The Setting Every Community Up for Retirement Enhancement (“SECURE”) Act passed the House of Representatives in May of 2019 with bipartisan support.  It was recently included in a 2020 appropriations bill that is anticipated to pass this week.

This proposed bill provides some benefits.  It expands Section 529 education savings accounts to include such categories as apprenticeships and homeschooling expenses; expands multiple-employer plan arrangement for those outside of the trade associations and professional organizations; and increases the small-employer retirement plan startup cost credit.   This will make it much easier for small businesses to offer retirement plans to their employees.  The rest of the article will focus on IRA’s.  Keep in mind that the IRA required minimum distribution rules discussed below also generally apply to all defined contribution plans (e.g., 401(k), profit-sharing, and 403(b) plans).   Let’s start with the good news first.

Repeal of the Maximum Age to Contribute

Currently, an individual may only contribute to a traditional IRA for years in which he or she has compensation and will not attain the age of 70.5 before the end of the tax year.  The SECURE Act would eliminate any age limit on the ability to contribute to a traditional IRA.  People are living longer and work past age 70.  They might as well be afforded the tax benefits afforded to everyone else as long as they are working.  This does not affect Roth IRA’s since there has never been an age limit to contribute to a Roth IRA.

Increases the Age for Required Minimum Distributions from 70.5 to 72

An IRA owner must begin taking Required Minimum Distributions by his “Required Beginning Date.” This is the later of the calendar year in which the plan participant retires, or April 1^st of the calendar year in which the individual reaches age 70.5.  If the account owner had not reached the age of 70.5 at the time of his death, the surviving spouse beneficiary may defer taking Required Minimum Distributions until such time as the deceased account owner would have reached age 70.5.  The SECURE Act would increase the age for taking Required Minimum Distributions to 72.  Again, this would make sense to have the retirement age triggers associated with these laws expand along with the participants’ increased lifespans.  This does not affect Roth IRA’s either since there is no Required Minimum Distribution which must be taken while the Roth IRA owner is still alive.

Now we get to the bad.  In short, it eliminates stretch IRA’s.  One commenter summed it up as “changing the rules of the game in the eight inning.”

Repeals the Stretch Feature for Most Inherited IRA’s

As the law currently stands, how distributions are distributed depends on the beneficiary’s relationship to the deceased and whether the participant died before or after his Required Beginning Date.

              If the Spouse is the Beneficiary

There are three options if the spouse is the designated beneficiary and the IRA owner died before the Required Beginning Date:  1)-The surviving spouse can elect to treat the IRA as the surviving spouse’s own IRA and defer distributions until his or her Required Beginning Date arrives.  2)-The surviving spouse can treat the IRA as an inherited one and take distributions over the surviving spouse’s life expectancy. This would defer distributions until the year in which the deceased IRA owner would have reached 70.5.  3)-Elect the 5-year rule in which the entire IRA balance must be distributed no later than December 31^st of the 5^th year after the IRA owner died.

There are two options if the spouse is the beneficiary and the IRA owner dies after the Required Beginning Date.  1)-Just as before, the surviving spouse can treat the IRA as the surviving spouse’s own.  2)-The surviving spouse can treat the IRA as an inherited one but must take distributions over the longer of the surviving spouse’s life expectancy or the deceased IRA owner’s life expectancy.

            If a Non-Spouse is the Beneficiary

Distributions are handled differently if the deceased lists a non-spouse as the beneficiary.  Treatment for this category depends on whether the IRA owner died before or after the Required Beginning Date.  If before the Required Beginning Date, the non-spouse beneficiary can take distributions over his/her life expectancy.  Additionally, the beneficiary may elect the 5-year rule.  If after the Required Beginning Date, the non-spouse beneficiary must take distributions over the life expectancy of the younger of the beneficiary or the deceased IRA owner.  If there are multiple designated beneficiaries, distributions will be taken over the oldest beneficiary’s life expectancy.  It is prudent to split the IRA into multiple accounts if there is a large gap in age between the beneficiaries. This allows the younger beneficiary/beneficiaries to stretch their portion of the IRA over the course of their individual lives and not the life of the oldest beneficiary.

Since there are no Required Beginning Date for a Roth IRA, the post-death minimum distribution rules will always be applied as though the Roth IRA owner died before his Required Beginning Date, regardless of when he dies.  Thus, the 5-year rule would be applied.

Comparing the Current System to the SECURE Act

The current system permits traditional IRA owners to pass on large parts of their estates in a tax efficient manner to their beneficiaries.  The beneficiaries may “stretch out” the distributions over a long period of time. This allows the distributions to be taxed at lower income rates.  A lump sum distribution or installments over a period of 5 years may be appealing to some, but the potentially large amounts of distributions could be taxed at higher ordinary income rates.

The SECURE Act would require inherited IRA’s to be distributed in full within 10 years of the plan participant’s death.  This rule would apply whether or not the plan owner died before or after his/her Required Beginning Date.  There are some notable exceptions to this otherwise termination of the ability to stretch out distributions from IRA’s.  The rules already in effect for surviving spouses would still apply.  A child of the plan owner who has not reached the age of majority would be exempt from the 10-year rule to a certain extent.  Once the child reaches majority, he/she shall cease to be an “Eligible Designated Beneficiary”, and the remaining amount shall be distributed within 10 years.  Other Eligible Designated Beneficiaries include disabled individuals that meet the definition of I.R.C. § 72(m)(7) and chronically ill individuals under the definition of I.R.C. §7702(B)(c)(2).

Updating Estate Plan in Anticipation of Eliminating the Stretch IRA

The elimination of the ability of those who inherit IRA to spread the tax impact over a long time period has one practical impact: making Roth IRAs more appealing.  The distributions from Roth IRAs are not taxed since the contributions were from after-tax income.  Thus, the aforementioned adverse consequences for beneficiaries of the 10-year rule wouldn’t affect the designated beneficiaries of Roth IRAs in any way.  If you are a young contributor hoping to transfer more of your retirement account to your beneficiaries and less to the government, it may be prudent to start contributing to a Roth IRA.  Contribution limits are $6,000, or $7,000 for those 50 years or older.

The only possible limitation would be if you make too much money.  In 2020 for single taxpayers, allowable contributions to Roth IRAs are reduced if income reaches $124,000.  No contribution is allowed if income exceeds $139,000.  This limit increases to $196,000 for married filing jointly taxpayers and is completely phased out once income exceeds $206,000.  However, high-income earners may utilize a “backdoor” Roth IRA.  Since traditional IRAs don’t have income limits for contributions, individuals can fund a traditional IRA with nondeductible contributions. They can then convert the account into a Roth IRA.

Choosing The Right IRA for You

Your intended beneficiaries will thank you for funding your IRA through the Roth approach.  The situation gets trickier for those that have already contributing large sums of money in their IRA accounts thinking their non-spouse beneficiary would be able to stretch out distributions for a long time.  However, there are a couple of strategies to maximize the effectiveness of your estate plan strategy in anticipation of the SECURE Act.

First, you should consider the income tax brackets of beneficiaries.  Consider designating IRA beneficiaries as those who typically fall into lower-income brackets to minimize overall tax liability.  If one has both a traditional IRA and a Roth IRA, consider leaving the traditional IRA to a lower-income beneficiary. You could then leave the Roth IRA to a high-income beneficiary.  For example, if the original plan was to provide for a child and his family but that child has since grown up and has a retirement plan of his own, consider naming a grandchild as the beneficiary.  The grandchild would still be subject to the 10-year rule, but the grandchild would presumably be taxed at a lower rate.

Roth IRA Conversions

Next, consider doing a Roth IRA conversion.  The amount being converted is included in the IRA owner’s gross income in the year of conversion and taxed at the ordinary income rate. If you are a business owner or farmer, there are ways to reduce your taxable income in the year in which you choose to do the conversion in order to not take a large tax hit.  For example, farmers may utilize section 179 on capital expenditures in order to create a farming loss in the year of the conversion.  However, now may be a good time to bite the bullet and do a large conversion.  The federal income tax rates may the lowest they will ever be.  President Trump’s Tax Cuts and Jobs Act changed the individual income tax brackets and rates to effectively lower taxes at the ordinary income level.

An alternative to doing one, large IRA to Roth IRA conversion is to do a series of conversions.  The advantages of doing so are illustrated by an example taken from a MarketWatch article which shows that a hypothetical single person with taxable income of $110,000 converting a $100,000 traditional IRA into a Roth IRA would cause about half the extra income from the conversion to be taxed at 32%.  However, spreading the $100,000 conversion over two years would permit the income from the conversion to be taxed at a lower rate.  This effectiveness of the multi-year conversion strategy can be even further bolstered by converting over many years when taxable income is lower. This could perhaps be done during a 5-10-year period after retirement.

Concluding Thoughts

Another option is to distribute tax-free RMDs directly to a charity, which is known as a Qualified Charitable Distribution.  Alternatively, life insurance policies could be purchased with IRA distributions. These could then be held in trust and paid out over a longer period of time.

The SECURE Act may be beneficial to retirees and include other provisions designed to make retirement accounts more inclusive for those employed by small employers.  However, as is often the case with major legislation, the good comes with the bad.  The Act should not be welcomed by non-spouse beneficiaries.  Contact the attorneys at Day Rettig Martin, P.C. to discuss modifying your estate plan strategy or creating one to efficiently pass your retirement accounts to the next generation.

 

According to a recent survey from Bank of America, only 11% of employees can name four of the distinguishing features of a health savings account (“HSA”).  The four HSA traits that employees don’t understand include the triple tax advantage; HSA funds can be invested; the assets are portable; and the high-deductible health plan eligibility requirement.

Triple Tax Advantage

HSAs offer three separate tax benefits.  Contributions are pre-tax, meaning the employee doesn’t pay taxes on the income received that goes into the HSA account.  This is similar in concept to a 401(k) or IRA.  Next, investment gains are tax-free.  Lastly, withdrawals for qualified medical expenses are not taxed.  In contrast, while a 401(k) or IRA offer pre-tax contributions and tax-free earnings, the withdrawals are taxed.  There is a penalty when withdrawals from an HSA account are made for nonqualified medical expenses.  However, once an individual reaches the age of 65, withdrawals can be made for nonmedical reasons without a penalty, but the amount would be treated as ordinary income for tax purposes.

Investing HSA Funds

HSA funds can be invested.  Early contributions to one’s HSA account at a young age can grow over time and provide funds for medical expenses which will likely be larger at an old age.

Portability of HSA Assets

HSA accounts are owned by the employee.  They stay with the individual and can be taken if the person changes jobs.  In contrast, Health Reimbursement Accounts (“HRA”) are funded exclusively by the employer.  Therefore, HRA accounts are not portable.

High-Deductible Health Plan Eligibility Requirement

To qualify, the employee must be on a high-deductible health insurance plan.  By definition this means having a deductible of at least $1,350 for individuals or $2,700 or more for families.  Additionally, out-of-pocket maximums can’t exceed $6,750 for individuals or $13,800 for families.  You know it’s a good deal when the government imposes restrictions on how much you can contribute.  Currently, the limits are set at $3,500 for individuals and $7,000 for families per year.  All of these figures are set to increase by $50 for individuals and $100 for families, respectively.

Please contact the attorneys at Day Rettig Martin, P.C. for assistance with your labor and employment law needs.

According to a study done by Forbes, the estimated average student loan balance of a 2017 college graduate is $28,650.  Most millennials are savvy enough now to understand the importance of investing for retirement early so as to take advantage of compound interest.  However, many have limited available funds early in their careers. This faces them with the conundrum of either investing or paying down student debt.  There has been much discussion recently in the Democratic debates about possible solutions.  Additionally, employers are attempting to assist and retain young workers in this tight labor market.

How Employers are Helping

Abbot Laboratories offers a very favorable benefit. They allow qualifying employees of the company’s 401(k) that contribute 2% of their eligible pay toward their student loans through payroll deductions to receive an employer match equal to 5% of their pay deposited into their 401(k).  A private letter ruling from the IRS, issued in August 2018, recognized for the first time this type of benefit. By the same token, other companies offer different types of student loan repayment programs.  A survey conducted by the International Foundation of Employee Benefit Plans showed 4% of organizations in the survey currently offer some type of student loan repayment assistance benefit. Additionally, 2% are in the process of implementing a program and 23% are considering a similar benefit in the future.

Furthermore, PwC started a program in September 2015 where it pays $100 per month towards a participating employee’s student debt.  An extra $100 per month for an employee with student debt of $31,000 planning on paying it off over 10 years at a 6% interest rate will help the employee save almost $11,000 in interest.  Correspondingly, the employee will be able to complete the obligation two years faster.

While an employer can provide up to $5,250 per year in tax-free employer-provided educational assistance, any student loan payments made by the employer will be treated as taxable income by the employee.  There currently is a bill in Congress called the Employer Participation in Repayment Act of 2019. If passed, this bill intends to allow employers to contribute up to $5,250 per year in student loan repayment assistance tax-free.

College costs continue to rise.  However, politicians, Congress, and employers recognize the problem and attempting to provide assistance.  In various ways, some plans may be more realistic than others.

July 15-16, 2019,  Attorney Ron Martin traveled to Indianapolis, Indiana, to attend the Association of Chapter Twelve Trustees Seminar.  During the Farm Crisis of the 1980’s, family farmers did not have efficient methods to reorganize using the Bankruptcy Code. Chapter 11 was simply too complex, and Chapter 13 was too limited. In 1986, Congress created Chapter 12  to help family farmers reorganize and restructure their debts and give them a “fighting chance” to stay on their land.  Chapter 12 was initially a temporary addition to the Bankruptcy Code; however, in 2005, it was made a permanent part of the Bankruptcy Code.

 

At this seminar, Ron attended sessions on topics such as: farm sales, tax considerations for Chapter 12, pre-bankruptcy planning, and more. He also was able to attend a seminar on updates to the Chapter 12 bankruptcy case law presented by Judge Diana Davis, former President of the Capital Region Bankruptcy Bar Association and the Capital Region Women’s Bar Association. Other seminars were also presented by forerunners in Chapter 12 bankruptcy.

 

Growing up on an Iowa farm, Ron Martin understands the difficulties presented to his Chapter 12 clients. He has focused his career on helping these individuals and continues to attend conferences such as this to be able to better help his clients. If you have any questions regarding debt restructuring or agricultural law matters, call Attorney Ron Martin.

Attorney John Sexton attended the Iowa State University Center for Agricultural Law and Taxation Summer Seminar on Agricultural Tax, Business & Transition Planning. Multiple attorneys spoke on the economic issues surrounding the agriculture community today. They also discussed how to best pass on family farm estates to future generations.

C Corporations for Family Farms

During the 1970s, Professor Neil Harl from Iowa State University advocated the creation of C corporations as the proper entity for farm operations. A great deal of experts now believe many of the advantages associated with incorporating in the 1970s are no longer prevalent today. Additionally, the double taxation feature of corporations results in an inefficient way to run the farm operations. Many clients now ask the question of whether it is possible to get out of the C corporation structure without incurring severe income tax consequences. The good news is that it is possible, but the bad news is that somebody must die.

Liquidating a C Corporation

What is the proper method of liquidating a C corporation farm? First: the farmer needs to convert the C corporation to an S corporation. Second: wait 5 years to avoid the built-in gains tax of IRC Section 1374. Third: wait for the death of a shareholder.

Ideally, all of the stock should be gifted to the parent with the shorter life expectancy. When that parent passes, the stock basis will get the stepped-up basis on the value of the farmland. The owner should now sell all assets of the corporation and liquidate the corporation in the same year as the parent’s death.

The estate (now the sole shareholder) recognizes capital gain of the amount of the value of the farmland at the time of death over the original basis amount. This gain also increases the basis of the stock which corresponds to the initial step up in basis for the value of the farmland. The corporation would then redeem the stock in liquidation. This would allow the estate to recognize a capital loss in the same amount as the initial capital gain. The beneficiaries would then receive the corporation’s land at the full stepped up basis.

Continuing the Family Farm

In the simplest form, the beneficiaries can divide the land equally and distribute it. Another option to consider is the parents can create a limited liability company. They would then distribute the membership interests to the children. The parents must take care in drafting the agreement if they wish to have certain family members continue to farm the land without the intervention of others.  The on-farm heir should be elected as the manager of the limited liability company. Removal of the manager would then require unanimous consent. The off-farm heirs would receive their portion as rental income.

I commonly see a lack of exit plans for the beneficiaries of a family farm corporation or limited liability company. The operating agreement needs to be detailed in describing triggering events and purchase price.

Our Experience

Farms have constantly continued to increase in size. This leaves the running of large farms under the purview of a C corporation or limited liability company to the children. Fiduciary duties arise out of these business entity structures. We have successfully brought derivative suits when minority shareholders are victims of breaches of fiduciary duties by directors and officers. Beneficiaries should be mindful they are still running a business even if it is just with family.

A recent Wall Street Journal article discussed the economic difficulties facing the typical family farmer today. The article said that farmers currently file for Chapter 12 bankruptcy protection at the highest levels in 10 years.  If you are a family farmer facing difficult financial situations, contact Attorney Ron Martin to discuss debt restructuring and Chapter 12 bankruptcy options.