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Distribution of an inherited IRA, and what a
business owner with two businesses should do to lower her tax burden.
Inherited IRA distributions
Dear Tax Talk:
My wife's mom died in August at the age of 79-1/2.
My wife is receiving a distribution from her mom's IRA of about
$80,000.
Her mom's accountant in Arizona believes that
the account must be cleared by Dec. 31, 2001. However, the BankOne
people who sent the forms believe she can take it over a longer
period.
Any help is appreciated.
Fred
Dear Fred:
The reason you are getting different answers is that the rules
are complex.
Since distributions were required to be made
to your mother-in-law because of her age, the key to understanding
your options is determining what method for calculating distributions
was being used at the time she began receiving distributions. The
IRA custodian should have knowledge of this. Her basic choices at
that time would have been:
- Distributions over her single life, recalculated
annually.
- Distributions over her life expectancy reduced
by 1 each subsequent year.
- Distributions over the joint lives of herself
and her designated beneficiary, your wife.
If distributions were made to your mother-in-law
under option 1, then your mom's accountant is right: the balance
of the IRA must be distributed by the end of 2001.
If distributions were made under option 2 above,
then you can continue to withdraw the IRA over your mother-in-law's
life expectancy reduced by 1 each year. In this case the BankOne
people are right.
If the distributions were made under option
3, then the distributions can continue over your wife's life expectancy.
Since the accountant and the custodian can't
seem to agree on the correct answer and the penalty for failing
to withdraw the correct amount is steep, I recommend that you consult
a pension specialist. A specialist will be in a better position
to evaluate your options and advise you on the proper course of
action.
You can read more in our Tax Tip
on IRAs and life expectancy choices.
Tips on
various business entities
Dear Tax Talk:
I am self-employed and operate a small home-based business in
marketing consulting. I have been operating it as a d.b.a. (doing
business as).
I am joining with a business partner to produce
large events nationwide. We think that the best way to protect our
personal assets is to form an LLC (Limited Liability Company) for
this project.
I still am operating the d.b.a. at a profit
but am trying to understand the additional tax consequences of forming
an LLC. My husband and I filed jointly and are in the 31 percent
tax bracket. Should I roll all the income into the LLC or keep that
project separate from the d.b.a.?
Thanks,
Chris Ann
Dear Chris Ann:
A Limited Liability Company (LLC) is a recent invention of business
entity under state law, which makes it in vogue. Costs of formation
are generally slightly more than a corporation. For tax purposes,
an LLC is taxed similar to a partnership, which in turn is similar
to a sole proprietorship. The biggest drawback to an LLC, outside
the area of rental real estate, is that the net earnings of the
partnership are subject to self-employment tax of 15.3 percent.
Rental income is generally not considered self-employment income
making an LLC attractive from the standpoint of limiting liability.
If you are in the 28 percent federal tax bracket
and your state has an 8 to 9 percent marginal tax bracket, your
net earnings from the partnership will be taxed at 51 to 52 percent.
This is also the same level of taxation that your d.b.a. is costing
you now. Giving more than half your money to the government discourages
you from wanting to get up to go to work.
So when changing your form of business entity,
one key factor is to reduce your taxes. Since the only tax you can
control is self-employment tax, the best option to do this is an
S Corporation. Since you will have a business partner in some of
your activities, but not all, both of you may want to consider separate
S Corporations. The two S Corporations can form a joint venture
for the common activities and you can roll up your d.b.a. into your
own S-corp. A joint venture is treated as a partnership for tax
purposes, but an S-corp partner does not pay self-employment tax.
This form of structure is referred to as a partnership of corporations
and offers ultimate flexibility to the partners while reducing taxes.
An LLC and a corporation require filing a charter
with the Secretary of State for the state in which you will be doing
business. A joint venture does not require a charter, but probably
requires a fictitious name filing. To open a bank account for all
the entities, you'll need to apply for federal tax identification
numbers on Form
SS-4. The corporations will also need to apply for S-status
on Form
2553 within 75 days of formation.
While the net earnings of an S Corporation are
not subject to self-employment tax, an S-corp. should pay a salary
to its owner/employees. Although salary is subject to FICA (Federal
Insurance Contributions Act payments toward future Social Security
and Medicare benefits) at a combined rate of 15.3 percent, not all
the earnings of the S-corp. have to be declared as salary. Some
of the earnings can be paid as dividends to the owner without incurring
additional income or self-employment tax.
Further, deductions are treated differently
in an S-corp than a partnership. Items that are not deductible by
the S-corp or flow to the shareholders separately do not increase
the amount of earnings of the corporation. In a partnership as in
a sole proprietorship, these items would increase the amount of
earnings subject to self-employment tax.
I recommend you spend some time searching our
site for tips on incorporating, especially the SmallBiz
business operations archives.
-- Posted Nov. 10,
2000
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