Friday, February 27, 2009

Importance of Filing a Gift Tax Return


By Richard Bell

The names have been changed to protect the innocent. This is a real life situation with some facts altered, if questions consult our firm, or your attorney.

Our CPA firm represents a large number of first generation small businesses, which were started by a 2nd mortgage on their house, or maxing out all credit cards.

Sometimes in establishing these companies, the parents use labor called children to work in the business. Most businesses start off as proprietorships and summary of income and expenses show up on Form 1040 Schedule C for several years till the business gets off the ground. When the business turns profitable, usually year 3 to 5, mom and dad, want to share the fruits of their labor with the son or daughter, who may or may not have a spouse. A parent will consult their attorney and transfer the asset/liabilities to a new corporation or limited liability company, which is now owned by mom, dad, brother, and sister in some percentage amounts. The company continues to grow, brother and sister, now have brought precious goods called grandchildren into the world, and all is blissful in the Garden of Eden, i.e. the corporate business. Things then go awry, the brother or sister and their spouses split up and file for divorce. The spouses ask for all prior year tax returns and financial statements on the family business, and a demand is made on the brother or sister by the ex-spouse to be, that the share of stock or LLC interest is now or will be owned by the ex-spouse, unless the company or child is willing to buy out the ex-spouse interest, under state law, which states that except for gift or inheritance, the stock certificate acquired during marriage is marital property and is split down the middle 50/50. The parents and children usually will have no desire to be partners or owners with ex’s , so it is down to the bank, to make a loan, to redeem the ex’s share of the stock or interest, which depletes the equity and working capital of the business, and is paid with after tax dollars.

While our CPA firm does not handle marriage counseling as a service, we could have recommended and insisted that the parents file gift tax returns, at the time that the proprietorship was changed to a corporation or LLC. This would have put all future stakeholders on notice that the ownership was obtained by gift. The attorney for the child, who owned part of the business, could have argued then that the stock was not marital property.

Often times we do not go the extra step to cover all basis, especially when we are broke, and starting a new business.

Wednesday, February 25, 2009

Raiding your 401(k) to Refinance

Clip from the Wall Street Journal – Tuesday, February 24, 2009

Raiding your 401(K) to Refinance

Mortgage brokers say that some of their clients are reaching into their retirement savings to “buy down” the principal on their mortgage in order to qualify for a lower-cost loan or because they don’t have enough equity in their home to refinance. While early withdrawals may be viable as a last resort, financial planners generally discourage them.
Here are answers to some questions homeowners should be asking.

Q: When are borrowers allowed to take money out of a 401(k) account to buy down a mortgage?

A: Only under narrow circumstances. Borrowers can’t take money out of their 401(k) unless they quality for a “hardship withdrawal,” as outlined in a company’s policy. For homeowners, Internal Revenue Service guidelines stipulate that such withdrawals can be made only for a first-time home purchase or to prevent foreclosure on a principal residence. While the IRS doesn’t set a maximum withdrawal limit, companies generally won’t allow employees to take out more than is absolutely needed to stave off an emergency.

That means that borrowers looking to withdraw in order to refinance would have to demonstrate that, without the money they would go into foreclosure.

“It is truly be a last resort,” says Dean Kohmann, vice president of 401(k) plan services at Charles Schwab Corp.

Q: What are the costs of an early withdrawal?

A: Borrowers must pay taxes on early withdrawals from either a 401(k) or an individual retirement account, and borrowers younger than 59 ½ usually must pay a 10% penalty. If borrowers withdraw from a 401(k) they must wait six months before they can begin contributing to their 401(k) again.

Q: Are there alternatives to taking an early withdrawal?

A: Yes, Many companies allow employees to borrow from a 401(k). Those loans are limited to half the value of the account up to $50,000, and loans generally have to be repaid within five years with interest. One big risk: If the borrower leaves the company, the loan must be repaid to avoid owing taxes.

If a homeowner must borrow from a 401(k) account to refinance a mortgage, the decision should be “part of a well-though-out plan as opposed to a quick fix,” say Mr. Kohmann.

Loans or withdrawals shouldn’t merely postpone a foreclosure for a few months and remember: 401(k) accounts can’t be touched by creditors in the event of a bankruptcy-which means that borrowing money from such an account may cause you to forfeit protection.