Spring is a great time to clean out that growing mountain of tax and financial papers that clutters your home and office. Here's what you need to keep and what you can throw out without fearing the wrath of the IRS.

Let's start with your "safety zone", the IRS statute of limitations. This limits the number of years during which the IRS can audit your tax returns. Once that period has expired, the IRS is prohibited from even asking you questions about those returns.

The concept behind it is that after a period of years, records are lost or misplaced and memory isn't as accurate as we would hope. There's a need for finality. Once the statute of limitations has expired, the IRS can't go after you for additional taxes, but you can't go after the IRS for additional refunds, either.

The Three-Year Rule

For assessment of additional taxes, the statute of limitation runs generally three years from the date you file your return. If you're looking for an additional refund, the limitations period is generally the later of three years from the date you filed the original return or two years from the date you paid the tax. There are some exceptions:

• If you don't report all your income and the unreported amount is more than 25% of the gross income actually shown on your return, the limitation period is six years.
• If you've claimed a loss from a worthless security, the limitation period is extended to seven years.
• If you file a 'fraudulent' return, or don't file at all, the limitations period never begins to run. The IRS can, in fact, get you at any time.
• If you're deciding what records you need or want to keep, you have to ask what your chances of an audit are. A tax audit is an IRS verification of items of income and deductions on your return. So you should keep records to support those items until the statute of limitations runs out.

Assuming that you've filed on time and paid what you should, you only have to keep your tax records for three years, but some records have to be kept longer than that.

Remember, the three-year rule relates to the information on your tax return. But, some of that information may relate to transactions more than three years old.

Here's a Checklist Of The Documents You Should Keep.

1. Capital gains and losses. Your gain is reduced by your basis -- your cost (including all commissions) plus, with mutual funds, any reinvested dividends and capital gains. But you may have bought that stock five years ago and you've been reinvesting those dividends and capital gains over the last decade. And don't forget those stock splits.
   
   So you don't ever want to throw these records away until after you sell the securities. And then if you're audited, you're going to have to prove those numbers. So you'll need to keep those records for at least three years after you file the return reporting their sales.
   
   
2. Expenses on your home. Cost records for your house and any improvements should be kept until the home is sold. It's just good practice, even though most homeowners won't face any tax problems. That's because profit of less than $250,000 on your home ($500,000 on a joint return) isn't subject to taxes under tax legislation enacted in 1997.
   
   If the profit is more than $250,000 ($500,000 on a joint return), or if you don't qualify for the full gain exclusion, then you're going to need those records for another three years after that return is filed. Most homeowners probably won't face that issue thanks to the 1997 tax law, but better safe than sorry.
   
   
3. Business records. We must warn you: Business records can become a nightmare. Non-residential real estate is now depreciated over 39 years. You could be audited on the depreciation up to three years after you file the return for the 39th year. That's a long time to hold onto receipts, but you may need to validate those numbers.
   
   You will still need to keep the records for basis until three years after the year in which your report your sale of the property on your tax return.
   
   
4. Employment, bank and brokerage statements. Keep all your W-2s, 1099s, brokerage and bank statements to prove income until three years after you file or longer if you need to. Don't even think about dumping checks, receipts, mileage logs, tax diaries and other documentation that substantiate your expenses.
   
   
5. Tax returns. Keep copies of your tax returns as well. You can't rely on the IRS to actually have a copy of your old returns. We recommend our clients keep tax returns at least 6 years. If you have the space or a scanner, you may want to keep them as long as you can.
   
   The bottom line is that you've got to keep those records until they can no longer affect your tax return, plus the three-year statute of limitations.
   
   
6. Social Security Records. You will need to keep some records for Social Security purposes, so check with the Social Security Administration each year to confirm that your payments have been appropriately credited. If they're wrong, you'll need your W-2 or copies of your Schedule C (if self employed) to prove the right amount. Don't dump those records until after you've validated those contributions on the annual statement you receive.
   
   You can confirm your payments and estimate your future benefits by filing Form SSA-7004 with the Social Security Administration. You can download the form, or apply online.

While it may bring you some psychological satisfaction to review your financial journey from poverty to wealth, if you find some tax returns that were filed with Roman numerals, it's probably time to clean out your attic.

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In March, RealtyTrac, a leading online market for foreclosure properties, reported that February 2010 foreclosures were actually down 2 percent from the previous month.

Yet, RealtyTrac indicates this break might not last long.  Even though the 6 percent year-to-year increase in February foreclosures was “the smallest annual increase” RealtyTrac recorded in 50 straight months, it believes that current foreclosure prevention programs and processing delays are keeping a lid on the numbers. If those programs end and processing glitches lift without an upswing in the economy or job market, the number of foreclosures could accelerate.

For individuals with some money to spend and invest, the troubled home market has its attractions. First, there’s the possibility of attractive real estate – albeit some in need of serious repair – at a bargain price. Then there are the sellers, both banks and individuals, who are at best eager, at worst, desperate to get out from under their obligations.  But the trail to ownership of properties that are under a cloud can be treacherous and it’s best to know what you’re doing.  It’s wise to consult a tax planner and a financial planning professional before making a move into this risky arena. Here are some of the things potential investors should know:

How foreclosure works:
A foreclosure happens when a buyer defaults on their payments and their lender takes legal steps to take back the property. Rules vary by state and local government, but generally, when a lender decides to foreclose on a property it files a notice of default or a lis pendens (Latin for "lawsuit pending"). This document is a public record, and for buyers – including other lenders -- it's the first step in locating a property in foreclosure. A buyer looking for foreclosures can look online (RealtyTrac is a good source) for lists of properties in default, but individuals with contacts inside lenders holding these properties have a particularly good leg up.

Pre-foreclosure sales are attractive, but often tough to close.
With so many homeowners struggling with payments, “pre-foreclosure” or “short sale” transactions are currently common, but fraught with obstacles. Short sales essentially allow a seller to sell their home for less than they owe as long as they get their lender to buy their story about a lost job or other financial hardships. The second obstacle is getting a real estate agent to work to sell the property for a far lower commission than they usually get.  Third, many states allow for very tight timeframes between the notice of default – the first news a homeowner is facing foreclosure, if they’re checking their mail – and an actual foreclosure notice. Deals of this variety need to close within days, not months.

How do people invest in foreclosure properties?
There are three primary ways this happens. First, you will see buyers coming in at the “pre-foreclosure” stage. Second, you will see buyers going after “REO” (real estate owned) properties – literally foreclosed real estate still on the books of a lender. Third, you’ll see foreclosures auctioned off at the public courthouse or in private auctions, depending on how the lender wants to market such properties to get them off their hands. Each process has its own conventions for inspecting the properties – sometimes prospective buyers get time to inspect what they might buy, other times little or none. It’s best to learn the process as a bystander before putting any skin in the game. The most knowledgeable foreclosure investors also have good intelligence on how heavy the lender’s inventory is with troubled properties – the more headaches they want to get rid of, the faster they’ll get rid of them.

Is it wise to borrow?
Given the current state of the lending industry, such a question might be a moot point even for the most-creditworthy individuals. Buying distressed property is primarily a cash game. It lowers the cost of entry and speeds these kinds of transactions where time is definitely of the essence. Even sophisticated foreclosure investors often discover ugly surprises when buying – property with greater damage than they anticipated, for example – and they may not have the flexibility to borrow to fix those unexpected problems after they borrowed to buy in the first place.

April 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Jim Oliver, a local member of FPA.

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Cash is the lifeblood of any small business. Here are some tips to help ensure that your business maintains a sufficient cash flow to meet its financial goals and keep running efficiently:

Toughen your credit policies. Review the payment terms you offer to customers and tighten them if slow payment is a problem area for your business. For instance, how long are customers given to pay? What action will be taken if a payment is missed? Be sure your credit terms are communicated effectively to customers before transactions are entered into.

     Tip: Consider requiring partial or full advance payments from new customers.

     Tip: For many businesses, a routine credit check should be performed before entering into a sales or service transaction with a new customer.

Come up with a budget - and stick to it. Surprisingly, many small businesses do not engage in the budgeting process. A budget can be extremely effective in helping you keep track of whether cost- and revenue-related goals are being met. Depending on the size and complexity of the business, the budget process might be informal or formal, lengthy or simple. Projected revenues and expenses should be broken down by months.

     Tip: If you don't already do so, budget for next year's revenues and expenses near the end of each year. Review budgeted to actual results monthly.

Tighten billing. If collecting bills has become a problem for your business, consider increasing the frequency at which customers are billed--e.g., from quarterly to monthly, or from monthly to every two weeks.

     Tip: Review your accounts receivable weekly or even daily to make sure slow payers are not allowed to slide.

If you have questions regarding your company's cash flow and credit/collection policies, please contact us.

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The self employed have many obstacles that most employees do not have to worry about. Besides the irregular paycheck and lack of unemployment and workmen’s compensation insurance, there is usually difficulty getting reasonably priced health insurance coverage. The self-employed must also pay both sides of Social Security and Medicare which is 15.3% vs. 7.65% for FICA.

On the other side of the self-employed coin, there is that truly American benefit of being your own boss and having unlimited income potential. For the successful entrepreneur, there are several retirement plan options available which offer significant tax sheltering opportunities. Like most financial decisions, the best plan depends on the specific situation. Read this article to find out more about those potential retirement plan opportunities.

ERISA and Non-Discrimination

Major considerations when dealing with group retirement plans are the ERISA (Employee Retirement Income Security Act) laws and non-discrimination provisions. ERISA was designed, among other things, to prevent employers from designing retirement plans which only benefit the owners or senior managers of a firm. This is important for small-business owners because, when considering retirement plan options, ERISA rules can play a big role in what an employer would be required to do for employees when designing plans. Some of these non-discrimination rules will be discussed when talking about each specific retirement plan option.

Keep in mind that self-employed and small business owners are both the employer and employee. Various retirement plans have restrictions for how each can fund the retirement plan. The owner generally controls the employer side of the equation, the only question is how much of plan contributions must be allocated to other employees. If there are no employees, then the non-discrimination rules do not apply. All amounts quoted are current for 2010.

With all employer plans, non-discrimination rules apply to “eligible employees”. The definition of eligible is different for different types of retirement plans. Some give a limited amount of employer discretion in defining an eligible employee, but that control is limited.  Because of the nuanced differences from plan to plan these definitions are not addressed in this explanation.

Comparison Criteria of the Various Plan Options

Savings Limits: The annual limits for how much money can be placed into the tax shelter.
Funding Flexibility: Some retirement plans require annual funding at certain levels; others can be skipped during lean years.
Plan Design Flexibility: Based upon ERISA and the particular tax code which authorizes each plan, different provisions can be included or modified to make the plan more advantageous to the owner.
Plan Setup & Funding: Some plans must be setup by a certain date and funding must occur during a calendar year or by other tax deadlines.
Administrative Cost: Retirement plans have some sort of annual reporting required. The total administrative costs generally vary by complexity and/or plan type.

Traditional & Roth IRA’s

The traditional IRA is available to all taxpayers who earn an income. Contributions can be made non-deductible if certain income limits are exceeded and the taxpayer or spouse is an “active participant” in another retirement plan that year (like a 401(k)). Because of low cost of administration and broad eligibility, the IRA is a great tool to use if eligible. Contributions can be made up to April 15 th for the previous tax year.

The Roth IRA allows for after-tax contributions which are tax-sheltered until 59 ½ and then become tax free. Income limits for participation do apply, but it is possible to convert traditional IRA’s to Roth IRA’s (see related blog article). Annual contribution limits to a Roth or traditional IRA are cumulative, meaning that total between both accounts is the annual limit, not double. There are income limits for Roth eligibility also.
 
Savings Limits: $5,000 under 50, $6,000 if 50+
Funding Flexibility: Plans can be funded in any particular year where income eligibility requirements and/or active participation status doesn’t disqualify participation.
Plan Design Flexibility: Investment options are very broad, but there is no flexibility in plan design.
Plan Setup & Funding: An IRA can be setup and funded anytime before April 15 th of the following year.
Administrative Cost: Minimal

SIMPLE IRA

The SIMPLE IRA was designed as a lost cost alternative to the 401(k) plan. Only employers with 100 or fewer employees can use a SIMPLE IRA.  Just like a 401(k) employees can choose to defer their own salary into the plan pre-tax.  The employer must match 3% of salary deferrals or instead of matching, can opt to give 2% to all employees, whether they contribute or not.

Because it is a simplified version of a 401(k), there is limited choice in how the plan is set-up. The employer chooses an investment company or insurance company for the investments in the SIMPLE IRA, but no separate recordkeeping or annual testing is required. It should be noted that a SIMPLE IRA must be set up by October 1st, and employee contributions must come from payroll during the calendar year. 

Savings Limits: $11,500 under 50, $14,000 if 50+, plus 2% or 3% of compensation/net income in an employer contribution.
Funding Flexibility: The employer match can be reduced to as little as 1% if needed on a short term basis but generally should be thought of as required. A reduction also requires advance notice to participants.
Plan Design Flexibility: There is minimal control on plan design. The SIMPLE IRA was designed to provide a 401(k) light program to employers of 100 or less, so most provisions and the plan document are standardized.
Plan Setup & Funding: Plans must be setup by October 1 st and employee deferrals must be made by payroll during the plan year, employer contributions must be made by the tax filing deadline plus extensions.
Administrative Cost: Minimal

SEP IRA

A SEP (Simplified Employee Pension) IRA is more like a profit sharing plan than a traditional 401(k). Employees can not contribute any money to the SEP IRA. The employer is the only source of funding. In order to keep things simple and non-discriminatory, the SEP IRA rules require that all employees receive the same percentage of their salary when contributions are made. The percentage contributed by the employer can fluctuate from year to year, but it must always be allocated in an equal percentage.

In the case of self employed, there is no concern to allocate anything if there are no employees. In short, the SEP IRA is like a supercharged personal IRA.  With little additional expense, it can be a powerful tool. It does not, however, provide flexibility in plan design.

Savings Limits: Employer contribution of up to 25% of compensation with a maximum of $49,000
Funding Flexibility: Funding does not have to be made every year and can change from year to year.
Plan Design Flexibility: There is minimal control on plan design. Just about all employees must be given an identical percentage contribution by the employer if they have met eligibility requirements.
Plan Setup & Funding: Can be setup and funded anytime up to the tax return date filing plus extensions
Administrative Cost:   Minimal

401(k)

The 401(k) has become the most common retirement savings vehicle in the United States. There are numerous ways to customize a 401(k) plan to suit the specific needs of each employer. An employer can set up a 401(k) plan and not provide any employer contributions. It can simply be set up as a savings vehicle for employees to defer their own savings into for pre-tax contributions. Recently, under the Pension Protection Act (PPA) of 2006, the Roth 401(k) was authorized. The major benefit is like that of a Roth IRA—after-tax payroll deferrals can be made which will be tax free in retirement. Unlike the Roth IRA, though, there is no income limit for participation.

An employer can design a 401(k) plan which has matching funds to employee deferrals and can add a profit sharing component which allows the employer to make additional contributions to employees. Those contributions can be made on a percentage basis of salary or several other methods which may maximize the allocation to certain employees. In order to use the 401(k) as a retention tool, a specific vesting schedule can be applied to employer contributions.

Under ERISA, 401(k) plans are required to be non-discriminatory. This means that when designing the allocation formula for profit sharing, the employer must use pre-approved allocation criteria to keep the plan qualified. Otherwise, an employer would just allocate the entire profit sharing allocation to themselves. The point of a group retirement is to benefit the employees, so those profit sharing allocations must be non-discriminatory.  

Even when talking about a 401(k) plan without profit sharing, there are non-discriminatory concerns. The plan must be checked annually to make sure that the highly paid employees are not the only ones contributing to the plan or own an excessively disproportionate percentage of the plan assets. If the highly paid employees don’t meet the annual testing rules,  future contributions may not be allowed or prior contributions may need to be refunded. Top heavy plans can be “corrected” by the employer making sufficient contributions for lower paid employees.

The flexibility of plan design makes the 401(k) very attractive compared to other retirement plan options, but with the flexibility comes added administrative cost and responsibility. The employer takes on a fiduciary role for the employees in the plan and a Third Party Administrator (TPA) is usually required to oversee the operation and reporting of the 401(k) plan.  The services of a TPA can easily range in the thousands of dollars annually.  These costs may be outweighed by the tax-sheltering and other benefits of a 401(k), but should be considered.
Administrative costs are a tax-deductible business expense or, in some cases, may be paid from fund assets. 

Using a prototype plan document approved by the IRS can help save time and money when setting up a plan. Additionally, most of the annual testing can be ignored if the 401(k) is a safe-harbor plan. With a safe-harbor plan, the employer must make matching contributions up to 4% of compensation, and those contributions must vest immediately. Of course, the cost of a safe harbor contribution may be more than the additional testing might cost.

The self-employed without eligible employees can open a solo 401(k). This is the same as a normal 401(k), but because there are no employees, there is no annual testing required. A solo 401(k) allows for a higher level of tax deferral than a SEP IRA at a lower income. The downside is that a solo 401(k) still has some annual reporting which is more than a SEP IRA. A solo 401(k) also is available for partners who have no eligible employees.

Savings Limits: Employee Deferrals of $16,500 under 50, $22,000 if 50+, Employer Contributions up to 25% of compensation with combined limit of $49,000.
Funding Flexibility: Under certain plan designs the employer contribution can be discretionary from year to year, but cannot be discriminatory. Other designs can require significant annual funding.
Plan Design Flexibility: A 401(k) can be designed in many different ways. The main limiting factor is making sure the plan is non-discriminatory to all eligible employees. The design has the most flexibility of all defined contribution plans.
Plan Setup & Funding: Plans can be setup anytime during the calendar year and employee deferrals must be made by payroll during each plan year, employer contributions must be made by the tax filing deadline plus extensions.
Administrative Cost: Moderate, annual reporting and plan accounting can be a significant expense, especially on small plans. More exotic plan designs can add to administrative cost considerably. The solo 401(k) plans can be much lower than a regular 401(k), but will still be more than a SEP or SIMPLE IRA.

Defined Benefit Plans

A defined benefit plan is what most people think of as the good old fashioned pension.  Instead of defining the contribution (as is done with every plan discussed so far), a defined benefit plan defines the benefit to be received. In a traditional pension, when you reach a certain age, you are entitled to a certain benefit, for instance, stipulated as a monthly payment for life.

The actual pension plan is responsible for collecting annual contributions for each eligible employee from the employer, employees, or both. The pension then invests those funds to pay the ultimate benefit at retirement. If the investments do not perform well, then the employer is ultimately responsible for paying that future benefit, which most likely will require larger contributions to make up for the poor investment performance.

In order to make sure a plan will have sufficient assets to pay future plan benefits, a defined benefit plan requires an actuarial valuation every year.  The plan TPA (Third Party Administrator) uses an actuary to check if the plan is on track. The actuary looks at life expectancies of all the plan participants and then figures out what contribution should be made to fully fund the pension plan for that year.

The major advantage of a defined benefit plan for a small business is that a virtually unlimited amount of annual income can be used to fund the plan. To fund a pension plan which would need to be able to pay out $50,000 - $200,000 per year for life is a large pot of money. If that same pension plan only has 10 years before retirement benefits are scheduled to commence, it could easily require hundreds of thousands of dollars annually for funding.

As you can imagine, the record keeping for a defined benefit plan is very expensive in relation to defined contribution plans. A small defined benefit plan can have $5,000 or more a year in TPA and actuary expenses.  Also, annual funding is not optional. There is some flexibility from year to year on funding, but once instituted, a defined benefit plan will need strong funding capability for years to come.

With the pension plan design, ERISA non-discrimination rules apply. The owner has to include (and fund) most employees in the pension plan. If the owner is older and most employees are young, the annual funding required for the owner will be much higher than younger lower paid employees, but highly paid older employees can make the defined benefit plan less desirable.

Savings Limits: Virtually unlimited, depending on age and compensation level. Funding required to sufficiently provide annual payments of up to $245,000 per year for life.
Funding Flexibility: Once implemented, the annual funding requirements usually are both significant and required annually.
Plan Design Flexibility: Plan design can be custom tailored for individual needs, but non-discrimination rules apply.
Plan Setup & Funding: Plans can be setup anytime during the calendar year and employee contributions must be made by payroll during each plan year, employer contributions must be made by the tax filing deadline plus extensions.
Administrative Cost: The most expensive option. Even small plans can require thousands for annual administration including an actuarial evaluation.

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This newsletter is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of this newsletter should not be acted upon without specific professional guidance. Please call us if you have questions.

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