may seem overwhelming. However, there are some best practices you can follow in building sound, companywide risk protection.
Start by making the decision to proactively manage your company’s risk. This isn’t a decision you can make by yourself: You’ll need to sell your colleagues on “risk religion,” from the top down. After you’ve gained commitment from key players, spend time assessing the risks your business may face.
The first task is to develop a comprehensive list of risks. Then determine the impact and likelihood of each one. Obvious risks may include:
- financial perils,
- information technology attacks or crashes,
- weather-related disasters,
- regulatory compliance debacles, and
- supplier/customer relationship mishaps.
And, because every business is different, you’ll likely need to add other risks unique to your business and industry.
Recognizing risks is only the first phase. Citigroup spelled out a lengthy roster of risks in its 2007 10-K, but that didn’t keep its top managers from heading to Congress in search of a financial bailout in 2008.
To truly address the risks, clarify what your company’s appetite and capacity for each risk is, and develop a cohesive philosophy and plan for how they should be handled. Ivan Inventor, for example, would face a number of perils involved with a new high-tech product, such as:
- product liability,
- protecting intellectual property,
- shortage of raw materials,
- lack of manufacturing capacity, and
- safety regulations.
Before rolling out the product, Ivan’s team will need to spend time developing and analyzing worst case scenarios for each risk, and then craft a plan to survive each one.
The key to success in the planning stage is conducting a detailed analysis of your business. Gather as much information as possible from each department and employee. Depending on your company’s size, engage workers in brainstorming sessions and workshops to help you analyze how specific events could alter your company’s landscape.
In addition to developing strategies, assign someone to manage each of the various aspects of risk. In other words; each risk should have an “owner.” If the list of risks seems overwhelming, manage the largest ones first and work your way down the list.
The ultimate goal is to embed ERM in your company culture, weaving it into every aspect of the business. Beware of top-down impositions during this phase. Squelching an otherwise free-wheeling company culture through ERM is actually one of the risks you face!
ERM software (including company “dashboards”) can be helpful in the risk management process, though not a prerequisite to success. Frequent monitoring of important metrics is an integral part of successful ERM, however.
Implementing ERM to the point where it’s part of your company DNA won’t happen overnight. With persistence, however, you can train your team to perceive risk management not as a separate function, but as part of daily life. Even though this won’t guarantee success in today’s markets, it can enhance your chances.
Expanded Business Tax Breaks |
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Two valuable tax breaks were expanded earlier this year that can provide many businesses with substantial benefits if they act soon. The American Recovery and Reinvestment Act of 2009 (ARRA) extended the 50% bonus depreciation through 2009, making it more affordable for businesses to invest in asset purchases this year. The act also expanded the net operating loss (NOL) carryback period for smaller businesses with 2008 NOLs, potentially providing them with a much needed cash infusion this year.
You can take the special 50% bonus depreciation allowance — in addition to normal depreciation — on certain assets placed in service during calendar year 2009. The bonus depreciation is equal to 50% of the property’s adjusted basis. Qualifying assets include:
- new tangible property with a recovery period of 20 years or less, such as office furniture and equipment;
- off-the-shelf computer software;
- water utility property; and
- qualified leasehold improvement property.
In addition, bonus depreciation allowed under the same act for property with a recovery period of 10 years or longer, transportation property, and certain aircraft was extended through 2010.
Even though the improved cash flow available through bonus depreciation will be a boon to companies caught in the credit crunch, there are a few traps to consider. As bonus depreciation expires, a “boomerang effect” is likely to impact cash flow negatively in years to come. When depreciation is front-loaded, older assets won’t provide their traditional tax shield later on, triggering higher taxable income in subsequent years.
In the final analysis, bonus depreciation doesn’t change the total amount that eventually will be written off — only the timing of the deduction. If you choose to take the 50% bonus depreciation in 2009, use that cash wisely with an eye toward subsequent years, when write-offs related to previous capital investments won’t be nearly as generous.
Generally, an NOL may be carried back two years to generate a current tax refund, providing a cash infusion in times of loss.
For 2008 (not 2009), ARRA extends the maximum NOL carryback to up to five years for small businesses with gross receipts of $15 million or less. You can choose whether to carry the loss back two, three, four or five years. Any loss not absorbed in the prior periods is then carried forward for up to 20 years. You also can choose to waive the carryback period entirely and carry the loss forward. So how do you decide which course to take?
If the prior years have minimal refund potential and you’re confident your company will have taxable income going forward, an election to forgo a carryback in favor of a carryforward (which will minimize your future years’ estimated tax payments) may make sense. If your business can benefit from the NOL carryback, however, you may want to carry the loss back and get crucial cash back now.
ARRA-related bonus depreciation provisions (discussed above) may also be helpful in maximizing your current year NOLs. If your business uses the accrual method of accounting for tax purposes, you can increase this year’s NOL with inventory write-downs, with bad debt write-offs or through a reduction of accrued expenses. Cash basis companies, on the other hand, may benefit from accelerating depreciation deductions, maximizing retirement plan funding, selling off devalued assets or prepaying deductible expenses before year end.
In considering your business’ carryback and carryforward options, be sure you evaluate any alternative minimum tax (AMT) implications and how your decision will impact state taxes. In the case of a sole proprietorship or flow-through entity, the new rules can also apply to an individual NOL caused by losses from a qualifying small business.
The best advice, as always, is to check with your tax advisor about the pros and cons of the tax strategies mentioned in this article. It could be that an NOL carryback, perhaps enhanced by the 50% bonus depreciation deduction, will provide the shot of cash your company needs during these difficult times.
The 411 on Enhanced Charitable |
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Those computer relics, barrels of food or boxes of books stacking up in your storage rooms or warehouse could actually be costing you money — not just in storage costs but also in lost tax savings. Fortunately, Uncle Sam has extended the enhanced charitable contribution deduction through Dec. 31, 2009. Under previous law, the deduction was limited to cost (if the charity didn’t resell the item). Understandably, this was a challenge for donors wishing to contribute items where fair market value exceeded cost.
The enhanced deduction allows businesses contributing food, computer equipment and books to qualifying organizations to receive a deduction of up to twice the cost or basis of an item, if the value is higher than cost. (Businesses donating books must certify in writing that they are suitable for, and will be used in, the recipient organization’s educational programs.)
Contributions of “apparently wholesome” foods by farmers and ranchers will be treated as qualified conservation contributions (under Internal Revenue Code Section 170) through the end of 2009. For purposes of this law, the IRS defines apparently wholesome foods as those which are intended for human consumption (meeting all legal requirements for quality and labeling), but which aren’t readily marketable because of age, freshness, surplus or other reasons.
The enhanced deduction for qualifying foods is equal to the lesser of your basis in the food plus half of its appreciation, or twice the food’s basis. In contrast to the 50% contribution limitation for most charitable deductions, qualified conservation contributions made by farmers are deductible up to 100% of taxable income. Additionally, unused deductions may be carried forward for up to 15 years.
S corporation shareholders also may benefit from special tax treatment when making charitable contributions of qualifying property. The expanded provisions include a special rule allowing shareholders to take into account their pro-rata share of charitable deductions — even if those deductions exceed the shareholder’s adjusted basis — through Dec. 31, 2009.
If your business owns books, food or computers that may qualify for the enhanced charitable contribution deduction, you may have a great opportunity in 2009 to reduce your tax burden with one sweep through your warehouse.
Economic Rebound Could Be Delayed |
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We all know that the U.S. economy went into a recession in late 2008. Although the economic turmoil was widely publicized, the true effect of the economic downturn did not begin to impact private companies until the first quarter of 2009. Many of our clients and friends are facing unique challenges in addressing this situation.
The first consideration is that it may take longer to pull out of the downturn and return to normalcy than anticipated. The effects of recession only really began to adversely affect private companies in the first quarter of 2009. Although the recent trends in the equity markets suggest an economic recovery, it will take longer for positive results to cycle through to private companies. These businesses are not the direct beneficiaries of government programs designed to stimulate the economy and the effect will only be of a secondary nature.
The second consideration is that businesses need to plan and adapt to the change in circumstances. Many private companies are facing a decline in revenues for 2009. These businesses are reacting by revising their forecasts and making continued assessments relative to their expenses and internal functions.
The third consideration is that the relationship between a business and their bank may never be the same. In some cases, the banker that the business dealt with on a regular basis may no longer be employed by the bank. In other situations, the bank may not be willing to renew or extend current loan commitments. The best approach in these situations is for a business to work closely with their bank and keep them apprised of developments at the company.
We are seeing our clients deal with the current crisis in a variety of ways. Please contact us to see how we can help with your situation.
Reader’s Corner |
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George Friedman’s new book, The Next 100 Years: A Forecast for the 21st Century is full of good news for America in the 21st century. He is the founder of Stratfor, a private global intelligence agency.
Friedman predicts decades of American dominance. "The United States is economically, militarily, and politically the most powerful country in the world, and there is no real challenger to that threat."
The history of the 21st century will be of two opposing struggles, Friedman writes. "One will be secondary powers forming coalitions to try to contain and control the United States. The second will be the United States acting preemptively to prevent an effective coalition from forming."
Friedman notes the long-term strategic goals of the United States increasing in order of importance and difficulty:
1. The complete domination of North America by the United States Army.
2. The elimination of any threat to the United States by any power in
the Western Hemisphere.
3. Complete control of all maritime approaches to the United States by the Navy in order to preclude
any possibility of invasion.
4. Complete domination of the World’s oceans to further secure the safety of the United States and guarantee
control over the international trading system.
5. The prevention of any other nation from challenging United States global naval power.
The book is written with the backdrop of these overall goals and describes how the World will attempt to control American behavior.
He describes the 2020 collapse of an overextended China and under-populated Russia. Both powers ultimately disintegrate into fragments.
By 2030, economic growth will slow due to an ever aging population. Immigration will be viewed as the solution as the borders are thrown open.
Turkey and Japan will be the beneficiaries of the decline of China and Russia. Turkey's sphere of influence will extend throughout the Muslim world, and Japan will be taking in a Chinese immigrant labor force and exerting itself in Eastern Russia. This will ultimately lead to these nations banding together to challenge American power in a mid-21st century World War in which America is aligned with Britain, Poland and China. This war will be very different as casualties will be low because the ground wars of the past give way to technological assaults and targeted attacks. In the end the United States will prevail and the defeated nations will be demilitarized and kept in check.
Friedman sees the 2060s and 2070s as a golden age of prosperity. Space exploration, energy development and demographics fuel the economy because no real military threat exists for the US.
In the end, the greatest challenge to America will not be external but internal. Mexican immigration will be necessary to keep our economy pumping, but it will essentially erase the border, and turn the Southwest into a Spanish-speaking subset of the US similar to Quebec. It will cause stress on American culture, as well as relations with the Mexican government. As Friedman concludes, North America will be the center of gravity for the international system, but who will control North America? For that, we must wait for the next book of 22nd Century predictions.
This book is fun to read as it presents a very positive yet realistic view of America. It certainly gives one some optimism in these tough economic times.
Some Interesting Facts |
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When one compares the projected fiscal year 2010 federal budget deficit of $1.6 trillion to government programs of the past the results are quite interesting.
According to Bianco Research President James Bianco, this amount far exceeds nine of the costliest events in American history:
| Event | Cost | Inflation Adjusted Cost | |
| Marshall Plan | $12.7 billion | $115.3 billion | |
| Louisiana Purchase | $15 million | $217 billion | |
| Race to the Moon | $36.4 billion | $237 billion | |
| S & L Crisis | $153 billion | $236 billion | |
| Korean War | $54 billion | $454 billion | |
| The New Deal | $32 billion (est) | $500 billion (est) | |
| Invasion of Iraq | $551 billion | $597 billion | |
| Vietnam War | $111 billion | $698 billion | |
| NASA | $416 billion | $851.2 billion |
The entire cost of World War II to the United States was $288 billion, $3.6 trillion when adjusted for inflation.