Tapping retirement money is a great way to fund a startup—if it doesn’t violate tax rules.
As the credit crisis has made it tougher for small businesses to get funding, some would-be entrepreneurs have exploited a loophole that lets them finance a startup with 401(k) retirement funds without facing any taxes or penalties. Now the technique is catching the attention of the IRS, which plans to step up audits of such transactions. “We are seeing problems,” says Monika Templeman, acting director of employee plans at the IRS. “It is open to abuse.”
The transactions typically require an entrepreneur to create a new corporation, establish a 401(k) plan for it, and move existing 401(k) funds into the plan. Money from the new 401(k) is used to buy shares in the new company, and that provides the business with capital while retaining the tax advantages of the 401(k). Without such a rollover, funds withdrawn from a 401(k) are subject to income taxes. A 10 percent penalty applies if the funds are withdrawn by a person under the age of 59 1/2. Templeman says the IRS has seen questionable valuations for the new stock, and in a few cases the money was used to buy recreational vehicles and other personal assets.
While financial advisers began promoting such rollovers in the early 1990s, the credit crisis has made them more attractive. This year at least 4,000 people are likely to use the strategy, an increase over previous years, according to companies that help craft the plans. The typical transaction involves between $100,000 and $200,000 in retirement funds. Advisers charge about $5,000 for the paperwork, plus annual fees of at least $800 to run the new 401(k) plan. “When you start comparing it with a 15 to 20 percent interest rate on a loan…people are saying ‘I’d rather be my own investor,’ ” says Jeremy Ames, chief executive of Guidant Financial Group, a Seattle company that helps business owners roll over 401(k)s.
Ames and other advocates of the rollovers say their transactions are legal. That doesn’t mean the IRS will see it that way. Stephen Dobrow, president of benefits consultancy Primark Benefits, says even plans the IRS has examined may face renewed scrutiny. The IRS, he says, “can still blow up those plans even though they’ve passed on them once.”
The bottom line: Using 401(k) funds to finance startups got more popular during the recession, but some of the transactions may violate tax law.
Amy Feldman – associate editor with Bloomberg Businessweek in New York.
The Internal Revenue Service will once again host a special nationwide open house on Saturday, June 5 to help taxpayers solve tax problems and respond to notices from the IRS.
Approximately 200 IRS offices, at least one in every state, will be open June 5 from 9 a.m. to 2 p.m. local time. IRS staff will be available on site or by telephone to help taxpayers work through their problems –– especially recently received tax notices –– and walk out with solutions.
“We’ve helped thousands of taxpayers resolve their problems the same day at these open houses,” IRS Commissioner Doug Shulman said. “If you have a question regarding a notice, a problem with your taxes or difficulty resolving a tough tax issue, we encourage you to come in and work with us.”
IRS locations will be equipped to handle issues involving notices and payments, return preparation, audits and a variety of other issues. At a previous IRS open house on May 15, close to 7,000 taxpayers sought and received assistance. About 97 percent of the taxpayers who came in for help had their issues resolved the same day.
At the June 5 open house, someone who has received a notice seeking additional information can speak with an IRS employee to get a clear explanation of what is necessary to satisfy the request. A taxpayer who cannot pay a tax balance due can discuss with an IRS professional whether an installment agreement is appropriate and, if so, fill out the paperwork then and there. Assistance with offers-in-compromise — an agreement between a taxpayer and the IRS that settles the taxpayer’s debt for less than the full amount owed — will also be available. Likewise, a taxpayer struggling to complete a certain IRS form or schedule can work directly with IRS staff to get the job done.
The open house on June 5 is the second of three events scheduled after tax season this year. The first was held on May 15. The next event, previously scheduled for Saturday June 26, will be held later this fall. Details regarding that event will be available later.
Why is Planning for Retirement Important? Check out the NFS June Financial Facts.
The summer travel season is almost upon us. Keep in mind that if your summertime travel is primarily for business or career-related education, then a portion of the trip may be tax-deductible. As long as most of your travel days are for business purposes, you can deduct the cost of travel (airfare, trains, car), hotel, parking, taxi service, meals, and so on.
As defined by the IRS, travel expenses are the Ordinary and Necessary expenses of traveling away from home for your business, profession, or job. An Ordinary expense is one that is common and accepted in your field of trade, business, or profession. A Necessary expense is one that is helpful and appropriate for your business. An expense does not have to be required to be considered necessary.
The key factor is that your trip must be primarily for business. Days of leisure can be added to a trip and still be considered primarily for business. The more days and time per day spent on business will help substantiate the trip. There are no set rules on how many days and how much time per day need to be spent on business for your trip to be considered business related.
Keep all the documentation for business-related travel, including confirmations of appointments, emails, phone records, registration to conferences, etc. The days spent traveling to and from a business trip are considered part of the trip. This includes the weekend if it is impractical to come home between weekday business meetings. Planning ahead can make this happen.
Traveling with Your Spouse
If a spouse goes with you on a business trip or to a business convention, his or her travel expenses can only be deducted if your spouse
- is your employee,
- has a bona fide business purpose for the travel, and
- would otherwise be allowed to deduct the travel expenses.
To be an employee, your spouse must be on the payroll and payroll taxes must be paid. If your spouse is not an employee and travels with you on vacation, you can still deduct the cost of your room at the single-occupancy-per-day rate, rather than half the rate. Meals could also be deductible. If you are paying for lunch or dinner for a customer or business associate and that person’s spouse, the full cost of the meals might qualify under the 50% meal deduction. Let us know if you’re unclear on this deduction; we can give you the details.
- Example: Bill drives to Boston on business and takes his wife, Joan, with him. Joan is not Bill’s employee. Joan occasionally types notes, performs similar services, and accompanies Bill to luncheons and dinners. The performance of these services does not establish that her presence on the trip is necessary for Bill’s business. Her expenses are not deductible. Bill pays $199 a day for a double room. A single room costs $149 a day. He can deduct the total cost of driving his car to and from Boston, but only $149 a day for his hotel room. If he uses public transportation, he can deduct only his fare. Further, if Bill has dinner with a customer and spouse, the meal may be deducted under the 50% meal deduction.
With travel outside of the United States, the transportation for business trips of one week or less may be deducted. However, only a portion of transportation costs for longer trips are deductible.
- Example: You live in New York. On May 4 you flew to Paris to attend a business conference that began on May 5. The conference ended at noon on May 14. That evening you flew to Dublin where you visited with friends until the afternoon of May 21, when you flew directly home to New York. The primary purpose for the trip was to attend the conference. If you had not stopped in Dublin, you would have arrived home the evening of May 14. You did not meet any of the exceptions that would allow you to consider your travel entirely for business. May 4 through May 14 (11 days) are business days and May 15 through May 21 (7 days) are non-business days.You can deduct the cost of your meals (subject to the 50% limit), lodging, and other business-related travel expenses while in Paris. You cannot deduct your expenses while in Dublin. You also cannot deduct 7/18 of what it would have cost you to travel round-trip between New York and Dublin.You paid $450 to fly from New York to Paris, $200 to fly from Paris to Dublin, and $500 to fly from Dublin back to New York. Round-trip airfare from New York to Dublin would have been $850. You figure the deductible part of your air travel expenses by subtracting 7/18 of the round-trip fare and other expenses you would have had in traveling directly between New York and Dublin ($850 – 7/18 = $331) from your total expenses in traveling from New York to Paris to Dublin and back to New York ($450 + $200 + $500 = $1,150). Your deductible air travel expense is $819 ($1,150 – $331).
What Expenses Are Deductible?
Here’s what you can deduct when you travel away from home for business.
You can deduct Transportation Expenses when you travel by airplane, train, bus, or car between your home and your business destination. If you were provided with a ticket or you are riding free as a result of a frequent traveler or similar program, your cost is zero. If you travel by ship, additional rules and limits apply.
Taxi, Commuter Bus, Subway, and Airport Limousine Fares
You can deduct the fares for these and other types of transportation that take you between
- the airport or station and your hotel, and
- the hotel and the work location of your customers or clients, your business meeting place, or your temporary work location.
Baggage and Shipping Expenses
You can deduct the cost of sending baggage and sample or display material between your regular and temporary work locations.
You can deduct the cost of operating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard mileage rate, as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses.
Lodging and Meals
You can deduct your lodging and meals if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. Meals include amounts spent for food, beverages, taxes, and related tips. Additional rules and limits may apply.
You can deduct the dry cleaning and laundry expenses you incur while away on business.
All business calls while on your business trip are deductible. This includes business communication by fax machine or other communication devices.
You may deduct the tips you pay for any expense listed above.
You can deduct other similar ordinary and necessary expenses related to your business travel. These expenses might include transportation to or from a business meal, public stenographer’s fees, computer rental fees, or Internet access fees.
If you have any questions on your “Summer Travel Tax Deductions”, please contact my office.