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GreenTrader Weblog
GreenTraderTax & GreenTraderFunds
March 27, 2010
Forex "self IBs" are a bad idea
We recently learned that certain forex brokerage firms have told traders they should form an introducing broker (IB) and/or management company primarily intended to earn fees related to their own trading accounts, including retirement accounts. These schemes are trouble on a number of fronts, including tax and regulatory.
Tax problems
Although these schemes may generate some savings on transaction costs, they often involve “tax inefficiency,” higher tax bills and some serious tax penalties and pitfalls.
For tax purposes, if your own retirement plan pays you a fee of any kind, it’s considered a “prohibited transaction” for “self-dealing.” There are significant IRS penalties and rules for prohibited transactions. We cover these problems on our retirement page (see the July 15, 2009 article). Your retirement plan can not invest in your own company, either.
In addition to the prohibited transaction penalties, the IRS will treat the IRA payments to the IRA owner as “early withdrawals” generally subject to ordinary income tax rates. Plus, if the IRA owner is under age 59 ½, he or she is subject to a 10 percent excise tax penalty reported on Form 5329.
Traders lacking traders tax status (business treatment) are stuck with restricted Section 212 investment expense treatment on the advisory fees paid to their own management company. In the case of IB transaction fees, if the trader elected capital gains treatment on forex — the opt-out election — he or she may face capital-loss limitations.
Often the fee payments aren't deductible — in a retirement plan or taxable account — whereas the fee income is subject to ordinary income tax rates plus SE tax costs. SE taxes are 15.3 percent of the SE base amount ($106,700 for 2009 and 2010) and 2.9 percent (Medicare portion) thereafter.
The fee income is often reported by the broker on Form 1099-Misc (non-employee compensation) and this net income is reportable on a Schedule C (Profit and Loss from Business) subject to ordinary income tax rates plus SE taxes. If you don’t have any other IB clients besides yourself (and your retirement plans), we believe it’s not appropriate to take business deductions for this activity on Schedule C.
Many forex traders don’t qualify for trader tax status (business treatment), and they must use the more restricted Section 212 investment expense treatment, which includes miscellaneous itemized deductions limited to 2 percent of adjusted gross income (AGI) and not deductible for the alternative minimum tax (AMT). Section 212 doesn't allow home-office expenses and travel education expenses.
The higher transaction payments channeled back to you as IB rebates may cause forex losses that are limited to the capital-loss limitation (with the capital gains election) or wasted forex losses if you have negative taxable income without trader tax status or forex losses inside a retirement plan.
Bottom line: These IB and management company schemes are very bad ideas for tax purposes and they can lead to some serious trouble with the IRS.
Regulatory matters
The Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) have new capital requirements for regulating forex IBs. We understand that some forex brokers are stopping this "self IB" scheme within a week or so. Hopefully, they won’t try to ship these schemes to their foreign-based platforms.
Year-end tax planning, part 3 - compensation in entities
If you have a trading entity for 2009 and plan to use it for 2009 retirement plan and/or health insurance premium AGI-deduction strategies, you must take certain vital actions before year-end. You need to pay all earned income fees and officer salaries before year-end.
* If you have an S-Corp election, you should use formal payroll rather than administration fees. We can recommend a low-cost payroll tax compliance service provider. There is not much time left to arrange this before year-end. There are some benefits to payroll over fees, such as using year-end tax withholding through payroll to avoid under-estimated income tax penalties from earlier in the year. With payroll, you may qualify for unemployment insurance benefits too.
* If you have an LLC or general partnership filing a partnership tax return, you should use administrative fees rather than payroll. That skips payroll tax compliance and you can simply issue a check to the trading entity owner/workers who performed administration services (one or both spouses). We can prepare the 1099-Misc. in January. If you took distributions of sufficient cash from your entity during the year, after year-end we can reclassify some of those payments to administration fees. Just make sure you have taken out enough money to cover your AGI-deduction needs before year-end. Otherwise, you may wind up losing these deductions.
* Mini 401k plans (otherwise known as Individual or Solo 401k plans) must be established (opened) before year-end too. For S-Corps using payroll, the retirement plan should be in the name of the entity. For administration fees, the retirement plan should be in your individual names. You can fund these retirement plans after year-end, up until the due date of your 2009 tax return including extensions. If you are not sure which plan is right for you, just be sure to open one with a leading brokerage firm before year-end. It's free to do. You can roll it over to different plan in early 2010 after studying your options.
* Roth IRA conversions must be executed by year-end. Don't worry, you can recharachterize the conversion by Oct. 15, 2010. Learn more about these conversions in our articles below.
* Federal Q4 estimated taxes are due Jan. 15, but it's generally more favorable to pay the state Q4 vouchers by Dec. 31 for a year-end deduction (unless it triggers AMT).
For other useful year-end tax planning strategies, read Green's article in Fidelity Investor's Publication, "Tax Tips for Traders," http://personal.fidelity.com/misc/framesets/iwarticle.shtml?pagename=AT0911_tax Active Trader magazine (Dec. issue), and on our site http://www.greencompany.com/EducationCenter/GTTRecStratYearEndPlanning.shtml .
Special note on using a new entity set up in Q4 2009, or Q1 2010.
A year-end strategy with entities - using new taxpayer MTM elections and AGI deductions such as retirement plans - can only work if we form the entity and you open the entity trading accounts within the week. That was last week when we wrote it and it's now too late to deploy this new strategy for Q4 2009. It's now wise to consider an entity formation for 2010, with an early January start date. That's usually better than operating as a sole proprietor for part of 2010 and with an entity for the balance of the 2010. Click here http://www.greencompany.com/Traders/TraderEntities.shtml to learn more and get started. September 23, 2009
Year-end tax planning, part 1
Most years, taxpayers take every opportunity to kick the tax-can down the road, by deferring and accelerating income. This year and next should be different, because tax rates are likely heading higher for the upper and middle class starting in 2011.
You have two choices this year-end. Minimize 2009 taxes as best you can to safeguard cash flow — paying as little taxes as possible and maximizing your refund. Or, view your tax situation over the next several years and minimize taxes over the long term. That second choice may mean accelerating income into 2010 to pay more taxes at lower tax rates vs. higher tax rates later on.
There are few ways that investors can follow this cash out strategy — by cashing out long-term investments earlier than planned or with a Roth IRA conversion.
Tax rates are on the rise.
The Bush tax cuts are set to expire in 2011. President Obama promised no tax rate increases on the middle-class, so only the upper two marginal income tax brackets are scheduled (in the Obama 2010 budget) to increase to 39.6 percent from 35 percent and 36 percent from 33 percent. The highest long-term capital gains tax rate will rise 5 percent to 20 percent. The House proposed a further increase to 24 percent to help finance health care reform.
Democrats currently have the power to enact their vision of fiscal (tax) policy. A common Democratic belief is supply-side economics only benefit the upper class and don’t trickle down to the middle-class and poor.
Conversely, Republicans tend to believe supply-side economics lifts all boats, and lower tax rates spur entrepreneurial-led growth, which creates jobs and raises absolute tax revenues. It’s always been difficult to prove who is right on these points.
Congressional leaders and President Obama are under pressure to lessen the escalating budget deficit. At the same time, leaders are proposing new spending programs — stimulus for the recession, health-care reform, and financial reform regulation. In the Democrats view, raising taxes on the rich is required to “pay go” for this new spending.
Many pundits have said President Obama may need to break his promise on raising taxes on the middle class too. Presidential surrogates have not denied this when asked about it on Sunday talk shows.
For a good short history of income tax in the US, see http://www.infoplease.com/ipa/A0005921.html .
With taxes headed higher, consider cashing-out your taxable portfolio now.
With the long-term capital gains rate scheduled to rise to 20 percent in 2011 (from 15 percent), consider selling long-term capital gains positions before year-end 2009 if the markets are at high levels. Holding short-term positions into 2010 to gain long-term status is another potentially worthwhile strategy; you can sell these positions before year-end 2010 and avoid the tax increase in 2011. The goal is to pay more taxes at lower tax rates vs. higher tax rates later on.
Cash out your retirement funds with a Roth retirement account conversion.
This same concept can be applied to your traditional retirement plan accounts in connection with a year-end Roth IRA conversion.
Traditional retirement plans have different tax benefits from Roth IRA plans. Traditional retirement plans offer tax deductions on annual contributions and temporary tax-free income build-up in the retirement account until you take ordinary income taxable distributions at retirement age (as early as age 59 ½ and no later than age 70 ½ ). Roth IRAs and Roth Mini 401ks have a different tax bargain. Rather than getting tax deductions up front for contributions, the Roth accounts are tax free for life.
The key difference is the permanent tax-free status on the contributions. In the traditional plans, the funds are ultimately taxed in retirement, and tax rates are forecasted to be higher when you retire. Conversely, with the Roth plans, the funds are never taxed at retirement age. We advocate a simple strategy: make annual tax deductions to a traditional retirement plan during high-income years (when you pay taxes at higher tax rates) and in years when you have losses, convert to a Roth IRA, paying taxes at lower rates. The goal is to get more assets into the Roth accounts.
Roth retirement accounts are attractive to traders because their “stock-in-trade” (business) is managing a portfolio for (active trading) growth and unlike all other types of taxpayers, they can escape taxes on their stock-in-trade.
Many situations call for taking advantage of the tax deduction on a traditional retirement plan contribution too. Traders need to financially engineer earned income with a fee or payroll in their own trading entity, as trading gains are not earned income. That earned income triggers self-employment (SE) taxes. Generally, a traditional retirement plan deduction saves more in income taxes than the trader must pay in SE taxes.
In years with large trading losses, which lead to material business net operating losses (NOLs), it may also be prudent to soak up the NOL with a Roth conversion, instead of filing a NOL carry-back refund claim return. Full-time and very active business traders don’t need to worry about the IRS as much and NOL carry back returns are generally better for them.
Roth IRA distributions can also prevent Social Security benefits from being subject to income tax. If combined AGI is more than $44,000 (2009 threshold), up to 85 percent of Social Security benefits are subject to income tax. If under the threshold, social security benefits are tax-free. Roth IRA distributions can help taxpayers qualify for other middle-class tax breaks too (also dependent on AGI).
Can the Roth tax pledge be trusted?
Some traders tell me they worry about the government will eventually decide to tax the income build-up in a Roth IRA. It can’t tax the original contributions, as they were not tax-deductions and paid for with after-tax dollars.
I highly doubt this will happen. The government wants to provide incentives for saving for retirement. Curiously, to save on cash flow, the government recently announced a new program offering taxpayers an option to divert a portion of their tax refund to their retirement savings account, instead of getting a tax refund. It reminds me of states such as California issuing IOUs for tax refunds in 2009.
Everyone can convert to a Roth in 2010.
The last scheduled juicy tax break from the Bush administration is the Roth IRA conversion loophole in 2010, waiving the normal “income threshold” for 2010 only and making it possible for any taxpayer (even otherwise barred married filing separate taxpayers) to convert to a Roth IRA. For any other year, the income threshold rule only allows the Roth conversion option if the taxpayer has a modified adjusted gross income (MAGI) of $100,000 or less for both joint and single filings.
The biggest drawback to the Roth conversion is you need sufficient cash flow to pay the conversion income taxes; you can’t use the converted amounts to pay those taxes, either. But the 2010 tax break also allows you to pay the conversion taxes over two years; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in 2012. Taxpayer's in the upper-two brackets (being raised in 2011) can opt out of the two year tax deferral, so they don't pay taxes at higher rates.
Qualified plans (like a Mini 401k), a SEP-IRA, or SIMPLE IRA may be converted to a Roth plan too.
A conversion from a regular IRA to a Roth IRA is subject to tax as if it were distributed from the traditional IRA, but at least it isn't subject to the 10% premature distribution tax (which otherwise would not apply if the taxpayer was over age 59 1/2).
Roth do-overs
Suppose you convert to a Roth IRA before year-end, pay taxes on the converted amounts, and then face a large loss on the Roth trading account. It could be from actual active trading losses or the market dropping in value. This unfortunate loss on permanently tax-free money can’t be deducted on your taxes.
Not to worry, there’s a fix: The IRS allows taxpayers to change their minds. The process is known as a Roth IRA recharacterization. Learn more at www.irs.gov and search Roth IRAs.
Generally, a taxpayer has until Oct. 15 of the following tax year to undo a Roth conversion. For example, a Roth conversion completed in December 2009 may be recharacterized by Oct. 15, 2010. If a taxpayer already filed his or her 2009 tax return before Oct. 15, 2010, the return can be amended, but it’s better to wait with an extension.
Just ask your administrator to do a "recharacterization."
Bottom line on the Roth conversion strategies.
If you qualify for a conversion, try it in 2009. Maybe the converted assets will rise in value. If they drop in value, consider a recharacterization for 2009 and possibly converting again in 2010 with the lower asset values.
If you skip the Roth conversion strategy, you may wind up taking traditional retirement plan distributions subject to much higher tax rates. Also note that lower 60/40 tax rates on futures and electing forex traders are not available on retirement plan distributions.
Here’s another good article: http://www.nytimes.com/2009/07/18/your-money/individual-retirement-account-iras/18money.html?_r=2&nl=your-money&emc=your-moneyema2 .
Check back later this week for more year-end tax planning tips. July 15, 2009
Retirement-plan strategies - Important Update
Important Update on July 15, 2009.
Click here http://www.greencompany.com/Traders/TraderRetirement.shtml for Robert A. Green, CPA's 10-page blog article (in pdf format) on retirement-plan strategies for traders. This same article is being edited into a shorter version for Green's Business of Trading column in Active Trader magazine (October 2009 issue).
Traders Have Retirement Choices
http://www.moneyshow.com/video/video.asp?wid=4269&t=3&scode=013790.
..Short video produced by MoneyShow.com featuring Robert A. Green, CPA. "Author and trader tax expert Robert Green reviews some of the retirement account options available to today's traders and how some may allow traders to write off expenses and trading costs." Released: 7/16/2009. May 29, 2009
GreenTrader self-directed retirement-plan strategies and services
May 29th blog article re-edited after the important updated July 15th blog article above:
You only need trader tax status if you want to make annual tax-deductible contributions to a retirement plan (or tax-free contributions to a Roth IRA). An entity with trader tax status can efficiently pay a tax-deductible (from gross income) administration fee, which creates the earned income needed for a retirement-plan contribution. Without trader tax status, that administration fee is only deductible as a miscellaneous itemized deduction, which is significantly limited with the 2-percent AGI limitation and add-back for AMT purposes (the nasty second-tax regime). That makes it less tax-efficient.
It’s wise to get a handle on your retirement-plan strategies in 2009, as a one-time only window of opportunity opens in 2010 with the last of the Bush tax cut breaks. All taxpayers can convert a traditional IRA (temporarily tax-free) to a Roth IRA (permanently tax-free) in 2010, as the annual income threshold of $100,000 of modified adjusted gross income (MAGI) is waived in 2010 only. Normally, in all other years, only taxpayers with MAGI of $100,000 or less can convert a Roth IRA. Business traders with large Section 475 MTM ordinary losses and even NOLs (net operating losses caused by MTM losses) can choose to absorb those losses with a Roth IRA conversion (a great strategy for 2009 too). You can also take advantage of lower tax rates in years with less income with a conversion. You can pay the conversion taxes in 2010 over two years too. We will have more content on this Roth IRA conversion strategy — check back soon.
It’s important to note that GreenTraderTax and the government — the Department of Labor under the Employee Retirement Income Security Act (ERISA) — also advocate long-term safety for retirement funds. Caution should be used to avoid “self dealing” and “prohibitive transactions” which are subject to onerous IRS tax penalties (details below). We offer great ideas and ways to tap your retirement funds for active trading, but we also want you to be cautious and consider the down side. We don’t want to enable individuals to lose their retirement funds in active trading and alternative investment activities.
We suggest starting with a half-hour consultation with our GreenTrader retirement-plan experts (Robert A. Green, CPA or Mark Durham, MBA). If we both agree that a GreenTrader self-directed retirement plan is a wise strategy for you and your family, we would be happy to consult with you further or you can upgrade to our retirement-plan services retainer (click here to learn more).
We provide consultation, design, execution-assistance (formation) and annual compliance and support services. We ask you to pay for third-party providers (if required) directly to avoid price mark-ups and to ensure that you will receive these third parties’ direct care and support. In some cases, we will negotiate special lower pricing and/or value-added services from our affiliates; it pays to work through us. We make sure to use these providers in every way possible, so you don’t pay us to do what’s included in their fixed prices. If you don’t need the added features of an intermediary trust retirement plan, we suggest a “cookie-cutter” self-directed retirement plan offered by leading brokers (which often costs much less).
As with our popular entity formation service, we don’t just form a retirement-plan strategy and walk away. Our clients count on us to provide ongoing support and annual service to ensure the plan works as designed, reaping all possible benefits in a compliant manner. Just as with our entity-formation and tax-preparation services, the final tax saving comes at tax time (year-end planning and preparation), when we crunch the numbers to see the various savings from different strategies.
We also prepare your annual tax Form 5500 Annual Return/Report of Employee Benefit Plan (if required) and handle annual maintenance and upgrades for your plan. Congress and the IRS often update employee benefit laws, and it’s vital to keep your plans compliant with all changes in the law. Our third-party providers make sure the plan paperwork reflects any changes.
Our retirement team consists of a leading retirement plan-professional (Mark Durham, MBA joined us after a 22-year career with Fidelity Investments), a retirement-plan/employee-benefits attorney (Louis Barr, JD) , a tax attorney (Mark Feldman, JD), a CPA from our trader tax practice area (Jaren Durham, CPA) who also is an expert in preparing 5500s, all our CPAs, and Robert A. Green, CPA/CEO.
Our retirement-plan content (including many magazine articles) below has grown over the years. It’s now better than ever with the 2009 roll out of our new GreenTrader self-directed retirement-plan services and related strategies (see below).
Here is the evolution of our retirement plan services and content for traders.
In 2000, we pointed out the great tax pitfall of traders taking “early withdrawals” from their retirement plans to fund their trading accounts. Many of these traders got caught in a double-tax whammy when the tech bubble burst. They were forced to pay very high income taxes on their early withdrawals from retirement plans (at higher ordinary income tax rates), plus they had to pay the onerous 10-percent excise tax penalty (reported on IRS Form 5329). The painful lesson back then was that too many business traders neglected to also elect Section 475 MTM (to protect themselves with ordinary loss treatment), so they were stuck with restricted capital loss treatment and had to carry over large trading losses to subsequent tax years (and many never used them in later years). The sad result was that they paid taxes on essentially breaking even. Many of these traders wound up owing the IRS and their states more than they could pay. With Section 475, they could have offset their retirement-plan early withdrawal ordinary income with Section 475 MTM ordinary trading losses, thereby not owing any tax except the 10-percent excise tax. The remedy at that time was to trade within your retirement plans and if you took early withdrawals, to make sure you elected Section 475 MTM. This same problem happened again in 2008 for many traders caught in the meltdown.
Now we are pleased to offer broader and better remedies to traders facing this conundrum and who need to access funds in their retirement plans for trading and other personal and business uses.
What’s changed? More brokers offer direct-access trading in cookie-cutter (free) IRAs in securities, futures and even forex. Good intermediary trust companies and even one broker (TD Ameritrade) offer qualified plan loans of up to $50,000, which traders can tap into to finance a trader tax status business entity. These trust companies provide qualified plan trading at most leading brokers, including many of the ones that don’t have their own qualified plan products (the preferred plan of choice for business traders is still the Mini 401(k) plan)
In the 2009 jobs recession and credit crisis, many people, including traders, are facing cash-flow shortages and the withdrawal of credit lines (on home equity loans) from their banks and credit card providers. Many traders are unable to finance their working trading capital and other living needs, especially after incurring large trading losses in 2008 and 2009 year-to-date. Finding a legal and tax-efficient way to tap into retirement funds to finance a trading business and/or living expenses can be a wise move (of last or first resort). Again, be cautious and think twice about using this type of financing to fund a losing business.
The key is using your retirement funds in a tax-efficient manner and not falling into a pitfall leading to ordinary income taxes, 10-percent excise taxes and onerous prohibited transaction penalties and consequences.
Even non-business-traders (active investors) with other business activities (such as me —an accountant) are interested in these retirement-plan strategies. As an example, if you are a conservative investor and have your retirement plan assets invested mostly in cash equivalents earning very low interest rates, consider borrowing from your retirement plans to pay down your mortgage and/or credit card debt, which probably has much higher interest rates (interest rates are sky rocketing on credit cards and remain high on jumbo mortgages too). Saving several basis points on interest rates is wise, even after forgoing some mortgage interest expense tax deductions. Personal-use credit card interest is not deductible, so focus on that first. As explained above, IRAs are unable to disperse a plan loan. You need a qualified plan, such as a business Mini 401(k) plan or a SEP IRA (self-employed business IRA).
We recommend the following strategy for established business traders. Borrow some retirement-plan funds to sufficiently replenish your trading business accounts in order to maintain your trader tax status and Section 475 MTM treatment. Some traders have fallen below “pattern day trader” amounts of $25,000 for securities and their broker then restricts day trading, only allowing 2/1 margin (rather than 4/1 margin for pattern day traders). A retirement-plan loan can be the answer. But don’t borrow all the money you can from the plan (up to 50 percent) — borrow only enough to replenish what you need.
The maximum term for a participant loan generally is limited to five years (unless financing the purchase of a residence). Participant loans are required to be amortized substantially evenly over the loan term, with at least quarterly payments of both principal and interest.
The loan must bear a reasonable rate of interest. The interest is treated as investment return and not a contribution. Accordingly, there will not be a basis adjustment and it will generate ordinary income upon distribution.
Even if otherwise deductible, the interest expense would not be deductible if the loan is a loan to a key employee or secured by amounts attributable to elective deferrals to a 401(k) plan.
Unfortunately, the interest part of this strategy is not very tax efficient, as the interest expenses (paid by the taxable account to the retirement plan) is not tax deductible. On the flip side, the interest income is ultimately taxed as part of later-year retirement-plan distributions. There is a benefit in that the interest income is not part of the annual retirement plan contribution limits — so you wind up with a higher payment into the retirement plan, which generates more tax-free build-up.
Why borrow the maximum amount allowed and then have to pay it back to the retirement plan over five years, after you pay annual taxes on the trading gains related to that plan loan funding? It may be wiser for you to leave as much of those retirement-plan assets as possible in the retirement plan itself and trade the plan as you like (securities, futures and forex in a self-administered plan trust account). That way, you build up the retirement assets without having to pay annual income taxes on the gains. If you have large losses with Section 475 in a taxable account (with full retirement-plan loan funding), you will enjoy NOL immediate tax-refund treatment. However, the IRS is beefing up attacks on trader tax status and if yours is weak, it may be more prudent to trade in the retirement account instead. Growth from tax-free compounding is far better than paying taxes every year in a taxable account.
We suggest a consultation with Robert Green and/or our retirement-plan expert Mark Durham, MBA to determine the best strategy for your needs.
Green will consult with you on qualification for trader tax status and if you can benefit from an entity and a retirement-plan contribution. He and/or Durham can advise you on using a retirement-plan strategy along with trader tax status and your entity, or using a self-administered retirement-plan strategy as a regular investor (to have plan loans and rights to trade securities, futures and forex).
We can fine tune the best overall retirement-plan strategy for you and work together with you and our affiliates to find the best cost versus benefits plan.
It’s important to note that trading securities on margin in your retirement plan (through an underlying hedge-fund investment) leads to Unrelated Business Taxable Income (UBTI) and Unrelated Business Income Tax (UBIT). Current tax law dictates that margin interest paid on trading also means the trading gains and income generated from that leverage (part only) is subject to annual income taxes — and is otherwise not protected by the tax-free status of the retirement plan.
Pension funds and college endowments invest in offshore hedge funds to avoid UBIT caused by using leverage in a domestic fund. Offshore hedge funds are known as “UBIT-blockers.” As part of Congress and the Obama administration’s agenda to reduce offshore tax breaks, Congress has proposed tax-law changes to encourage pensions and other tax-free institutional funds to invest in domestic funds rather than offshore funds. Congress proposes to eliminate the UBIT blocker tax loophole, not by causing offshore funds to generate UBIT on par with domestic funds, but rather in a more positive manner — by simply removing UBIT entirely in domestic funds.
These potential changes to UBIT rules could help traders using their own retirement plans too. Perhaps UBIT won’t apply in this instance either. It’s also important to note that trading futures and forex in a retirement plan does not generate UBTI as that type of leverage does not generate margin-interest expense.
Notes from our attorney on UBIT issues:
• Qualified plans are subject to the unrelated business income tax (UBIT) on its unrelated business taxable income (UBTI). While interest income and securities gains are generally considered exempt from UBIT, if an investment is "debt financed," it is subject to tax in proportion to the financed amount. Accordingly, margin investments within a plan may be taxable. Also, revenue received from unexercised stock options (puts and calls) regularly issued on stocks held in the trust's portfolio may constitute UBTI and not "passive" investment income.
• Points for possible additional review:
A. Since there is no tracking of loan proceeds, there should be no prohibited transaction issue (not a plan investment); however, in the event that the business adopting the plan is premised on the use of a plan loan, query as to whether the validity of the business will be questioned.
B. Even though non-financed investment activities generally do not generate UBTI, will active trading ever rise to the level of an "unrelated business" if trust funds are utilized as a "trader" activity?
Comment from Green. We don’t want a taxable trading business (or hedge fund) to be solely funded from a retirement plan account. Rather, we prefer it to be less than 50 percent funded so the IRS can not take the position that the retirement plan is running a business.
Borrow what you need and leave as much of those assets as possible within your retirement plan, and trade them in the retirement plan as you like (securities, futures and forex). The funds traded within the retirement plan build up tax free until retirement (and they are permanently tax free in a Roth IRA). Trading losses incurred within the retirement plan reduce your tax basis, which reduces taxes to be paid on later year distributions from the plan. If you need to cover more living expenses later on, perhaps because you have trading losses in your taxable accounts, you can always borrow more retirement assets as you need them over time. We recommend this strategy rather than taking a larger loan to start.
Many traders have been asking us for these value-added retirement-plan features. They want the ability to borrow money from their own retirement plans to finance their trading business, especially during this recession. Their brokers have said no. Their only alternative has been taking an ill-advised early withdrawal from their retirement plans, subject to ordinary income taxes plus a nasty 10 percent excise tax penalty.
We can set up a GreenTrader self-administered retirement plan to meet your specific needs. Self-administered means you (and not our firm) are responsible for your investment decisions. (We don’t offer investment advice because GreenTrader is not an investment adviser.)
We provide support for compliance and administration, including 5500 tax filings, loan agreement setup and maintenance.
Many of our plans are fairly simple to set up and reasonably priced. The added-value features and tax benefits far exceed the set up and annual maintenance costs.
If you are interested in a GreenTrader self-directed retirement plan, please email us at retirementplans@greencompany.com and tell us the features you are most interested in.
Our retirement-plan professional Mark Durham, MBA, recently joined us after a long and successful career at Fidelity. Mr. Durham is working on these plans along with Robert Green, CPA, and our outside employee-benefits attorney, Louis Barr, JD, and tax attorney, Mark Feldman, JD. We are using the leading non-prototype plan engines with opinion letters, too.