Taxpayers are free to move money from one IRA to another, so long as they complete the transaction within 60 days. If they hold on to the funds for 61 days, they have a taxable distribution on their hands, and possible penalty taxes as well.

However, the IRS is authorized to waive the requirement if there is a good reason. Here are two actual cases, taken from private letter ruling requests submitted to the IRS last year.

Situation 1. Taxpayer 1 withdrew funds from his IRA, intending to roll them over, but was hospitalized during the subsequent 60 days and couldn’t complete the transaction within the time frame. In fact, he died soon after. Taxpayer 1’s executor then asked the IRS to waive the 60-day requirement so that she could complete the rollover (avoiding significant income taxes on Taxpayer 1’s final income tax return).

Situation 2. A certificate of deposit in Taxpayer 2’s IRA matured, and she put the funds into her checking account, intending to deposit them in another IRA that she owned. However, Taxpayer 2 was the sole caregiver for her husband, who suffered from a heart attack, a hip replacement, a series of seizures and a stroke, and so she had trouble staying focused on financial issues. What’s more, during the 60-day period Taxpayer 2’s daughter fell ill, was hospitalized and subsequently died. Taxpayer 2 asked the IRS to waive the 60-day rule.
In the private letter rulings, the IRS granted both requests.

The elements that the IRS takes into consideration when waiving he 60-day rule are outlined in Revenue Procedure 2003-16. Factors other than medical developments that may come into play include postal errors, errors by a financial institution, what was done with the money, and how much time has elapsed since the IRA withdrawal. Also, the IRS notes, the waiver does not apply to required minimum distribution amounts.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Most of James Mitchell’s fortune was held in his revocable living trust. Six days before his death in 2005, he transferred a 5% interest in two real estate properties to an irrevocable trust for his sons. The reason for the transfer was to keep the properties in the family at least until the sons reached age 45.
Mitchell had inherited a fortune from his father. After Mitchell’s death his executor discovered that the father had a collection of paintings that had been crated and placed in storage. Whether Mitchell was even aware of the paintings was unknown.
Mitchell’s estate filed a timely federal estate tax return, indicating a gross estate value of $17 million and a transfer tax of nearly $7 million. On audit the IRS sought to increase the value of estate assets substantially, resulting in a $10 million deficiency.
The value of two Western paintings, one by Frederic Remington and another by Charles Marion Russell, was one point of contention for the court to examine. The other was the value of the 5% gifted interest and the 95% retained interest in the real estate.

The real estate

The IRS did not challenge the transfer to the trust. Before trial the parties had agreed to stipulate the fractional interest discounts to apply to the gift and retained interests for each property. The disagreement was over the fundamental value of the properties, which were each unique. One was a single-family oceanfront property in a gated community in Montecito, California, near Santa Barbara. The other was a 4,065 acre ranch in Santa Ynez, California, one of the largest ranches in the area. One would be hard pressed to find comparable sales for either piece of real estate.
Fortunately, Mitchell had held both properties for their income value. Both were subject to long-term leases ($160,000 per year for the beachfront property). The estate used an income capitalization method to determine the value of the leases over their projected life and added the value of the reversionary interest expected at the end of the lease. The IRS argued that income capitalization is more appropriate for commercial property, not residential property. The Service instead offered a “lease buyout” valuation method, in which the estate would incur the expenses of breaking the lease to allow for a sale of the property.
The Tax Court held that the income capitalization method was appropriate because the properties were generating income. The lease buyout analysis has not been accepted by any court, nor is it generally recognized by real property appraisers.

The paintings

The estate’s art appraisers offered a value of $1.2 million for the Remington painting and $750,000 for the Russell. The IRS believed that the value should be double those figures.
To assist in situations such as this, the IRS has an Art Advisory Panel of 25 volunteer art experts to assist with difficult valuations. The panelists are not told whether an item is being valued for purposes of a charitable deduction or for measuring an estate tax obligation, thus ensuring their objectivity. In this case, the panel believed that the Remington had a maximum value of $850,000, and the Russell could be worth from $300,000 to $1 million.
However, the Service in this case rejected the recommendation of the Panel in favor of its own appraisers’ reports, believing that the Panel may have been inexperienced in Western art. However, the IRS experts didn’t have the requisite expertise either. In fact, the Tax Court noted, only the estate’s expert had credentials in that area.
The estate’s expert relied only on public sales and looked at a large pool of sales of Western art. The IRS appraiser looked at a smaller number of transactions, including private sales. Those private sales are poorly documented and less reliable, the Tax Court held. Ultimately, the estate’s position prevailed.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Two new taxes went into effect in 2013, as a result of the adoption of health care reform. An additional 0.9% Medicare tax applies to wages in excess of $200,000 ($250,000 for marrieds filing jointly). This applies to the employee only, not to the employer. For the first time, an element of the Social Security tax will not be applied at a flat rate.
Another first: Social Security taxes apply to investment income. For those whose adjusted gross income (AGI) is above $200,000 ($250,000 for marrieds filing jointly, $125,000 for marrieds filing separately), a 3.8% additional tax will apply to investment income above the threshold.

What is taxed, and what is not

“Investment income” includes interest, dividends, rents, royalties and capital gains. Pension income, IRA distributions and municipal bond income will not be hit by the 3.8% tax. The taxable portion of annuity payments will be subject to the tax unless they are part of a company pension plan.
Note that, because the income is keyed to adjusted taxable income, having substantial itemized deductions will not affect this tax—even if a loss is large enough to bring taxable income down to zero! Also, the capital gain on the sale of a personal residence could be taxed if it is larger than the $250,000 exclusion ($500,000 for couples).

Examples

John and Mary (example is fictitious) have pension and Social Security income of $80,000 and investment income of $170,000. They will not owe additional tax, because their total AGI is right at the threshold.
Now assume that the couple takes a $60,000 withdrawal from their IRA. IRA withdrawals are not hit by the 3.8% tax, but they will be added to the couple’s AGI. That pushes $60,000 of their investment income into the taxable zone.

Portfolio impact

Higher taxes could make municipal bond income even more. That could push up prices for muni bonds, driving down yields and increasing the spread compared to taxable instruments.
The opposite effect might be seen with dividend-paying stocks. Dividends will be less tax efficient than capital gains. If investors come to value dividends less highly, the prices of such stocks may suffer.
One way to take more control over one’s tax exposure is to convert traditional IRAs to Roth IRAs. That will eliminate the need for required minimum distributions from the IRA, which might trigger excess taxes. What’s more, distributions from the Roth IRA are potentially tax free, and as such, they would not increase AGI and the taxes on investment income.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

New estimates suggest that 70% of Americans who reach age 65 will, at some point, need extended health care. The U.S. Department of Health and Human Services projects that some 20% of retirees could require five or more years of such care. To pay for this care, many are turning to long-term care insurance (LTCI). However, these policies come with a profusion of confusing choices.

Here are five sample areas that you need to come to grips with before buying an LTCI policy. There are no right or wrong answers here. If one chooses all the most expensive approaches, the premiums could become unaffordable. A balancing of costs and benefits is needed, with a prudent regard for current and future resources.

Daily or monthly benefits. LTCI benefits are capped at some number of dollars per day for care. The testing for the cap may be done on a daily or a monthly basis. The different approaches may lead to markedly different benefit payments for a given set of circumstances.
Imagine that John’s policy has a $400-per-day benefit, calculated daily. He needs 15 days of care in a month, and the care costs $600 per day. John’s benefit will be limited to $6,000, the $400 times the 15 days.
Mary has a $400-per-day benefit, but it is calculated on a monthly aggregate basis. If she has the same 15 days of $600 expense for care that John has, her benefit will cover the entire $9,000 in expenses. In effect, she gets some credit for the days in the month with no expenses.

Elimination period. LTCI benefits typically start being paid after an “elimination period.” The period begins once an individual becomes unable to perform one or more of the activities of daily life as a result of injury or disease. Some policies define the elimination period in terms of service days, that is, days when services are received. Days when no services are received don’t count. Thus, if care is required only every other day, a policy owner will have to wait much longer before receiving benefits. A policy that does not link the elimination period to service days will begin paying benefits sooner.

Reimbursements versus cash benefits. Some policies reimburse the owners for expenses as they are incurred and submitted to the insurance company for approval. Others simply pay a stated cash benefit each month once the conditions for making the claim are satisfied. With the cash approach, the owner can use the money for expenses, such as copays, that usually are not covered in reimbursement plans.

Partial payment for home care. Some policies pay only 50% or 75% of the stated benefit if the care is received in the home. At first blush, this may seem reasonable because home care is much less expensive than care in a nursing home. But let’s say that an individual incurs $5,000 of monthly expenses for in-home care. With a 100% benefit, those costs would be covered in full. If the benefit is reduced by 50%, the policy owner must pay the $2,500 difference.

Cost-of-living adjustments. Although inflation has been pretty tame in recent years, health care costs have been rising steadily. Most observers expect health care costs to continue to grow in the coming years. Therefore, a cost-of-living feature can be a very important safeguard against having an LCTI policy provide inadequate benefits in the future. Alternatively, some advisors recommend the “guaranteed purchase option.” In this approach, there is no automatic inflation adjustment. Instead, the insured has the opportunity to increase benefits every three years without having to prove insurability. This approach postpones the higher premiums needed to support the higher benefits.

Over the course of our financial lives, we buy many types of insurance—life, auto, homeowner’s. By shopping for insurance over the years, we become familiar with the choices and tradeoffs. We might change policies many times. LTCI policies are different; most people will buy this policy only once. Therefore, it is especially important to read the fine print on any LTCI policy, or to work with an advisor who understands the ins and outs of these policies and can explain them to your satisfaction.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.