Month: July 2015

401k Basis

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I know.  Could these titles be any more creative? Probably not. Anyway. So, what about 401k plans?  What’s the basis there? Well, it’s similar to the situation with IRAs and Roth IRAs – so similar, in fact, that 401(k)s can be conveniently separated into two classes: 401(k) plans and Roth 401(k) plans. A regular 401k is like an IRA in the sense that contributions to the 401k plan are made before taxes are taken.  Taxable income for the year is reduced, and the contribution to the plan grow (hopefully).  When they are withdrawn, they are taxed as ordinary income.  The gain is calculated by the basis – the amounts of the contributions. Just as an ordinary 401k shares attributes with an ordinary IRA, a Roth 401(k) bears parallels to a Roth IRA. Contributions to the Roth 401(k) are after-tax; as such, when they are withdrawn, they are tax free. Therefore, basis works about the same for the 401(k) (regular and Roth) plans as it does for IRAs.

What’s Your Basis?

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What do you do with an inherited IRA? Someone asked me this recently.  Man, oh, man. That’s a broad question.  But I’ll try to narrow down the focus.  What he was trying to get at was this: what is the basis of the IRA that you inherit? Generally, when you inherit something, you get a stepped-up basis in that asset. Say, your aunt dies and leaves you her house.  The house is currently worth $300,000; she purchased it 30 years ago for $100,000.  If your aunt had sold the house right before she passed away, she would recognize $200,000 in gain – sale price over her basis in the house. However, because your aunt left you the house in her will, the basis of the house is stepped-up to its fair market value at the time of your aunt’s passing – in this case, $300,000.  If you were to turn around and immediately sell the house at its fair market value, you would recognize no gain and receive the $300,000 sale price free of any …

Carried Interest Update – New IRS Rules

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The other day we wrote about carried interest and how it’s recently become a target of the Clinton campaign. Seems as if the Clinton campaign isn’t the only party looking at carried interest like it has a bullseye on its back. The New York Times reported on Wednesday that the IRS issued proposed rules to close the carried interest loophole – or make the hole a lot smaller, at the very least. The proposed rules are designed to smoke out and recharacterize carried interest, or – as the rules call it – disguised payments.  The new rules set out six nonexclusive factors that examine whether the compensation arrangements more closely resemble those in an employee-employer context (i.e.: salary), rather than a partner-partnership context (i.e.: capital gains), and whether various badges of partnership bestowed on an individual serve no business purpose other than to mitigate or eliminate tax on compensation. As we pointed out last week, partners who run private equity funds or hedge funds often receive capital outlays that are disproportionately outsized given the partners’ actual capital …

Sinning. Bad for You. Good for Government. Or Is It?

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A South Carolina newspaper reported Monday that the town of Lexington, South Carolina, is entertaining plans to implement a “meal tax.” The new law, if passed, would impose a 2% tax on eating out, takeout meals, and snacks. While the article doesn’t say that the measure is a “sin tax” or a “vice tax,” as sin or vice taxes often correspond to the consumption of more frequently vilified items or services such  cigarettes or alcohol, the proposal does resemble your standard vice tax, in that it targets a specific behavior and aims to generate revenue. But do vice taxes work?  Do they modify behavior?  Do they generate the anticipated or desired revenue? The Chicago Fed published a paper in May that seeks to answer both of those questions. According to the Chicago Fed paper, despite their apparently laudable goals (reduce bad behavior, raise revenue), sin taxes are fraught with problems including, but not limited to, equity and diminishing returns.  First, sin taxes are regressive, affecting lower income consumers at disproportionately greater rates than wealthier consumers.  Second, there is the …

Mid Term Capital Gains? What? At THESE Rates?

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Various news outlets are reporting that Hillary Clinton is soon to roll out her proposals to change how capital gains are taxed. Currently, capital gains are taxed based on whether they are long-term capital gains (LTCG) or short-term capital gains (STCG).  LTCG derive from investments that are held for a year or more; they are taxed at a rate of 20% plus the Medicare surcharge of 3.8%. STCG derive from investments held for less than a year, and are taxed at ordinary income rates, just like a person’s salary. According to reports in Time, and Slate, Clinton is expected to push for a tax scheme on capital gains that applies gradual changes to the tax rate – or a sliding scale.  Rather than an abrupt transition from LTCG rates to STCG rates, she is proposing a sliding scale that has more tiers than the current scheme, and therefore incentivizes a greater variety of investment strategies than mere short term vs. long term.

To Be Young and Capitalized

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The Atlantic today posted an article attributing much of the wealth of this Millennial generation (both real and perceived) to one thing – their parents. From graduating college debt free to being able to afford home ownership, the article surmises that the economics of today simply don’t allow millennials to afford the things they can ostensibly own without significant parental financial assistance. The article stops short of detailing how that assistance is rendered.  The simplest way would be through gifting.  However, there are limits to gifting. Notably, a person can only gift $14,000 to a person per year before they have to report any excess gift amount that would be subject to gift tax.  So, for instance, a parent could gift $14,000 to a child with no gift tax consequences; however, a parent gifting $17,000 to his or her child would have to report the tax on $3,000 of that particular gift. A parent making that $17,000 gift could avoid gift tax by applying his or her unified credit – the unified credit is the …

Of Future Presidents and Hedge Funds: Carried Interest

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In a campaign speech at New York’s New School Monday, Hillary Clinton pledged that, if elected president, she would work to close the carried interest tax loophole. The what? Exactly.  The carried interest loophole. Or, how to make billions and never pay a dime of income tax. Where to begin?  How about some context.  Carried interest is a form of compensation with significant tax advantages for the investment professionals running private equity or hedge funds. How does it work? And why would a presidential candidate make it a part of her platform early on?  Why would or how could a wonky and obscure tax break for fund managers gain traction with every day voters? First, how it works.  Hedge funds and private equity funds are frequently set up as partnerships, limited partnerships, or limited liability companies electing to be taxed as partnerships; they are often pass-through entities, and are taxed at only one level – the shareholder level.  Moreover, the shareholders are often the actual investment professionals running or managing the fund.  The fund is …