Tax and Business Alert - September 2004

Selecting Your Retirement Plan Beneficiary

Your retirement plan savings (that is, qualified plans and IRAs) are important to your financial well-being. They are one of the few places you can accumulate income without currently paying tax. In addition, the power of compounding pretax dollars can make a retirement plan one of the most powerful investments you have.

When you reach age 70½ (or, in some cases, retire), you must start drawing a minimum amount from your traditional IRAs and qualified plans each year. However, distributions from Roth IRAs are not required during your lifetime. If your distributions begin prematurely (generally, before age 59½) you may be hit with a 10% penalty on the amount of your withdrawal.

Your primary (initial) beneficiary's identity affects the amount and timing of retirement plan distributions required by federal tax law after your death and, under specific circumstances, before your death. When you die, the primary beneficiary designation in effect at the date of death will determine not only who gets the retirement plan assets, but also how quickly your account must be paid out to your beneficiary (and therefore, how quickly the benefits of tax deferral are lost). A contingent (secondary) beneficiary should also be named in the event of the death of you and your primary beneficiary.

Nontax considerations also heavily influence the selection of a qualified plan or IRA beneficiary. These factors include marital status, health and financial needs; the financial status of any dependents; and wealth disposition issues. If you are charitably inclined, a tax-efficient strategy is to leave retirement plan assets to charity and use nonretirement plan assets to fund other bequests. With proper planning, both tax and nontax objectives can often be met when choosing a retirement plan beneficiary.

It is important to review beneficiary designations upon any change in life event, but particularly when a divorce occurs. The beneficiary designation form, not the divorce decree, determines who gets your retirement plan assets when you die. Accordingly, if you do not update your beneficiary designation after a divorce, your ex-spouse may inadvertently end up with retirement assets planned for your present spouse or other beneficiary.

Please call us to discuss the tax aspects of retirement plan beneficiary designations and other personal or business tax planning issues.

Filing a Joint Return in the Year of Death

A decedent's tax year ends on the date of his or her death, although the due date of the tax return remains the same, typically April 15th of the following year. A final individual income tax return must be filed for the year of the decedent's death. If a surviving spouse does not remarry during the year, the spouse may file a joint return with the decedent for the year of death, but is not required to do so. The joint return will include income and deductions for the decedent prior to the date of death and the surviving spouse's income and deductions for the entire year. If the surviving spouse remarries before the close of the tax year that includes the date of death, a separate return must be prepared for the decedent.

Advantages of filing a joint return. Since the surviving spouse's tax year does not end upon the death of the decedent, it may be possible to reduce the combined income tax liability of the decedent and spouse by (a) accelerating or postponing income or deductions to maximize use of the joint tax rates; (b) using one spouse's excess deductions against the income of the other spouse (e.g., excess donations of the decedent who died before generating the income needed to offset the deduction); (c) increasing IRA contributions to take advantage of the spousal rules; and (d) including the decedent's capital loss, net operating loss (NOL), and allowable passive activity loss carryovers to offset income of the surviving spouse. Any capital loss or NOL carryover of the decedent that is not used on the final return (whether it is a separate or joint return) will expire unused.

Disadvantages of filing a joint return. Some disadvantages of filing a joint return for the decedent's final tax year include the fact that (a) the decedent's estate and the surviving spouse are jointly and severally liable for any tax, interest, and penalties due on the joint return and (b) filing a joint return can negatively impact the amount of the decedent's deductions that are subject to Adjusted Gross Income (AGI) limits (i.e., medical, casualty and miscellaneous itemized deductions) since AGI is based on joint income rather than separate income.

Interesting Government Benefits Website

GovBenefits.gov at www.govbenefits.gov provides information from federal and state government agencies and facilitates personalized access to government assistance programs. Information on 426 federal and 123 state programs is available from this website. You may use available online screening tools to anonymously determine if there are government programs available to you.

GovLoans.gov at www.govloans.gov provides information on loan programs from five federal government agencies: the Department of Agriculture, the Department of Education, the Department of Housing and Urban Development, the Department of Veterans Affairs, and the Small Business Administration. You may determine maximum loan amounts, interest rates, and other loan requirements using this website.

Tax Term

Long-term capital gain (on stock)--The gain from the sale of stock investments owned for more than 12 months generally qualifies for long-term capital gain treatment. The maximum tax rate for an individual on a long-term capital gain from the sale of stock is 15% (sales in 2004). This compares favorably with the maximum ordinary individual income tax rate of 35% (in 2004).

The Basics of Roth IRA Distrbution

The Roth IRA, named after former Senator William V. Roth, Jr., was first available on January 1, 1998, as a result of the Taxpayer Relief Act of 1997. Contributions to a Roth IRA are nondeductible, but if certain conditions are met, subsequent distributions are tax free. Distributions of earnings from a Roth IRA are generally not taxable if made no sooner than five years from the first day of the first tax year for which a regular contribution was made and such distributions are either:

· Made after you reach age 59¼.
· Made to your designated beneficiary or estate after your death.
· Attributable to your being disabled.
· Made for first-time home purchase expenses up to $10,000.

Distributions to the extent attributable to earnings that do not meet these requirements are subject to regular income tax plus a 10% penalty unless an exception applies. Exceptions to the early distribution penalty include:

· Distributions made on account of death or disability.
· Distributions used to pay medical expenses.
· Payments structured as a series of substantially equal payments.
· Distributions used for first-time home purchases (up to $10,000).
· Distributions used to pay for higher education expenses.

No portion of a Roth IRA distribution is taxable until the cumulative distributions from all of your Roth IRA accounts exceed the total amount of contributions. Thus, contributions to a Roth IRA can be withdrawn tax-free and penalty-free at any time. This is true even if the five-year waiting period has not expired and you are not yet age 59¼.

Example: Tax-free withdrawal of principal from a Roth IRA.

George is age 50 when he sets up two Roth IRA accounts in 2001. He contributes $1,000 to each account that year and $1,000 to each in 2002 and 2003, so he has made total contributions to each account of $3,000. On July 10, 2004, he has $4,500 in Account One and $4,000 in Account Two (resulting from contributions plus earnings). He withdraws all $4,500 from Account One. The distribution is not a qualified distribution because George is not yet age 59¼ and the five-year waiting period has not expired. But, even though the distribution is composed of $3,000 principal and $1,500 earnings from Account One, the withdrawal is considered to come first from George's $6,000 of total Roth IRA contributions, so the entire withdrawal is tax-free and penalty-free.

Unlike traditional IRAs, there is no minimum amount that you must withdraw each year and there is no age requirement as to when you must begin distributions.

Distributions from a Roth IRA made to a surviving spouse can be treated as distributions from the surviving spouse's own Roth IRA. This enables the surviving spouse to delay distribution until his or her death, if desired. A nonspouse beneficiary must receive the entire balance of the Roth IRA within five years of the owner's date of death, or if so elected, over the beneficiary's life expectancy. For estate tax purposes, the value of your Roth IRA is included in the value of your estate.

Evaluating Franchise Opportunities

The franchise concept is attractive because you can go into business for yourself without being by yourself. Theoretically, this means reduced risk of failure. But buying a franchised business makes sense only if you believe that you could not achieve the same or better financial results on your own as a completely independent operator.

You should evaluate information on a franchisor to determine if the company possesses the experience, financial resources, management, and name recognition to give you a meaningful advantage in that line of business. If the franchisor does not have these qualities, the franchise arrangement may offer little or no real benefit to you.

Information useful in researching franchise and other business opportunities is available on the Internet. For example, A Consumer Guide to Buying a Franchise is available from the Federal Trade Commission at www.ftc.gov/bcp/conline/pubs/invest/buyfran.htm. A quick way to become familiar with the world of franchising is to review the annual list of
500 top-rated franchises compiled by Entrepreneur Magazine at www.entrepreneur.com.

Financial information about publicly held franchisors is readily available. For private companies, obtain a Dun & Bradstreet or other credit report, and check supplier and creditor references. It's also a good idea to check with the SBA and Better Business Bureau in areas where franchises are operated.

For each franchisor you are seriously interested in, obtain the names of at least three franchisees. If possible, visit the franchise locations in person. Ask the franchisees about:

· Their overall satisfaction with the franchise and the franchisor.
· Whether the franchisor has provided the promised level of support.
· Their sales and profit levels (if possible, obtain recent financial statements).
· Whether the level of initial training was satisfactory.
· Whether they would buy the same franchise again.
· Other information they believe is valuable.

You should look into more than just the corporate side of a franchisor. If information from reliable sources casts doubt on the character and business ethics of the franchisor's principals, red flags should go up. If a history of questionable behavior is uncovered, you should look elsewhere for a business opportunity.