The tax season this year – 2020 taxes filed in 2021 – will be unlike recent years for many reasons. One major change is the almost certain delays you may expect in connection with the preparation and filing of your taxes. The potential for delay is based on several factors, most of which will be out of your control but which you may want to understand and allow for this year. 

First, we have the substantial backlog at the IRS for 2019 returns that have NOT yet been processed. Between individual returns and business returns, over ten million are outstanding. This could not only affect the taxpayers whose returns haven’t been addressed but also contribute to a delay for many of the rest of us. 

In a good year, many filings are delayed by late arriving K-1s and 1099s, a problem mainly attributable to the slowness of individuals, businesses and other entities to gather the information and prepare the required forms. Naturally, this is less of an issue where the forms are delivered to the taxpayer electronically but there is always a wait for them to be prepared. This year, the second factor relates directly to these required forms most of us need to prepare our returns. The factor, much more troubling than the IRS backlog, is the abject failure of the USPS to handle first class mail expeditiously, particularly in recent months. 

In the last two months, we have seen or have heard from credible sources that first class mail often has been arriving two weeks or more (and as much as five weeks) AFTER the mailing date as indicated by the cancellation of the postage. There is nothing first class about this treatment and it erodes trust in the postal service. If you , like many of us, typically receive some tax documents in the mail, be prepared to wait indefinitely for it to arrive. 

Please note, however, that some first class mail seems to be arriving within a week of its mailing and so is not nearly as problematic. The inconsistency in treatment and the lack of any meaningful explanation are reminders to stay alert and know when something should be arriving and be prepared to take action when it does not.

There is no time like the present for investors to consider their financial situations and planning and act to make changes under current rules. With the national debt sky-high, the economy ravaged by COVID lockdowns and everyone seemingly asking for funding of a wide variety of pet projects, the one thing that seems certain is that the government will be squeezing more revenue out of taxpayers. Make no mistake: this revenue seeking won’t simply impact high income and wealthy taxpayers. Taxpayers at all levels of the economy will be facing increased government demands not simply for income tax but for increased taxes on services, on the sale and consumption of goods, on ownership of real and intangible property and more. Even if your income is in the bottom quintile, you will feel the pain of the tax bite on everyday living even if you manage to avoid the income tax itself.

Planning related to income may include moving income into the current year when rates are likely to be lower than next year (or at least equal, making sure contributions to qualified retirement plans are maximized, taking capital gains to the extent they qualify for the zero tax rate or even when they fall below the maximum rate and so on. Other tax planning might include making gifts up to the annual exclusion to family members, charitable gifts as desired and taxable gifts in trust to take advantage of the high lifetime exclusions.  Note that making gifts in kind to family members, they take the cost basis the donor had in the gifted securities and if basis is low, those recipients could also benefit tax-wise from the low capital gains rate for low and middle income taxpayers.

Finally, tax planning may include decisions to accelerate decisions on purchases with an eye to take advantage of current sales and other taxes. It follows that upon the advent of various tax increases one would reduce or postpone various forms of consumption and with those choices experience a reduction in the total taxes you pay in future.

A popular approach to investing is offered through the Robin Hood app. This service allows an investor to participate in the market without requiring any minimum investment and without charging any commission on the trades by an investor. Available investment choices include stock, ETFs, options, a number of ADRs, and even cryptocurrency. A margin account is also available, subject to meeting the regulatory requirement of a $2,000 minimum. The Robin Hood service is offered as a web platform or as a mobile app trading platform. This approach may satisfy the needs of many investors but it is important to understand its limitations.

At present, investing with Robin Hood is limited to taxable accounts and it cannot be used with one’s retirement accounts such as a 401(k) or IRA. Investment in mutual funds is not supported and some ETFs may not be available. Research and data on investment choices is very limited, though there is an option to purchase an upgrade to Robin Hood Gold, which does offer independent (Morningstar) research. Customer support is somewhat limited as well, relying on e-mail and social media to address investor issues.

Robin Hood (and its competitors such as SoFi and Interactive Brokers) provides an easy, inexpensive and useful way to handle investing within the limits described. These limitations should not be a bar to many investors, depending on their needs. Since accounts are taxable, an investor will benefit from remembering that short term gains for positions held for less than one year are taxed as ordinary income. Also be aware that wash sale rules require a waiting period prior to or after a sale before repurchasing the same or substantially identical security. With that knowledge in hand, happy investing!

Not every product or service sells itself and those offering most products and services devote substantial effort and funding to ensure that the desired sales happen. In the financial industry, a firm’s offering of incentives to its sales employees to push particular products has (rightly) come under fire and increasing regulation to the point that many incentive programs have been terminated or at least significantly limited.

One reason for the change is that although the firm compensates those salespeople, the funds for that compensation ultimately come from the customers. Although it is true of most sales, it is further complicated in the financial industry. This is not only because customers may not understand that the product or service costs more because of the cost of the sales incentives but more importantly because the salespeople typically will not suggest, recommend or offer other available products or services which are equally useful and very often cheaper. This is a real concern where the seller – financial firm – is obligated to act in the best interests of its customers and is required to make full disclosure and not place its interests above those of its clients. Incentives often mean the customer pays more than they should and likely gets less than they should.

The underlying issue is the perverse nature of sales incentives generally since they encourage a one- dimensional approach to sales – making as many sales as possible to receive a reward, usually financial. A striking example outside the financial industry is when the government intervenes with sales incentives as it did with the food stamp program. The push on government employees to sign up as many participants as possible, without regard to the intent and requirements of the program or the actual needs of individuals, led to a huge increase in participation in the program, the cost of its administration and of course the cost of the benefits themselves. You probably know who paid for that – not the government or its employees but the taxpayers.

At bottom, relying on sales incentives always creates winners and losers and you shouldn’t be surprised that the entity offering those incentives is rarely the loser.     

 

Most IRA owners have named one or more primary beneficiaries to the account in the event of the owner’s death. Oftentimes successor beneficiaries are also named to ensure the funds pass as desired where the primary beneficiary has died as well. The beneficiaries will be required to take distributions as specified in the tax code and pay the associated taxes, though they may also take additional distributions as desired. The distributed funds are not protected from the beneficiary’s creditors and a spendthrift may quickly exhaust the IRA. This lack of control may not be the ideal result in every case and the IRA owner may wish to consider further planning for the IRA account(s).

IRA trusts allow for some flexibility in terms of how the funds are distributed to the beneficiaries following the plan owner’s death. Most typical is the conduit trust which passes the full amount of the required minimum distributions directly to the beneficiary, together with any additional distributions received by the trust from the IRA. The trust can provide that any additional distributions (above the RMD) must satisfy conditions stated in the trust, protecting the funds from being dissipated quickly.

The accumulation trust is more restrictive for the beneficiary as it does not pass the entire RMD to the beneficiary and instead retains a portion of the RMD in the trust. This has the benefit of allowing the trust to grow while the assets in the trust benefit from continued asset protection. The downside, of course, is that the trust will be required to pay the taxes on the retained RMD and other distributions and usually at a much higher rate than an individual beneficiary.

Where there may be a need to exercise some control over the IRA and preserve asset protection, an IRA trust may be a valid consideration. Consult with your tax professional and other advisors to ensure that this approach could work and how it will further your estate and tax planning goals. This is a constantly changing area of the law and what might have worked in the past may not work going forward. 

As the pandemic with its related restrictions and uncertainties drags along, we are seeing more clients changing their near-term plans and goals.  Initially, many of us simply deferred activities, presumably for a few months while the pandemic (hopefully) ran its course. Now, with no clear end to the pandemic nor any return to something approaching normalcy in sight, people are making significant changes to their plans. These changes are wide ranging and appear to have affected different age groups in markedly different ways.

These changes can be very significant, including changes in employment status, residence location, major purchases and the like, all driven by the impacts of the pandemic. Other types of changes, also important, focus more on our leisure time, including reduction or elimination of participation in entertainment and sporting events, vacation travel, and of course dining and other socializing. All of these factors affect our personal levels of stress and any sense of well being and that, in turn, will definitely affect our planning going forward.

If you are feeling that the pandemic has changed things enough that you should consider making significant changes in your life plans, talk with your friends and family and don’t forget to reach out to your advisers as well. For those of us who are advisers, remember that when advising clients on their planning for investment, retirement and other aspects of their lives, we need to be aware of these changes that clients may be considering (or may even have avoided considering) so that we can best advise them on how to adjust their planning to meet changing needs and expectations. 

After all the hype and noise about Form CRS, which was first required to be issued this summer, it appears that the intended audience – investment clients – are generally uninterested in the new disclosures and not engaged in the process of asking questions of their advisers. Research shows that almost no-one who received the new form, among the tens of thousands of clients who did, raised any issue or question with their advisor regarding Form CRS and its use.

Not surprisingly, this logically fits in with the response of clients to required disclosures generally: adding a few new pages with a somewhat different approach to the pile does not engender interest in persons already overwhelmed with information and fine print (much of it irrelevant and/or confusing). It probably provided employment to the rule drafters at the SEC and to a variety of attorneys and compliance persons who were well paid to help firms generate the documents newly required. The actual benefit to those most directly impacted – clients and their advisors – not so much.

Whether you are an advisor or investor, it would be interesting (and helpful) if you would share your thoughts and experiences on this latest venture of the regulators to ostensibly help investors. As an investor, have you asked your advisor(s) any questions based on what Form CRS addresses and suggests you ask? If you are an advisor, have your clients acknowledged and made use of the disclosures in any meaningful way? 

A feature of many 401(k) plans (as well as 403(b) and 457 plans) is the ability of the plan participant to take a loan from the plan to assist in meeting near term goals. This is particularly effective where there is no other desirable source of funds and the participant has stable employment. Such a loan can be a real benefit in times like the present where the pandemic has caused stress and change from what used to be normal.

The primary reason for considering this source of funding is the ability to avoid having the loan treated as a taxable distribution from the plan and so not subject to either regular income taxation or to the ten percent penalty assessed on early distributions for those younger than age 59½. Of course, in order to enjoy the benefits of such a loan, it is necessary for the plan participant to repay the loan to the plan, typically within five years while making regular payments on a quarterly basis.

The rules governing the loans are also limiting in terms of the amount which may be withdrawn from the plan as a loan. The maximum amount is $50,000 and the loan cannot exceed 50% of the value of the plan account or $10,000, whichever is less. This means that large plan balances will not be usable to fund large loans but smaller amounts – more in keeping with most short term cash needs – can be funded to the extent noted above.

The biggest risk to a plan participant is, not surprisingly, job loss. If the employment is terminated, then the outstanding balance of the loan generally must be repaid to the plan. Prior law required this repayment to occur within 60 days if the participant wished to avoid income tax and penalties on the unpaid amount. Current law now extends that time frame to the date of the tax filing deadline for the year in which the termination of employment (or of the plan itself) occurred. There are other situations in which the participant may be subject to taxation and penalties, such as where the installment payments on the loan are not made timely. Care should be taken to fulfill all the requirements of the loan for this technique to prove useful.

The question of what happens with one’s assets at death is a major aspect of planning for many of us. Necessarily, that planning must address the possibility of death being earlier or later than what normally might be expected and so directions should be in place to meet any eventuality. Of course, the beauty of the planning is that in most cases we can revisit the plan and update as circumstances change and time passes.

That brings us to those who have invested in qualified retirement plans and who have children who are presently minors. In order to provide for those children, it is not uncommon to name them as designated beneficiaries. Of course, a minor child would not be able to control the plan benefits as that role would be fulfilled by a trustee until the child reaches majority. One of the advantages of naming a child as beneficiary is that under the new law, the stretch for distributions over the beneficiary’s life expectancy continues throughout the child’s minority. It is only when the child reaches their majority that the ten year rule for distribution kicks in.

State law typically governs as to when a child reaches majority and varies somewhat from state to state. However, it is important to note that where a child may be considered as not having attained their majority where the child is under the age of 26 and has not yet completed a specified course of education. This would delay the expiration of the stretch and defer the ten year rule until the child was 26 (and theoretically better able to manage the funds). A child who is disabled is also considered as not having attained majority and would be able to benefit from the stretch indefinitely.

This approach is not for everyone and would not fit the plan participant’s desires in some cases. However, this does have the advantage of not requiring the creation and administration of a trust for the child as would be necessary with other types of assets. Consult with your tax and planning professionals to see how this could benefit you and your children.

In this rather unusual year, it is important that you do not forget to file your Federal Income Tax return this week. Many, many taxpayers took advantage of the IRS postponing the due date for the 2019 tax returns by 91 days to July 15, 2020. This step was taken in response to some of the confusion and uncertainties surrounding the pandemic and was meant to be a help to taxpayers but not an excuse from the obligation of filing and paying tax.

Of course, taxpayers may still request an extension to the filing of their returns until October 15, 2020, provided of course that the taxpayer pays the amount due by July 15, 2020. That extension is in line with the usual rules; it was the extension of the initial filing date of April 15 that was unusual. Note that a failure to file and pay now may subject a taxpayer to various penalties as well as interest which accumulates steadily on unpaid balances at a three percent annual rate.

Given the number of returns that must be processed, don’t be surprised if your tax professionals are quite busy, just as they normally would be at this point in April. Perhaps enough taxpayers have already submitted their returns that the remaining returns won’t be as burdensome as in a typical year. In any event, if you haven’t already gotten your return completed or at least organized, don’t dawdle but get your paperwork in order and an appointment scheduled with your tax professional.

If worst comes to worst, filing an extension and submitting a payment is not too difficult a process and will allow you another three months to get all your information organized to allow for filing that return. Whatever you do, though, don’t ignore the need to file and pay since an extension is not the same as an exemption!