Just for Fun

Retirement Minded

Huselton, Morgan & Maultsby colleagues, don’t become giddy.  My retirement is still a few years away.

However, I am approaching a traditionally epochal birthday, so my thoughts turn to the next chapter of my life.  It is time to start thinking seriously about what retirement will look like and where it will be spent.  So, to the internet I went.  I wanted to see where my current residences (and likely permanent co-choices) rank.  Are Texas and Michigan good choices?

After looking at a number of websites, I have decided to share some opinions about where are the best states to retire.

Wallethub.com published in 2017 a ranking of best states to retire based on four factors. Florida #1, Wyoming #2 (powered by its affordability ranking) and South Dakota #3 (primarily ascendant because of its health care ranking).  Michigan #15 and Texas #18.

Based on eight factors, Bankrate.com published also in 2017 a ranking of the best retirement states.  New Hampshire #1 (#2 in “well-being”), Colorado #2 (somewhere between #1 and #8 in legalized marijuana use), and Maine #3 (#2 in “senior” – I don’t know what this means, but it must be important in retirement rankings).  Michigan #22 and TX #24.

The magazine Kiplinger last published a full ranking of states to retire in 2015, it appears.  The rankings were based on seven factors.  Delaware #1, Florida #2 and West Virginia #3.  Michigan #21 and Texas #42.  Interestingly, the Kiplinger “best states to retire” ranking in 2016 had South Dakota #1, Utah #2 and Georgia #3.  Quite a change.  Retirees must be fickle.

While my choices don’t rank with Florida and South Dakota (huh?), I conclude that my choices are pretty good.  They actually are lot better than good, if you know anything about Traverse City, MI.

My research revealed a sobering tidbit.  Kiplinger in 2016 said that a retiring couple, both 65 years of age, should expect to spend in retirement on healthcare $387,731 on average.

Then, when I finished my research, I asked Mrs. Maultsby where she thinks the best place is to retire.  Her analysis was succinct:  Where the grandchildren are.  Well, that settles the matter.

VKM

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Tax Policy

Trump’s Tax Plan – Kind of Like a Butt Sketch

First, let me acknowledge that Butt Sketch is trademarked by Krandel Lee Newton.  I give him all the well-deserved credit for the term and the concept.  Mr. Newton and his crew of associate Butt Sketchers are famous across the nation now.  About 25 years ago, the Cedar Hill, Texas resident was a bit less well-known when he sketched the lovely Beth McAllister, four friends (whom we saw last weekend), and me.  Beth had agreed that night to be my bride.  We have another of his sketches of the two of us dating some 20 years later and executed at a little party we hosted.   Including our two portraits, Mr. Newton says that he has memorialized over 600,000 backsides.

The Butt Sketch is a charcoal caricature (usually full length) from behind the fully-clothed subjects. The result is a sketch, not a full-blown portrait. It has just enough detail to make the subjects recognizable, if you know them pretty well.

President Trump released a one-page outline of his tax plan on April 26, 2017.  It has just enough detail to recognize it as a tax proposal.  Particulars are meager.

I’ll give President Trump his due.  He fancies himself as a negotiator without peer.  I will not argue that he is a pretty good, if sometimes ruthless, bargainer.  Look at this vague plan as his opening bid.  While the outline hints at some interesting and welcome reforms, the framework he proposes faces opposition from 360 degrees.  It has technical and practical shortfalls, one of the biggest being the apparent ballooning of the national debt: Everybody gets a tax cut, according to the plan.  There are no revenue offsets even hinted.

So, an army of people will be trying to influence, change and add detail to President Trump’s Butt Sketch of a tax plan.  It will be interesting.

VKM

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Personal Taxes

Home Is Where The Dog Is

Three times during this spring busy season I researched extensively the facts and the law surrounding the states of residence of taxpayers in order to determine where state taxes should or should not be paid. Maybe I should have just posed a simple question:  “Where’s your dog?”

In February 2017, the State of New York Division of Tax Appeals (the “Court”) decided the case of Gregory Blatt.  Mr. Blatt was an attorney who in 2009 had worked for several years for InterActive Corporation (“IAC”) as general counsel.  He lived in New York City.  After a corporate reorganization, Mr. Blatt decided to move on.  He spoke to IAC Chairman and CEO Barry Diller about his plans.

Mr. Diller wanted to keep Mr. Blatt as part of IAC.  He asked him if he wanted to run IAC company Match.com., based in Dallas.    Shortly after breaking up with his long-time live-in girlfriend, single Mr. Blatt is given the chance to run dating sites that include Match.com and Tinder.  Hmm. . .

Mr. Blatt was tempted to swipe right on the deal.  But there was one drawback – Dallas.  Mr. Blatt was a sophisticate from the East Coast.  What possibly would there be to do in the heart of the hinterlands?  So, Mr. Blatt negotiated to work at least half the time in New York.  He kept his apartment and his boat in New York.  He took the Dallas job in early 2009.  Match would pay his Dallas living expenses.

He rented a very nice apartment in the Ashton, in the heart of Dallas’ Uptown.  He fell in love with Dallas, the thriving social scene in Uptown, the great restaurants within walking distance, the sports and entertainment venues easily accessible.  (Full disclosure – I live about three blocks from the Ashton – Mr. Blatt is right!)

While not discussed directly in the case, I am sure of another factor.  He had to have fallen for Texas women.  And, he’s the guy that runs Tinder!

He embraced Texas.  He made the final commitment in late 2009 – he moved his dog to Big D.

Towards the end of 2010, Mr. Blatt got the opportunity be the CEO of IAC.  He tried to run IAC from Dallas, because he now fully appreciated the charms of Texas.  But he ultimately decided to move back to New York in 2011.  He claimed to be a Texas resident for most of 2009 and for 2010.  He avoided over $400,000 in New York state income taxes by so claiming.  New York’s Department of Revenue took issue with his self-classification as a Texan.

The Court conceded that Mr. Blatt did not live more than 183 days in New York in 2009 or 2010.  So, he was not a statutory resident of New York.  His residency hinged on his domicile – the place in which an individual taxpayer intends to be his permanent home.  When this saga began, he was domiciled in New York.  To change domicile (from New York to anyplace else), “a taxpayer must prove his subjective intent based upon the objective manifestation of that intent displayed through his conduct.”

The Court pointed out that Mr. Blatt submitted over 100 statements of fact regarding his intentions.  Only one seemed to really matter:

“In reviewing the factors of a change in domicile, historically, the move of items near and dear tend to demonstrate a person’s intention.  As borne out by the evidence in this case, petitioner’s dog was his near and dear item which reflected his ultimate change in domicile to Dallas.“

VKM

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Tax Policy

Where Does All the Money Go?

If you are like me, you know pretty much where your income comes from.  Where does it go?  That sometimes can be a little less transparent.

As I straightened up my office last night at the end of the tax busy season, I ran across a recent study published annually by The Committee for a Responsible Federal Budget that explores government spending.  It addresses the following question:  In 2016, how was $100 of taxes collected spent?

The answer:

Health – including Medicare, Medicaid and other health programs – $26.26
Social Security – $23.61
Defense and Military Benefits – $19.82
Interest – $6.25
13 other categories – $24.06

Where does the money come from?  The most recent year for which I could readily locate sources was the Federal fiscal year 2015.   A study by the Center on Budget and Policy Priorities said of taxes:

47% comes from individual income taxes
33% comes from payroll taxes
11% comes from corporate taxes
9% comes from all other taxes

The estate tax is part of “all other.”  In 2015, fewer than two of every 1,000 estates owed any estate tax.  The estate tax made up 0.6 percent of total federal receipts in 2015.

While not “revenue,” borrowings financed $438 billion of the $3.7 trillion Federal budget.

So, that’s where taxes go and that’s where taxes come from.

Happy April 18!

VKM

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Tax Court

Alternative Investments in IRAs – Part II: Be Creative

WARNING:  Do not try the following strategy unless, at least:

  • Your daddy built a big company that exports products
  • You have the nerve to battle the IRS for many years
  • You have creative and careful tax advisors (like me!)
  • You have the money to hire white-shoe lawyers, who probably charge $1,000 per hour, to represent you in Tax Court
  • Preferably, you live within or relocate to be within the geographic boundaries of the Sixth Circuit Court of Appeals (MI, OH, KY or TN)

If you qualify, then read on, oh lucky, wealthy and intrepid taxpayer.

In my last blog, I urged caution when considering the acquisition of alternative investments in IRAs.  I still so urge.  However, the Sixth Circuit’s recent decision in Summa Holdings does inspire one to consider being creative.

Let’s start with the headline, as stated by nationally renowned IRA expert Ed Slott:  “$7,000 in Roth IRA contributions that became $6 million in tax-free gains.”

Do I have your attention?

Next, we consider quick explanations of two important tax-beneficial provisions of the Internal Revenue Code:  Roth IRAs and DISCs (Domestic International Sales Corporations).

A taxpayer may contribute after-tax dollars to a Roth IRA.  The earnings and gains within the Roth are, in most cases, not taxed.  If a taxpayer owns the Roth for at least 5 years and is at least 59 ½ years of age, distributions to the owner of the IRA are not taxed.  Sweet.  Why not put all my after-tax earnings in a Roth?  The limits on contributions to Roth IRAs are low, if your income is below a certain threshold that permits you even to make a Roth IRA contribution.  If you are not at least 50 years of age, then in 2017 you can contribute no more than $5,500.  The limit was $3,500 in 2001, when the Benenson brothers started the series of actions that resulted in the Summa Holdings case.

DISCs were created by Congress to subsidize U.S. exports.  Using DISCs can reduce tax rates on income from exports.  An exporter avoids corporate income tax by paying the DISC “commissions” of up to 4% of gross receipts or 50% of net income from qualified exports.  The DISC pays no tax on its commission income (up to $10,000,000 in a year) and may hold on to the money indefinitely, though the DISC shareholders must pay annual interest on their shares of the deferred tax liability.

Money and other assets in a DISC may exit the DISC as dividends to shareholders.  Individuals treat the dividends as qualified dividends and pay taxes on the dividends at long-term capital gains tax rates.  If an IRA owns the DISC, it must pay tax on its dividends at the high unrelated business income tax rates.

What kind of business operations must the DISC conduct to earn these benefits for its shareholders? None, nothing, nada.

So what did the Benenson brothers do?

  1. In 2001, each contributed $3,500 to his Roth IRA.
  2. Through a series of transactions, their Roth IRAs formed companies that resulted in a DISC.
  3. The DISC contracted with Summa Holdings, owned primarily by a trust for their benefit, to receive export commissions.
  4. The DISC made distributions to the Roths, which paid UBIT and retained the after-tax distributions.
  5. By the end of 2008, the two Roths initially funded with $3,500 each had each accumulated over $3,000,000. Earnings on the non-DISC investments of the Roth will never be taxed to the Roth and distributions will never be taxed to the Roth owners, if distributions don’t occur before age 59 ½.

The IRS came a-calling.  The Revenuers claimed that the “substance-over-form” doctrine applied to negate the transactions and the benefits.  The IRS recast the transaction as dividends from Summa Holdings to its shareholders (the trust and the boys’ parents).  The Tax Court agreed.

The Sixth Circuit disagreed with the IRS and the Tax Court.  The Court stated that the IRS stretched substance-over-form past its limits, which, in the Court’s opinion, are when the taxpayer’s formal characterization of a transaction fails to capture the economic reality and would distort the meaning of the Code.

The Sixth Circuit said that the taxpayers’ transactions fit well within the boundaries of the statutes enacted by Congress.  If Congress wants to change the statute, it can; the IRS cannot change the statute.  The Sixth Circuit pointed out that the whole DISC idea is a form-over-substance arrangement authorized by Congress to promote exports.

So, the taxpayers got a great result.  The general issue is probably not resolved.  Two similar cases are being pursued in two other Federal Circuits. A statute addressing economic substance has been enacted since the taxable years under consideration.  The Sixth Circuit’s apparent narrowing of the ubiquitous substance-over-form doctrine may have much broader reverberations.

In any case, under the right circumstances, being creative, bold and an IRA owner can be quite lucrative.

Ending Note.  On an evening that you have nothing better to do, you might read the Summa Holdings opinion written by Judge Sutton.  One can surmise that any court opinion starting with references to the bat-crazy Roman Emperor Caligula is going to be entertaining.

VKM

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Personal Taxes

Unconventional Investments in IRAs – Part I: Be Careful

I remember when Individual Retirement Accounts (“IRAs”) were first established in 1974.  (Yep, I’m no spring chicken.)  At first, these tax-deferred IRAs were restricted to those workers who were not already covered by a qualified employment-based retirement plan.  In 1981, that restriction was removed.  IRAs became big business. Then Roth IRAs came along in 1997.  The Investment Company Institute reported that at yearend 2015, people had IRAs worth $7.3 trillion.

Many people assume that any income inside an IRA is nontaxable.  Quite a few IRA holders don’t think much about what kind of investment they place in their IRAs.

I could write a book about all the problems you can have, if you are not careful with your IRAs.  I won’t do that; I wrote a book in my last blog.  Let me touch on just a few of the key problems into which one can run.

Excepting general prohibitions on investing retirement funds in life insurance or collectibles, you can invest your IRA funds in a broad spectrum of assets.  Most of the investments in IRAs are publicly-traded stocks, marketable bonds, mutual funds and ETFs.  For the most part, income and gains from those kinds of investments are not taxed currently to either the IRA or the IRA holder.  However, beyond a threshold of $1,000 per year per IRA, IRAs may have to pay tax on income and gains from some kinds of “unconventional” investments, such as hedge funds, private equity funds, publicly traded partnerships, real estate, and closely-held businesses operated as partnerships or limited liability companies treated as partnerships for tax purposes.  This tax is levied on “unrelated business taxable income” (“UBTI”).  The tax is levied also on “unrelated debt-financed income” (“UDFI”) of the IRA.  The IRA must file a Form 990-T and pay tax at rates that quickly reach top individual rates.

Recently, The Wall Street Journal reported that Ms. Fanny Handel, a retiree from Queens, was shocked and dismayed to get a notice from the IRS in 2015 that her IRA owed $92,000 in taxes, penalties and interests.  Her IRA had invested in Kinder Morgan, an energy publicly traded partnership.  Upon a taxable merger, Kinder Morgan generated a lot of income and gain for its limited partners.  Ms. Fanny or her IRA paid the tax, but got a bit of break from the IRS on the penalties and interest.

So, one’s IRA can owe tax, if one has UBTI or UDFI in one’s IRA.  Your problems don’t stop there.   You can’t engage in prohibited transactions (a) with disqualified persons or (b) involving self-dealing.  Just a few examples of prohibited transactions in an IRA include: (1) having your IRA purchase for you a vacation home; (2) selling your own assets to the IRA; (3) taking a salary from an IRA-funded business; and (4) personally working on and/or paying for repairs on a rental property that your IRA owns.  If you do engage in a prohibited transaction, what happens?  The entire IRA loses its tax-favored status as an IRA, and the account is treated as distributing all of its assets to the IRA owner at the fair market value on the first day of the year in which the transaction occurred.  If it’s a traditional IRA, you may have a huge tax bill.  If you are less than 59 ½ years old when this happens, you’ll also owe a 10% early distribution penalty.

Let’s throw in one more complexity – valuing unconventional assets.  This is can be a particularly vexing problem when you reach 70 ½ years of age, the age at which you must begin taking required minimum distributions (“RMDs”) from traditional IRAs. Generally, you calculate the RMD by applying a percentage to the value of your IRA accounts at the beginning of the year of the RMD.  What if you underestimate the value of the unconventional assets (for example, stock in a private company) in your IRA accounts and, thus, don’t distribute enough to satisfy your RMD?  You pay an excise tax equal to 50% of the amount that the RMD exceeds what you paid.

Now, wait a minute, you might say.  Does not the IRA custodian have to keep up with all the particulars of your IRA investments, including valuing your unconventional assets?  Usually, no.  Does not the IRA custodian prepare the IRA Form 990-T for and pay the tax from your IRA? It depends; often not.  When your IRA invests in unconventional assets, you should assume that you are assuming a lot of responsibilities.

The Government Accountability Office released a report in December 2016 and suggested that the IRS give a lot more guidance to and, basically, post big warning signs for IRA holders who are invested in, or are thinking of investing in, unconventional assets.  Good idea.

So, placing unconventional assets in an IRA can cause problems.  On the other hand, placing unconventional assets can create significant wealth.  I’ll discuss a very creative example of this wealth-building in my next blog, Alternative Investments in IRAs – Part II:  Be Creative.

VKM

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