Do you own too much company stock?

Employees often have too much of their employer’s company stock in their 401(k) or other retirement plan. Employees feel they know their company best, overlooking the risks of having too much of an investment in any one company, including their own.

What are some of the risks of loading up on your employer’s stock?

* Tremendous bet in a “safe haven.” Overweighting investment holdings in any company minimizes diversification, exposing your portfolio to increased downside return risk. The belief that employer shares are less risky is an illusion.

* Double whammy potential. No company is protected from economic downturns. If your employer’s performance weakens, you may lose your income if you lose your job, as well as value in your retirement plan.

* Lock-up periods. Some companies prohibit employees from converting the employer retirement match contributions in company stock into other investments until after a number of years. In this case, use your own contributions to diversify your holdings.

* Tendency to forget. As you move closer to retirement, you may forget the riskiness of your employer’s stock to your portfolio. At the same time, contributions of company stock may be growing, based on higher benefit matches – just when portfolio diversification is becoming more important.

Your goal should be to create a well-balanced portfolio that suits your age and your risk tolerance. Call us for assistance in reviewing your retirement situation.

New rules in 2010 for Roth IRA conversions

Beginning in 2010, the rules governing Roth IRA conversions will undergo a significant change.

Traditional IRA to Roth IRA conversions will be available to everyone, creating a financial planning opportunity that didn’t exist previously. Under the 2009 rules, taxpayers with income of more than $100,000 cannot convert a traditional IRA to a Roth IRA. Tax legislation enacted in 2006 changed the rules and ends the $100,000 income limit, effective January 1, 2010.

The Roth IRA has been a popular investment vehicle, with its ability to give taxpayers tax-free distributions once the account has been in existence for five years and the taxpayer has reached age 59½. Another Roth benefit is the lack of required minimum distributions once the owner reaches age 70½.

* The conversion to a Roth does have a cost. When you convert a traditional deductible IRA to a Roth, you must include the entire amount converted in your taxable income.

If you do a conversion in 2010, you are allowed to report half of the income on your 2011 tax return and the remaining half on your 2012 tax return. You can also choose to pay the taxes due on the conversion on your 2010 return. While prepaying seems counterintuitive, remember that present federal tax rates are set to expire December 31, 2010. Postponing income into future years could mean a bigger tax bill.

The new conversion rules are particularly advantageous to those upper-income taxpayers who could never participate in a Roth. Now taxpayers in high tax brackets will have access to Roth IRAs. One possible strategy is to set up a traditional IRA with nondeductible contributions in 2009 and then convert it to a Roth in 2010.

It’s important to weigh the pros and cons of a conversion in your individual situation. Please give us a call if you would like to discuss the best strategy for you.

New law expands benefits for taxpayers

The new Worker, Homeownership, and Business Assistance Act of 2009 contains several key provisions affecting individuals and business owners. Here’s a brief summary.

Homebuyer’s credit

Under prior law, an eligible first-time homebuyer could claim a maximum credit of $8,000 for a principal residence purchased before December 1, 2009. But the credit began to phase out for single filers with a modified adjusted gross income (MAGI) above $75,000 and joint filers above $150,000.

Under the new law, the credit is available for home purchases made before May 1, 2010, (July 1, 2010, if a binding contract exists before May 1). Also, the phase-out threshold increases to $125,000 of MAGI for single filers and $225,000 for joint filers. The homebuyer credit may be elected on a 2009 tax return for a qualified purchase in 2010.

Not just for first-timers: If you buy a home after November 6, 2009, and have owned and used the previous home as your principal residence for five consecutive years in the last eight years, you may claim a credit of up to $6,500. New limit for everyone: No credit is allowed for purchases after November 6, 2009, if the price exceeds $800,000.

NOL carryback

Normally, a business can carry back a net operating loss (NOL) for only two years before carrying it forward for up to 20 years. A prior law change allowed a carryback for three, four, or five years to qualified small business for NOLs in tax years beginning or ending in 2008.

The new law extends the longer carryback regardless of the size of the business. This election is generally available for NOLs incurred in either 2008 or 2009.

Caveat: Under the new law, an NOL carried back to the fifth year is limited to 50% of the taxable income for the year. Any remaining NOL may offset income in the remaining four years.

Other provisions

Unemployment benefits are extended for up to 14 weeks (20 weeks for individuals in states with high unemployment rates). But the tax exclusion for the first $2,400 of unemployment benefits received in 2009 isn’t extended.

Finally, the new law includes several revenue-raisers to pay for the favorable changes, such as expanded use of e-filing by small tax return preparers, an extension of the FUTA surtax, and increased penalties for failing to file partnership and S corporation returns.

Wages or dividends? An important S corporation issue

S corporations are the most popular form of corporate business structure. There are excellent tax planning benefits uniquely available to S corporation shareholders who are also employees, not the least of which is the opportunity to manage self-employment and payroll tax liabilities. Unlike sole proprietorships, for example, S corporations can pay wages to shareholder-employees and also distribute income to them as corporate dividends, which are free of the payroll taxes that apply to wages.

• Do a comparison. If your business is a sole proprietorship with net income of $200,000, 92.35% of this amount (or $184,700) will be subject to self-employment tax. The social security portion of the tax is 12.4% on the first $106,800. The Medicare tax of 2.9% applies to the full $184,700. So your self-employment tax will be $18,600. You can take a deduction for 50% of this tax.

If you incorporate and elect to be taxed as an S corporation, the result can be dramatically different. Again assume that your business income is $200,000, and the corporation pays you a salary of $60,000 (which you can demonstrate as reasonable). You and the corporation, as your employer, will pay a combined 15.3% on your $60,000 salary as payroll (FICA) taxes. The total tax is $9,180. The remaining $140,000 of business income can be distributed to you as S corporation dividends free of payroll or self-employment taxes. The result is a significant tax savings.

The IRS is very much aware of the potential for abuse by taxpayers paying unreasonably high or low salaries. In the example above, if the IRS determined that your salary was set low to avoid taxes, you could face a reclassification of all or part of your $140,000 S corporation dividends as wages subject to payroll taxes. The key: Pay reasonable and well-documented salaries.

• So what is “reasonable”? Determining whether wages are reasonable involves many factors, including the nature of the services performed, the responsibilities involved, the time spent, the size and complexity of the business, prevailing economic conditions, compensation paid by comparable firms for comparable services, and salaries paid in prior years. There are no hard and fast rules, and there is no definition of “reasonable” in the tax law. To analyze this strategy for your particular business situation, give us a call.

Not much change in IRS inflation-adjusted tax numbers for 2010

The IRS is required to adjust many tax numbers for inflation each year. Because there was little inflation last year, there’s very little change in 2010 numbers. Here are the numbers you’ll need for your 2010 planning.

• The standard mileage rate for business driving drops from 55¢ per mile to 50¢ per mile, effective January 1, 2010. The rate for medical and moving mileage drops from 24¢ per mile to 16.5¢ per mile. The general rate for charitable mileage remains at 14¢ per mile.
• The maximum earnings subject to social security tax remains at $106,800. The earnings limit for those under full retirement age is $14,160. For those at full retirement age, there is no earnings limit.
• The “nanny tax” threshold remains at $1,700 for 2010. If you pay household workers more than this amount during the year, you’re responsible for payroll taxes.
• The “kiddie tax” threshold is unchanged for 2010. If your child under age 19 (under age 24 for students) has more than $1,900 of unearned income this year (e.g., dividends and interest income), the excess could be taxed at your highest rate.
• The maximum individual retirement account (IRA) contribution you can make in 2010 remains unchanged at $5,000 if you’re under age 50 and at $6,000 if you are 50 or older.
• The maximum amount of wages employees can put into a 401(k) plan remains at $16,500. The 2010 maximum allowed for SIMPLE plans is $11,500. If you are 50 or older, you can contribute up to $22,000 to a 401(k) and $14,000 to a SIMPLE plan.

For details or for assistance as you begin your 2010 tax planning, give our office a call.

It’s tax time again

It’s time to file various tax returns once again. If any of the following tax deadlines will apply to you, circle the dates on your 2010 calendar.

• January 15 – Due date for the fourth quarterly installment of 2009 estimated taxes for individuals unless you file your tax return and pay any taxes due by February 1.
• February 1 – Employers must furnish 2009 W-2 statements to employees. Payers must furnish payees with Form 1099s for various payments made. The deadline for providing Form 1099-B and consolidated statements to customers is February 16.
• February 1 – Employers must generally file annual federal unemployment tax returns.
• March 1 – Payers must file information returns, such as Form 1099s, with the IRS. This deadline is extended to March 31 for electronic filing.
• March 1 – Employers must send Form W-2 copies to the Social Security Administration. This deadline is extended to March 31 for electronic filing.
• March 1 – Farmers and fishermen who did not make 2009 estimated tax payments must file 2009 tax returns and pay taxes in full.
• April 15 – Individual income tax returns for 2009 are due.