Just in time for the holiday season, the IRS has released regulations for certain persons who hold “specified foreign financial assets.” FATCA contains a number of provisions that are intended to make it more difficult to use foreign accounts to shelter income from US tax.

New disclosure form. A new form, Form 8938, Statement of Specified Foreign Financial Assets, that will need to be filed by certain taxpayers for tax year 2011. The form must be included with your tax return each year in which the aggregate balance of your foreign financial assets exceeds $50,000 on the last day of the year or more than $75,000 at any time during the tax year.

Who must file? The new filing requirement generally applies to individuals with specified foreign financial assets.

The foreign financial assets generally include:
1. Any financial account maintained by a foreign financial institution
2. If not held at an account at a financial institution
o Stock or securities issued by foreign persons;
o Any other financial instrument or contract held for investment issued by non US person; and
o Any interest in a foreign entity
If you have been filing Form TD F 90-22.1, Report of Foreign Bank Account and Financial Accounts (FBAR’s), or Form 5471, Information Return of US Person with Respect to Certain Foreign Corporations, the new disclosure may seem redundant. However, situations exist where a foreign asset may be required to be reported on both the FBAR and the new disclosure form.

Penalties for Non-Compliance . If you fail to file, FATCA imposes a $10,000 penalty in addition to a 40% penalty on any understatement of tax attributable to undisclosed financial assets.

The US reporting requirements are getting tighter. If you feel you need assistance in this area, please contact us.

Example. Jane Smith operates a 10-employee business, and she currently covers her employees with health insurance at a cost to her business of $60,000.
Before the new law, Ms. Smith deducted the cost of the insurance and received a tax benefit of $24,000 in her 40 percent tax bracket ($60,000 times 40 percent).

This year, because of the new law, Ms. Smith makes not a single change in her business operations, but because of the new law, she receives a tax credit equal to 35 percent of the $60,000 she paid for health insurance and then she deducts the remainder, for a current-year tax benefit of $36,600. She’s smiling. This new law gives her a tax gift of $12,600.

Ms. Smith receives this gift each year for six taxable years (four years under phase 1 and two years under phase 2). In six years, Ms. Smith will have more than $75,600 in extra cash (note—this calculation includes the incremental increase in the tax credit from 35 to 50 percent in 2014 and 2015).

What will the small-business provisions of the new health care law give you?

The Rules You Want to Know

You qualify for the full 35 percent current-year tax credit on the dollar amount you pay for your employees’ health insurance when you

1. employ 10 or fewer full-time equivalent employees (phaseouts start with 11 equivalent employees),
2. pay each of those full-time equivalent employees an annual full-time equivalent wage of less than $25,000 (phaseouts start at $26,000),2 and
3. pay premiums of no less than 50 percent of the average employee-only small-group coverage premiums, as determined by the U.S. Department of Health and Human Services (these will be posted by the IRS on its Web site by the end of April 2010).

You calculate your full-time equivalent employees by dividing the total hours worked by all employees during the employer’s tax year by 2,080.4 For any one worker, you may not count more than 2,080 hours.

Example. You have 17 employees total, including those who work part-time. This group works 18,000 hours during the year. You have eight full-time equivalent employees (18,000 hours divided by 2,080 equals 8.65, which is then, by law,6 rounded down to the nearest whole number, which makes eight employees your number).

Your payroll is $192,000 for the year. Divide that by eight and you get an annual full-time
equivalent wage of $24,000.

The next test: Did you pay at least 50 percent of the health insurance premium for single
(employee-only) coverage? You can pay more, and you can even pay for family coverage, but you may not pay less than 50 percent of the employee-only coverage.

Phaseout of Credits

The new law contains two provisions that injure or kill your credit:

1. If you have more than 10 full-time equivalent employees, you reduce your credit by 1/15th for each excess employee. (Here, the law kills your credit in total when you have 25 or more full-time equivalent employees.)
2. If the average full-time equivalent wage exceeds $25,000, you reduce your credit by 1/25th for each $1,000 in excess of $25,000. (Here, the law kills your credit in total when you pay an average full-time equivalent wage of $50,000.)

The combination of the two provisions can kill your credit before you reach either the 25-employee limit or the $50,000 wage limit.

Phaseout Example

Example. For 2010, you have 12 full-time equivalent employees with average annual wages of $30,000. You pay $96,000 in health care premiums that cover at least 50 percent of the employee-only cost, as determined by the average premium for the small-group market in your state.
Your credit is calculated as follows:

Description Calculation Amount

Summary

To find your big smile in this new health care law, consider the following two phaseouts.

Do you have 10 or fewer full-time equivalent employees? (If “yes,” smile.)
Is the annual full-time equivalent wage less than $25,000? (If “yes,” another smile!)

Planning might assist you in this regard. Perhaps you could hire a lower-paid employee or two to help the wage averages.

If you already provide health insurance for your employees, you have to simply thank lawmakers for their generosity, because you are now receiving an extra award for what you already do.

Finally, getting the tax credit for six years is a great bonus for those with plans in place already and certainly an incentive for those small businesses thinking about putting a health insurance plan in place.

You have to like the small-business health care tax credit and the absence of a penalty for small businesses that do not participate.

The IRS has released a draft of Schedule UTP, Uncertain Tax Positions Statement, with accompanying draft instructions, that it proposes to be used by certain taxpayers required to report uncertain tax positions. FIN 48 requires that taxpayers with uncertain tax positions account for and report those positions that affect their income tax liability. The draft Schedule UTP and instructions provide that certain taxpayers will be required to file Schedule UTP beginning with the 2010 tax year.  The requirement only applies to taxpayers required to file Forms 1120, 1120 L, 1120 PC and 1120 F, if they have uncertain tax positions and assets equal to or in excess of $10 million and if they or a related party issued audited financial statements. The draft instructions provide that a taxpayer filing a Schedule UTP will be treated as filing a Form 8275 and Form 8275-R due to the fact that those two forms duplicate information reported on Schedule UTP.

The Internal Revenue Service announced it is developing a schedule requiring certain taxpayers to report uncertain tax positions on their tax returns. The Service is now releasing the draft schedule, Schedule UTP, accompanied by draft instructions that provide a further explanation of the Service’s proposal. The Service invites public comment on the draft schedule and instructions. The schedule and instructions will be finalized after the Service has received and considered all of the comments regarding the overall proposal and the draft schedule and instructions.

The draft schedule and instructions provide that, beginning with the 2010 tax year, the following taxpayers with both uncertain tax positions and assets equal to or exceeding $10 million will be required to file Schedule UTP if they or a related party issued audited financial statements:

• Corporations who are required to file a Form 1120, U.S. Corporation Income Tax Return;
• Insurance companies who are required to file a Form 1120 L, U.S. Life Insurance Company Income Tax Return or Form 1120 PC, U.S. Property and Casualty Insurance Company Income Tax Return; and
• Foreign corporations who are required to file Form 1120 F, U.S. Income Tax Return of a Foreign Corporation.

The draft schedule and instructions also provide that, for 2010 tax years, the Service will not require a Schedule UTP from Form 1120 series filers other than those identified above (such as real estate investment trusts or regulated investment companies), pass-through entities, or tax-exempt organizations. The Service will determine the timing of the requirement to file Schedule UTP for these entities after comments have been received and considered.
The Service is reviewing the extent to which the proposed Schedule UTP duplicates other reporting requirements, such as Form 8275, Disclosure Statement; Form 8275-R, Regulation Disclosure Statement; Form 8886, Reportable Transaction Disclosure Statement; and the Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More. The draft instructions provide that a taxpayer will be treated as having filed a Form 8275 or Form 8275-R for tax positions that are properly reported on Schedule UTP. The Service is considering other circumstances under which a tax position reported on Schedule UTP need not be separately reported elsewhere on the tax return or another disclosure statement.

Schedule UTP asks for information about tax positions that affect the United States federal income tax liabilities of certain corporations that issue or are included in an audited financial statement and have assets equal to or exceeding $10 million.

Tax positions to be reported

Schedule UTP requires the reporting of a corporation’s federal income tax positions for which the corporation or a related party has recorded a reserve in an audited financial statement. Schedule UTP also requires the reporting of tax positions taken by the corporation in a tax return for which a reserve has not been recorded by the corporation or a related party based on an expectation to litigate or an IRS administrative practice.
A tax position is required to be reported on a Schedule UTP attached to a particular tax year’s return if:

1. at least 60 days before filing the tax return a reserve has been recorded with respect to that tax position, or at least 60 days before filing the tax return a decision was made not to record a reserve based on an expectation to litigate or an IRS administrative practice, and
2. the tax position has been taken by the corporation in a tax return for the current tax year or a prior tax year. 

A tax position must be reported regardless of whether the audited financial statement is prepared based on United States generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS), or other country-specific accounting standards, including a modified version of any of the above (for example, modified GAAP) that requires a taxpayer to record a reserve for federal income tax positions.

A tax position is based on the unit of account in the audited financial statements in which the reserve is recorded. A tax position taken in a tax return means a tax position that would result in an adjustment to a line item on that tax return if the position is not sustained. A line item on a tax return may be affected by multiple units of account, in which case each unit of account must be reported separately on Schedule UTP.

Starting in January 2010 the income ceiling for Roth conversions is eliminated.  This presents an interesting dilemma for individuals who can afford the conversion: convert now and accelerate taxable income, which breaks a general cardinal rule of paying tax before it is due.  On the other hand, a Roth IRA, unlike a traditional IRA, would enable both tax-free withdrawals and the avoidance of the required minimum distribution (RMD) rules– allowing more wealth to accumulate tax-free for a longer period of time.  The Roth conversion analysis is a decision that involves paying taxes now vs. the opportunity to grow wealth tax-free for a longer period of time.

Although conversion to a Roth IRA does trigger immediate taxable income, Congress provided a special incentive in 2010 to jump-start Roth conversions. In 2010 (and 2010 only), individuals will have the choice of recognizing their conversion income in 2010 or averaging it over 2011 and 2012. The latter option, which must be elected, allows you to pay taxes on the converted amount ratably over two years, instead of recognizing it all as income in one year. You will be taxed at the rates in effect for 2011 and 2012.

For some taxpayers, their tax rate may rise after 2010 even if their income does not. President Obama has proposed, and Congress is expected to enact, legislation to restore the top two pre-2001 marginal income tax rates after 2010. This means that the top two brackets could be 39.6 percent and 36 percent after 2010. There is the option to pay the full tax on the Roth conversion on your 2010 income tax return, at 2010 income tax rates.

An IRA to Roth IRA conversion should be considered by individuals who:

• Can afford the tax on the converted amounts;
• Anticipate being in the same or higher tax bracket in the future than they are currently in;
• Have a significant amount of time before reaching retirement to allow assets to grow tax-free and recoup dollars that may have been lost due to the conversion tax;
• Anticipate a taxable estate; and
• Wish to grow assets tax-free and leave assets to children who could take tax-free distributions over their life expectancy.

Convert Nondeductible IRAs?
Individuals who have nondeductible IRAs (or a mix of nondeductible and deductible) can convert and pay little or no tax.  Nondeductible IRAs are not taxable when converted to Roth IRAs if the account holder has no appreciation in the IRAs and doesn’t own deductible IRAs.  For example, a married couple, ineligible to contribute directly to a Roth IRA and with no existing IRAs can contribute $5,000 each to a nondeductible IRA for 2009 and 2010.  Then, the next day they can convert the nondeductible IRA to a Roth IRA.  The result is a transfer of $20,000 in taxable assets to a Roth IRA which will never again be subject to income tax if certain holding requirements are met.  Individuals with a mix of deductible and nondeductible IRAs must prorate the conversion, so regardless of which specific account or amount they convert, part will be treated as taxable and part as nontaxable.  For example, an individual has $100,000 in a deductible IRA and $50,000 in a nondeductible IRA.  If that individual were to convert $30,000 to a Roth IRA, he would recognize $20,000 of taxable income on the conversion (100,000/150,000 * 30,000).

Roth Redo: A Money-Back Guarantee?
If you’re not satisfied with your conversion, you may want to take a mulligan.  With Roth conversions, you can.  For example, say Jack, a 60 year old individual with a combined 45% effective tax rate converts $1 million from a traditional IRA to a Roth IRA on January 15th, 2010, resulting in a $450,000 tax liability.  He proceeds to watch the value of his Roth IRA decline by 25% to $750,000 over the next 21 months, as a result of poor investment performance.  At that point (up to October 15 of the following year) he can “recharacterize” the IRA as a traditional IRA and, if he wishes, try the conversion again the following year, at presumably a lower tax cost.

The year 2008 aside, it’s unusual to experience a 25% decline in a well-diversified, balanced portfolio.  However, any one asset class could have an off year or two, which leads into the next Roth conversion strategy.  Consider breaking out your new Roth IRA into 3-5 separate accounts consisting of uncorrelated asset classes.  You can then cherry pick the losing account to achieve a lower tax cost via recharacterization, while leaving the winners to keep growing and eventually pay out tax-free profits.  For example, assume Jack placed one-third of his Roth assets in taxable bonds, one-third in international stocks, and one-third in U.S. growth stocks.  In the 21 month period ending October 2011, his taxable bond Roth account returned 5%, international stocks declined 30%, and U.S. growth stock returned 10%.  Jack could recharacterize the Roth IRA invested in international stocks which lost $100,000 in value, thereby reducing his Roth IRA conversion tax liability.

There are a significant number of tax and financial considerations that come into play when determining whether to convert your traditional IRA to a Roth IRA.  Please consult with your tax and financial professional about this new 2010 planning opportunity.

Others with IRA balances may be interested in making a tax-free transfer to a new IRA custodian, or in splitting the current IRA account for various reasons.

Tax-free transfers may be made by trustee-to-trustee transfer, direct rollover or 60-day rollover.

We have found that in thinking about transfers, clients want to know:

• Does the account they’re starting with qualify for a tax-free transfer to another qualified account?
• Is the vehicle into which they intend to transfer a qualified plan balance one that can accept a tax-free transfer?
• What administrative procedures need to be followed to accomplish the transfer?
• What special considerations need to be evaluated to help determine whether the proposed transfer makes economic and tax sense?

Rollover distributions from the following plans are eligible for tax-free transfers:

• IRAs
• Qualified pension plans
• Tax-sheltered annuities (403(b) plans)
• Governmental 457(b) plans
• A 403(a) annuity

Rollover distributions can generally be transferred to a traditional IRA or pension plan on a tax-free basis if the pension plan will accept them.

Distributions that might otherwise qualify for a tax-free rollover might be defeated by one or more of the following complications:

• The 20% mandatory withholding on distributions from pension plans may make it difficult for the participant to accomplish a complete rollover of a taxable distribution.
• The prerequisite within a pension plan of a triggering event prior to the distribution of a pension balance may mean that a distribution is not allowed at all.
• The fact that the source of funds intended for rollover is from a beneficiary account rather than the participant’s own IRA may mean rollover is not allowed.
• Multiple IRA rollovers in the same 12-month period may be disallowed by IRS rules.

When done properly, rollovers offer the opportunity to continue tax-deferred growth on  retirement assets.  If done improperly, an attempted rollover may result in a large unexpected income tax result, and cause you to be liable for an extra 10% penalty tax, plus any state penalties.

As always, please feel free to call to discuss these or other financial security issues of concern.

Need a Quick Infusion of Cash Influx for Your Business?

Income Taxes Paid Years Ago May Be Coming Back To You

The new “Worker, Homeownership, and Business Assistance Act of 2009″ signed by President Obama on November 9 into law gives corporations a chance to apply net operating losses to income generated in profitable years, going back to 2003. The new statute extends a small-business tax benefit for another year and lifts a cap of $15 million in annual revenues, this making it available to midsize and large businesses.

Specifically, the extended rules enable companies to take NOLs from either calendar or fiscal 2008 or 2009 tax years, and apply those losses to taxable income going back as far as 2003 or 2004, respectively. That results in recalculation of the company’s tax bill on a lowered taxable income for the prior years and collection of tax refunds from the government. This ability to recoup cash taxes will permit companies to sustain business operations and make investments during uncertain economic times.

The IRS has announced that it will shortly issue guidance on how to cash in on the new law. In the past, companies have collected NOL refunds in one of two ways. The quickest way has been to file a “tentative” claim with the IRS and wait for the agency’s ruling during a six-week processing. Alternatively, a more time-consuming method was filing an amended return for the earlier year.
We at Perisho are committed to assisting our clients in reaching their financial goals and are looking whether your business may be eligible for cash refunds under the Act.

Own a Home and Looking to Downsize?

A Tax Credit May Be Available for You

The ‘’Worker, Homeownership, and Business Assistance Act of 2009’’ has also extended and liberalized the First-Time Homebuyer Credit by making it available to higher-income taxpayers and to existing homeowners who buy another principal residence. The deadline has been extended through July 1, 2010, but the purchase price of a new home was capped at $800,000. Thus, given real estate values of many California’s localities, the credit is basically limited to home-buyers who consider downsizing their existing principal residence.

To qualify for the $6,500 tax credit, a taxpayer must have maintained the same principal residence for any 5-consecutive year period during the last 8 years. Since the AGI phase-out range has been raised to $125,000 – $145,000 (for single taxpayers), $225,000 – $245,000 (for married filing jointly), it might make sense to wait to defer the purchase until early next year. There’s no requirement for the existing principal residence to be sold in order to qualify for a FTHTC on the replacement principal residence. The replacement residence can be purchased to beat the new deadlines under the Act before the old home is sold. The prior principal residence can be retained in the hope of achieving a better selling price later on.

Health Care Reform Fundamentally Changes Health-Care Related Tax Rules

The “Affordable Health Care for America Act” passed by the House of Representatives on November 7 would substantially alter the ways in which employers provide health coverage to employees. It also would require most people to get health coverage or pay a penalty tax and hit high earners with a surtax. The following is the summary of the key tax-related provisions in the House bill.

For tax years beginning after 2012, employers would have to either provide health insurance to their employees or make a contribution to help fund affordable health insurance. Those choosing to offer coverage would have to contribute at least 72.5% of premiums for workers, 65% for families. Employers not offering qualified coverage would pay a payroll tax equal to 8% of their payroll to help cover expenses of employees who seek coverage through the exchange. Small businesses with annual payrolls below $500,000 would be exempt from coverage requirements and the payroll tax. The 8% contribution requirement would be phased in for small businesses with an annual payroll between $500,000 and $750,000. For the first two years that an employer offers qualified coverage, tax credits would be available for businesses with 10 or fewer employees and less than $20,000 in average wages.

Individuals would be required to obtain health insurance coverage or pay an additional tax equal to the lower of 2.5% of their AGI above the filing threshold or the average premium on the insurance exchange.

Starting in 2011, the penalty on distributions from health savings accounts that are not used to pay for medical expenditures would be increased from 10% to 20%. Nontaxable reimbursements from health flexible spending accounts, health reimbursement arrangements, and health savings accounts would exclude over-the-counter medications. Starting in 2013, contributions to health flexible spending arrangements would be limited to $2,500.

Also starting in 2011, a 5.4% tax surcharge would be imposed on individuals with modified adjusted gross income in excess of $500,000 ($1 million for married filing jointly. No credits would be allowed against this tax and the surcharge would not be taken into account in computing alternative minimum tax liability.

Beginning in 2012, businesses would be required to file information returns for all payments in excess of $600 in a calendar year whether the recipients are individuals or business entities.

Overhaul of California Tax System Is On The Way

On September 29, 2009, the Commission on the 21st Century Economy appointed by Governor Schwarzenegger to re-examine and revamp California’s revenue collection system to withstand the volatility of budget cycles, released its final report and recommendations. The Commission has recommended several significant changes to California’s tax system with a five-year phase-in plan beginning in 2012. Here are a few highlights of the Commission’s proposal:

• Retain progressive tax nature but reduce personal income tax rate for every taxpayer. The new tax rate would be 2.75 percent for taxable income up to $56,000 for joint filers ($28,000 for single) and 6.5 percent for taxable income above that amount.
• Eliminate the existing corporation tax, which is currently at 8.84%, and minimum franchise tax of $800.
• Eliminate the current 5 % state general purpose sales tax over a 5-year period, with the exception of the sales tax on gas and diesel fuels.
• Institute a business net receipts tax not to exceed 4%, applied to the net receipts of businesses. Small businesses with less than $500,000 in gross annual receipts would be exempt from this tax. This tax would have a much broader base than the sales tax (since it would apply not only to goods but also to services and to sales into the state from businesses located outside the state) and, unlike the sales tax, be deductible against federal taxes.
• Establish new Rainy Day Reserve Fund by raising the target for the reserve from 5% of revenues to 12.5% and restrict the government’s ability to use reserve assets so that the reserve is available to help fund services during recessionary periods.

Traditionally, the owner of a permanent life insurance policy had one choice when he or she wanted to cash in a policy—surrender the policy and receive the cash value.

Beginning about twenty years ago, some third party companies began to offer the owners of policies on terminally ill insureds the ability to viaticate the policy. In such cases, the viatical settlement company would make an offer to the owner to purchase the policy for a substantial percentage of the policy’s death benefit.

Since that time, the market has expanded to situations involving more healthy insureds. The focus is less on viatical settlements and more on life settlements.

From the life insurance policyowner’s perspective, when should a life settlement be pursued? In general, if the insured is older than age 60, and the insurance is no longer needed, then life settlement should be considered. From an economic perspective, life settlements tend to be more attractive if one or more of the following factors are present:

• The insured is in worse shape health-wise than when the policy was originally purchased.
• The policy has been in force for ten years or more.
• The policy has a substantial death benefit.

From the consumer’s perspective, a life settlement only makes sense when the amount received is greater than any surrender value from the contract. However, that’s not the end of the analysis. The policyowner must also consider the following:

• Keeping the policy in force, particularly where life expectancy is very short, may be a more efficient economic decision than settlement for the consumer.
• Privacy is lost as the settlement company investigates the insured’s health status.
• When the settlement company buys the policy, it will generally keep the face amount in force. The insured will lose some life insurance capacity that might be otherwise available.
• The insured will likely lose the ability to know who owns the life policy after the contract is settled.
• Taxes have an impact on how much of the settlement the policyowner can actually keep.

Earlier this year, the IRS published its stance on the tax results when a policyowner settles a life policy. In the ruling, the Service answered many of the questions that experts had been unsure about. The IRS’s answers have a significant impact on those who are—or will be—considering life settlements.

Some of our clients may have reason to consider a life settlement, and are likely to need help in evaluating whether a life settlement makes sense. We can provide professional help to shop for the best deal, weigh the risks and calculate the costs of pursuing a life settlement.

As always, please feel free to call to discuss these or other financial security issues of concern.

Companies are turning to tightening up extended payment terms given to customers while holding onto cash by postponing payments to banks and to vendors. Even if your customers are paying on time, they may, in fact, be financially unstable and – without your knowledge – could be delaying payments to other trade creditors. Alternatively, other customers could be delaying payments, not because they are unstable, but out of fear that their banks will tighten up on their credit lines or not lend to them in the future.

In a recent survey of corporate credit managers, 94% said they suspect that their customers are leaning on them for their working capital needs more than they were during the past few years. This push-pull condition between receivables and payables creates a strain, particularly for smaller companies, by wanting to hold on to valuable customers during tough times but still needing to get cash in the door. And granting extended payment terms, when requested by valuable customers, can make it more difficult to assess a customer’s financial viability.

What are signs that your customer might be tanking?
Buying Habits Changes.
Even if customers are paying on time, are they still purchasing in previous patterns? Also, beware of customers that suddenly start to buy more. Pre-bankrupt customers might be stocking up on inventory, knowing they won’t be liable for the goods later on.

Changing Payment Patterns.
This could be the most obvious clue. If your customer is falling further behind in making payments, or requests to spread payment windows out further or a payment plan over a period of time, or requests renegotiation of previous arrangements, this calls upon you to hone your credit skepticism.

Higher Demands or Nit-Picking.
Higher product returns, requests for discounts because of damages, unreasonable demands on delivery, such as taking discounts if goods do not arrive timely in a tight delivery schedule, could all be warning signs.

Financial Information.
If you have access to your customer’s financial statements or other financial information, consider the following:

• Shrinking Cash Flow. Watch cash balances over time, and note how much they rely on equity, short-term debt and long-term debt.
• High DSO (Days Sales Outstanding). Customers who are struggling to collect their own receivables may have trouble paying yours.
• Large Accruals. Often companies in financial stress carry large and/or increasing accruals on their balance sheet.
• Tax Liens. Since companies usually pay their taxes on time, this is the first indicator that the company is likely going to default on your payments.

Tight Lips and Persistent Rumors.
If a customer previously shared financial information with you, but now claims it is “against policy”, consider if this is a “red herring” to distract you from catching problems. At the same time, keep your ears open for negative news about your customers by paying attention to news articles, comments from your sales team and other companies’ credit managers.

Steps You Can Take
Tighten up on how you extend credit.
Just like the banking community, until recently companies have granted credit too easily based on little or no financial information, in order to speed up a sales transaction or to not risk offending the customer. Use the current economic environment to get more extensive financial information from privately-held customers and to rein in sales people giving extended payment terms.

Closely Monitor Outstanding Balances.
If a customer used to pay in 30 days and is now paying in 60 days, your credit exposure is going to double. You need to evaluate if you wish to take on this additional risk, especially without compensation, such as pricing increases or late payment finance charges.

Riskiest Customers.
Bankrupt companies can sue for payments made within 90 days of filing for up to two years after entering bankruptcy court, requiring you to return payments already received (preference claims). If you suspect a customer may enter bankruptcy, you can demand cash on delivery, payment in advance of a shipment or a letter of credit, all of which are methods of payment not subject to preference claims. If a customer is already in bankruptcy court, ask them to add your company to their “critical vendor” list. Depending on the judge’s ruling, this group of vendors may be paid immediately over other suppliers if the bankrupt company can demonstrate that the vendor’s products or services are crucial to the company’s turnaround efforts.

The economic downturn and credit crisis has required that companies of all sizes keep a careful watch on their suppliers’ credit terms, as well as their customers’ continued viability, in order to protect their own trade credit financing and operating results. While choices for smaller companies may be more limited than those for large companies when trying to maintain ongoing business relationships for the time when the economic hardships ease, the considerations in this article should provide ideas for striking a balance between enhancing business and managing risks.

Investments and Transactions That are Off-Limits

The Internal Revenue Code specifically disallows certain assets as IRA investments. These include life insurance contracts and most collectibles. Excepted from this rule are certain gold, silver, and platinum coins, and bullion physically held by IRA trustees. Also disallowed is pledging IRA assets as security for a loan. Pledging IRA assets causes the portion of the account pledged to be treated as a distribution from the account, subject to income taxes and possibly withdrawal penalties if the IRA owner is under age 59 1/2.

Prohibited Transactions

IRA owners must also watch out for so-called self-dealing rules, or prohibited transactions. In general, these rules prohibit using IRA assets for the benefit of ‘disqualified persons’, and prohibit loans between the IRA and disqualified persons. Disqualified persons is defined as IRA owners and beneficiaries, and includes certain family members and controlled entities. Should a prohibited transaction occur, excise taxes, income taxes and loss of the account’s status as an IRA might result, with accompanying income tax liabilities and potential withdrawal penalties. Careful consideration must be given to whether or not the IRA owner or other disqualified person will benefit from a potential investment in any way other than by the investment return to the IRA account.

Unrelated Business Taxable Income

Unrelated business taxable income (UBTI) arises in IRAs in one of two ways:

• An IRA may invest in an unincorporated active business as a sole owner or as a partner; or
• The IRA may hold investments that are debt-financed (for example, real estate with acquisition financing).

If the alternative investment were to produce income, the income may be subject to income taxes on UBTI in excess of a $1,000 exemption. Trust tax rates would apply, which tend to be higher than individual tax rates. Also, the account would need to have enough cash available to pay the taxes. However, rental income is specifically excluded from the UBTI provisions, as are gains from the sale or other disposition of the property as long as it is not inventory or other business property. However, the debt-financed rules above still apply to rental property.

Valuations, Distributions

There are many situations in which IRAs are required to report the value of their assets and/or use those values for important tax calculations. Annually, IRA asset values are reported on Form 5498.  When account owners attain age 59 ½, and/or after their deaths, required minimum distributions (RMDs) must be calculated. Also, when IRA assets are distributed, their fair market values are used to determine the taxable amount of the distributions. Performing these valuations may require additional expense and involve hiring valuation experts. This is much different than simply selling marketable securities or checking public price quotes when values are needed.

Similarly, making distributions of partial interests in alternative investments may be cumbersome and expensive. RMDs to the account owner and distributions to multiple beneficiaries after the account owner’s death will require valuations and careful planning, or potentially the sale of the asset, in order to facilitate the required distributions.

Administrative Difficulties

Certain proposed unconventional IRA investments may pose administrative hurdles or risks within the IRAs. One concern would be investments that might require expenditures that could exceed cash that can be readily raised within the IRAs. In that category falls real estate requiring expenditures for real estate taxes, insurance and maintenance, and partnerships that could make capital calls on partners. Keep in mind that any payments of such expenses by IRA owners would be treated as contributions to the IRA subject to the limits on annual IRA contributions. Also, borrowing within the IRA to make the expenditures would likely be a hassle and cause debt-financed UBTI.

Planning is Key

Although administering unconventional investments within an IRA can be tricky, with dire consequences for slip-ups, some investors may be ready to explore their IRA options. With investment values at historic lows, this may be the perfect time to do so. Please contact us if you would like to start this discussion. We can help you navigate the waters if you are considering bailing out your IRA.