GreenTrader Weblog

STATE LAW CHANGES

Several large states - which traders also happen to call home - have repealed taxes or made other important changes that traders should know about.

This GreenTrader state tax alert includes news about Florida’s intangible tax, California’s LLC user fee, Texas’s franchise tax on entities, and New York State LLC publishing requirements.

Florida

Florida’s Senate repealed the intangible personal property tax effective January 1, 2007, and Florida Governor Bush indicated he would sign this repeal.  Learn more about the current tax here http://www.myflorida.com/dor/taxes/ippt.html.

 

The current tax rate was cut in half in 2005, and it is assessed on non-cash portfolios at year end. Most traders avoid this tax by going to cash at year end. With its coming full repeal, sunny Florida becomes even more of a tax-free state, with no income tax or intangibles property tax.

Florida is very popular with traders; Florida entities are very inexpensive to form and maintain, and also have zero pass-through entity-level income taxation.

Come visit us at the Traders Expo in Ft. Lauderdale, Florida on June 7.  Learn more here http://www.greencompany.com/EducationCenter/InteractiveTradeShows.shtml.

California

California has the highest income tax rates for individuals.

For traders interested in entities, California also has high annual minimum taxes ($800), plus some nasty stealth taxes on pass-through entities like LLCs and S-Corps.

Traders consider entities for late year MTM elections, retirement plan and health insurance premium deductions, and other good reasons. Learn more here http://www.greencompany.com/Traders/TraderEntities.shtml.

 

The entity of choice in California for business traders only is the general partnership.  It lacks liability protection on the entity level, but the good news is that traders don’t usually need that. Plus, there are no minimum taxes of any kind. 

The next best entity of choice for business traders is the LLC. You have entity-level protection, but you pay for that with the $800 annual minimum tax, plus there is a sneaky LLC user fee. See LLC user fee information here http://www.ftb.ca.gov/law/legis/01_02bills/ab898_050101.pdf. The fee has been reduced over the years.

Currently, if your income is between $250,000 and $500,000, the LLC user fee is $900, which is not too bad. There also has been confusion about whether the income number applies to trading proceeds (which can be huge for traders) or net trading gains (the real income). We have determined that it applies to the trading gain amount. 

Good news alert. Recently, a California court ruled that the California LLC user fee is unconstitutional. Of course, California is expected to fight this decision; so don’t count your chickens until they are hatched. It is advised to file refund claims now.

California S-Corps owe a 1.5% franchise tax, so traders often skip S-Corps in CA. There is no sense in paying that franchise tax on capital gains, which rate applies with or without mark-to-market accounting.

S-Corps are useful to reduce payroll or self-employment (SE) taxes, but these taxes don’t apply to most traders (who are exempt from self-employment tax) on trading gains. Only traders that are members of options or futures exchanges owe SE tax.

Money managers absolutely need entity-level liability protection, so we recommend LLCs or S-Corps for them. It depends on whether they get incentive fees or profit allocations; the former is subject to self employment taxes in LLCs, and the latter is not. Conversely, S-Corps do not pass through earned income, so they are useful when incentive fees are collected, as opposed to profit allocations. Learn more about the difference here http://www.greencompany.com/HedgeFunds/OffDocGTTTaxStrategies.shtml. 

Texas

Texas probably is the largest individual tax-free state, and many traders call it home. Like similar states not taxing individuals (e.g., Washington state), Texas has taxed entities to help balance their budget.

Good news alert. Texas just passed significant relief to its franchise tax on entities, providing for lower tax rates, higher hurdle rates for triggering the tax, and some additional exemptions. The new law seems to help small businesses more.

Currently, Texas assesses a franchise tax on all entities other than general and limited partnerships, which remain exempt in the new law as well. Traders often choose general partnerships to avoid the tax, and money managers choose the limited partnership, as they need liability protection.

The Texas franchise tax kicks in if your entity has “receipts” (or revenues) of $150,000 or more. Trading gains (with or without MTM) equate to receipts, not trading proceeds.

Once you trigger the Texas franchise tax, all net income is subject to a tax rate of 4.5%. You can reduce the tax with expenses, including guaranteed payments or salaries to owners.

The rule changes take effect January 1, 2008, and the hurdle (receipts) rate is raised to $300,000 from $150,000, so fewer companies will trigger this tax. The franchise tax rate also is reduced to 1%.

New York Sate

New York State has made its publishing requirement for LLCs & LPs mandatory, effective June 1, 2006. Corporations and general partnerships have no publishing requirement in New York State.

The cost for publishing in a compliant manner is approximately $1,200, which includes two newspapers. It costs less to get compliant for older LLCs.

In the past, many business traders – as opposed to money managers – skipped the LLC publishing requirement to save money. They figured they did not need court protection, as they have no customers.

Money managers need liability protection, and they should be compliant with New York State LLC publishing rules. For their business plans, the added $1,200 publishing cost is reasonable.

Unless you formed your LLC in NYS before Jan 1, 1999, you should consider publishing in one paper, rather than the normal two required papers, before the June 1, 2006 deadline in order to become compliant (and grandfathered) under the new rules. Otherwise, you chance possible suspension. Pre-1999 LLCs can skip the publishing requirement and still be grandfathered.

It’s not yet clear what the consequences of suspension are for noncompliance on the publishing requirement.

With suspension, existing business trader LLCs may remain on similar ground, not being able to use the court system. There is no mention in the law about fines or closing non-compliant LLCs. Worst case: Business traders can close their LLCs and form general partnerships or S-Corps.

LLCs user fees in New State are $250 per partner, whereas general partnerships have zero taxes on the entity-level.

Contact us for more information about your situation. We also can arrange your LLC publishing at low rates.

In New York State, the S-Corp is a good alternative to the LLC, except if you live and work in New York City. New York City does not acknowledge S-Corps and instead treats them as C-Corps subject to high entity-level tax rates. C-Corps often avoid double taxation by paying salaries to owners, but New York City also has an alternative tax, which prevents complete avoidance of double taxation in this manner.

 

LLCs are subject to New York City UBT taxes of 4%; but if trading is your only income in the LLC, then you are exempt from NYC UBT taxes. If you mix in some commission income or advisory fee income, you subject the LLC to UBT tax on all income including trading gains.

 

State taxation is complex for all taxpayers, but there are special twists and strategies that are best for business traders and money managers. GreenTrader can help you get the best results.

We hope to hear from you soon.

 

Take care,
Robert A. Green, CPA & CEO
Customer Service: 877-662-2014 (toll-free), or 646-216-8061
Author of The Tax Guide for Traders published by McGraw-Hill
Green & Company CPAs, LLC www.greentradertax.com www.greencompany.com
GreenTraderLaw PLLC www.greentraderlaw.com (non-lawyer member)

skype address: rgreencpa

 

A trader wins an important case in Tax Court about mark-to-market accounting.

L.S. Vines, (May 11, 2006) 126 TC No. 15.

The Tax Court reversed the IRS denial of a taxpayer's private letter ruling request for an extension on filing a mark-to-market accounting election IRC 475(f). The Tax Court said the taxpayer acted reasonably and in good faith and the IRS's interests won't be prejudiced.

Chalk up one big Tax Court victory for business traders in dealing with the IRS and this may help turn the tide in favor of business traders in future dealings with the IRS.

What’s this Tax Court case all about?

Many traders missed the April 15 due date for the current year mark-to-market (MTM) IRC 475(f) election. Without MTM, traders are stuck with "capital loss" treatment and cannot deduct their trading losses as "ordinary losses." This significantly reduces a trader’s opportunity for net operating loss refunds.

If you act by Oct. 15, you may be able to receive an extension of time to file your current year MTM election. Reg § 301.9100-1 "Extensions of time to make elections" provides relief for late elections. Note the maximum extension period is six months. The MTM election due date was April 15, so the extended due date is Oct. 15.

To file the MTM extension, a trader needs to file a private letter ruling (PLR) to elect mark-to-market accounting (MTM) IRC 475 within six months of the election deadline.

Before this latest Tax Court victory, we used to say the following: The PLR procedure is painstaking and expensive, and for traders seeking relief to use MTM, the chance of success is extremely small. To date, the IRS website has published only a few PLRs for traders seeking to use MTM, and the IRS has denied all of these PLRs.

Hurray! This recent Tax Court case victory overturns the IRS, and the Tax Court goes further in chiding the IRS to do a better job in defining the PLR requirements for MTM extensions.

The Tax Court tells the IRS to better define things.

In the Vines TC ruling, the Tax Court instructed the IRS to better define their rules for MTM election extensions using PLRs.

The court further indicated the IRS no longer may overplay their “prejudice” argument to deny extension requests, which has been the case to date for all such IRS rulings on the subject. 

In this writer’s opinion, the prejudice argument can be structurally flawed. Consider that almost every taxpayer request involves a refund; doesn’t that prejudice the government’s position?

It must be prejudice with hindsight.

This case better defines the law. Prejudice alone is not enough; hindsight by the taxpayer must be established by the IRS.

Here is an example of clear taxpayer hindsight that would prejudice the government’s position.

A trader has trading gains for the year-to-date period ending April 15, the date when the MTM election is due. The trader figures he does not need MTM and decides to skip the MTM election on the due date. The trader goes on to lose prior gains and then figures he can benefit from MTM for the entire tax year. The trader files an MTM extension filing using the PLR process before the due date of October 15.

In this example, the IRS can easily argue that the trader, using hindsight, changed his mind, and the government’s position is prejudiced with that hindsight. 

Note that the Vines case is the reverse of the above example. Vines did not trade after April 15; he lost his money before April 15. Therefore, Vines did not use hindsight. 

There are other factors that come into play as well.

Reading between the lines of this Tax Court decision may provide additional leeway to traders in seeking MTM extension filings.

Unless a taxpayer clearly appears to be using hindsight to prejudice the government’s case, there may be more room to win relief filings. 

We recommend that you consult with our firm to study your case and determine the best options to proceed. Learn more about private letter rulings for this type of relief here: http://www.greencompany.com/EducationCenter/GTTRecMTMprivateletterruling.shtml.

We may be able to develop a winning strategy for your case. 

If we feel you don’t have a winning case for a private letter ruling for late MTM election relief, consider achieving MTM in other ways.

For example, you may form a new entity like an LLC, which is a “new taxpayer” and may elect MTM internally within 75 days of inception, but that election will apply for the balance of the tax year only. 

Consider also a defacto husband-wife general partnership, which may apply from the start of the tax year. Learn more about entities for traders here: http://www.greencompany.com/Traders/TraderEntities.shtml.             

If you have any questions about MTM, MTM extensions, private letter rulings, or entities, email us at info@greencompany.com, or call us at 877-662-2014 (toll-free) or 646-216-8061.

Roth IRAs may be expanded

Update on May 12, 2006.

The tax bill passed and there is good and bad news here. The waived income limit on Roth IRA conversions break was included, but the start  date is 2010 only.

==============================

May 3, 2006

Today's Wall Street Journal (5/3) reported that a temporary new tax deal is in the works to allow Roth IRA conversions without regard to an income limit for a one or two year period. Get it while it’s hot!

The current tax law only allows Roth IRA conversions if a taxpayer’s income is under $100,000; which rules out many wealthier taxpayers.

What’s the allure of a Roth IRA? Convert a tax-deferred retirement plan into a permanently tax-deferred retirement plan, simply by converting a regular retirement plan into a Roth IRA.

With regular retirement plans, you only defer taxes until your retirement years. When you can least afford to pay high taxes, you are forced to pay taxes on your retirement fund distributions. Plus the way the budget problem is going; Congress may be forced to raise tax rates just when you retire. Consider that tax rates are at historic low rates and the tide is turning back towards higher rates. 

Conversely, with a Roth IRA, you benefit from permanent tax-deferral as opposed to only timing benefits with regular retirement funds.

There are some catches with Roth IRAs and conversions but they remain the best deal in town for many taxpayers.

You don’t get tax deductions for Roth IRA contributions, since you don’t pay taxes later on the distributions. That’s fair.

When you convert a regular IRA to a Roth IRA you need to square up with the IRS and your state. The converted amount (less any basis) is treated as an “early withdrawal” and subject to income tax. But consider that you are paying at the current low tax rates which may be increased soon. Most importantly, all future build up in the accounts will be permanently tax-free. 

Unlike other early withdrawals from retirement plans, the Roth IRA conversion is not subject to that nasty 10% excise tax penalty.

As far as the federal and state governments are concerned, Roth IRA conversions are a good deal of sorts and a quick fix. They plug immediate revenue shortfalls in exchange for future shortfalls.

For the Bush White House and GOP it's a master stroke in the tax change battles!
The GOP could not successfully change the tax code to free up portfolio income from taxation; although they tried hard on a number of occasions. 

Now with this simple nonchalant rule change, the GOP may be achieving tax change victory.

It’s a master stroke in the face of widespread Democratic opposition to tax changes at this stage of Bush’s precarious political life.

Consider why. The Bush White House has been pushing hard for “loud” tax change to free portfolio income from income taxation. In 2003, the GOP tried to free qualifying dividends from taxation. As a negotiated compromise to tax war, qualifying dividends were afforded long term capital gains rates and those rates were also reduced to 15% from 20%. 

This move makes great sense. Ask yourself, what is permanently tax-free now and the answer is Roth IRA accounts. By relaxing the income test rule for Roth IRA conversions, wealthy (GOP type) taxpayers can free up their retirement plan portfolio income growth from future taxation. Bingo the same desired result! 

This “soft” rule change is not “loud” and it therefore it should not awaken a public outcry. But it can be just as effective; minus the political kudos’ points.

Its smart tax negotiations for the GOP. Currently, they don't have the political capital to continue pushing their prior tax change agenda, so going through a back door makes more sense. The Roth IRA conversion tax payments may be a good tease to win Democratic approval. 

This rule change will be great news for traders.
Traders usually outperform other types of taxpayers in trading and growing their retirement plan accounts. With Roth IRAs, traders have a good opportunity to actively trade for profit in these accounts with zero future taxation.

URL for this WSJ article:
http://online.wsj.com/article/SB114661294217641978.html

For more about retirement plans for traders, see http://www.greencompany.com/Traders/TraderRetirement.shtml

If you have questions about Roth IRAs and retirement plans, consider a consultation with our firm.

Thank you.

Robert A. Green, CPA & CEO
GreenTrader companies