Tax Reform: Summary Of The Changes

The conference version of the tax bill was released on Friday. The House and the Senate will be voting to approve the updated tax bill this week with what seems to be wide spread support from the Republican party which is all they need to sign the bill into law before Christmas. Most of the changes will not take effect until 2018 with new tax rates for individuals set to expire in 2025. At which time the tax rates and brackets will return to their current state. Here is a run down of some of the main changes baked into the updated tax bill:

Individual Tax Rates

They are keeping 7 tax brackets with only minor changes to percentages in each bracket. The top tax bracket was reduced from 39.6% to 37%.

Capital Gains Rates

There were no changes to the capital gains rates and they threw out the controversial mandatory FIFO rule for calculating capital gains tax when selling securities.

Standard Deduction and Personal Exemptions

They did double the standard deduction limits. Single tax payers will receive a $12,000 standard deduction and married couples filing joint will receive a $24,000 standard deduction.The personal exemptions are eliminated.

Mortgage Interest Deduction

New mortgages would be capped at $750,000 for purposes of the home mortgage interest deduction.

State and Local Tax Deductions

State and local tax deduction will remain but will be capped at $10,000. An ouch for New York State. That $10,000 can be a combination of your property tax and either sales or income tax (whichever is larger or will get you to the cap of $10,000).Oh and you cannot prepay your 2018 state income taxes in 2017 to avoid the cap. They made it clear that if you prepay your 2018 state income taxes in 2017, you will not be able to deduct them in 2017.

Medical Expense Deductions

Medical expense deductions will remain for 2017 and 2018 and they lowered the AGI threshold to 7.5%. Beginning in 2019, the threshold will change back to the 10% threshold.

Miscellaneous Expense Deductions

Under the current rules, you are able to deduct miscellaneous expenses that exceed 2% of your AGI. That was eliminated. This includes unreimbursed business expenses and home office expenses.

A Few Quick Ones

Student Loan Interest: Still deductible

Teacher Out-of-Pocket Expenses: Still deductible

Tuition Waivers: Still not taxable

Fringe Benefits (including moving expenses): Will be taxable starting in 2018 (except for military)

Child Tax Credit: Doubled to $2,000 per child

Gain Exclusion On Sale Of Primary Residence: No Change

Obamacare Individual Mandate: Eliminated

Corporate AMT: Eliminated

Individual AMT: Remains but exemption is increased: Individuals: $70,300 Married: $109,400

Corporate Tax Rate: Drops to 21% in 2018

Federal Estate Tax: Remains but exemption limit doubles

Alimony

For divorce agreements signed after December 31, 2018, alimony will no longer be deducible. This only applies to divorce agreements executed or modified after December 31, 2018.

529 Plans

Under current tax law, you do not pay taxes on the earnings for distributions from 529 accounts for qualified college expenses. The new tax reform allows 529 account owners to distribute up to $10,000 per student for public, private and religious elementary and secondary schools, as well as home school students.

Pass-Through Income For Business

This is still a little cloudy but in general under the conference bill, owners of pass-through companies and sole proprietors will be taxed at their individual tax rates less a 20% deduction for business-related income, subject to certain wage limits and exceptions. The deduction would be disallowed for businesses offering "professional services" above a threshold amount; phase-ins begin at $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

M&A Activity: Make Sure You Address The Seller’s 401(k) Plan

Buying a company is an exciting experience.  However, many companies during a merger or acquisition fail to address the issues surrounding the seller’s retirement plan which can come back to haunt the buyer in a big way.   I completely understand why this happens.  Purchase price, valuations, tax issues, terms, holdbacks, and new employment agreements tend to dominate the conversations throughout the business transaction.   But lurking in the dark, below these main areas of focus, lives the seller’s 401(k) plan.  Welcome to the land of unintended consequences where unexpected liabilities, big dollar outlays, and transition issues live.

Asset Sale or Stock Sale

Whether the transaction is a stock sale or asset sale will greatly influence the series of decisions that the buyer will need to make regarding the seller’s 401(k) plan.  In an asset sale, it is common that employees of the seller’s company are terminated from employment and subsequently “rehired” by the buyer’s company.  With asset sales, as part of the purchase agreement, the seller will often times be required to terminate their retirement plan prior to the closing date.

Terminating the seller’s plan prior to the closing date has a few advantages from both the buyer’s standpoint and from the standpoint of the seller’s employees. Here are the advantages for the buyer:

Advantage 1:  The Seller Is Responsible For Terminating Their Plan

From the buyer’s standpoint, it’s much easier and cost effective to have the seller terminate their own plan.  The seller is the point of contact at the third party administration firm, they are listed as the trustee, they are the signer for the final 5500, and they typically have a good personal relationship with their service providers.  Once the transaction is complete, it can be a headache for the buyer to track down the authorized signers on the seller’s plan to get all of the contact information changed over and allows the buyer’s firm to file the final 5500.

The seller’s “good relationship” with their service providers is key. The seller has to call these companies and let them know that they are losing the plan since the plan is terminating.  There are a lot of steps that need to be completed by those 401(k) service providers after the closing date of the transaction.  If they are dealing with the seller, their “client”, they may be more helpful and accommodating in working through the termination process even though they losing the business. If they get a random call for the “new contact” for the plan, you risk getting put at the bottom of the pile

Part of the termination process involves getting all of the participant balances out of the plan. This includes terminated employees of the seller’s company that may be difficult for the buyer to get in contact with.   It’s typically easier for the seller to coordinate the distribution efforts for the terminated plan.

Advantage 2:  The Buyer Does Not Inherit Liability Issues From The Seller’s Plan

This is typically the main reason why the buyer will require the seller to terminate their plan prior to the closing date.  Employer sponsored retirement plans have a lot of moving parts.  If you take over a seller’s 401(k) plan to make the transition “easier”, you run the risk of inheriting all of the compliance issues associated with their plan. Maybe they forgot to file a 5500 a few years ago, maybe their TPA made a mistake on their year-end testing last year, or maybe they neglected to issues a required notice to their employees knowing that they were going to be selling the company that year.  By having the seller terminate their plan prior to the closing date, the buyer can better protect themselves from unexpected liabilities that could arise down the road from the seller’s 401(k) plan.

Now, let’s transition the conversation over to the advantages for the seller’s employees.

Advantage 1: Distribution Options

A common goal of the successor company is to make the transition for the seller’s employees as positive as possible right out of the gate.  Remember this rule:  “People like options”.  Having the seller terminate their retirement plan prior to the closing date of the transactions gives their employees some options. A plan termination is a “distributable event” meaning the employees have control over what they would like to do with their balance in the seller’s 401(k) plan.  This is also true for the employees that are “rehired” by the buyer.  The employees have the option to:

• Rollover their 401(k) balance in the buyer’s plan (if eligible)

• Rollover their 401(k) balance into a rollover IRA

• Take a cash distribution

• Some combination of options 1, 2, and 3

The employees retain the power of choice.

If instead of terminating the seller’s plan,  what happens if the buyer decides to “merge” the seller’s plan in their 401(k) plan?  With plan mergers, the employees lose all of the distribution options listed above. Since there was not a plan termination, the employees are forced to move their balances into the buyer’s plan.

Advantage 2:  Credit For Service With The Seller’s Company

In many acquisitions, again to keep the new employees happy, the buyer will allow the incoming employee to use their years of service with the seller’s company toward the eligibility requirements in the buyer’s plan.  This prevents the seller’s employees from coming in and having to satisfy the plan’s eligibility requirements as if they were a new employee without any prior service.  If the plan is terminated prior to the closing date of the transaction, the buyer can allow this by making an amendment to their 401(k) plan.

If the plan terminates after the closing date of the transaction, the plan technically belonged to the buyer when the plan terminated.  There is an ERISA rule, called the “successor plan rule”, that states when an employee is covered by a 401(k) plan and the plan terminates, that employee cannot be covered by another 401(k) plan sponsored by the same employer for a period of 12 months following the date of the plan termination.  If it was the buyer’s intent to allow the seller’s employees to use their years of service with the selling company for purposes of satisfy the eligibility requirement in the buyer’s plan, you now have a big issue. Those employees are excluded from participating in the buyer’s plan for a year.  This situation can be a speed bump for building rapport with the seller’s employees.

Loan Issue

If a company allows 401(k) loans and the plan terminates, it puts the employee in a very bad situation. If the employee is unable to come up with the cash to payoff their outstanding loan balance in full, they get taxed and possibly penalized on their outstanding loan balance in the plan.

Example: Jill takes a $30,000 loan from her 401(k) plan in May 2017.  In August 2017, her company Tough Love Inc., announces that it has sold the company to a private equity firm and it will be immediately terminating the plan.  Jill is 40 years old and has a $28,000 outstanding loan balance in the plan.  When the plan terminates, the loan will be processed as an early distribution, not eligible for rollover, and she will have to pay income tax and the 10% early withdrawal penalty on the $28,000 outstanding loan balance. Ouch!!!

From the seller’s standpoint, to soften the tax hit, we have seen companies provide employees with a severance package or final bonus to offset some of the tax hit from the loan distribution.

From the buyer’s standpoint, you can amend the plan to allow employees of the seller’s company to rollover their outstanding 401(k) loan balance into your plan.  While this seems like a great option, proceed with extreme caution.  These “loan rollovers” get complicated very quickly.  There is usually a window of time where the employee’s money is moving over from seller’s 401(k) plan over to the buyer’s 401(k) plan, and during that time period a loan payment may be missed.  This now becomes a compliance issue for the buyer’s plan because you have to work with the employee to make up those missed loan payments.  Otherwise the loan could go into default.

Example, Jill has her outstanding loan and the buyer amends the plan to allow the direct rollover of outstanding loan balances in the seller’s plan.  Payroll stopped from the seller’s company in August, so no loan payments have been made, but the seller’s 401(k) provider did not process the direct rollover until December.  When the loan balance rolls over, if the loan is not “current” as of the quarter end, the buyer’s plan will need to default her loan.

Our advice, handle this outstanding 401(k) loan issue with care.  It can have a large negative impact on the employees. If an employee owes $10,000 to the IRS in taxes and penalties due to a forced loan distribution, they may bring that stress to work with them.

Stock Sale

In a stock sale, the employees do not terminate and then get rehired like in an asset sale.  It’s a “transfer of ownership” as opposed to “a sale followed by a purchase”.  In an asset sale, employees go to sleep one night employed by Company A and then wake up the next morning employed by Company B.  In a stock sale, employees go to sleep employed by Company A, they wake up in the morning still employed by Company A, but ownership of Company A has been transferred to someone else.

With a stock sale, the seller’s plan typically merges into the buyer’s plan, assuming there is enough ownership to make them a “controlled group”.  If there are multiple buyers, the buyers should consult with the TPA of their retirement plans or an ERISA attorney to determine if a controlled group will exist after the transaction is completed.   If there is not enough common ownership to constitute a “controlled group”, the buyer can decide whether to continue to maintain the seller’s 401(k) plan as a standalone plan or create a multiple employer plan.    The basic definition of a “controlled group” is an entity or group of individuals that own 80% or more of another company.

Stock Sales: Do Your Due Diligence!!!

In a stock sale, since the buyer will either be merging the seller’s plan into their own or continuing to maintain the seller’s plan as a standalone, you are inheriting any and all compliance issues associated with that plan.  The seller’s issues become the buyer’s issues the day of the closing.   The buyer should have an ERISA attorney that performs a detailed information request and due diligence on the seller’s 401(k) plan prior the closing date.

Seller Uses A PEO

Last issue.  If the selling company uses a Professional Employer Organization (PEO) for their 401(k) services and the transaction is going to be a stock sale, make sure you get all of the information that you need to complete a mid-year valuation or the merged 5500 for the year PRIOR to the closing date.  We have found that it’s very difficult to get information from PEO firms after the acquisition has been completed.

The Transition Rule

There is some relief provided by ERISA for mergers and acquisitions.  If a control group exists, you have until the end of the year following the year of the acquisition to test the plans together.  This is called the “transition rule”.   However, if the buyer makes “significant” changes to the seller’s plan during the transition period, that may void the ability to delay combined testing.  Unfortunately, there is not clear guidance as to what is considered a “significant change” so the buyer should consult with their TPA firm or ERISA  attorney before making any changes to their own plan or the seller’s plan that could impact the rights, benefits, or features available to the plan participants.

Horror Stories

There are so many real life horror stories out there involving companies that go through the acquisition process without conducting the proper due diligence and transition planning with regard to the seller’s retirement plan.  It never ends well!!  As the buyer, it’s worth the time and the money to make sure your team of advisors have adequately addressed any issues surrounding the seller’s retirement plan prior to the closing date. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Lower Your Tax Bill By Directing Your Mandatory IRA Distributions To Charity

When you turn 70 ½, you will have the option to process Qualified Charitable Distributions (QCD) which are distributions from your pre-tax IRA directly to a charitable organization.  Even though the SECURE Act changed the RMD start age from 70 1/2 to age 73, your are still eligible to make these QCDs beginning the calendar year that you turn age 70 1/2 . At age 73, you must begin taking required minimum distributions (RMD) from your pre-tax IRA’s and unless you are still working, your employer sponsored retirement plans as well.  The IRS forces you to take these distributions whether you need them or not.  Why is that?  They want to begin collecting income taxes on your tax deferred retirement assets.

Some retirees find themselves in the fortunate situation of not needing this additional income so the RMD’s just create additional tax liability.  If you are charitably inclined and would prefer to avoid the additional tax liability, you can make a charitable contribution directly from your IRA and avoid all or a portion of the tax liability generated by the required minimum distribution requirement.

It Does Not Work For 401(k)’s

You can only make “qualified charitable contributions” from an IRA.  This option is not available for 401(k), 403(b), and other qualified retirement plans. If you wish to execute this strategy, you would have to process a direct rollover of your FULL 401(k) balance to a rollover IRA and then process the distribution from your IRA to charity.

The reason why I emphases the word “full” for your 401(k) rollover is due to the IRS “aggregation rule”.  Assuming that you no longer work for the company that sponsors your 401(k) account, you are age 73 or older, and you have both a 401(k) account and a separate IRA account, you will need to take an RMD from both the 401(k) account and the IRA separately.  The IRS allows you to aggregate your IRA’s together for purposes of taking RMD’s.  If you have 10 separate IRA’s, you can total up the required distribution amounts for each IRA, and then take that amount from a single IRA account.   The IRS does not allow you to aggregate 401(k) accounts for purposes of satisfying your RMD requirement.  Thus, if it’s your intention to completely avoid taxes on your RMD requirement, you will have to make sure all of your retirement accounts have been moved into an IRA.

Contributions Must Be Made Directly To Charity

Another important rule. At no point can the IRA distribution ever hit your checking account.  To complete the qualified charitable contribution, the money must go directly from your IRA to the charity or not-for-profit organization.   Typically this is completed by issuing a “third party check” from your IRA.  You provide your IRA provider with payment instructions for the check and the mailing address of the charitable organization. If at any point during this process you take receipt of the distribution from your IRA, the full amount will be taxable to you and the qualified charitable contribution will be void.

Tax Lesson

For many retirees, their income is lower in the retirement years and they have less itemized deductions since the kids are out of the house and the mortgage is paid off.  Given this set of circumstances, it may make sense to change from itemizing to taking the standard deduction when preparing your taxes.  Charitable contributions are an itemized deduction. Thus, if you take the standard deduction for your taxes, you no longer receive the tax benefit of your contributions to charity. By making IRA distributions directly to a charity, you are able to take the standard deduction but still capture the tax benefit of making a charitable contribution because you avoid tax on an IRA distribution that otherwise would have been taxable income to you.

Example: Church Offering

Instead of putting cash or personal checks in the offering each Sunday, you may consider directing all or a portion of your required minimum distribution from your IRA directly to the church or religious organization.  Usually having a conversation with your church or religious organization about your new “offering structure” helps to ease the awkward feeling of passing the offering basket without making a contribution each week.

Example: Annual Contributions To Charity

In this example, let’s assume that each year I typically issue a personal check of $2,000 to my favorite charity, Big Brother Big Sisters,  a not-for-profit organization.   I’m turning 70½ this year and my accountant tells me that it would be more beneficial to take the standard deduction instead of itemizing.  My RMD for the year is $5,000.  I can contact my IRA provider, have them issuing a check directly to the charity for $2,000 and issue me a check for the remaining $3,000.  I will only have to pay taxes on the $3,000 that I received as opposed to the full $5,000.  I win, the charity wins, and the IRS kind of loses.  I’m ok with that situation.

Don’t Accept Anything From The Charity In Return

This is a very important rule.  Sometimes when you make a charitable contribution, as a sign of gratitude, the charity will send you a coffee mug, gift basket, etc.  When this happens, you will typically get a letter from the charity confirming your contribution but the amount listed in the letter will be slightly lower than the actual dollar amount contributed.  The charity will often reduce the contribution by the amount of the gift that was given.  If this happens, the total amount of the charitable contribution fails the “qualified charitable contribution” requirement and you will be taxed on the full amount.  Plus, you already gave the money to charity so you have spend the funds that you could use to pay the taxes.  Not good

Limits

While this will not be an issue for many of us, there is a $100,000 per person limit for these qualified charitable contributions from IRA’s.

Summary

While there are a number of rules to follow when making these qualified charitable contributions from IRA’s, it can be a great strategy that allows retirees to continue contributing to their favorite charities, religious organizations, and/or not-for-profit organizations, while reducing their overall tax liability. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: At What Cost?

The Republicans are in a tough situation.  There is a tremendous amount of pressure on them to get tax reform done by the end of the year.  This type of pressure can have ugly side effects.  It’s similar to the Hail Mary play at the end of a football game.  Everyone, including the quarterback, has their eyes fixed on the end zone but nobody realizes that no one is covering one of the defensive lineman and he’s just waiting for the ball to be hiked.   The game ends without the ball leaving the quarterback’s hands.

The Big Play

Tax reform is the big play.  If it works, it could lead to an extension of the current economic rally and more.  I’m a supporter of tax reform for the purpose of accelerating job growth both now and in the future.  It’s not just about U.S. companies keeping jobs in the U.S. That has been the game for the past two decades.  The new game is about attracting foreign companies to set up shop in the U.S. and then hire U.S. workers to run their plants, companies, subsidiaries, etc.  Right now we have the highest corporate tax rate in the world which has not only prevented foreign companies from coming here but it has also caused U.S. companies to move jobs outside of the United States.  If everyone wants more pie, you have to focus on making the pie bigger, otherwise we are all just going to sit around and fight over who’s piece is bigger.

Easier Said Than Done

How do we make the pie bigger?  We have to lower the corporate tax rate which will entice foreign companies to come here to produce the goods and services that they are already selling in the U.S.   Which is easy to do if the government has a big piggy bank of money to help offset the tax revenue that will be lost in the short term from these tax cuts. But we don’t.

$1.5 Trillion In Debt Approved

Tax reform made some headway in mid-October when the Senate passed the budget. Within that budget was a provision that would allow the national debt to increase by approximately $1.5 trillion dollars to help offset the short-term revenue loss cause by tax reform.  While $1.5 trillion sounds like a lot of money, and don’t get me wrong, it is, let’s put that number in context with some of the proposals that are baked into the proposed tax reform.

Pass-Through Entities

One of the provisions in the proposed tax reform is that income from “pass-through” businesses would be taxed at a flat rate of 25%. 

A little background on pass-through business income: sole proprietorships, S corporations, limited liability companies (LLCs), and partnerships are known as pass-through businesses. These entities are called pass-throughs, because the profits of these firms are passed directly through the business to the owners and are taxed on the owners’ individual income tax returns. 

How many businesses in the U.S. are pass-through entities?  The Tax Foundation states on its website that pass-through entities “make up the vast majority of businesses and more than 60 percent of net business income in America. In addition, pass-through businesses account for more than half of the private sector workforce and 37 percent of total private sector payroll.” 

At a conference in D.C., the American Society of Pension Professionals and Actuaries (ASPPA), estimated that the “pass through 25% flat tax rate” will cost the government $6 trillion - $7 trillion in tax revenue. That is a far cry from the $1.5 trillion that was approved in the budget and remember that is just one of the many proposed tax cuts in the tax reform package.

Are Democrats Needed To Pass Tax Reform?

Since $1.5 trillion was approved in the budget by the senate, if the proposed tax reform is able to prove that it will add $1.5 trillion or less to the national debt, the Republicans can get tax reform passed through a “reconciliation package” which does not require any Democrats to step across the aisle.  If the tax reform forecasts exceed that $1.5 trillion threshold, then they would need support from a handful of Democrats to get the tax reformed passed which is unlikely.

Revenue Hunting

To stay below that $1.5 trillion threshold, the Republicans are “revenue hunting”.  For example, if the proposed tax reform package is expected to cost $5 trillion, they would need to find $3.5 trillion in new sources of tax revenue to get the net cost below the $1.5 trillion debt limit.

State & Local Tax Deductions – Gone?

One for those new revenue sources that is included in the tax reform is taking away the ability to deduct state and local income taxes.   This provision has created a divide among Republicans. Since many southern states do not have state income tax, many Republicans representing southern states support this provision.   Visa versa, Republicans representing states from the northeast are generally opposed to this provision since many of their states have high state and local incomes taxes.   There are other provisions within the proposed tax reform that create the same “it depends on where you live” battle ground within the Republican party.

Obamacare

One of the main reasons why the Trump administration pushed so hard for the Repeal and Replace of Obamacare was “revenue hunting”.  They needed the tax savings from the repeal and replace of Obamacare to carrry over to fill the hole that will be created by the proposed tax reform.  Since that did not happen, they are now looking high and low for other revenue sources.

Retirement Accounts At Risk?

If the Republicans fail to get tax reform through they run the risk of losing face with their supporters since they have yet to get any of the major reforms through that they campaigned on.  Tax reform was supposed to be a layup, not a Hail Mary and this is where the hazard lies.  Republicans, out of the desperation to get tax reform through, may start making cuts where they shouldn’t.  There are rumors that the Republican Party may consider making cuts to the 401(k) contribution limits and employers sponsored retirement plan.  Even though Trump tweeted on October 23, 2017 that he would not touch 401(k)’s as part of tax reform, they are running out of the options for other places that they can find new sources of tax revenue.  If it comes down to the 1 yard line and they have the make the decision between making deep cuts to 401(k) plans or passing the tax reform, retirement plans may end up being the sacrificial lamb.  There are other consequences that retirement plans may face if the proposed tax reform is passed but it’s too broad to get into in this article. We will write a separate article on that topic.

Tax Reform May Be Delayed

Given all the variables in the mix, passing tax reform before December 31st is starting to look like a tall order to fill.  If the Republicans are looking for new sources of revenue, they should probably look for sources that are uniform across state lines otherwise they risk splintering the Republican Party like we saw during the attempt to Repeal and Replace Obamacare.  We are encouraging everyone to pay attention to the details buried in the tax reform.  While I support tax reform to secure the country’s place in the world both now and in the future, if provisions that make up the tax reform are rushed just to get something done, we run the risk of repeating the short lived glory that tax reform saw during the Reagan Era.   They passed sweeping tax cuts, the deficits spiked, and they were forced to raise tax rates a few years later. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Do Single(k) Plans Work?

What is a Single(k) Plan?

A Single(k) plan is an employer-sponsored retirement plan for owner-only entities, meaning you have no full-time employees. These owner-only entities get the benefits of having a full-fledged 401(k) plan without the large administrative costs associated with traditional 401(k) plans.

What is the definition of a “full-time” employee?

Oftentimes, a small company will have some part-time staff. It does not matter whether you consider them “part-time”, the definition of full-time employee is defined by the IRS as working 1000 hours in a 12-month period. If you have a “full-time” employee, you would not be eligible to sponsor a Single(k) plan.

Types of Contributions

There are two types of contributions to these plans. Employee deferral contributions and employer profit sharing contributions. The employee deferral piece works like a 401(k) plan. If you are under the age of 50 you can contribute $23,500, in 2025, in employee deferrals. If you are 50-59 or 64 or older, you get the $7,500 catch up contribution so you can contribute $31,000 in employee deferrals. Beginning in 2025, if you are age 60-63, instead of the $7,500 catch-up, you can contribute an additional $11,250 for a total of $34,750 in employee deferrals.

The reason why these plans are a little different than other employer sponsored plans is the employee deferral piece allows you to put 100% of your compensation into these plans up to those dollar thresholds.

In addition to the employee deferrals, you can also contribute 20% of your net earned income in the form of a profit-sharing contribution. For example, if you make $100,000 in net earned income from self-employment and you are age 53, you could contribute $31,000 in employee deferrals and then you could contribute an additional $20,000 in the form of a profit-sharing contribution. Making your total pre-tax contribution $51,000.

Establishment Deadline

The deadline for establishing a Solo(k) plan varies based on how the business is incorporated. If the business is an S-Corp or multi-member partnership, the business owner(s) must have the Solo(k) plan setup by December 31st. If the business is a sole proprietor or single member LLC, the Solo(k) plan can be setup by the tax filing deadline plus extension. 

Loans & Roth Deferrals

Single(k) plans provide all of the benefits to the owner of a full 401(k) plan at a fraction of the cost. You can set up the plan to allow 401(k) loan and Roth deferral contributions.

SEP IRA vs Single(k) Plans

A lot of small business owners find themselves in a position where they are trying to decide between setting up a SEP IRA or a Single(k) plan. One of the big factors, that is often times the deciding factor, is how much the owner intends to contribute to the plan. The SEP IRA limits the business owner to just the 20% of net earned income. Whereas the Single(k) plan allows the 20% of net earned income plus the employee deferral contribution amount. However, if 20% of your net earned income would satisfy your target amount then the SEP IRA may be the right choice.

Advanced Strategy Using A Single(k) Plan

Here is a great tax strategy if you have one spouse that is the primary breadwinner bringing in most of the income and the other has self-employment income for a side business. If the spouse with the self-employment income is over the age of 50 and makes $20,000 in net earned income, they could set up a Single(k) Plan and defer the full $20,000 into their Single(k) plan as employee deferrals. If they had a SEP IRA, the max contribution would have been $4,000.

A huge tax savings for a married couple that is looking to lower their tax liability.

About Rob……...

Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.

The Fiduciary Rule: Exposing Your 401(K) Advisor’s Secrets

It’s here.  On June 9, 2017, the long awaited Fiduciary Rule for 401(k) plans will arrive.  The wirehouse and broker-dealer community within the investment industry has fought this new rule every step of the way.  Why? Because their secrets are about to be exposed.  Fee gouging in these 401(k) plans has spiraled out of control and it has gone on for way too long.  While the Fiduciary Rule was designed to better protect plan participants within these employer sponsored retirement plans, the response from the broker-dealer community, in an effort to protect themselves, may actually drive the fees in 401(k) plans higher than they are now.

If your company sponsors an employer sponsored retirement plan and your investment advisor is a broker with one of the main stream wirehouse or broker dealers then they may be approaching you within the next few months regarding a “platform change” for your 401(k) plan.  Best advice, start asking questions before you sign anything!!  The brokerage community is going to try to gift wrap this change and present this as a value added service to their current 401(k) clients when the reality is this change is being forced onto the brokerage community and they are at great risk at losing their 401(k) clients to independent registered investment advisory firms that have served as co-fiduciaries to their plans along.

The Fiduciary Rule requires all investment advisors that handle 401(k) plans to act in the best interest of their clients.  Up until now may brokers were not held to this standard. As long as they delivered the appropriate disclosure documents to the client, the regulations did not require them to act in their client’s best interest. Crazy right?  Well that’s all about to change and the response of the brokerage community will shock you.

I will preface this article by stating that there have been a variety of responses by the broker-dealer community to this new regulation.  While we cannot reasonably gather information on every broker-dealers response to the Fiduciary Rule, this article will provide information on how many of the brokerage firms are responding to the new legislation given our independent research.

SECRET #1:

Many of the brokerage dealers are restricting what 401(k) platforms their brokers can use.  If the broker currently has 401(k) clients that maintain a plan with a 401(k) platform outside of their new “approved list”, they are forcing them to move the plan to a pre-approved platform or the broker will be required to resign as the advisor to the plan.  Even though your current 401(k) platform may be better than the new proposed platform, the broker may attempt to move your plan so they can keep the plan assets.  How is this remotely in your employee’s best interest? But it’s happening.  We have been told that some of these 401(k) providers end up on the “pre-approve list” because they are willing to share fees with the broker dealer. If you don’t share fees, you don’t make the list.  Really ugly stuff!!

SECRET #2:

Because these wirehouses and broker-dealers know that their brokers are not “experts” in 401(k) plans, many of the brokerage firms are requiring their 401(k) plans to add a third-party fiduciary service which usually results in higher plan fees.  The question to ask is “if you were so concerned about our fiduciary liability why did you wait until now to present this third party fiduciary service?”  They are doing this to protect themselves, not the client.   Also, many of these third party fiduciary services could standardize the investment menu and take the control of the investment menu away from the broker.  Which begs the question, what are you paying the broker for?

SECRET #3:

Some broker-dealers are responding to the Fiduciary Rule by forcing their brokers to move all their 401(k) plans to a “fee based platform” versus a commission based platform.  The plan participants may have paid commissions on investments when they were purchased within their 401(k) account and now could be forced out of those investments and locked into a fee based fee structure after they already paid a commission on their balance.  This situation will be common for 401(k) plans that are comprised primarily of self-directed brokerage accounts.  Make sure you ask the advisor about the impact of the fee structure change and any deferred sales charges that may be imposed due to the platform change.

SECRET #4:

The plan fees are often times buried.  The 401(k) industry has gotten very good at hiding fees.  They talk in percentages and basis points but rarely talk in hard dollars.  One percent does not sound like a lot but if you have a $2 million dollar 401(k) plan that equals $20,000 in fees coming out of the plans assets every year.  Most of the fees are buried in the mutual fund expense ratios and you basically have to be an investment expert to figure out how much you are paying.  This has continued to go on because very rarely do companies write a check for their 401(k) fees. Most plans debit plan assets for their plan fees but the fees are real.

With all of these changes taking place, now is the perfect time to take a good hard look at your company’s employer sponsored retirement plan.  If your current investment advisor approaches you with a recommended “platform change” that is a red flag.  Start asking a lot of questions and it may be a good time to put your plan out to bid to see if you can negotiate a better overall solution for you and your employees.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Who Pays The Tax On A Cash Gift?

This question comes up a lot when a parent makes a cash gift to a child or when a grandparent gifts to a grandchild.  When you make a cash gift to someone else, who pays the tax on that gift?  The short answer is “typically no one does”.    Each individual has a federal “lifetime gift tax exclusion” of $13,990,000 which means that I would have to give away $13.99 million dollars before I would owe “gift tax” on a gift.  For married couples, they each have a $13.99 million dollar exclusion so they would have to gift away $27.98M before they would owe any gift tax. When a gift is made, the person making the gift does not pay tax and the person receiving the gift does not pay tax below those lifetime thresholds.

“But I thought you could only gift $19,000 per year per person?”  The $19,000 per year amount is the IRS “gift exclusion amount” not the “limit”. You can gift $19,000 per year to any number of people and it will not count toward your $13.99M lifetime exclusion amount.  A married couple can gift $38,000 per year to any one person and it will not count toward their $27.98 million lifetime exclusion.  If you do not plan on making gifts above your lifetime threshold amount you do not have to worry about anyone paying taxes on your cash gifts.

Let’s look at an example.  I’m married and I decide to gift $20,000 to each of my three children.  When I make that gift of $60,000 ($20K x 3) I do not owe tax on that gift and my kids do not owe tax on the gift.  Also, that $60,000 does not count toward my lifetime exclusion amount because it’s under the $38,000 annual exclusion for a married couple to each child.

In the next example, I’m single and I gift $1,000,000 my neighbor. I do not owe tax on that gift and my neighbor does not owe any tax on the gift because it is below my $13.99M threshold. However, since I made a gift to one person in excess of my $19,000 annual exclusion, I do have to file a gift tax return when I file my taxes that year acknowledging that I made a gift $981,000 in excess of my annual exclusion.  This is how the IRS tracks the gift amounts that count against my $13.99M lifetime exclusion.

Important note: This article speaks to the federal tax liability on gifts. If you live in a state that has state income tax, your state’s gift tax exclusion limits may vary from the federal limits.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Should I Gift A Stock To My Kids Or Just Let Them Inherit It?

Many of our clients own individual stocks that they either bought a long time ago or inherited from a family member.  If they do not need to liquidate the stock in retirement to supplement their income, the question comes up “should I just gift the stock to my kids while I’m still alive or should I just let them inherit it after I pass away?”   The right answer is largely influenced by the amount of appreciation or depreciation in the stock.

Gifting Stock

When you make a non-cash gift such as a stock, house, or even a business, the person receiving the gift assumes your cost basis in the assets.  They do not receive a “step-up” in basis at the time the gift is made.  Example, I buy XYZ Corp stock in 1995 for $10,000.  In 2017, those shares of XYZ are now worth $100,000.  If I gift them to my kids,  no one owes tax on the gift at the time that the gift is made but my kids carry over my cost basis in the stock.   If my kids hold the stock for 10 more years and sell it for $150,000, their basis in the stock is $10,000, and they owe capital gains tax on the $140,000 gain.  Thus, creating an adverse tax consequence for my kids.

Inheriting Stock

Instead, let’s say I continue to hold XYZ stock and when I pass away my kids inherited the stock.  If I pass away in 10 years and the stock is worth $150,000 then my kids receive a “step-up” in basis which means that their cost basis in the stock is the value of the stock as of the date of my death.  They inherit the stock at $150,000 value, sell it the next day, and they owe $0 in taxes due to the step-up in basis upon my death.

In general, if you have assets that have low cost basis it is usually better for your heirs to inherit the assets as opposed to gifting it to them.

The concept is often times reversed for assets that have depreciated in value…..with an important twist.  If I purchase XYZ Corp stock in 1995 for $10,000 but in 2017 it’s only worth $5,000, if I sold the stock myself I would capture the realized investment loss and could use it to offset investment gains or reduce my income by $3,000 for the IRS realized loss allowance.

Here is a very important rule......

In most cases, do not gift a depreciated asset to someone else.  Why?  When you gift an asset that has depreciated in value the carry over basis rules change.  For an asset that has depreciated in value, the carry over basis for the person receiving the gift is the higher of the fair market value of the asset or the cost basis of the person making the gift.  In other words, the loss evaporates when I gift the asset to someone else and no one gets the tax advantage of using the realized loss for tax purposes.   It would be better if I sold the stock, captured the investment loss, and then gifted the cash.

If they inherit the stock that has lost value there is no value to the step-up in basis because the stock has not appreciated in value. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.