Retirement plan investments in publicly traded partnerships generate tax bills

October 31, 2014 | By: Robert A. Green, CPA

Many traders and investors are interested in using their IRA and other retirement plan accounts (collectively referred to as “retirement plans”) for making “alternative investments” in publicly traded Master Limited Partnerships (MLPs). Most MLPs conduct business in energy, pipelines, and natural resources. (Learn more about publicly traded partnerships at The National Association of Publicly Traded Partnerships and see its list of PTPs Currently Traded on U.S. Exchanges.) Retirement plans also make alternative investments in hedge funds organized as domestic limited partnerships or offshore corporations.

Publicly traded partnerships (including MLPs) and hedge fund LPs use the partnership structure as opposed to a corporate structure. That allows organizers to pass through significant tax breaks on a Schedule K-1, including intangible drilling costs (IDC) and depreciation to individual investors. Taxes are paid on the investor/owner level, so the partnership structure avoids double taxation. Conversely, corporations owe taxes on the entity level and investor/owners pay taxes on dividends received from the corporation. (Real Estate Investment Trusts do not use a partnership structure.)

Tax problems for retirement plans investing in MLPs
Most MLPs conduct business activities including energy, pipelines and natural resources. But hedge funds do not — they buy and sell securities, futures, options and forex, which are considered portfolio income activities. Private equity and venture capital funds using the partnership structure also may pass through business activity income.

When retirement plans conduct or invest in a business activity, they must file separate tax forms to report Unrelated Business Income (UBI) and often owe Unrelated Business Income Tax (UBIT). MLPs issue Schedule K-1s reporting business income, expense and loss to retirement plan investor/owners. That’s the problem! The retirement plan then has UBI, and it may owe UBIT. Instead of the MLP being a tax-advantaged investment as advertised, it turns into a potential tax nightmare investment.

Form 990-T
According to Form 990-T and its instructions “Who Must File,” when a retirement plan has “gross income of $1,000 or more from a regularly conducted unrelated trade or business” it must file a Form 990-T (Exempt Organization Business Income Tax Return). While the retirement plan may deduct IDC and depreciation from net UBI, gross income will probably exceed $1,000 causing the need to file Form 990-T. UBIT tax brackets go up to 39.6%, which matches the top individual tax rate. (See the UBIT rates and brackets in the instructions.) File Form 990-T to report net UBI losses so there is a UBI loss carryforward to subsequent tax years.

Don’t overlook the need to file Form 990-T
Noncompliance with Form 990-T rules can lead to back taxes, penalties and interest. It can lead to “blowing up” a retirement plan, which means all assets are deemed ordinary income. And if the beneficiary is under age 59½, it’s considered an “early withdrawal,” subject to a 10% excise tax penalty. Schedule K-1s are complex, and UBI reporting can be confusing especially if the retirement plan receives several Schedule K-1s from different investments. Don’t look to brokers for help; most have passed off this problem to retirement plan trustees and beneficial owners (and that is you!).

In our July 2013 blog and Webinar “The DOs and DON’Ts of using IRAs and other retirement plans in trading activities and alternative investments,” we cautioned investors on making alternative investments in their retirement plan accounts. We talked about UBIT, self-dealing and prohibited transactions. We explained that U.S. pension funds invest in offshore hedge funds organized as corporations since the offshore corporations are “UBIT blockers.”

If your retirement plan is invested in a publicly traded partnership, assess your tax situation immediately, catch up with Form 990-T filing compliance and consider selling those investments. It’s better to buy them in a taxable account.

Darren Neuschwander CPA and Star Johnson CPA contributed to this article. 

 



Obamacare ushers in several new tax forms for 2014

October 30, 2014 | By: Robert A. Green, CPA

Register for our Webinar Take charge of your Obamacare tax matters today on November 12, 2014 4:15 PM – 5:15 PM EST

The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees to comply with Obamacare on 2014 tax filings. In this post, I help clarify the details of the mandate to avoid confusion.

There are three scenarios for dealing with the mandate on 2014 tax returns:

  1. Off-exchange coverage: If you had ACA-compliant health insurance coverage for all of 2014 — either an individual plan purchased directly from an insurance company (off exchange), an employer plan or government-sponsored programs like Medicare or Medicaid — there’s little to do. Expect to receive new IRS Form 1095-B reporting your health insurance coverage from an insurance company and, if applicable, a Form 1095-C from your employer. Give the 1095s to your accountant and you’re finished. There won’t be any penalties, premium tax credits or return of exchange subsidies.
  2. On-exchange coverage: If you purchased your 2014 health insurance on an exchange (marketplace), you must file new tax Form 8962 (Premium Tax Credit).  When you applied for your 2014 health insurance coverage, you submitted estimates of your 2014 income which the exchange relied on for pricing your plan, perhaps offering a subsidized plan with “advanced credits.” The purpose of Form 8962 is to determine your rightful premium tax credit based on income reported on your 2014 tax return, and to reconcile advanced credits (if any) with the premium tax credit calculated on Form 8962.  Its likely estimates won’t match actual income, especially for traders who have fluctuations in trading gains and losses.Therefore, one of three things will happen on Form 8962:

i.            You will have a tax liability caused by advanced credits being greater than the premium tax credit.

ii.            You will have a tax credit caused by advanced credits being less than the premium tax credit.

iii.            No tax liability or credit because you used an exchange but did not receive an advanced credit and there is no premium tax credit.

The Obamacare Website says individuals can use an exchange even without getting a subsidized plan, but we heard from taxpayers that they were not permitted to use some state exchanges unless they qualified for subsidies.
Expect to receive new “tax information document” IRS Form 1095-A from the exchange reporting your coverage and any advanced credits paid for a subsidized plan. Give the 1095s to your accountant and they will prepare Form 8962. Tax software should have an input area to enter Form 1095 information and calculate Form 8962 and the premium tax credit.

  1. No health insurance coverage: If you did not have ACA-compliant health insurance coverage for 2014 — and that includes large gaps in coverage — and you don’t qualify for an exemption from Obamacare, then you will owe a shared-responsibility payment (tax penalty). File tax Form 8965 if you claim an exemption. As of Oct. 29, the IRS had not yet released a draft tax form for calculating the shared responsibility payment. For 2014, it’s either $95 or 1% of household income — whichever amount is larger. (More details below.)

The 2014 Form 1040 has three lines dealing with the Obamacare health insurance mandate:

  1. Tax (line 46): Excess advance premium tax credit repayment. Attach Form 8962.
  2. Payment (line 69): Net premium tax credit. Attach Form 8962.
  3. Other Taxes (line 61): Health care: individual responsibility (see instructions). Full-year coverage (box to check).

Open enrollment through exchanges
Traders should consider special strategies for purchasing 2015 health insurance coverage through exchanges and the open enrollment period runs from Nov. 15, 2014 to Feb. 15, 2015.  Most individuals will purchase 2015 insurance before they deal with Obamacare tax compliance on 2014 tax returns.

If you want to receive a premium tax credit, you need to enroll through an exchange, not directly with an insurance provider or employer. You can only file a Form 8962 for a premium tax credit if you enroll through an exchange. You can’t receive premium tax credit if you are eligible for other “minimum essential coverage,” such as employer-sponsored coverage that is considered adequate and affordable.  Traders should use a reasonable basis for providing the exchange with an estimate of income, perhaps qualifying for a subsidized plan with advanced credits. You will have to square up with the IRS on Form 8962, but at least you are in the game for filing a Form 8962 and receiving a premium tax credit. Many traders may have low income in 2015 and they should keep this opportunity open. High-income sole proprietors have confidence they won’t get a premium tax credit and they can skip the exchange all together if working directly with an insurance provider is more convenient.

The exchange system is inconvenient for traders who have fluctuating income
Most individuals consider ACA-compliant non-subsidized health insurance plans expensive. If your household income is above 400% of the Federal Poverty Line, you or your family won’t qualify for a subsidized plan on the exchange. You may even face obstacles in using an exchange. No worries, you can purchase an individual or employer ACA-compliant health insurance plan directly through an insurance company. Just keep in mind that rules out the possibility of getting a premium tax credit if you wind up with household income under 400% of the Federal Poverty Line since the insurance must be purchased through an exchange to qualify for the credit.

Many traders have wide fluctuations in trading gains and losses from year-to-year. They could easily fall under 400% of the Federal Poverty Line in 2014 and qualify for an exchange-subsidized plan for the year of 2015. But these traders may wind up with large trading gains in 2015, thereby triggering an “excess advance premium tax credit repayment” (claw back of subsidies) on their 2015 Form 8962.  The big problem is the exchange requires an estimate of income before the coverage year starts, and traders don’t know their income until the year ends.

There are five new Obamacare tax forms for 2014 (and there may be a sixth one for calculating the shared responsibility payment)

  1. Form 1095-A: Health Insurance Marketplace Statement. The exchange issues this tax information form to individuals who purchased insurance through an exchange for 2014. (Similar to a bank or broker that issues a tax information Form 1099.) Its instructions state: “You received this Form 1095-A because you or a family member enrolled in health insurance coverage through the Health Insurance Marketplace. This Form 1095-A provides information you need to complete Form 8962, Premium Tax Credit (PTC). You must complete Form 8962 and file it with your tax return if you want to claim the premium tax credit or if you received premium assistance through advance credit payments (whether or not you otherwise are required to file a tax return). The Marketplace has also reported this information to the IRS. If you or your family members enrolled at the Marketplace in more than one qualified health plan policy, you will receive a Form 1095-A for each policy.”If the Form 1095-A does not list any advanced credits and you are confident your income will be well above 400% of the Federal Poverty Line, you don’t have to prepare Form 8962.  Some taxpayers may easily generate the form with their tax software and choose to attach it with their return just in case IRS computers look for it.
  2. Form 1095-B: Health Coverage. The insurance provider issues this tax information form to individuals. Its instructions state: “This Form 1095-B provides information needed to report on your income tax return that you, your spouse and individuals you claim as dependents had qualifying health coverage (referred to as “minimum essential coverage”) for some or all months during the year. Individuals who do not have minimum essential coverage and do not qualify for an exemption may be liable for the individual shared responsibility payment. Minimum essential coverage includes government-sponsored programs, eligible employer-sponsored plans, individual market plans and miscellaneous coverage designated by the Department of Health and Human Services. For more information on minimum essential coverage, see Pub. 974, Premium Tax Credit (PTC).”
  3. Form 1095-C: Employer-Provided Health Insurance Offer and Coverage. The employer issues this tax information form to individuals. Its instructions state: “This Form 1095-C includes information about the health coverage offered to you by your employer. Form 1095-C, Part II, includes information about the coverage, if any, your employer offered to you and your spouse and dependent(s). If you purchased health insurance coverage through the Health Insurance Marketplace and wish to claim the premium tax credit, this information will assist you in determining whether you are eligible. For more information about the premium tax credit, see Pub. 974, Premium Tax Credit (PTC).”
  4. Form 8962: Premium Tax Credit.  This tax form is prepared by taxpayers and/or their tax preparers. Its instructions state: “Complete Form 8962 only for health insurance coverage in a qualified health plan (described later) purchased through a Health Insurance Marketplace (also known as an exchange). This includes a qualified health plan purchased on www.healthcare.gov.”Caution: An “excess advance premium tax credit repayment” increases estimated income taxes due, whereas a “net premium tax credit” does not reduce estimated taxes due. (That’s inconsistent and unfair in our view.)

The Federal Poverty Line and household income
Exchange subsidies and the Form 8962 premium tax credit are granted to individuals and families with household incomes between 100% and 400% of the “Federal Poverty Line.” Household income is also used for calculating the Obamacare shared responsibility payment for not having minimum essential coverage or an exemption from coverage (Form 8965). Household income is basically taxpayer’s adjusted gross income reported on their tax return plus: Social Security payments excluded from AGI, tax-exempt income (i.e. municipal bond interest), and Form 2555 exclusions for U.S. residents abroad (foreign earned income and housing allowance). Household income also includes the income of any dependents that are covered on the family insurance plan.

An Obamacare website https://www.healthcare.gov/income-and-household-information/income/ confirms household income includes “Social Security payments, including disability payments — but not Supplemental Security Income (SSI).” According to Form 8962 instructions, social security benefits otherwise not subject to income tax are “added back” since you start with modified AGI rather than just AGI. Eighty-five percent of Social Security payments are included in AGI if the taxpayer exceeds the Social Security AGI threshold of $44,000 for married filing joint and $34,000 for all other taxpayers. Taxpayers under those thresholds exclude 100% of Social Security payments from AGI. Including all social security payments in household income pushes many seniors above the Federal Poverty Line and prevents them from getting a premium tax credit, but most seniors don’t use the exchange because they are covered under Medicare.

For a full description of household income, see Form 8962 instructions.

Federal Poverty Line Chart
(based on Form 8962 instructions; these numbers are slightly different for Hawaii and Alaska residents)

Family 100% of
Federal Poverty
400% of Federal
Size Line Poverty Line
1            11,490             45,960
2            15,510             62,040
3            19,530             78,120
4            23,550             94,200
5            27,570           110,280
6            31,590           126,360
7            35,610           142,440
8            39,630           158,520
  1. Form 8965:Health Coverage Exemptions and instructions. Individuals need to fill out this tax form to claim an exemption from Obamacare for all or part of 2014. There are many exemptions and the IRS wants to be sure you qualify and claim the correct one. Otherwise you will owe a shared responsibility payment. For one-page summaries of the exemptions available, see http://www.irs.gov/uac/ACA-Individual-Shared-Responsibility-Provision-Exemptions or IRS Publication 5172 – Facts about Health Coverage Exemptions.According to ObamaCare Mandate: Exemption and Tax Penalty, “The mandate’s exemptions cover a variety of people, including: members of certain religious groups and Native American tribes; undocumented immigrants (who are not eligible for health insurance subsidies under the law); incarcerated individuals; people whose incomes are so low they don’t have to file taxes (currently $9,500 for individuals and $19,000 for married couples); and people for whom health insurance is considered unaffordable (where insurance premiums after employer contributions and federal subsidies exceed 8% of family income); and those going without insurance for less than three months in a row … Hardship Exemption Update: If you had your plan canceled in 2014 due to the Affordable Care Act you now qualify for a hardship exemption in 2014. That means you won’t have to pay the fee if you decide to go without insurance and will qualify for low premium, high out-of-pocket catastrophic plans on your State’s health insurance marketplace.”

Obamacare is progressive taxation
Obamacare is the epitome of progressive taxation and transfer payments using fiscal policy. Upper-income taxpayers pay more to subsidize lower-income folks, and middle-class taxpayers pay their fair share of more expensive coverage that can’t rider out pre-existing conditions. Like many new major social programs enacted before it, some Obamacare tax hikes started on upper-income taxpayers before the new benefits were even provided, including Obamacare Net Investment Income Tax, which started in 2013 even though Obamacare benefits didn’t start until 2014. (Read more about Net Investment Income Tax reported on Form 8960.)

Open question: Are federal exchange subsidies legal?
One court ruled that federal exchange subsidies are illegal and another court overruled it. The issue may be heard by the Supreme Court soon. Obamacare law contemplated all states having an exchange but many states balked and chose to participate in HealthCare.gov, the federal exchange. Read more: http://www.cnbc.com/id/102137279.

Bottom line

Consult with your tax adviser to discuss how Obamacare taxes will affect your 2014 tax return and how it may be best for you to obtain coverage for 2015.  There’s still plenty of confusion and new surprises will arise, so stay tuned for updates on our blog.

Darren Neuschwander, CPA and Star Johnson, CPA contributed to this article. 


2014 year-end tax planning for traders

October 21, 2014 | By: Robert A. Green, CPA

Join us for our Oct. 28 Webinar covering this blog, or watch the recording afterwards. 

Traders should consider general year-end planning strategies like deferring income and accelerating expenses, but they should also be aware of some other special tactics. In this article, I touch upon 20+ ideas for tax savings on your 2014 tax return.

1. Avoid NIT if you can.
As of Jan. 1, 2013, if you have adjusted gross income (AGI) over $250,000 (married) and $200,000 (single), then additional investment income will be subject to the 3.8% Net Investment Income Tax (NIT). (Read Net Investment Income Tax.)

2. Accelerate income to utilize lower tax brackets
There are some situations where it’s better to accelerate income and defer expenses, such as if you happen to be in a low tax bracket in 2014 due to trading losses and or other types of expenses and losses. Take advantage of ordinary tax rates up to 28%, a good regular tax rate and the highest alternative minimum tax (AMT) rate.

If you hold a security for 12 months before selling, it’s considered a long-term capital gain subject to rates that are lower than the ordinary rates for short-term capital gains. Look in your investment portfolio for positions with material unrealized capital gains. Consider selling some or all of the long-term winners before year-end. The long-term capital gain tax rate is graduated: 0%, 15% and 20%.  The 0% rate applies up to $73,800 of taxable income for married filing joint and $36,900 for single filers. The long-term rate applies to qualified dividends, too.

3. Accelerate more income with a Roth IRA conversion
Another good way to accelerate income to utilize lower tax brackets is by executing a Roth IRA conversion before year-end. You can break up an IRA into pieces in order to convert a certain amount. You can always recharacterize the conversion in 2015 if it doesn’t work well — for example, if you lose the money in the Roth account and prefer a do over or if your tax rates in 2015 are far lower than 2014. (Read our Oct. 7 blog Last chance to reverse 2013 Roth IRA conversion by Oct. 15, 2014.)

4. Get a handle on wash sale loss deferrals
Wash sale loss deferrals accelerate income if you don’t have a capital loss limitation. Many taxpayers hate wash sales because they cause tax liability on phantom income, with the IRS deferring losses into the next tax year.

Smart investors, business traders and investment managers spend November and December identifying and avoiding potential wash sale losses on “substantially identical positions” (i.e., between Apple stock and Apple options at different strike prices). Don’t wait until you receive broker-issued Form 1099-Bs in February to find out you have a huge tax problem with wash sale loss deferrals which might increase your 2014 tax bill significantly. (Read Cost-Basis Reporting and Form 8949.)

5. Use Tradelog to better manage wash sales
Run TradeLog software before year-end to calculate and avoid wash sales, handle cost-basis reporting correctly and generate Form 8949 for tax filings. Keep running it through the end of January for wash sale loss calculations since they are triggered 30 days before and 30 days after taking a loss (if you re-enter that position). TradeLog’s “Potential Wash” report can be used to avoid wash-sale loss surprises. Once you spot a potential wash sale, sell all open positions before year-end and don’t buy them back for 31 days. (Read Accounting Solutions and purchase Tradelog.)

6. Break the chain on wash sales with an entity
Consider trading in a separate entity in Q4 or on Jan. 1 to disconnect your individual trades under a different taxpayer ID number for the entity. A single-member LLC (SMLLC) disregarded entity doesn’t work here; you need a partnership or S-Corp return. (Read Entity Solutions.)

7. Avoid wash sales in IRAs
Don’t forget to run TradeLog on your individual IRA accounts too. Avoid permanent wash sale losses between individual taxable accounts and IRAs. Don’t trade substantially identical positions between taxable and IRA accounts.

8. Take advantage of tax loss selling
Most financial media recommend “tax loss selling” as part of year-end tax planning. If you have capital gains year-to-date, sell a few losing positions to reduce capital gains taxes. Remember, don’t rush to buy back that losing position within 30 days (in January) as that can cause a wash sale loss deferral at year-end 2014, thereby defeating the purpose of tax loss selling.

9. Hold winning positions at year-end
Investors, business traders and hedge fund managers often hold open winning positions in securities with unrealized gains at year-end in order to defer taxes and perhaps achieve lower long-term capital gains rates in 2015 or subsequent years.

10. Utilize capital losses to maximum advantage
If you have significant capital losses and carryovers in 2014, consider selling open winning positions before year-end to utilize those capital losses. There’s no sense holding a winning position open for 12 months to achieve a long-term capital gain if that gain is offset with a capital loss carryover.

Per tax publisher Thompson Reuters, “Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses must be used to offset short-term capital gains before they are used to offset long-term capital gains. A taxpayer should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income.”

11. Section 475 traders are exempt from wash sale rules
Business traders should learn about Section 475 MTM business ordinary gain or loss treatment. While short-term capital gains on securities are taxed at ordinary rates, short-term capital losses are subject to the $3,000 capital loss limitation and problematic wash sale loss rules. The main tax benefit of Section 475 is that 475 trading losses are business ordinary losses without any limitation, and are included in net operating loss (NOL) calculations. Section 475 trades are exempt from the wash sale rules, too. New taxpayers (entities) are entitled to elect Section 475 within 75 days of inception, so this is a good solution for traders late in the year.  (Read Section 475 MTM Accounting.)

12. Turn 2014 unrealized capital losses into 2015 ordinary losses
If business traders qualifying for trader tax status don’t have Section 475 in 2014, they can elect it for 2015 by April 15, 2015. That 2015 election converts unrealized business trading gains and losses at the end of 2014 into ordinary gains or losses on Jan. 1, 2015 — that’s the required Section 481(a) adjustment. A negative Section 481(a) adjustment on Jan. 1 from unrealized losses on Dec. 31, 2014 is far better than a capital loss carried over from 2014 to 2015. In this case, wash sales are good because they are part of a Section 481(a) adjustment, rather than being a capital loss carryover. Traders generally have a hard time using up large capital loss carryovers. In this case, the business trader wants to skip tax loss selling and it’s beneficial to have an unrealized capital loss at year-end.

13. Learn the rules for segregation of investments
Some business traders and many hedge fund managers skip Section 475 MTM elections because they have a hard time following the rules for “contemporaneous” segregation of investments from business trading positions. The IRS is increasingly challenging traders over the segregation of investment rules. Hedge fund managers also don’t want investors paying taxes on open positions, as investors would request redemptions to pay the tax bill while managers have cash funds tied up in those open positions. (Read our Aug. 13 blog IRS warns Section 475 traders.)

14. Assess your qualification for trader tax status
Section 475 hinges on trader tax status (TTS), so active retail traders and hedge fund managers should assess their qualification before year-end. Sole proprietors and hedge funds can claim TTS after they assess the facts and circumstances, but Section 475 MTM is not allowed after the fact. It had to be elected with the IRS by April 15, 2014 for 2014 or within 75 days of a “new taxpayer” (i.e., a new entity) filed in the entity books and records (an internal election). (Read Trader Tax Status: How to Qualify.)

15. Forex can be ordinary or capital treatment
By default forex receives Section 988 ordinary gain or loss treatment. Forex traders may file an internal contemporaneous election (known as a forex “capital gains” election) to opt out of this treatment. Major forex forward contracts for which regulated futures contracts trade on U.S. futures exchanges are  labeled “foreign currency contracts” under Section 1256(g). Section 1256 has the tax benefit of lower 60/40 tax rates: 60% is subject to lower long-term capital gains rates and the other 40% is taxed at ordinary rates. Section 1256 is mark-to-market at year-end, whereas Section 988 is realized transactions only. We make a case for treating forex spot like forex forwards in Section 1256(g). (Read Forex tax treatment.)

16. Decide whether to accelerate or defer expenses.
Currently, 2015 tax rates match 2014 rates. This means if you are in a high tax bracket it’s a good idea to defer income and accelerate business expenses and itemized deductions. (Using credit cards on the last days of the year counts.) You may not qualify for TTS in 2015, so get business deductions while you still can. Investment expenses exclude home office, education, and startup costs. (Business expenses allow them.) If you don’t qualify for TTS at year-end but will in 2015, then defer business expenses to 2015.

17. Get employee-benefit plan deductions with entities
Trading gains are not considered earned income, so traders need an entity to pay the owner/trader compensation to unlock valuable employee-benefit-plan tax deductions, including retirement and health insurance premiums. (Traders generally save thousands of dollars with these strategies.) S-corps and C-corps should execute payroll and partnerships administration fees before year-end.  To avoid under-estimated tax penalties, increase tax withholding through year-end payroll. (Read Entity Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)

18. Establish retirement plans before year-end
Business traders should open an employer 401(k) plan before year-end in an S-Corp trading entity or C-Corp management company — otherwise, they will miss the boat on the best retirement plan choice for most traders. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. For sole proprietors, an Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer 401(k) plan.

Make sure to pay compensation before year-end to execute these employee-benefit plan deduction strategies. High income traders should consider a defined benefit (DB) plan where you can contribute much higher amounts per year (up to $210,000 for 2014).  DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction. Can you afford a Roth contribution too? See 2014 retirement plan limits on the IRS site  (click here for DB plans). Don’t overlook required minimum distributions (RMD) rules for traditional retirement plans.  (Read Retirement Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)

19. Get a handle on accounting first
Focus on accounting before year-end to get a proper handle on tax planning. Accounting for securities trading is complex with cost-basis reporting, wash sales and reporting realized gains and losses only. We recommend Tradelog software to download your trades and handle this accounting.

20. GTT Tracker app for expense accounting
For expenses and asset purchases, we recommend our GTT Tracker accounting solution and app. Account for expenses and assets, including fixed assets (equipment), intangible assets (software), Section 195 startup costs and Section 248 organization costs. GTT Tracker prepares a full accounting and it properly documents your trading expenses and other business expenses. It’s a single-entry accounting system that is extremely effective and easy to use. The software allows you to download bank account and credit card transactions and follow IRS rules for compliance and documentation on a daily basis. Don’t be stuck trying to remember who you had dinner with and what the business purpose was at year-end. The IRS is tough on these issues in exams. (Read GTT Tracker with GTT TradeCounter.)

21. Expenses must be in order by year-end
Execute expense reimbursements before year-end — a requirement in S-Corps and suggested in partnerships. Learn how to handle the health insurance premium deduction, which is tricky with S-Corps. Employee-benefit plan deductions determine the amount of compensation needed to unlock those deductions. S-Corps should consider using salaries in December and engaging a payroll processing firm — we recommend paychex.com.

22. Get your Obamacare matters in order
Obamacare health insurance mandate tax penalties apply on 2014 tax returns for the first time. Many traders may qualify for penalty abatement under a financial hardship exemption. Many have also received notices to repay all or a portion of health-exchange subsidies received. There’s a whole new batch of Obamacare tax forms to fill out, and the first year will generate a lot of confusion.

23. Consider a C-Corp
A C-Corp is taxed separately from individuals and the top C-Corp tax rate (35%) is lower than the top individual tax rate (up to 44% with NIT). But there’s also double taxation with C-Corps: once on the entity level and again when qualified dividends are paid on the individual level.  Double taxation is less of an issue in states with no individual income tax.

There are a number of ways to get income into the C-Corp. House intellectual property there, charging your trading entity royalties. Have the C-Corp get a profit allocation from the trading entity. Have the C-Corp charge the trading entity administration fees. C-Corps can have a medical reimbursement plan, which is a good way to pay for high deductible Affordable Care Act-compliant health insurance plans.

24. Catch up with estimated taxes at year-end
Don’t forget to get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, considering the underestimated tax penalty like a low-cost margin loan. The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state(s) before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit.


Will “tax extenders” be renewed retroactively for 2014?

October 9, 2014 | By: Robert A. Green, CPA

The IRS commissioner recently told Congress that further delay on anticipated renewal of “tax extenders” will delay the 2014 tax-filing season and 2014 tax refunds. Many taxpayers are hoping Congress renews tax extenders retroactively to all of 2014 so it increases their 2014 tax refunds. I can see a case for non-renewal of tax extenders.

The IRS needs a long lead time
Each year, the IRS and tax publishers need to finalize tax forms and software on a timely basis. Last minute tax law changes often throw a monkey wrench into that process. When Congress passes new tax law, the IRS has to codify those laws with proposed regulations and final regulations. The last step is drafting and finalizing tax forms and related instructions. Factor in government bureaucracy and this entire process can take a lot of time. Congress passed the Affordable Care Act (ObamaCare) in March 2010, yet it took the IRS several years to finalize regulations and 2013 Net Investment Income Tax Form 8960. Form 8960 was released late for the 2013 tax filing season – delaying last year’s tax season. The IRS just released 2014 ObamaCare insurance-mandate tax forms, which is early in this case (see upcoming blog).

Renewal of tax extenders is not certain
Congress allowed the entire list of “tax extenders” to expire at the end of 2013. Unlike in prior years, Congress did not renew the tax extenders during its annual game of political brinksmanship. If Congress permanently passed tax extenders, it would blow a huge hole in the budget deficit forecast and that’s a political problem.

In “A major tax reform bill in 2014 is unlikely, and “tax extenders” may be history, too,” I predicted Republicans might block renewal of tax extenders for leverage in discussing an overhaul of the tax code – otherwise known as “tax reform.” Why pass a bunch of tax breaks separately, without taking the opportunity to also simplify and fix the tax code at the same time?

My latest thoughts about tax extenders and tax reform
Why pass tax extenders just before the major election in November 2014? Congressmen campaign on tax policy raising money from the tax-benefit lobby. Pundits currently predict that Republicans may win narrow control of the Senate, but not filibuster-proof. Republicans could press for their vision of tax reform with the mantle in both houses of Congress. With ongoing public controversy over corporate tax inversions and U.S. companies moving abroad, a Republican Congress can probably exert pressure on the White House to pass corporate tax reform. Most small businesses uses pass-through entities like LLCs and S-Corps, which means they pay their business taxes on individual tax returns. For this reason, Congress should include individual tax reform in the tax reform bill, too. You can’t leave a large gap between individual and corporate tax rates.

The 2015 Congress sits in late January 2015, which means the 2014 lame-duck Congress will deal with year-end calls for renewing tax extenders. It’s highly unlikely the latter will deal with tax reform.

Is the IRS Commissioner weighing in to politics by pressuring Congress on tax extenders before the November election? Tax extenders lapsed at the end of 2013. Shouldn’t the IRS create tax forms based on current tax law? It’s certainly not easy with a last-minute Congress.

I vote for tax reform over just renewing tax extenders. For those that cry wolf, I question if corporations will reduce their research and development, or investments in new technology and equipment simply because the U.S. Treasury won’t subsidize them. American big and small businesses need to innovate and stay technologically advanced or they will lose their worldwide competitive edge.

As we approach the year-end holidays, many lobbyists, corporations and individuals will write letters to their Congressmen crying foul over tax extenders, Congress may cave and renew tax extenders. It’s tough to do tax planning with this routine.


Tax relief for Canadians living in the U.S.

| By: Robert A. Green, CPA

In the past, many Canadians living in the U.S. were surprised and dismayed to learn they owed U.S. taxes, penalties and interest on income accumulating inside their Canadian retirement plans. These U.S. residents figured their Canadian retirement plans were automatically afforded the same tax-deferral treatment as U.S. retirement plans, with income only being taxable when distributed from the plan. They were unaware they had to file an IRS election for deferral treatment.

That wasn’t the only surprise — many Canadians didn’t realize they had to report Canadian retirement plans on U.S. Treasury FBAR filings (foreign bank account reports).

We’re happy to see the IRS acknowledged the tax-deferral problem and it now provides relief. In Revenue Procedure 2014-55, the IRS repeals the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral. The new rules are retroactive, so it abates back taxes, interest and penalties and that spells “relief.”

This relief applies to U.S. taxpayers with Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). The IRS altered regulations governing annual reporting requirements, mostly doing away with the election requirement and there is no longer a need to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans).

Foreign retirement accounts must still be reported on FinCEN Form 114, Report of Foreign Bank and Financial Account. (Read more on International Tax Matters in our Trader Tax Center.)


Last chance to reverse 2013 Roth IRA conversion by Oct. 15, 2014

October 7, 2014 | By: Robert A. Green, CPA

If you converted a traditional IRA to a Roth IRA in 2013, the IRS allows you to “recharacterize” the conversion if necessary. (See IRS law on this at Reg. 1.408A-5.) But the due date of Oct. 15, 2014 is quickly approaching. You can reverse a 2013 Roth conversion by executing a direct transfer of funds from it back into a traditional IRA. If you already filed your 2013 individual tax return reporting the Roth conversion amount in gross income, you’ll need to file an amended tax return to reduce the income accordingly. Generally, when financial markets rise, there are fewer recharacterizations, but if your account dropped in value, it may be a good idea.


Estates should consider a “portability election”

| By: Robert A. Green, CPA

When an estate is under the estate tax return filing threshold ($5 million for 2011, $5.12 million for 2012, and $5.25 million for 2013), trustees should still consider filing a Form 706 estate tax return. Trustees can make a “portability election” allowing the surviving spouse to use the decedent spouse’s unused exclusion amount. The IRS allows late elections for estates created after 2011 and before 2014; the due date is Dec. 31, 2014. After that date, it’s too late. See Rev. Proc. 2014-18.


Foreign partners in a U.S. trading partnership can be tax free

August 19, 2014 | By: Robert A. Green, CPA

Non-resident alien traders often ask us these two tax questions:

• “If I open an individual brokerage account in the U.S. to trade securities, futures and forex, will I be liable for U.S. taxes on my trading gains?”

• “If I become a partner in a U.S. proprietary trading firm filing a partnership tax return, do I owe U.S. taxes on my Schedule K-1 income?”

The answer to the first question is no. Trading gains are considered portfolio income which is not effectively connected income (ECI) in the U.S. Generally, non-resident aliens are liable for U.S. tax on income from business and real property in the U.S. There is tax withholding on dividend payments and sales of master limited partnerships (MLPs). There is no withholding in connection with futures or forex trading.

The answer to the second question is more complex. Typically, foreign partners in U.S. partnerships are considered to have U.S. ECI on their Schedule K-1 income. But if the partnership is a trading company — in financial markets, not goods — the income is considered portfolio income, including the partner’s share. Typically, U.S. partnerships withhold taxes on foreign partners, but that is not required if the foreign partner only has portfolio income not subject to U.S. tax. It gets more complicated with dividends in the partnership, since there was no withholding of dividends tax for the share owned by the foreign partner.

864(b) Trading Safe Harbor
According to research by tax attorney Mark Feldman, if the partnership is doing just forex trading (or other types of trading in stock, securities or futures), then it is probable that a foreign partner will not be subject to U.S. tax based on the following:

Generally, under Section 875(1), if a partnership is engaged in a trade or business in the U.S. (“ETB”), a nonresident alien partner of the partnership is automatically ETB. However, Section 864(b)(2)(A)(ii)&(B)(ii), provides an exception to ETB if a nonresident alien trades for his own account—even if through a principal office located in the US. It seems that this exception overrides the general rule of Section 875(1); after all, a deemed presence under 875(1) should be no worse than an actual presence in a principal office.

See FSA 199909004: Section 1.864-2(c)(2)(iii) provides rules for determining whether the taxpayer’s principal office is in the United States. . . . However, we note that the Taxpayer Relief Act of 1997, P.L. 105-34, section 1162(a), removed the requirement that the partnership have its principal office outside the United States. Therefore, for taxable years beginning after December 31, 1997, even if it was determined that USP [US partnership, with its principal office in the US] was a trader rather than investor in stocks and securities, FC [foreign corp, which was a partner in USP] nevertheless would not be subject to tax on its distributive share of USP’s capital gains due to the section 864(b)(2)(A)(ii) safe harbor. After December 31, 1997, FC would fail the trading safe harbor in section 864(b)(2)(A)(ii) only if either FC or USP was also a dealer in stocks or securities.

The FSA is presumably basing itself on this language in Treas. Reg. 1.864-2(c)(2)(ii) (which was not yet amended to reflect the repeal of the principal office requirement, otherwise known as the Ten Commandments, in 1997):

Partnerships. A nonresident alien individual, foreign partnership, foreign estate, foreign trust, or foreign corporation shall not be considered to be engaged in trade or business within the United States solely because such person is a member of a partnership (whether domestic or foreign) which, pursuant to discretionary authority granted to such partnership by such person, effects transactions in the United States in stocks or securities for the partnership’s own account or solely because an employee of such partnership, or a broker, commission agent, custodian, or other agent, pursuant to discretionary authority granted by such partnership, effects transactions in the United States in stocks or securities for the account of such partnership. This subdivision shall not apply, however, to any member of (a) a partnership which is a dealer in stocks or securities or (b) a partnership (other than a partnership in which, at any time during the last half of its taxable year, more than 50 percent of either the capital interest or the profits interest is owned, directly or indirectly, by five or fewer partners who are individuals) the principal business of which is trading in stocks or securities for its own account, if the principal office of such partnership is in the United States at any time during the taxable year.

Presumably, after the regulation is amended, part (b) of the last quoted sentence will be removed. Also, PLR 8850041 (not reliable for precedent) says that Section 864(b)(2)(B) “commodities” include forex.

Bottom line
“It’s my understanding that a non-U.S. person that is a member of a prop trading firm is subject to the exemption in 864 for trading for your own account provided that the prop trading firm is not a dealer,” tax attorney Roger Lorence says. “In some cases, a prop trading firm is a member of a commodities exchange or a securities exchange, but this is as a customer member. The prop trader receives better fees and commissions, but is not actually making a market or otherwise trading. So long as the prop trading firm is a customer member, then there’s no ETB issue. However, there can be state issues where the state diverges from the federal rules of 864.”


IRS warns Section 475 traders

August 13, 2014 | By: Robert A. Green, CPA

The IRS Chief Counsel (ICC) recently gave auditors advice on challenging Section 475 mark-to-market (MTM) traders trying to game the system with segregated investment positions. Section 475 MTM means ordinary gain or business loss treatment, whereas investment positions are capital gain or loss treatment. It’s important not to mix up the two on tax return filings. If you are unclear on your situation, check with one of our CPAs.

In new IRS Chief Counsel Advice 201432016, the IRS focuses on options created on “basket transactions,” which I feel are rarely used tax avoidance schemes. During the past decade, some very large hedge funds parked their trading activity inside of banks and arranged option transactions with the banks to reclaim their trading profits after year-end. These hedge funds avoided application of Section 475 MTM income on their trading gains during the tax year, and replaced it with an option allowing them tax deferral and long-term capital gains tax rates in the following year(s). They converted 40% ordinary tax rates to 20% capital gains rates and received a tax deferral to boot. Their tax savings from these transactions was in the billions of dollars and it attracted the attention of Congress and the IRS. The hedge funds’ arguments about “economic substance” sound pretty hollow to me in relation to tax savings from this tax avoidance scheme. The IRS wants to treat these segregated option transactions as part of the trader’s Section 475 MTM ordinary income trading activities, since they see a connection to those activities (see rules below). To learn more about these schemes, read Hedge Fund Chief Testifies at Senate Tax-Avoidance Hearing (New York Times, July 22, 2014).

There’s a lesson for retail traders using Section 475
We haven’t seen retail traders attempt these complex schemes with bank counterparties. Yet it’s a good time to revisit the segregation rules in Section 475 MTM. It’s a nuanced area of the law and it can have significant consequences on tax returns for business traders who have investments.

All business traders using or considering Section 475 MTM should learn its segregation of investment rules. (One way to prevent this problem is to conduct your business trading activity in an entity separate from individual and IRA investment accounts. The entity has a different taxpayer identification number, so there is no connection in the activity.)

We’ve recommended Section 475 MTM since 1997 when Congress expanded it for traders. The biggest tax benefit is unrestricted business ordinary loss treatment, with taxpayers escaping the onerous rules for wash-sale loss deferrals and the capital loss limitation ($3,000 against ordinary income per year on individual tax returns). Section 475 MTM can be the ticket to receiving huge tax refunds, often on NOL carryback returns.

An example of investments vs. business trades
Many traders want to make long-term investments as well in order to benefit from deferral on taxable income (until sale) and to hold investment securities 12 months for lower long-term capital gains tax rates (currently up to 20% vs. 39.6% the ordinary tax rate on short-term capital gains).

Each year we run into a handful of confusing situations on what’s considered a trading position vs. an investment position. Here’s a common example: A trader may want to house his investment portfolio inside a business trading account for portfolio margining purposes and hyperactively trade stock options around his core investment stock positions.

Suppose a trader holds Apple stock as an investment and trades Apple options for business around it to manage risk. Apple stock and Apple stock options are substantially identical positions for purposes of wash sales and Section 475 MTM. By doing this type of commingling activity, the trader may inadvertently subject his Apple stock investment to Section 475 MTM treatment at year-end, thereby losing deferral on the stock and subjecting his gains to ordinary rates rather than lower long-term capital gains rates.

There are all sorts of scenarios that can come up and in some cases it appears to benefit the taxpayer. It’s important to keep in mind that the IRS is entitled to apply the rules in a way that does not prejudice the government’s position. In the previous example, if the trader had a material loss in the Apple stock held for investment, the IRS is entitled to bar the application of Section 475 on that losing investment position. The IRS can have its cake and can eat it too.

Segregation of investment position rules
Per Thomson Reuters/Tax & Accounting, “Any securities held by the trader are subject to marking unless they fall within the exception to marking under Code Sec. 475(f)(1)(B). In the case of traders, there is only one exception to marking. Under that exception, two requirements must be met. First, it must be established to IRS’s satisfaction that the security has no connection to the activities of such person as a trader. (Code Sec. 475(f)(1)(B)(i)) Second, any such security must be clearly identified in such person’s records as being described in Code Sec. 475(f)(1)(B)(i) before the close of the day on which it was acquired, originated or entered into (or such other time as IRS may by regs prescribe). (Code Sec. 475(f)(1)(B)(ii)) An identification that a security is held for investment for financial reporting purposes is not sufficient for Code Sec. 475 purposes. (Rev Rul 97-39, 1997-2 CB 62).

Generally, gains and losses recognized under Code Sec. 475 are ordinary income or loss to a trader that has made an election under Code Sec. 475(f). (Code Sec. 475(d)(3)(A)(i) and Code Sec. 475(f)(1)(D)) However, Code Sec. 475(d)(3)(B) provides exceptions to the automatically ordinary rule under Code Sec. 475(d)(3)(A). If a taxpayer can establish that it held securities as hedges, or that the securities were not held in connection with its trading business, or that a security is improperly identified (see Code Sec. 475(d)(2) ), then gains and losses are not automatically ordinary. (Code Sec. 475(d)(3)(B)(i), Code Sec. 475(d)(3)(B)(ii) and Code Sec. 475(d)(3)(B)(iii)) Character must then be determined by other relevant Code sections.”

Many hedge funds and some traders skip a Section 475 election because they don’t want to be burdened with identifying investments on the time and date of purchase. They establish a trade and may let their profits run and morph the position into an investment position for long-term capital gain and deferral.

How Section 475 MTM and the segregation rules work
A business trader using Section 475 MTM has ordinary gain or loss treatment, plus open business positions are marked-to-market as imputed sales at year-end. On the first day of the subsequent year, the trader imputes a purchase of that same position at the same year-end price.

Duly segregated investment positions are not subject to Section 475 MTM. For example, a business trader organized as a sole proprietor may have a business trading account at Interactive Brokers and a segregated investment account held jointly with his spouse at Fidelity for making long-term investments. Like all professionals, it’s expected that a business trader would have investments, too.

It’s important for the business trader to contemporaneously segregate investment positions from business positions in “form and substance.” Form means a separate account and substance means don’t trade substantially identical positions with business trading positions. While proposed IRS regulations required a separate account, that rule never became final law, so a trader can have investment positions within a business trading account. Just make sure to email yourself contemporaneously when purchasing an investment position. Don’t trade around investment positions with your business positions, as that runs afoul of the substance rule. The lines of distinction can be blurred in some cases and you should consult a trader tax expert about it.

Read Green’s 2014 Trader Tax Guide Chapter 2 on Section 475 MTM to learn more.

Recent trader tax court cases
In recent trader tax court cases covered on our blog, Assaderaghi, Nelson and Endicott, the IRS won denial of trader tax status partially because these option traders did not segregate active option trading from investing in stocks (similar to the example above). However, even if these traders did follow segregation rules and our above guidance, I still don’t think they traded options enough to qualify for trader tax status. They also sought Section 475 MTM ordinary loss treatment on stock investments, which is not possible.

Bottom line
Section 475 MTM is fantastic for most business traders — we call it “tax loss insurance.” But the fine print requires discipline on dealing with investments. It’s best to trade in a separate entity to skip these handcuffs.

 


IRS issues final regs on straddle-by-straddle identification

July 25, 2014 | By: Robert A. Green, CPA

Per TaxAnalysts on July 17, 3014, “The IRS has issued final regulations relating to section 1092 identified mixed straddles established after Aug. 18, 2014, explaining how to account for unrealized gain or loss on a position held by a taxpayer before the time the taxpayer establishes a mixed straddle using straddle-by-straddle identification. (T.D. 9678).”

Straddle rules are very complex. We suggest a consultation with our tax attorney.


Retirement plan investments in publicly traded partnerships generate tax bills More By: Robert A. Green, CPA On: 10/31/14
Obamacare ushers in several new tax forms for 2014 More By: Robert A. Green, CPA On: 10/30/14
2014 year-end tax planning for traders More By: Robert A. Green, CPA On: 10/21/14
Will “tax extenders” be renewed retroactively for 2014? More By: Robert A. Green, CPA On: 10/09/14
Tax relief for Canadians living in the U.S. More By: Robert A. Green, CPA On: 10/09/14