Tax Planning Thoughts

While you don’t have to make a final decision until the end of the year, it is worth taking some time now to think about converting your traditional IRA or other tax qualified retirement plan to a Roth IRA.  This decision process requires many assumptions.  My preference is using facts to make financial decisions, but sometimes that option just isn’t available.   

A quick summary on traditional qualified plans vs. Roth IRAs yields the following bottom line.   Are you better off deferring taxes until you are age 70 ½ or should you get it over with now, and then get tax-free distributions from your retirement savings?

• The IRA / qualified plan money is contributed on a pre-tax basis.  If it stays in the plan until after you are 59½ years old, you will pay taxes on withdrawal.  If you try to take the money out earlier, you pay the taxes plus a 10% penalty.  Once you reach age 70½ you have to start taking a specified portion in distributions, as the IRS is done waiting to get the taxes due on that money.  You age-out of being able to contribute to a traditional IRA once you have to take those mandatory distributions
• With a Roth IRA, the contributions are made after taxes.  Earnings may be withdrawn without tax or penalty if you meet the 59½ age threshold and the money has been in the account at least five years.  There are no mandatory distributions.  So while you don’t get the turbo charge of pre-tax contributions and then getting deferral on the growth, on the other hand, what is in the account is yours to keep.    The Roth IRA doesn’t have an age restriction for contributions, but there are income limits that cause many upper income people to be ineligible for this type of plan. 

This brings us to 2010 -- a year that is notable because the income limitations on converting qualified retirement plans to a Roth have been removed.   This means you can roll over money in other qualified pIans regardless of your income.  In addition, moving the IRA into a Roth will not trigger tax penalty even if you haven’t reached the age where the IRA can be accessed.  However, all taxes owed must be paid.  If you make the decision to do this before the end of 2010, you can elect to pay the taxes over two years -- waiting to make the payments in 2011 and 2012.

Here’s where the assumptions stuff comes into play.  Normally, using the time value of money approach to managing your finances, paying later is always better.  However, if the Bush tax cuts expire in 2011, you could pay more in taxes that year than you would have if you took the hit in 2010.  Another assumption to watch out for is the Medicare surtax on investment income.  This tax is scheduled to start in 2013, and if you are in a higher income bracket you won’t pay it on your Roth distributions, but you will on your traditional IRA. 

One offset to all the crystal ball gazing skills involved in the conversion decision is talking to a tax advisor.  While it’s still an assumption, I’m convinced a thorough review of all your specific considerations this year is an especially good investment.



Tougher Times for Small Business

It appears the view on how business is doing today may be driven by the size of the company.  It’s not just that big global giants are fine and everyone else is struggling.  Instead it seems that some of the good news from globally diverse companies that are managing costs effectively is in fact reaching a broader group of businesses.  The National Association for Business Economics Survey reports continued business growth, albeit at a slowing rate.  The survey uses an index that measures the net of firms reporting business strength vs. weakness in their industry.  It was 42 in July, down from the year’s high of 51 in April.  However, there is significant variability buried in that number.  (You need to be an NABE member to see the survey details, so this is just a reaction to the summary.)  The high index score was 69 in the “goods-producing” sector while the finance, insurance and real estate sector was a 16.  Based on what one reads in the news these days it’s a good bet that finance and insurance were pulled down by real estate on that one. 

 Job creation trends in the NABE Survey are going in the right direction.  Firms increasing payrolls were up to 31% (vs. 6% a year ago).  Firms cutting jobs dropped to 14% from 36% a year ago.  Those with plans to add employees in the coming six months rose to 39%.  All of the participants indicated they expect positive economic growth for the remainder of 2010, though the rate they expect that growth to occur has declined since the start of the year. 

These results are in stark contrast to the Kaufman Survey of Independent Businesses and the Intuit Small Business Index.  Intuit surveys firms with less than 20 employees, and the view from this group’s perspective is not pretty.  Their survey shows the small business hiring trend dropping below the national employment figures, going up less than 1% in June.  Hours worked per employee did go up as well, but at a slower rate than earlier in the year.  The only thing that continued a steady upward climb was compensation per employee. 

 My take on these conflicting pictures of the economy is that as businesses get smaller and therefore more dependent on local economic conditions; the impact of the slow recovery is stronger.  That would auger well for good economic news to come.  However, if this were the opening of an episode of Forensic Accounting CSI, there would be plenty of discussion about why this is a weak conclusion.  Correlation does not create causality.  Particularly given the diversity of the research being looked at,  sample selection may be creating significant distortion.  Since no alternatives are as attractive, I’ll trying hanging on to the ‘good things come to those who wait’ school of economic theory.      



Truth is Stranger Than Fiction

This totally cracks me up. 

 First there’s a report from the Treasury Inspector General’s Office that 23% of electronic returns filed using a new and improved (at an estimated cost of $574 million) E-Filing system were rejected.  To be fair, the glitch occurred in February and was corrected before filing volume went crazy.  Then there’s the news that the IRS made a mistake in calculating the amount of tax owed in a big Tax Court case. (The $325 million dollar error means a company that owns Retirement Communities does not owe $128 million in back taxes.) 

So, it appears the national bean counters can’t add and can’t properly test the technology used to keep track of the bazillion dollars worth of tax return information that goes through their doors each year.  However, in a customer satisfaction survey, IRS e-filing scores higher than Facebook for providing a positive customer experience! 

 Now, don’t get me wrong.  I’m not against giving taxpayers a positive experience while they’re paying up.  Still, when hiring for the IRS do we really need people with stronger social sensibilities than technical competencies?  Perhaps a checkbox on the tax return where contributions can be sent to the Office of Personnel Management in Washington D.C. to help with IRS job screening criteria will help.  LOL      



How You Spend Also Matters

Apparently small business owners are not finding solace in shades of tough economic news.  The National Federation of Independent Businesses’ Small Business Optimism Index is down about three points after a few months of upticks.  A net one percent of owners surveyed are planning to add jobs, and while capital expenditures are up compared to last year, they are only two points above a 35-year record low.  Still, businesses that can hire or purchase equipment should have some good news come tax time. 

One of the top concerns of small business owners is that they can’t keep up with understanding all the recent tax law changes.   Shockingly, many small business owners don’t spend what little free time they have reading updates to the tax code.  This is not a recommended area for self-help, but it is definitely worth talking to someone who knows something about tax breaks this year.  Even a business that has cut costs to the max (or should that be to the min) still can structure spending to reduce the tax bill. 

Hiring someone who has been out of work at least 60 days gives a business a break on payroll taxes.  The employer can keep the 6.2% of wages usually paid for social security taxes for the remainder of the year.  If the employee stays on the payroll for 52 consecutive weeks there’s an additional $1,000 in the form of a tax credit available for the employer.  

While $1,000 per employee isn’t serious money, it is worth noting that a tax credit is more powerful for your bottom line than a tax deduction.  If you owe $30,000 in taxes, the tax credit gives you a full $1,000 off.  If you get a $1,000 deduction, that lowers the number used to calculate your tax liability – but the tax savings you get is only a percentage of the amount deducted.    

One other spot to look for savings is the extension of  the Section 179 deduction.   (After having just “dissed” deductions, let me clarify that they only look lame next to credits.   I actually spend much of my working day looking for deductions. ) Section 179 deals with deductions for capital expenditures .  Usually Uncle Sam is very picky about how much expense can go on your tax return for assets that will be used in the business for more than a year.  However, thanks to Section 179, this restriction becomes optional, and the full cost may be taken in one year.  A key condition is that the asset must be purchased and put to use in your business in that same year.  There’s a cap of $250,000 for this deduction (this is the part that got extended), and it only works well if your business purchased less than $800,000 of equipment in a year.  (In other words it really is targeted for small businesses).  The caps are set to drop in 2011, so if you can spend, there’s more tax savings to be had in 2010.

For any given business, these breaks may not be a big deal.  Still, they can be added to a menu of little tactics that add up to profitability.  Given the slog we’re looking at in terms of making any business work (unless you make iPhones for a living) it’s worth making sure you’re diligent in both keeping track of your expenses and how they interact with the new tax laws.