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Mezrah Consulting is proud to support the "Building a Better Future Together", St. Joseph School and Parish 2021 Ford Bronco Sport – Badlands Drawing. The video link below provides an overview of their efforts underway and those served by this charity. It highlights the possibilities in building better futures for those in need: "https://player.vimeo.com/video/530359960". For more information on how to contribute, go to St. Joseph School and Parish (charityraffles.org).

November 2017 Autumn is a busy time at Mezrah Consulting, however, we still make time to support our community through sponsoring and participating in various charitable events. Below are two recent contributions that we have made to our local community and beyond. On Tuesday, November 14, 2017, The University of Alabama held its River Pitch Competition. The competition gives students and community members an opportunity to engage in a 3-minute pitch of a business idea to of a panel of judges.  Mezrah Consulting sponsored the event and Todd Mezrah, a proud alumnus of The University of Alabama, was invited to be one of the River Pitch judges. The participants had the opportunity to win $1,000 and, more importantly, to meet business leaders who could give them valuable feedback, help them more fully develop their business idea, and assist in improving their pitch. River Pitch is a joint effort of the Alabama Entrepreneurship Institute and The EDGE Entrepreneurship Center. Both of these organizations are part of The University of Alabama Culverhouse College of Commerce, the Chamber of Commerce of West Alabama, and the city of Tuscaloosa. Annual Monin Flavor RideOn Wednesday, October 11, 2017, Todd Mezrah will be joining the team at Monin Gourmet Flavorings for the Monin Flavor Ride to raise funds for the Helen David Relief Fund at the USBG National Charity Foundation. The bike ride starts and ends at Clearwater Beach. The team will cross four bridges and parallel a Designated Scenic Highway for much of the route. The Helen David Relief Fund honors the memory of Tony Abou-Ganim’s cousin, Port Huron, a MI bar owner and community leader who passed from breast cancer. The USBG National Charity Foundation works to support the lifelong stability and well being of service industry professionals through education and service activities. Mezrah Consulting was happy to support the Kiwanis Clubs of Antelope Valley in Palmdale, CA, by adopting a Flock of Ducks for their 12th Annual Antelope Valley Rubber Duck Race. The race took place on September 1, 2017, at the Lazy River at Dry Town Water Park. The rubber ducks were released to float one lap around the Lazy River and the first twelve ducks around the water attraction were the winners. The rubber ducks had numbers on their bottoms that corresponded to prizes, including a $1,000,000 prize (unfortunately, the Million Dollar Duck wasn’t one of the first 12)! The Kiwanis Club of Antelope Valley supports projects such as scholarships at four local high schools, the Annual Adopt-A-Family during the holiday season, providing a hot meal quarterly for food insecure families in conjunction with Grace Resource, and their 30 year project with Palmdale School District recognizing excellent student behavior.

March 31, 2021 (republished) When people think of deferred compensation plans (DCP), several words typically come to mind – “income deferral,” “saving for retirement,” “tax-deferred growth,” “tax-deferred earnings,” and, perhaps, even the words “non-qualified.” Deferring income and accumulating wealth on a tax-favored basis is traditionally thought of as making elections to defer salary, bonuses, incentive compensation, and even equity forms of compensation (e.g. RSUs and PSUs) in order to warehouse cash pre-tax for some future use. While all of the above is accurate and focuses on the benefits and value to the executive participant, there are uses of a deferred compensation plan that can provide a company with a planning tool of its own. We are not talking about the company deferring its own income but rather leveraging the integrity of the deferred compensation plan structure to provide the company with a competitive advantage in mergers and acquisitions (M&A). Adapting the use of one’s deferred compensation plan as part of a company’s overall M&A strategy can be a significant differentiator in getting a deal to close for both the acquiring company and the seller. The ideal M&A profile of a company where a DCP can be utilized is typically a privately owned entity with few majority shareholders. This is prevalent in industries that are consolidating and where companies are effectively being rolled up into larger institutions. The size of the company or the amount of the purchase price is not relevant. The most common fact patterns where deferred compensation plans can be effective in an M&A transaction are as follows: The seller’s purchase price and company value are higher than the buyer are willing to pay. The seller is tax sensitive and does not want a lump sum payout. The seller is not interested in a taxable earn out. The buyer would like to integrate performance into the purchase price by establishing performance milestones that would justify the company’s purchase price. The buyer would like to retain the senior management team of the seller after an acquisition. The buyer is looking for a means to better compete against competitors’ bids. The key to any acquisition is finding common ground and, more importantly, a balance that satisfies everyone’s interests. The seller wants the highest price with the least tax cost. The buyer wants to pay the lowest price on a tax-favored basis or, alternatively, pay an amount (or part of the total purchase price) based on some measure of future performance. A DCP can be utilized to create this dynamic balance in finding a win-win for both the buyer and the seller. Rather than being limited by traditional purchase options, the DCP offers opportunities that can include more favorable economics. Opportunities A and B are examples that illustrate this idea. Opportunity A: Seller desires a purchase price of $5 million. Buyer values the business at $4 million. Buyer offers seller $4 million with an additional $1 million in a DCP to meet seller’s asking requirements. $1 million in DCP vests over three years based on performance and certain milestones being achieved. Buyer economics are such that, if performance metrics are not met and milestones are not achieved, then only $4 million is paid for the business. (note: The $1 million contribution into the DCP would revert back to the buyer; see Exhibit II.) If performance metrics and milestones are achieved, the buyer will effectively be able to pay out 20% of the sale price on a tax-deductible basis. Seller will get 20% of their sale price tax-deferred, which creates more favorable economics for the seller, i.e. a higher purchase price with $1 million growing tax-deferred. Opportunity B: Seller’s asking price of $5 million is met by a competitor of the buyer. Buyer offers $6 million to get the deal done to effectively block a competitor’s bid. Buyer’s offer of $6 million includes a $1 million contribution to a DCP. Buyer ties the DCP contribution to years of service of the seller’s participants as a means of retaining talent. Economics to the seller are more favorable: higher purchase price overall with $1 million growing tax-deferred. The graphic below compares for the Seller the advantages of a DCP assuming cumulative after-tax distributions associated with Opportunities A and B as compared to a traditional all-cash purchase. The graphic on the following page compares the participants’ cumulative benefit to the buyer’s cumulative P&L impact associated with a $1 million DCP contribution and assumes a three-year vesting schedule (based on meeting performance metrics, years of service, and other milestones). The return of corporate cash represents the refund to the buyer if the acquired company does not meet the vesting criteria requirements (note: vesting can require years of service, performance, or both). If M&A is an important part of your business plan and is vital to achieving your financial goals, then you should consider the use of a DCP to give you that competitive acquisition edge! As illustrated, it can be advantageous for both the buyer and the seller. Other non-traditional uses of DCPs that should also be considered are the creation of a deferred signing bonus and the deferral of severance benefits. Contributions from deferring signing bonuses and severance benefits can vest over a period of time and can include both a service and performance element. Deferred signing bonuses are ideal when you are looking to make an executive whole for benefits that they might be giving up by leaving their existing company or if you just want your company to be more competitive in luring the executive away. Having the ability to make planning decisions ahead of time in this way could save your new executive unnecessary taxes in addition to providing another opportunity for them to accumulate wealth on a pre-tax basis. If you already have a deferred compensation plan in place, it is important to understand the integrity of the structure and its many uses beyond just thinking about it as a way to defer traditional forms of compensation. If you don’t have a deferred compensation plan and your business strategy revolves around actively looking to acquire other companies, we would encourage you to contact Mezrah Consulting to explore the implementation of a deferred compensation plan and to better understand its cash flow costs, P&L impact, and strategic advantages. To download a PDF version of this blog article, click here.

June 2018 Deferred Compensation Plans can be designed and funded to have little to no P&L impact. However, even the most well thought out plans can put a company in a negative P&L position without proper management and oversight. Having the appropriate processes in place is paramount for managing an “on balance” plan. It is important to understand that asset and liability will rarely if ever, match given all the variables and movement involved in a non-qualified deferred compensation plan. The key is to understand and build processes around each variable so unanticipated expenses are not incurred. The variables involved in effectively managing a deferred compensation plan include the following: 1) Timing of Funding 2) Funding Projections 3) Timing of Payroll Deferrals 4) Timing of Payouts 5) Timing of Crediting Interest to a Participant 6) Participant Ability to Asset Allocate 7) Asset Structure Costs Timing of Funding The key to reducing the P&L risk of the plan is timing. There are two components to timing when investments are made: 1) the timing of the funding itself and 2) the timing of the movement of money into appropriate investments. There are several funding options, including funding in arrears, funding upfront (annually, quarterly, or monthly), and funding every pay period. Funding in arrears is almost a guarantee that a company will incur additional expenses unless the market rate of interest is negative over the same time period. Alternatively, funding every pay period creates the most errors in terms of timing and the increase in administrative work needed. Funding upfront clearly provides for the tightest management of assets against liabilities as the dollars can be better controlled and moved as needed based on deferrals. While one may optimize the plan by addressing its funding aspect, the timing on when dollars are moved into the specified investment funds is important to keep in mind. If dollars are not moved from cash into appropriate investments in concert with when participants are credited, then balance sheet mismatching can occur. Moving the money even a day or two later than planned can prove to be onerous because of market swings. For example, the graphic below shows that, over 3, 5, and 10 years, there were 297, 505, and 1,270 days respectively in which the market moved more than 50 basis points; it also indicates that there were 144, 217, and 699 days when the market moved more than 100 basis points. This level of volatility highlights the importance of making sure that interest credited is always in line with asset earnings. Source: S&P 500 Daily Returns Funding Projections While funding upfront is the most conservative and prudent method for eliminating P&L impact, (assuming the right processes are in place for moving the money and the plan design accommodates appropriate participant crediting of accounts), the amounts funded upfront are purely based on projections of anticipated deferrals. These projections can be impacted by new plan participants, increased bonus and commission amounts, and unanticipated increases in salary with resultant increases in deferral amounts (as opposed to decreases). Unanticipated increases can leave big gaps in asset amounts as compared to the liability. While these gaps can be made up, they can promote potential expense in an up market. It is important to always anticipate the compensation variables noted and, when possible, stay ahead of them and proactively allocate additional funding when needed. Timing of Payroll Deferrals As each payroll occurs and dollars are deferred, participants’ accounts are increased and interest can immediately be earned on the new deferral dollars. If interest is immediately earned but assets have not yet been moved or funding has not occurred in concert with the new deferrals, P&L impact can occur. Timing of Payouts When payouts are made, whether from corporate cash or plan assets, funding projections, or funding amounts, the relationship between asset and liability can be impacted. It is important to understand and anticipate future projected payouts when considering asset/liability management. Accommodating material payouts is even more important as they can bring about substantial changes and drive unanticipated financial consequences. Timing of Crediting Interest to a Participant Crediting interest in line with the movement of assets is essential if one is to appropriately manage the P&L of the deferred compensation plan. Typically, interest is credited on the day that deferrals are made to the plan. This immediate crediting of interest does not leave much time for the plan administrator to allocate the assets in a timely manner. If a trustee is involved, there may be other delays in moving assets into the appropriate investment funds. Ideally, crediting of a participant’s deferrals should not begin until the assets are in a position to be moved. Moreover, the plan document should dictate when interest is credited. Administratively, some thought should be given to these processes to accommodate for potential delays with language that notes that interest will be credited “as soon as administratively feasible” so that no unnecessary financial stress is put on the plan. As with payrolls, funding, and payouts, timing is everything! Participant Ability to Asset Allocate Providing the participant with the opportunity to asset allocate at any time and immediately crediting interest based on the new investment allocations is yet another variable that can impact the expense of the plan. This approach does not provide for timely alignment of assets with liability and will undoubtedly create unnecessary expense. As an alternative, a company should consider allowing for reallocation elections to be made at any time but not transact on those elections until the next pay period. This allows for appropriate timing with the other scheduled deferrals (and processes) and a crediting of interest that can be effectuated with reduced risk of expense to the company. Asset Structure Costs It is important to understand that there are costs associated with any asset structure. These costs typically can be assessed daily, monthly, or quarterly. Costs can include investment management fees, costs of insurance (assumes COLI funding), and taxes. Measuring these costs and understanding their impact and timing is essential. Costs can create underfunded positions putting the assets at a disadvantage during an up market. In this situation, there are fewer assets earning interest than interest credited to the liability. Executive Summary It should go without saying that the financial management of a deferred compensation plan is ever- moving and requires a significant investment of discipline, dedication to process, and an understanding of all the variables. Companies should not expect their plan assets to always be equal to their liabilities. With that said, they should be close; earnings on assets should be commensurate with earnings credited to the liability. The highest probability of accomplishing this asset/liability matching is to partner with a consulting firm that controls both the asset and the liability. Working with a firm that administers the deferred compensation plan and the in-formal funding in concert with one another and providing all of the necessary accounting and asset/liability reconciliation is essential. We internally at Mezrah Consulting practice completing a detailed monthly reconciliation which is paramount in identifying and addressing any meaningful variances or discrepancies so they do not persist. Constantly evaluating and improving processes, obtaining a detailed reconciliation, and amending the plan document as needed should prove to be a worthwhile expedition in better plan management.

Click here to request the article, “The Compensation Recovery Plan: A Creative Solution to the COVID-19 Impact on Compensation.” A Compensation Recovery Plan should be considered by companies who are focused on retaining key employees and rewarding them for successfully navigating through the economic impact of COVID-19. Moreover, the value proposition of delivering an encouraging incentive during these challenging times can be extremely positive both psychologically and economically to each plan participant.

Click here to request an article about “Recover Losses in Your 401(k) with a Deferred Compensation Plan.” The value of leveraging a deferred compensation plan during a time when values in 401(k) plans have been significantly impaired can be substantial. Being able to better control the timing on rebuilding pre-tax retirement plan accounts is paramount from a wealth building and goal planning perspective. Although there are limitations on what can be deferred into a 401(k) plan annually, there are comparably little to no limitations on the amount that can be deferred into a deferred compensation plan.

February 16, 2021 Download our 2020 Market Review which provides a snapshot of the tumultuous year. The US endured a global pandemic, layoffs, a volatile economy, and a contentious presidential election, but the markets persevered.

Captive International Magazine July 24, 2017 831(b) captive insurance companies have been under the microscope for six months as the Internal Revenue Service subjects them to the greatest possible scrutiny. What’s behind this sudden concern? US Captive investigates. The past year or so has not been a happy one for managers of 831(b)s captive insurance companies who had a previously happy relationship with the Internal Revenue Service (IRS). In November last year, the IRS announced in Notice 2016-66 that it was placing all 831(b)s under full scrutiny, meaning that it was going to put all of them under a financial microscope to make sure they were legitimate. It was a decision that stunned the industry. In a December 2016 report about the Notice from the International Risk Management Institute (IRMI), Donald J. Riggin, CEO of The ART of Captives, a consultancy specializing in alternative risk financing techniques wrote: “In Notice 2016-66, the IRS made a transaction of interest announcement. A transaction of interest is one that the IRS suspects may be illegal but doesn’t have enough information to make the determination. If its suspicions are confirmed through the collection of certain data, the transaction becomes ‘listed’, meaning that it has been determined to be a prohibited transaction.” Riggin said there are two requirements compelling promoters and taxpayers to divulge the details of the 831(b) transaction, only one of which must be satisfied. First, if the captive’s loss ratio is 70 percent or lower, compliance is required. Second, regardless of the loss ratio, if the captive has provided any type of loan or another sort of financial transfer to its parent company or any other company or individual, compliance is required. Moreover, the disclosures must include data from up to five years of captive activity. In addition, he added, the 70 percent loss ratio requirement is somewhat high given the fact that commercial insurers’ acceptable loss ratios run between 60 and 65 percent depending on the line of insurance. By design, the vast majority of 831(b) tax shelter captives have extremely low loss ratios, as losses reduce the amount of premiums subject to the tax advantage. Formed with good reason Section 831(b) captives’ claim to fame is that earnings from premiums are not subject to federal income taxes; only interest income is taxed. The maximum annual premium was $1.2 million, but this increased to $2.2 million on January 1, 2017. The primary users of these captives have been small to middle-market, privately owned companies. The 831(b) captive was created in 1986 as part of that year’s tax overhaul. As IRMI points out, they were originally designed to help small agriculturally-focused insurers weather the liability crisis of the mid-1980s and compete effectively with their larger brethren. “The tax advantage provided by Section 831(b) did not long escape the notice of estate and tax planners,” says Riggin. “For almost 20 years, firms have used these small captives to shield a portion of their clients’ earnings from income tax on the premiums. For over five years, the IRS has been investigating these transactions and has concluded that many of them may constitute illegal tax shelters. In these cases, the captive promoters appear to follow the rules of captive insurance, but, in reality, these efforts only hide the true nature of their tax shelter strategies. “However, there is a variety of perfectly acceptable reasons for a captive or small insurer to elect to be taxed under section 831(b). This assumes that taxation is not the primary reason for forming the captive and that the transaction creates economic substance for all parties.” Todd Mezrah, CEO of Mezrah Consulting, clarifies saying: “Primarily what 831(b)s allow you to do is insure the risks of an operating entity where traditional commercial coverage for those risks might not exist, or where the coverage might exist but might be too costly to obtain. If you’re in one of those two situations an 831(b) might make sense. These types of exposures may include loss of franchise, loss of a key supplier, or loss of a key customer. Those aren’t normal and customary risks that are prevalent in the commercial marketplace today. Typically you can’t call up a third party property and casualty broker and say ‘can you write me a policy for loss of my key customers’—they’ll look at you as if you’re crazy,” he says. “But that’s a legitimate risk—and a pretty big one, especially for a small business which might be depending on a customer for 20 or 30 percent or more of its revenue. “If there are specific risks to an individual company’s industry, type of business, demographics or all of the above, that’s where an 831(b) can really come into play.” Take a look in the mirror If 831(b)s are so useful, why the sudden degree of scrutiny from the IRS? For Michael Mathisen, partner at Baker Tilly, the recent close inspections are partly the fault of the captive insurance industry itself, or rather one part of it. One of the major problems with 831(b)s was that there was some over-zealousness on the part of the captives industry, with some captive companies selling these vehicles to clients. A lot of these clients either didn’t understand, or they were not a proper fit for, a captive insurance company,” says Mathisen. “They were sold these 831(b)s as a way to arbitrage tax rates and save money ad infinitum if they keep it going forever. If that’s the only reason to set up a captive insurance company then the IRS looks at it and says‘no, that’s tax avoidance, not insurance’. “We’ve always talked about and accepted captive insurance companies as a true risk-bearing vehicle. If they’re set up like an insurance company, and they are treated by the owner as an insurance company—you pay premiums and you pay claims—then it’s treated as an insurance company.” However, according to Mathieson, captive managers went to companies that had no idea how insurance companies were run. “Under the old law those companies were basically told if they put in $1.2 million of premium this year and they can invest it and get, say, 8 percent return, or a little under $100,000 of investment income on that, that’s all they’re going to be taxed on if they’re set up as an 831(b). “In addition, they’re not going to have any claims, so they get a deduction for that $1.2 million on their corporate side, which on a 34 percent rate is a $400,000 benefit to them. If there are no claims ever then that’s a permanent benefit, and even if they close it further down the road when it comes back out, that could be a dividend that has a preferential rate of 20 percent. “They’ve taken a deduction of the 34 percent, and they’ve had a 20 percent income, so they’ve arbitraged 14 percent of their taxes.” Mathisen points out that if that was the sole purpose of setting up the captive insurance company then the IRS—rightly—says they’re not going to treat that as an insurance company, they’re going to treat it as a general corporate entity and deny deductions for the ‘premiums’. They’re going to treat it as something set up to have money put in it, so they’re not going to allow it to be classified as an 831(b) and they’re going to tax it appropriately, deny your deductions and when the owners take the money out the IRS will look at the interest accrued,” he says. “The thing about an 831(b) is that if you set it up for risk management purposes—which is what you should be doing—then you should get over the first hurdle. The whole analysis of the 831(b) and the captive should be: ‘do I need a captive?’. “That should be the first question you ask. That and ‘do I need it for risk management purposes? Do I have things on my books that I am at risk for, but either I’m not buying insurance because it’s too expensive or there’s really not the insurance out there for the type of risk I have, but it is an insurable type of risk, so I can put that in there, I can take premiums on it and yes, I’m going to have losses’.” Mathisen adds that the second part of this, one that captives overlook, is that insurance companies have premiums in, but they also pay losses. The captives that are bound to fail have no claims for years. As a result, when the IRS looks at 831(b)s they’d see five, six, seven years of premiums being put in but not a single dollar of claims. The IRS might, therefore, say there’s no insurance company in the world that had zero claims, with the exception of big cat riders, and 831(b)s are not cat riders. Overzealous or fair business? The IRS also looks at the type of risk. Mathisen claims that’s the other place where captive insurance management companies got overzealous because everyone understands that there are alternative risks out there, types of risk that aren’t traditional risks that you might be able to put into a captive insurance company. In addition, he claims, they went so far as to monetize foreign currency risk, when it’s clear that with foreign currency you can buy options on it, or futures, and there are all sorts of financial products that can be bought for currency risk. It’s not an insurable risk, but in their zeal to come up with that million-odd number for their clients to show the biggest benefit for them and to allow them to sell the product to their clients, these captive managers came up with these types of risk that the insurance industry doesn’t believe are insurable—and which the IRS says are not insurable. “This is why the IRS intervened to get this area tightened up, so only real captives can get the benefit,” says Mathisen. The last part the IRS sees as abusive was that 831(b) captives were being used as wealth transfer vehicles, going outside the estate and gift tax. People were setting up 831(b)s and making their children the owners of those captives. A combination of no claims and annual premiums meant that such 831(b)s could get very wealthy, very quickly, with no state or gift tax but still allowing tax deductions on the premiums, so the IRS came up with rules looking at ownership. Why has the IRS been treating 831(b)s as questionable? “In two words: bad actors. A lot of bad actors have attempted to take advantage of 831(b)s, by either manufacturing risks that don’t exist specific to their business, for example, kidnapping insurance for executives when there’s no danger of that or earthquake insurance for the state of Nevada. Those aren’t legitimate exposures to insure,” Mezrah replies. “These entities are manufacturing risks that are not real risks specific to their business and in addition, even though they might be legitimate risks they’re not going out to a third party actuarial firm to promulgate the premiums, which should be market-based premiums associated with those risks. “For instance, while cyber insurance is a big deal at the moment and could be covered via an 831(b), bad actors could be manufacturing a million-dollar premium for that exposure without going to an actuarial firm to evaluate what the true premiums would be given the client’s risk profile,” he continues. “Risk profiles would take into account items such as the revenues, the size of the business, type of business, prior loss history and more. By not getting the proper evaluation done, they’re just putting a number down as to what the premium would be. They’re not doing what they should to justify the existence of their own insurance companies—they might not even have a bona fide insurance company.” Separating wheat from chaff There are, however, a lot of good players out there and some very good captive managers. The great majority of captive managers do things for a risk management purpose, says Mathisen. But there are, as in every industry, players who go too far. “When Baker Tilly takes on a client that has a captive, or wants to know if they should be going into a captive, the company does due diligence on the client’s behalf, as it goes through the captive management plan, and asks what is or is not real insurance, and what is the proper type of risk that should be in the plan, looking at what the IRS would think if they audited the client,” he says. “As long as they are done correctly, for the correct reasons and on the correct basis, 831(b)s are perfectly legitimate vehicles. Moreover, in addition to being set up for the correct reasons, if they are needed over a long-term period they need to be correctly maintained and treated over that time period, with the operators sticking to the rules so that the IRS or any other regulators cannot make any complaint about misuse or changes. “831(b) captives can be incredibly valuable vehicles for a company. Set it up properly and treat it properly, in the way that a real insurance company would be treated—if you honor those steps the IRS, even if they are taking a hard look at these vehicles, can’t complain.” Mezrah agrees. “How do we deal with this? How about just follow the rules,” he says. “There are clear rules in 831(b)s that give guidelines on what would be considered a bona fide insurance company. You have to have risk distribution and risk transfer. You need an actuarial evaluation and your own business plan, and that needs to be submitted to the state of jurisdiction—there’s a formal process. “Follow the rules and do what the IRS is saying you can, within the guidelines. You can’t make stuff up. Even if the risk is a legitimate one you need to go out and confirm market-based pricing for that particular risk. There are certain things that the IRS is going to require you to do in order to fulfill the opportunity to utilize 831(b)s to code. “Unfortunately, because we’ve had a lot of bad actors in the US, the IRS has been scrutinizing all captives to try to figure out for themselves who’s following the rules and who are some of the bad actors. As of now, everyone’s guilty until proven innocent. In the IRS’s defense there’s been so much abuse out there in the marketplace that it has something of a right to assume guilt before innocence,” he says. “The reality is that even for the professional firms who did follow the letter of the law, have the appropriate documentation, claims history, appropriate risk sharing and distribution—they’ve done everything right—the attitude of the IRS is ‘right, looks ok, but who actually knows, let’s dig deeper and deeper’. It’s a monumental effort to try and defend yourself when in fact you have done everything right.” As a result, Mezrah says, some of the firms that have done everything right are being punished, so to speak, with excessive scrutiny on the part of the IRS. “A few hundred audits are being done right now by the IRS. It’s a lot of legal costs, time and resources, and for a small company that can be a big burden. Some might have had an actuarially justified premium of $250,000 paid into their captive and then spent $50,000 in legal fees defending what they did, which has been fully documented and above board. They wonder when is this going to stop, and how much more in legal fees will they have to pay? “The IRS needs to trust someone, to trust a structure, a model, a list of practitioners—maybe have an approved list—but they’re on a witch-hunt. You can appreciate it from their perspective—if someone put in $1.2 million which has now increased to $2.2 million and it’s not legitimate, then the government has lost a million dollars in revenue, so they’d be a bit upset,” he concludes. Note: This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.

There is a general understanding that an element of the small captive insurance company industry is improperly using the tax exemption 831(b) to shield taxable income. In an effort to study and minimize the abuse, the IRS, on November 1, 2016, issued Notice 2016-66 identifying a specified captive insurance company design defined under IRS code section 831(b) as a “transaction of interest.” Taxpayers owning and using any 831(b) captive need to be aware of these changes to determine if they might be covered by it, and if so, what they need to do now and moving forward. If disclosure obligations are not followed properly, significant penalties can be applied for noncompliance. What changed? It is important to understand exactly what the IRS is now terming a transaction of interest. If the transaction is yielding tax benefits that abuse the law to achieve benefits that the IRS views as inappropriate, it can classify that transaction as an abusive tax shelter. Before the IRS can make a determination that a transaction is or is not abusive, it can identify the transaction as a “transaction of interest.” Not all 831(b) captives are transactions of interest and even if a captive is labeled a transaction of interest, it does not necessarily mean it’s abusive. If a captive insurance company is structured in a way that marks it as a transaction of interest, then several parties related to that structure have a reporting requirement. If not supported by the law, it would have potential penalties, however, just being classified as a transaction of interest does not mean or imply that there is any additional tax required or that there is any penalty for underpayment of taxes. Visit the IRS website to further understand how a transaction of interest is being defined. The reporting obligation can be time-consuming and applies to the captive itself, its owners, the insured company and the company promoting the captive. All of these may be considered participants and must file a Form 8886. These are described in detail here. The Forms must be filed by January 30, 2017, which is a hard deadline carrying heavy penalties if missed. Additionally, any material advisor, anybody who gave paid advice (subject to minimum fee requirements) constituting a “tax statement” to the participants, will need to complete an alternate form. Any affected 831(b) captive must disclose certain information on IRS Form 8918, Material Advisor Disclosure Statement. The information provided is meant as a general overview, and captive participants and advisors are cautioned to work with their own tax counsel to fully understand the implications of the Notice 2016-66. If you own an 831(b) micro-captive and are unsure of your need to complete Form 8886, please contact Mezrah Consulting.

February 2, 2017 Recently, the Joint Committee on Taxation (JCT) released the annual update for its tax expenditure list, which included the exclusion for death benefits for the first time. The JCT defines a tax expenditure as, “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” This move was foreshadowed by last year’s JCT tax expenditure report, which indicated that the committee was considering adding death benefits to the list. The JCT estimated the cost of the exclusion to be $128.3 billion over five years. Despite the updated JCT tax expenditure list, it is unlikely that this latest report will impact the current development of tax reform legislation in Congress. Currently, our tax system does not tax income proceeds from any form of insurance—whether from life insurance, disability insurance, health insurance, homeowner’s insurance, or auto insurance—and Mezrah Consulting will continue to assist organizations educating the JCT about the current and appropriate tax treatment of death benefits. In December 2015, the JCT removed inside build-up from the tax expenditure list, recognizing its appropriate tax treatment. If you have any questions regarding income tax proceeds from death benefits, please call Mezrah Consulting at (813) 367-1111 or email us at MezrahClientServices@mezrahconsulting.com. Source: AALU

December 22, 2017 (Updated March 16, 2018) H.R. 1: An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 (“Act”) enacted by Congress on December 20, 2017, is the most comprehensive tax reform measure since 1986. President Trump will sign this legislation into law before the end of the year if sixty Senators agree to waive the PayGo rules to avoid imposing its required spending cuts in 2018. If not, the President may defer signing the Act until January. While the Act contains extensive provisions changing income tax law, the summary below is limited to those provisions most relevant to our audience. Effective Dates To pass this legislation with a majority vote in the Senate instead of the normally required sixty votes, the legislation was enacted as a budget reconciliation measure. The Senate’s “Byrd” rule prohibits legislation enacted under budget reconciliation from adding to the deficit outside of the ten-year budget window and requires that it constrain any increase within that window to the 1.5 trillion dollars permitted by the previously adopted budget resolution. Although the original name of the bill (“Tax Cut and Jobs Act”) was held to violate the Byrd rule and removed, the bill is likely to continue to be referred to by that name. In order to permit significant changes enacted for corporations to become permanent, including the new 21% income tax rate, it was necessary to provide that virtually all the provisions in the legislation affecting individuals’ sunset or expire after 2025. Virtually all the provisions of the Act affecting individuals, including those which lower tax rates, increase exemptions, and repeal deductions, will expire after 2025. Without further legislation, the tax code in 2026 will look very much like it does today for individual taxpayers. Of course, if the balance of power in Washington shifts, there could be new tax legislation enacted even before 2026. Maximum Tax Rate The Act lowers the maximum income tax rate applicable to individuals to 37% beginning in 2018. The maximum rate will become applicable when taxable income exceeds $600,000 on a joint return, $500,000 on the return of a single individual, and $300,000 on the return of a married person filing separately. The maximum tax rate on long-term capital gain income and qualified dividend income will remain at 20% and the 3.8% Medicare tax is also retained. After 2025, the maximum rate will revert to 39.6%. Itemized Deductions Charitable contributions. The Act increases the limitation on the deduction of cash contributions to publicly supported charities and private operating foundations from 50% of the taxpayer’s adjusted gross income to 60% beginning in 2018. State and local taxes. Beginning in 2018, the Act will repeal all deductions for state and local taxes in excess of $10,000. A taxpayer may deduct up to $10,000 of state property or income taxes (or sales taxes in lieu of income taxes).  For many people, it will be beneficial to pay the remaining balance due on any 2017 state income or property taxes in December, provided they are not currently subject to the Alternative Minimum Tax (AMT) and will not become subject as a result of those payments. The Act prohibits any deduction in 2017 for 2018 state taxes that are paid during 2017, so there is likely no benefit to prepayments of anticipated taxes owed for 2018. An accountant can help with this analysis. Home mortgage interest. After December 31, 2017, the Act reduces the maximum amount of home mortgage loan on which interest can be deducted from $1,000,000 to $750,000. Existing loans incurred before December 15, 2017, are grandfathered at the prior $1,000,000 amount. The deduction of interest on home equity loans of up to $100,000 loan amount is repealed beginning in 2018. There is an exception to this limitation when a home equity loan is considered “acquisition indebtedness.” Acquisition indebtedness is determined if the proceeds from a home equity loan are used to acquire another home or make substantial improvements to the taxpayer’s residence, with a caveat that all mortgage loans combined do not exceed the previously stated thresholds. Medical expenses. The Act leaves intact the deduction for medical expenses, which the House bill would have repealed. For 2017 and 2018, the adjusted gross income threshold above which medical expenses may be deducted is lowered from 10% to 7.5% for purposes of the regular income tax and the AMT. Alimony payments. The Act repeals the deduction for alimony payments and establishes that the spouse receiving alimony will not be taxed on such amounts but not until after 2018. Casualty losses. The Act limits the deduction for casualty losses to losses sustained from events declared by the president to be disasters beginning in 2018. Miscellaneous itemized deductions. The Act repeals all the miscellaneous itemized deductions that were subject to the floor of 2% of adjusted gross income beginning in 2018. This encompasses a variety of deductions, including fees for tax return preparation, unreimbursed employee business expenses, investment fees and expenses, and union and professional dues. Student loan interest. The Act leaves intact the deduction for interest expense incurred on a student loan. This deduction would have been repealed by the House bill. Child tax credit. The child tax credit has been increased from $1,000 to $2,000 per qualifying child. This credit phases out for taxpayers whose taxable income is over $400,000 for married couples and over $200,000 in all other cases. There’s also a new, nonrefundable credit of $500 for each dependent who is not a qualifying child. Overall limitation on itemized deductions. The phase-out of itemized deductions is repealed for tax years after 2017. Alternative Minimum Tax The alternative minimum tax will remain a part of our tax system for individuals with an increase of the exemption amount to $109,400 for married taxpayers filing a joint return and $70,300 for single individuals. The income level where the exemption phases out was increased to $1,000,000 for married taxpayers filing a joint return and $500,000 for single individuals. Many people who were subject to the AMT in the past will find it no longer applies to them beginning in 2018. For many people, the principal item that caused them to become subject to AMT was the deduction of state and local income and property taxes. Beginning in 2018, this deduction will be limited to $10,000 per year, which will result in fewer people being subject to AMT. The deduction of miscellaneous itemized deductions also contributed to individuals becoming subject to AMT, and these deductions are also repealed beginning in 2018. The Act did repeal the corporate alternative minimum tax, which the Senate Bill would have retained.  Considerable concern had been raised that retaining the corporate alternative minimum tax would have taken away much of the value of certain tax credits, e.g. the research and development credit. Business Income Received by Individuals and From Pass-Through Entities The Act generally followed the approach adopted by the Senate regarding income received by individuals from pass-through entities and proprietorship businesses. New IRC Section 199A provides a deduction in the amount of 20% of the taxpayer’s net qualified business income, which results in a maximum effective income tax rate on qualified business income of 29.6% when coupled with the 37% maximum income tax rate. The deduction is limited to an amount equal to the greater of (a) 50% of the W-2 wages paid by the business or (b) the sum of 25% of the W-2 wages paid by the business and 2.5% of the unadjusted tax basis of the depreciable assets used in the business whose depreciation life has not expired. For this purpose, an asset is given a minimum depreciation life of 10 years. The use of “unadjusted basis” will generally mean that depreciable assets will be considered at their original purchase cost when computing the 2.5% number. This limitation establishes a significant advantage for businesses that employ significant numbers of people or significant amounts of capital. There is an exception to this limitation for individuals with taxable income of less than $157,500 or married couples filing jointly with taxable income of less than $315,000 of taxable income. In both cases, taxable income does not take into consideration the pass-through deduction. Furthermore, the deduction phases out over the next $50,000 of taxable income for individuals and over the next $100,000 of taxable income for married couples filing jointly, with both phase-out intervals being subject to inflation adjustments. The provision is not applicable to service-based businesses except for those earning below the above threshold amount. Engineering and architectural firms were excluded from the prohibition generally applied to service-based businesses. Qualified business income does not include income earned outside of the United States (except for Puerto Rico), investment income such as interest (other than interest generated by the business), dividends or dividend or dividend equivalent amounts, commodities gains, foreign currency gains, income received from notional principal contracts (derivatives), and income from annuities not related to the business. All short and long-term capital gains are excluded as well. Dividends from REITS (excluding capital gain dividends), dividends from cooperatives, and income from a qualified publicly traded partnership also qualify for the 20% pass-through deduction. Carried Interests A carried interest is generally an interest in future profits to be earned by a partnership or limited liability company that a service provider will receive. The interest is generally granted for the performance of services rather than the provision of capital to the business. Critics of the existing carried interest rule have suggested that it is not good tax policy to permit an employee to ultimately recognize capital gain income as compensation for services. The Act preserves current law treatment of carried interests; however, the interest must be held for a minimum of three years in order to result in capital gain treatment for the service provider. Limitation on the Deduction of Business Losses For taxpayers other than corporations, business losses in excess of $250,000 for an unmarried taxpayer and $500,000 for a married couple filing jointly cannot be deducted against other non-business income after 2017. Any disallowed amounts will be carried forward as a net operating loss, which can be deducted against business income in future years. There is an exception to this limitation when all or part of the tax year’s loss is considered a “farming loss.” Farming losses are permitted to be carried back two years. Like-Kind Exchanges IRC Section 1031 is amended to limit tax-deferred exchanges to those involving real property. Exchanges of like-kind personal property will be subject to taxation after 2017. The most significant impact of this change for many high net worth families is that it will no longer be possible to do like-kind exchanges of aircraft and works of art. Sale of Stock The House bill contained a provision that would have eliminated a taxpayer’s ability to “specifically identify” the particular shares of stock that had been sold by the taxpayer. This rule allows a taxpayer to choose its shares having the highest tax basis. Under the House bill, taxpayers would have been required to use the “first in-first out” identification method, which would have resulted in higher taxes where the taxpayer’s earliest purchased shares were purchased at the lowest price. As the Act did not include this provision, taxpayers will still be permitted to specifically identify the shares that they sell. Section 529 Plans The Act expands the levels of education for which expenses can be paid with funds held in Section 529 plans. Currently, such funds can only be used for expenses related to post-secondary education. Beginning in 2018, up to $10,000 per student per year can be used to pay expenses associated elementary or secondary education, regardless of whether that education is public, private, or religious. A provision that would have allowed the payment of such expenses for homeschooling was removed after the Senate Parliamentarian ruled that the provision violated the Byrd rule because the provision was extraneous to the budget. Business Tax Reform Corporate tax rate. The Act permanently lowers the income tax rate for C corporations to 21% beginning in 2018. Cost recovery. The Act provides for an immediate deduction for 100% of the cost of qualified property placed in service after September 27, 2017, and before January 1, 2023. From 2023 through 2026, the percentage that can be deducted declines 20 percentage points each year. No expensing will be permitted under the provision in 2027.  For longer production property and certain aircraft, the deductible amount begins declining by 20 percentage points each year from 2024 through 2027. The provision will apply to used property as well as new property.  In general, qualified property is personal property with a depreciable life of 20 years or less and also includes motion picture and television productions for which a deduction would have been allowed under Section 181 (without regard to the dollar limitations imposed by that section). Property used in a real estate trade or business does not qualify. Cost recovery with respect to real property. The Conference Agreement dropped a provision in the Senate bill that would have reduced the recovery period for the cost of both residential and nonresidential real property from 39 years and 27.5 years respectively to 25 years for both types of property. The 39 year and 27.5 year periods will remain in effect.  The Conference Agreement did follow the Senate bill in consolidating qualified improvement property, qualified leasehold improvement property, and qualified restaurant property into a new single definition called “qualified improvement property.”  This property includes any improvement made to a nonresidential building after the building has been placed in service but does not include expenditures for enlarging the building, escalators or elevators, or the internal structural framework of the building. Expenditures constituting qualified improvement property can be depreciated over 15 years. Increase in the amount that can be expensed under IRC Section 179. The Act increased the amount that can be expensed under IRC Section 179 to $1,000,000 beginning in 2018. Additionally, it increases the amount where the phase-out of the deduction begins to $2,500,000. Business interest expense. Beginning in 2018, the deduction of interest by a business would be limited to 30% of its adjusted taxable income plus the amount of business interest income. For tax years beginning before January 1, 2022, taxable income is increased by the amount of deductions taken for depreciation, depletion, and amortization thereby yielding a higher deduction limit. An exception to the limitation is provided for businesses having average gross receipts of $25 million or less for the three prior taxable years. Real property businesses can elect to be exempted from the limitation by agreeing to use the alternative depreciation system, which results in somewhat longer depreciation periods for buildings. Limitation on deduction of net operating losses. The JCTA repeals the 2-year carryback period for net operating losses incurred after 2017 but allows an indefinite carryover period. Only 80% of taxable income may be eliminated by a net operating loss deduction after 2017. Repatriation of Foreign Earnings. The bifurcated effective tax rates for the transitional deemed repatriation of foreign earnings are higher than under the earlier bills, ending up at 15.5% (for cash and cash equivalents) and 8% (for earnings invested in non-cash assets). Corporate Compensation Provisions Revises the definition of a covered employee. The definition of a covered employee to an applicable employer has been revised to include anyone who served as the principal executive officer or the principal financial officer at any time during the year and the three other most highly compensated officers for the taxable year. Also, anyone who is a covered employee in 2017 or later will always be considered a covered employee. Provision taxing deferred compensation on vesting is dropped. A provision of the Senate bill that would include deferred compensation in income when it is no longer subject to a “substantial risk of forfeiture” – effectively on vesting – even if not payable until a future year was dropped by the Conference Committee. Limitations on executive compensation. Section 162(m) currently imposes an annual limit of $1,000,000 on the deductibility of compensation paid by a public company to each of its covered employees (the CEO and the three other highest-paid executive officers excluding the CFO). The Act amends Section 162(m) to repeal prior exceptions for performance-based compensation including stock options and commissions and expands the list of covered employees to include the CFO. Once an employee is covered, they will continue to be included for as long as they receive compensation from the company (including after termination of employment). The amendment applies to taxable years beginning after December 31, 2017, with a grandfather provision for contracts that were binding on November 2, 2017. Excise tax on executive compensation paid by tax-exempt organizations. The Act imposes a 21% excise tax on tax-exempt employers for payment of compensation in excess of $1,000,000 to the five highest paid employees of the organization. Deferral of qualified broad-based equity awards. The Act allows employees who are granted stock options or restricted stock units through a broad-based employee plan covering at least 80% of employees to elect to defer recognition of gain on exercise of the options or vesting of the units for up to five years if such election is made within 30 days after such rights vest or become transferable.  However, such a plan and election are not available to 1% owners or the four highest compensated officers. Individual Compensation Provisions Withholding. The IRS has issued new withholding tables that take effect no later than February 15, 2018. Furthermore, a withholding calculator is available at IRS.gov, which allows individuals to review and compare the amount of Federal taxes their employer is withholding on each paycheck to the withholding amount determined by the calculator. Filing a new W-4 tax form may be advantageous when an employee’s withholding amount (determined by the W-4 tax form the employer has on file) and the amount determined by the calculator vary. Doing so helps ensure the appropriate amount of Federal income taxes are being withheld from each paycheck. Recharacterizations. Recharacterizations can no longer be used to unwind a Roth IRA conversion. Further, contributions to a Roth IRA can no longer be recharacterized as a contribution to a traditional IRA. However, a taxpayer can recharacterize a current year traditional or Roth IRA contribution to the other type of contribution before the due date for the individual’s return (the IRS issued an FAQ on January 18, 2018, that states 2017 conversions can be recharacterized until October 15, 2018). Retirement plans – rollover of qualified plan loan offsets. The deadline to avoid having a qualified plan loan be treated as a taxable distribution because of an individual’s separation from service or in the event of plan termination has been extended from 60 days to the due date for filing an individual’s Federal income tax return (for the tax year the loan offset occurs). If the plan permits, employees may also rollover the loan balance to an eligible retirement plan by the same deadline. SNAPSHOT COMPARISON: NOTABLE PROVISIONS Note: (1) highlighted areas indicate items of change from prior proposals in the Senate’s bill and (2) provisions noted as expiring will revert to current law at the start of the specified year. It appears almost certain that the Act will be signed into law by year-end and will have a significant effect on individuals and businesses at all income levels for years to come. Mezrah Consulting will continue to report on any changes in tax provisions and, more specifically, any taxation regarding deferred compensation plans that could impact the executive and/or the company. As always, thank you for your relationship and confidence. It is appreciated.

February 3, 2015 SUMMARY: The Administration’s 2016 Budget renews many prior proposals relating to retirement plans and adds a few new provisions, including (1) limiting the total accrual of certain retirement benefits; (2) eliminating “stretch” payments; (3) allowing 60-day rollovers by non-spouse beneficiaries; (4) simplifying the required minimum distribution rules; (5) implementing mandates and financial incentives for employers to provide retirement plans; (6) facilitating annuity portability; (7) requiring employers to cover long-term part-time workers; and (8) limiting Roth conversions to pre-tax contributions. The retirement plan-related provisions of the 2016 Budget are almost identical to those contained in the President’s budget and revenue proposals for FY2015, with a few revisions, although several new provisions have been added. The following is a description of the most significant renewed or newly-introduced retirement plan-related proposals. RENEWED PROVISIONS Limitation on the Total Accrual of Certain Retirement Benefits. The 2016 Budget would limit the maximum amount an individual could accrue in the aggregate under all IRAs and qualified retirement arrangements in which he or she participated. This limit applies to IRAs and to qualified plans, 403(b) annuities, and funded 457(b) arrangements, regardless of the identity of the employer maintaining the arrangement. The 2016 Budget would limit the maximum accrual in any year to the actuarial value of a joint-and-100% survivor annuity beginning at age 62 in an amount equal to the maximum annual benefit that could be provided that year under a qualified defined benefit plan under Internal Revenue Code (“Code”) § 415(b). This annual amount is $210,000 for 2015, and the 2016 Budget estimates the current maximum accrual to be approximately $3.4 million. The limit, once reached, applies to any additional contributions and accruals, not to future investment earnings on plan and IRA account balances. Thus, earnings may allow total accounts to exceed this limit. In addition, if the participant’s accounts suffer investment losses or generate earnings less than the amount by which the limit is increased to account for inflation, such that the total aggregate value of all IRAs and plans subject to this rule drop below the maximum permissible amount, additional contributions or accruals can be made to bring the aggregate accrual to the limit. Comment: This limitation would affect high earners and individuals who have participated in qualified retirement plans and IRAs for many years and who derived substantial investment earnings on the amounts deferred under those arrangements. For these individuals, this limitation could shift their attention to other products, such as life insurance. This cap would be very complicated to administer and would significantly increase burdens on plan participants, who would face new obligations (such as obtaining an actuarial valuation of their aggregate retirement savings). Individual participants would bear the onus for complying with this limitation and would be required to remove amounts contributed to these retirement arrangements if the cap is exceeded. Employers also would need to cooperate with those plan participants who need to remove amounts from employer-sponsored plans. Elimination of “Stretch” Payments. Currently, the required minimum distribution (“RMD”) rules applicable to qualified plans and IRAs allow plan/account distributions made after the death of the plan participant or IRA holder to be made over the life expectancy of the designated beneficiary, thereby “stretching” out the period of distribution and, therefore, the deferral of taxation on distributions. Under the 2016 Budget, distributions to non-spouse beneficiaries of qualified plan accounts or IRAs would be required to take a distribution of the entire inherited account balance within five years. Exceptions to this rule apply in limited circumstances to any beneficiary who, as of the date of the participant’s death, is: (1) disabled, (2) a chronically ill individual, (3) an individual not more than ten years younger than the participant or IRA holder, or (4) a minor child (but the exception applies only until the child reaches majority). Comment: This provision also has appeared in recent proposed legislation. Its enactment would eliminate stretch IRA planning and the appeal of Roth conversions (because why incur income tax now when the deferral benefits will be limited to only five years?), but it may increase the attractiveness of life insurance (i.e., if the IRA funds will ultimately be taxed anyway, it may make sense to place the money into annuities, life insurance, or an irrevocable life insurance trust). Allow All Inherited Plan and IRA Balances to Be Rolled Over within 60 Days. Currently, transfers of amounts inherited by surviving non-spouse beneficiaries under an employer retirement plan or IRA are transferrable to a non-spousal inherited IRA only by a direct rollover or trustee-to-trustee transfer. The 2016 Budget would expand the roll-over options for these beneficiaries by allowing 60-day rollovers of such assets. The liberalized rollover treatment would be available only if the beneficiary informs the new IRA provider that the IRA is being established as an inherited IRA so that the IRA provider can title the IRA accordingly. Simplification of RMD Rules. RMDs must be taken from qualified plans and IRAs (but not Roth IRAs) shortly after the plan participant has both terminated employment with the plan sponsor and attained age 70-1/2. In addition, RMDs must be made to 5% owners of the plan sponsor without regard to termination of employment, and complicated rules apply to distributions made after a participant’s death. The 2016 Budget would eliminate RMDs to an individual if, as of a measurement date, the individual’s aggregate value of IRA and tax-qualified plan accumulations (disregarding the value of any defined benefit plan benefits that have already begun to be paid in any life annuity form) does not exceed $100,000, and the RMD requirements would phase in ratably for individuals with aggregate benefits between $100,000 and $110,000. In addition, the 2016 Budget would make the RMD rules, subject to the exemption described above, applicable to amounts held in Roth IRAs. Relatedly, individuals could not make additional contributions to Roth IRAs after attaining age 70-1/2. Comment: This provision likely would have no effect on many taxpayers, because individuals who have actively and meaningfully participated in qualified plans and IRAs over the course of their working lives will have accumulated amounts in excess of the applicable threshold and, thus, will remain subject to the current RMD rules. Automatic Enrollment in IRAs and Financial Incentives for Small Employers to Provide Retirement Plans. The 2016 Budget would require employers who have been in business for at least two years and who have more than ten employees to offer an automatic IRA option, pursuant to which contributions would be made on a salary reduction basis unless the employee opts out. Employers offering a qualified retirement plan, a SEP or a SIMPLE to its employees would be exempt from this requirement, unless it excludes from participation in its existing arrangement employees other than those who are covered by a collective bargaining agreement, are under age 18, are nonresident aliens or have not completed the plan’s eligibility waiting period. In such a case, it would have to offer the automatic IRA arrangements to those excluded employees. The 2016 Budget also provides various financial incentives for employers to implement certain retirement plans or plan features. First, small employers (those that have no more than 100 employees) that offer an automatic IRA arrangement could claim a temporary non-refundable tax credit for the employer’s expenses associated with the arrangement up to $1,000 per year for three years. These employers would also be entitled to an additional non-refundable credit of $25 per enrolled employee up to $250 per year for six years. The credit would be available both to employers required to offer automatic IRAs and employers not required to do so (e.g., they do not have more than ten employees). Second, in conjunction with the automatic IRA proposal, to encourage employers not currently sponsoring a qualified retirement plan, SEP, or SIMPLE to do so, the non-refundable “start-up costs” tax credit for a small employer that adopts such an arrangement would be tripled from the current maximum of $500 per year for three years to a maximum of $1,500 per year for three years. The expanded credit would extend to four years (rather than three) for any employer that adopts a new qualified retirement plan, SEP, or SIMPLE during the three years beginning when it first offers (or first is required to offer) an automatic IRA arrangement. This expanded credit for “start-up costs” of small employers would be allowed against administrative costs and employer plan contributions. Like the current “start-up costs” credit, the expanded credit would encourage small employers to adopt a new 401(k), SIMPLE, or other employer plan and would not apply to automatic IRAs or other payroll deduction IRAs. Finally, small employers would be allowed a $500 credit per year for up to three years for new plans that include auto-enrollment. This credit would be in addition to the credit for “start-up costs.” Small employers would also be allowed a credit of $500 per year for up to three years if they added auto-enrollment as a feature to an existing plan. Elimination of Deduction for Dividends on Stock of Publicly Traded Corporations Held in ESOPs. Generally, a corporation is not entitled to a deduction for dividends it pays on its stock. However, an exception to this rule applies to certain dividends paid on stock held under a tax-qualified employee stock ownership plan (“ESOP”). The 2016 Budget would deny this deduction for stock held by an ESOP that is maintained by a publicly traded corporation. Comment: ESOPs have been afforded the dividend deduction and other incentives to employers to encourage employee investment in employer stock because that ownership has been considered to enhance employee productivity and company performance. The Administration questions whether the degree of employee ownership of employer stock provided through an ESOP in a publicly traded company is sufficient to bring about these benefits and, therefore, whether the sponsors of these ESOPs deserve to receive the dividend deduction. This provision, however, should not affect those sponsors who have established ESOPs as an efficient means of transferring ownership of all or a part of their business, because those transactions are rarely, if ever, effected by publicly traded companies. NEW PROVISIONS Facilitating Annuity Portability. The 2016 Budget would permit a plan to allow participants to transfer a distribution of a lifetime income investment through a direct rollover to an IRA or another retirement plan if the annuity investment is no longer authorized to be held under the plan, without regard to whether another event permitting a distribution (such as a severance from employment) has occurred. In other words, a person holding an annuity contract in his or her qualified plan account, which the plan no longer allows, could take a distribution of that annuity contract and roll it over to an IRA even if the participant is not otherwise entitled to a plan distribution. The distribution would not be subject to the 10% additional tax on early distributions, regardless of the participant’s age or circumstances at the time of distribution. By requiring the distribution to be accomplished through a direct rollover to an IRA or another retirement plan, the proposal would keep assets within the retirement system to the extent possible. Comment: The provision is intended to enable a participant to retain his or her annuity investment and not have to liquidate it simply because a plan no longer permits the investment. It reflects the Administration’s targeted efforts over time to enhance the extent to which defined contribution retirement plans offer distribution alternatives that provide a lifetime stream of income. Require Retirement Plans to Allow Long-Term Part-Time Workers to Participate. The 2016 Budget would expand access to employer-sponsored retirement plans for part-time employees by requiring employers with retirement plans to permit employees who have worked for the employer for at least 500 hours per year for three or more consecutive years to make voluntary contributions to the plan. The proposal would also require a plan to credit, for each year in which such an employee worked at least 500 hours, a year of service for purposes of vesting in any employer contributions; the proposal does not, however, require the employer to make contributions on behalf of these employees (though it is unclear how these part-time employees would be required to be treated for purposes of applicable non-discrimination testing). Limit Roth Conversion to Pre-Tax Dollars. Taxpayers are eligible to make contributions to a Roth IRA only if their modified adjusted gross income does not exceed an established threshold. There is no similar limit on a taxpayer’s ability to contribute to a traditional IRA, though contributions by individuals earning in excess of a specified threshold are made on an after-tax basis. Also, there are annual limits on the amount that can be contributed during any year to a designated Roth account under a qualified plan, but there is no similar limit on the amount that can be contributed to the plan, if the plan allows, on an after-tax basis. Individuals can convert amounts held in a traditional IRA to a Roth IRA. Similarly, if a plan so allows, a participant can convert amounts held on his or her behalf under the plan into amounts held in a designated Roth account. The 2016 Budget would allow Roth conversions only with respect to amounts that would be includible in income if the amounts were distributed to the individual. Thus, the proposal would prohibit Roth conversions of amounts contributed to IRAs or qualified plans on an after-tax basis so that taxpayers would be precluded from circumventing restrictions on their ability to make Roth contributions in the first instance. Expand Penalty-Free Withdrawals for Long-Term Unemployed. Early withdrawals from a qualified retirement plan or an IRA are subject to a 10% additional tax unless an exception applies. One exception is for an IRA distribution after separation from employment if, among other things, the aggregate of all distributions made in each year in the two-year period that includes the period during which the individual received unemployment compensation for at least 12 weeks does not exceed the premiums paid during the taxable year for health insurance. This exception applies only to distributions from IRAs; it is not available for distributions from a qualified retirement plan. The 2016 Budget would expand this exception from the 10% additional tax to cover more distributions to long-term unemployed individuals from an IRA, not just those sufficient to cover the cost of health insurance coverage. The exception would also apply to distributions from a 401(k) or other qualified defined contribution plan. An individual would be eligible for this expanded exception with respect to any distribution from an IRA or qualified defined contribution plan if: (1) the individual has been unemployed for more than 26 weeks by reason of a separation from employment and has received unemployment compensation for that period (or, if less, for the maximum period for which unemployment compensation is available under State law applicable to the individual), (2) the distribution is made during the taxable year in which the unemployment compensation is paid or in the following taxable year, and (3) the aggregate of all such distributions does not exceed specified limits. Repeal of Exclusion for Net Unrealized Appreciation in Employer Securities. If a participant receives a distribution from a qualified plan that includes shares of the stock of the employer maintaining the plan, some or all of the net unrealized appreciation (“NUA”) in the employer securities is excluded from the participant’s gross income in the year of the distribution. NUA is the excess of the market value of the employer stock at the time of distribution over the cost or other basis of that stock to the trust. NUA is generally taxed as a capital gain at the time the employer stock is ultimately sold by the recipient. The 2016 Budget would repeal this exclusion from gross income for participants who had not yet attained age 50 as of December 31, 2015; older participants would be unaffected by this proposal. Require Form W-2 Reporting for Employer Contributions to Defined Contribution Plans. The 2016 Budget would require employers to report on an employee’s Form W-2 for any taxable year the amount of all contributions made on the employee’s behalf to a qualified defined contribution retirement plan. The Administration believes that this change would provide individuals with a better understanding of their overall compensation and retirement savings. In addition, it is thought to facilitate compliance with the annual limits on allocations under defined contribution plans. TAKE AWAYS The Administration’s proposals may face strong legislative resistance by Republican Congressional majorities, particularly to the extent any provisions are characterized as constituting a tax increase. These proposals are important, however, because they may indicate significant changes to the laws affecting retirement plans and related financial planning, particularly if tax reform efforts gain steam. Because these provisions could affect AALU members who consult on retirement plan administration and/or financial planning relating to retirement plans, AALU will remain vigilant in monitoring of legislative activity and interacting with those who will craft pertinent legislation. Mezrah Consulting will continue to keep you apprised of any further information relating to tax reforms targeting high net worth individuals. Your business and confidence are appreciated. Source: AALU, February 2015</> #Tax