Individual Retirement Accounts (IRAs) are one of the most popular ways to save for retirement, and most workers are familiar with the general rules surrounding their use. However, when an IRA is passed down through inheritance, the rules change. While inheriting an IRA can be a boon, it’s crucial to understand the rules governing it to avoid unnecessary taxes or penalties. 

Understanding IRAs: the basics

Before diving into the intricacies of inherited IRAs, it’s helpful to understand the foundational principles governing them. 

Traditional vs. Roth IRAs

With a traditional IRA, contributions are tax-deductible, which means you don’t pay taxes on the money you put in, only on what you take out. When you make withdrawals in retirement, they are taxed as ordinary income. 

With a Roth IRA, contributions are made with after-tax dollars, so withdrawals are generally tax-free in retirement. 

Required minimum distributions (RMDs)

Required minimum distributions (RMDs) refer to the minimum amount that account holders are obligated to withdraw from their IRA annually once they reach a certain age. For traditional IRAs, this obligation begins at age 72 (73 if you reach age 72 after Dec. 31, 2022). 

Roth IRAs do not impose RMDs during the lifespan of the account holder. 

Inherited IRAs: distinct rules for different beneficiaries

In the context of inheritance, the relationship between the original owner and the beneficiary dictates the operational rules of the IRA. It also matters whether the original owner died before or after they started taking RMDs. 

The simplest scenario is when a surviving spouse inherits an IRA after their partner’s passing. In such a case, the surviving spouse has the unique option to treat the IRA as their own, which means they can make contributions or delay distributions until they would normally be required to take RMDs. This is the only scenario where a beneficiary can treat the inherited IRA the same as a personal IRA.

General rules for non-spousal beneficiaries

When you inherit an IRA, and you’re not the spouse of the original owner, you need to keep the following general rules in mind: 

• No contributions. You cannot contribute to an inherited IRA the way you would a personal IRA. You can take money out, but you can’t put anything in. 

• No commingling. You cannot merge funds from your personal IRA with an inherited one and vice versa. 

• Ten-year rule. The ten-year rule requires most non-spousal beneficiaries to liquidate the entire balance of an inherited IRA within a span of ten years. 

• Continuation of RMDs. If the original owner had already started taking RMDs, the beneficiary must continue taking the RMDs after the owner’s death, regardless of the beneficiary’s age. In addition to the RMDs, the beneficiary is still obligated to liquidate the account within ten years. 

• Absence of RMDs. If the original owner had not started taking RMDs, the beneficiary is not required to withdraw a set amount each year, but they are still bound by the ten-year rule. 

Eligible designated beneficiaries

Although relatively rare, there is another distribution option for a select group of individuals the IRS refers to as “eligible designated beneficiaries” or EDBs. 

EDBs can include heirs who are:

• Less than ten years younger than the deceased, 

• Chronically ill, 

• Disabled, or

• Minor children of the original account owner. 

These beneficiaries have the option to stretch RMDs over their life expectancy or the original owner’s remaining life expectancy, whichever is longer. They can also adhere to the ten-year rule if the original owner had not started taking RMDs yet, although this is an option and not a requirement. 

Tax implications of inherited IRAs

Inherited traditional IRAs come with strings attached in the form of taxes. However, inherited Roth IRAs come with a bit of a silver lining. Since the original contributions were made with post-tax dollars, distributions are typically tax-free. But there’s a catch: the account must have been open for at least five years. If not, the earnings will be subject to taxes, but the contributions made by the original owner remain tax-free. 

Most beneficiaries are subject to a 10-year payout period for IRAs inherited in 2020 or later. If you fail to withdraw the full balance by the end of this period, you could face a penalty of 50% of the amount that should have been distributed. 

Also, missing a required minimum distribution or taking less than the required amount results in a 25% penalty on the shortfall. 

Strategic moves for inherited IRAs

Inherited IRAs might be complex, but they also come with many possibilities. Knowing the nuances can help you get the most out of your inheritance while sidestepping potential pitfalls. 

You have the power of movement. 

Just because you’ve inherited an IRA held by a particular custodian doesn’t mean you’re tied to them for life. If the investment options don’t align with your goals, or if you’re unsatisfied with the service, it’s possible to move your inheritance to a different custodian. But this needs to be done via direct transfer. This means funds must move directly between the institutions without you ever taking possession. Any indirect movement could be considered a taxable distribution. 

It’s also imperative that the receiving account is explicitly labeled as an inherited IRA to avoid tax complications. 

Consider your tax bracket. 

If you’re on the cusp of a higher tax bracket in a given year, it might be wise to delay a distribution if you’re subject to the 10-year rule. Or, you could take a smaller distribution to avoid pushing yourself into that higher bracket. 

Leverage charitable distributions. 

If you’re 70 ½  or older, you may want to consider Qualified Charitable Distributions. You can transfer up to $100,000 annually from the IRA to a qualified charity, which will count toward your RMDs. The donated amount is excluded from your taxable income. 

Consult a professional advisor

There are many variables when it comes to inherited IRAs, and each person’s situation is unique. While this article provides an overview of inherited IRAs, it is not a substitute for speaking with one of our expert advisors about your specific situation. Contact our office to discuss minimizing taxes and adhering to all IRS rules for your IRA.

The scariest tax proposals and possibilities in all of state and local tax

With Tax-tober quickly coming to a close, RSM US’s Washington National Tax state and local tax (SALT) practice decided to grab a wooden stake, puree some garlic, melt all the silver we could find, light a torch and see what could be unearthed from some of the scariest SALT proposals and scenarios we’ve seen or considered. Turn on a light, definitely do not answer the phone, and find out what keeps us up at a night.

SALT Tax-tober brings spooky ghouls and goblins

Brian Kirkell

Time is ticking toward another Halloween. However, this one holds a strange poignancy for me. My daughter has announced to everyone in the house that (in her words) America’s repressive “grow up fast and get a job” social construct will make this her last chance to trick-or-treat without the negative judgment and ill-will of candy givers neighborhood-wide. Why do we do this? Why do we feel the need to arbitrarily take away an environment where fear and joy can be safely experienced all at once?

For the sake of Tax-tober, it makes as little sense to me as all of the proposals states are floating to restrict or eliminate ballot measures.

Only about half the states allow citizens to get measures on the ballot, and, if you live in one of them, you are lucky. You can directly participate in your state’s governance based purely upon having an idea and the passion to see it through. And there’s no better place to focus than the manner in which a state or locality can exert its tax authority.

Some will seek to expand that authority. Some will seek to restrict it. Most of what is proposed will never make it to the ballot, or will not pass if it does. But there’s magic in the possibility; magic in one of the few forms of direct democracy we have available to us. 

States, don’t limit it. Don’t take it away. While you’re at it, how about something that incentivizes everyone to get out there and trick-or-treat? Let’s prove my daughter wrong. Otherwise, someday she might just try to get enough support for a ballot measure mandating a tax-free Halloween for everyone.

David Brunori

Brian thinks the challenges to direct democracy are scary. I would tend to agree, but I am not sure initiatives and referendums are the avenue for developing all tax policy. Not all voters are as smart as his daughter. If you put single-sales factor on the ballot, most voters’ eyes will glaze over.

My colleague, Mo, takes a more lighthearted view below of what is scary in the SALT world. Sales tax exemptions are certainly frightful, particularly for vendors who must determine what is or is not subject to tax. There are literally hundreds of fun—and spooky—examples.

Remember, if vendors do not collect and remit tax on what is actually taxable, they are on the hook. In my experience—and I have been practicing throughout most of the ’Friday the 13th’ movies—many vendors will err on the side of taxability. Better to collect the tax on things not subject to tax, than to face a revenue department auditor. Now there’s a nightmare you can’t just wake up from.

But what I find most petrifying is that many states are still considering worldwide combined reporting. New Hampshire is thinking about it right now. Mandatory worldwide reporting is as terrifyingly anti-business as you can get. Companies are not going to stop doing business overseas. But they may stop doing business in a state with worldwide. Like the poor counselors at Camp Crystal Lake, you would hope state legislators would know better.

Mo Bell-Jacobs

With the jack-o’-lantern lit, I always come back to the outright frightening example I’ve used to teach sales tax for over a decade. In Pennsylvania, decorative pumpkins are subject to sales tax, but pumpkins as food are not. No wonder sales tax compliance is hated more than Frankenstein’s monster.

Yes, I recognize there is a logic to the different tax treatment, but I’m not sure my mom would understand and she is much smarter than I am. It could be worse, we could discuss the taxability of frozen pizzas, or how many nuts it takes for a Snickers bar to no longer be taxed as candy (pitch forks and torches down, Streamline states).

What’s keeping me most on edge lately is a subject I know not to feed after midnight: the continued state tax cuts to corporate and individual income taxes.

I’m less concerned about corporate taxes due to the minor amount of revenue generated overall, but individual income taxes nationwide account for over 36% of most state tax collections. Through the second quarter of this year, we’ve experienced four quarters of no or negative individual income tax growth. And yet, states continue to slash individual income taxes. Adding on, state sales tax growth slowed to near zero in the second quarter.

My Elm Street nightmare wouldn’t be complete without a warning—the tax collection data is beginning to show a revenue crunch. Cutting individual income taxes without looking to the horizon is exactly how trolls turn to stone and vampires combust into dust.

While it is true states are some of the most prepared in history to weather a fiscal crisis thanks to boosted rainy-day funds, drastically cutting revenue drivers because revenue is good today ignores that it may not be good tomorrow. The economy is cyclical, just like a new Halloween movie every few years. I urge restraint and good fiscal policy during uncertain times.

Finally, with my new-found authority to trick-or-treat at age 41 thanks to Brian’s daughter, I’ll mostly skip the direct ballot debate this time. And although I’d rather not have voters directly decide tax policy, I think restricting ballot measures could be more akin to finding a strange plant during a total eclipse and naming it after your crush—that is to say, a questionable idea.

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This article was written by David Brunori, Brian Kirkell, Mo Bell-Jacobs and originally appeared on 2023-10-20.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/salt-tax-tober-brings-spooky-ghouls-and-goblins.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Rising costs of capital are squeezing middle market firms, according to an RSM US Middle Market Business Index special report on financing.

Rising costs of capital are squeezing middle market firms, according to an RSM US Middle Market Business Index special report on financing. The rising costs will make financing more expensive and also make it tougher for businesses to access capital, which is already more of a challenge for many small and midsize businesses than their larger counterparts.

Streamlining the finance and accounting function can help middle market companies weather this environment. Optimized finance and accounting departments can provide lenders with higher-quality data and better visibility into the business.

“That will ultimately put the business in a better position to work with lenders and raise capital,” says Michael Smith, finance and accounting outsourcing leader at RSM US LLP. “But those things can’t happen unless you optimize your finance department.”

Here are some ways businesses can enhance their accounting and finance departments to mitigate the challenges of surging financing costs:

• Assess opportunities for automation: Even companies that already use automation technologies should look for ways to automate manual functions to produce more timely reporting while freeing up employee time for more critical tasks.

  For example, in the finance department, organizations can use robotic process automation to automate the creation of journal entries, which is often a manual process.

  “Automation doesn’t have to be all or nothing,” says Smith. “Even if something can be automated but still needs to be reviewed by a person, that can still save time.” One example is using exception reporting tools; instead of an employee having to look through an entire dataset for accuracy, such tools can flag anomalies for human review.

  Automation usually goes hand in hand with enabling a clear data strategy, too. Better information and analytics will ultimately allow the business to spend more efficiently.

• Explore scalable alternative staffing models: Like automation, outsourcing isn’t usually an all-or-nothing approach, either. For most companies, co-sourcing—keeping some functions in-house and working with an external provider for others—is a key solution to improve efficiency.

  It’s also important to ensure your staffing approach is scalable depending on changes the business may experience throughout its life cycle. The finance and accounting teams may need to expand or contract at different times. When a company needs to adopt a new accounting standard, for example, it might make more sense to work with a third party for that adoption. Teams should continually assess which functions are better candidates for outsourcing.

• Leverage the FP&A function to its full extent: The financial planning and analysis function will be key in helping organizations navigate the implications of higher financing costs across the entire company.

  “It’s not just about the function of accounting and finance; FP&A plays a key role in helping the business understand itself and where capital should be deployed,” says Patrick Brennan, a financial consulting leader at RSM US LLP.

  FP&A teams might zero in on customer profitability metrics, variance analysis, key financial performance indicators and operational KPIs, plus a clear understanding of cost structures, including fixed versus variable costs. Using tools such as Microsoft Power BI to pull all that information into a dashboard enables a company to tell a comprehensive story on business and financial performance.

• Revisit your pricing structure: Depending on their sector, some businesses may not have revisited their product or service prices following the disruption and inflation of recent years, and for many of those, now is the time to do so.

  “We get so cost-conscious in times of rising capital costs, but we don’t always address how to price products and services,” says Brennan. “The FP&A function can also help the organization think about pricing and other untapped areas for value creation.”

• Have the right people in place: Companies need to be careful not to get too caught up in buying new technologies without having the right people on their teams to achieve success as costs rise and the margin for error shrinks.

  “Profits can mask many problems. And since profits are shrinking, it’s important to have the right team and technology in place,” says Smith. The two should work harmoniously together, with employees leveraging technology to its fullest and most efficient extent.

Meeting a higher threshold

Alongside these action items, companies must also be prepared to meet a higher bar for the internal and external projects they pursue.

“In a lower interest rate environment, plenty of projects might make sense,” says Brennan. “But in this environment, potentially fewer projects achieve the hurdle rates necessary to proceed. That means certain businesses face more pressure on the investments and the capital expenditures that fuel growth.”

Middle market organizations will need to be more strategic in how they prioritize going forward, balancing cost optimization with enabling growth as market conditions continue to evolve. Working with an advisor to explore the critical points above can be a good place to start.

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This article was written by RSM US LLP and originally appeared on 2023-10-19.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/financial-management/how-midsize-companies-can-optimize-finance-accounting-functions.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Effective working capital management can make all the difference between success and failure in the business world. But how can businesses manage their working capital effectively? 

In this article, we’ll explore the basics of working capital management. We’ll also dive into specific techniques that you can use to better manage capital and optimize liquidity.

What is the importance of working capital? 

Working capital is a crucial financial metric that measures your company’s ability to meet its short-term financial obligations. It’s the difference between your current assets, such as cash, accounts receivable, and inventory, and your current liabilities, such as accounts payable, short-term loans, and other obligations due within a year. 

Working capital is critical for the survival and growth of a business regardless of its size or industry. A company with a strong working capital management plan is better positioned to withstand unexpected financial challenges, such as economic changes, cash flow disruptions, and unexpected expenses. Effective working capital management can also help a company improve its profitability by reducing the need for costly short-term financing options. 

Working capital ratios to track

There are several important working capital ratios that you can use to track your financial health and manage your cash flow effectively. These ratios provide insights into your liquidity, efficiency, and overall financial performance and can help identify potential areas for improvement. 

Current ratio

The current ratio measures your ability to pay your short-term debts using current assets. It is calculated by dividing current assets by current liabilities. A good current ratio varies depending on the industry and the company’s circumstances. However, as a general rule, a current ratio of 2:1 or higher is considered good.

A low current ratio indicates that your business may not have sufficient liquidity to cover your short-term debts and operational expenses. It may also signal to investors that your company is not well-managed or is experiencing financial stress. 

On the other hand, an excessively high current ratio suggests that your company has excess funds tied up in current assets, which could be better utilized elsewhere. It can also mean your company is not efficiently managing its inventory. 

Quick Ratio (aka Acid-Test Ratio)

The quick ratio is similar to the current ratio, but it measures a company’s ability to pay off its current liabilities with its most liquid assets, such as cash, marketable securities, and accounts receivable. It is calculated by dividing quick assets by current liabilities. A higher quick ratio indicates that a company has sufficient cash and other liquid assets to cover its short-term obligations.

Inventory Turnover Ratio

The inventory turnover ratio shows how effectively your business manages its inventory levels. It is calculated by dividing the cost of goods sold by the average balance sheet inventory. This ratio indicates how quickly you’re using and replacing your inventory. 

A low ratio may suggest that your company is holding onto excessive inventory levels, which can lead to increased costs and obsolescence risk. Conversely, a high inventory ratio could indicate inadequate inventory levels, potentially leading to missed sales opportunities. 

Days Sales Outstanding Ratio

The days sales outstanding ratio measures the efficiency of your company’s accounts receivable management. It reveals the average time you take to collect payment after a sale transaction. The lower the ratio, the better your company is performing. 

The ratio is calculated by dividing accounts receivable by average daily sales. The result shows how quickly your company turns its outstanding receivables into cash. A low ratio suggests that you are collecting payments more efficiently, which can positively impact your cash flow, profitability, and overall financial health. 

Days Payable Outstanding Ratio

The days payable outstanding ratio measures how quickly a company pays its suppliers. It is calculated by dividing accounts payable by average daily purchases. A high DPO indicates that a company manages its cash flow well and has a strong bargaining position with its suppliers.

Managing Working Capital

Measuring working capital is one thing, while managing working capital is another. The following are strategies to help improve your working capital metrics.  

Analyze current financial statements and create projections

Current financial statements are required to calculate your working capital ratios accurately. While your financial statements and working capital metrics provide current and historical insight, projections will help you analyze and navigate the future. Create and maintain income statement, cash flow, and balance sheet projections. All too often, business owners focus on income projections when changes in the balance sheet can greatly affect cash flow. For example, an investment in machinery or equipment or non-renewal of a loan can drain cash normally available for operations.  

Perform a scenario analysis

Stress test your projections across multiple scenarios and consider how your company might navigate through them, especially in today’s volatile, uncertain, complex, and ambiguous (VUCA) business environment. This is referred to as scenario analysis, and it can help you develop contingency plans to manage your working capital better and avoid cash flow shortfalls. 

To perform an analysis, consider various scenarios, both positive and negative. For example, a positive scenario could be launching a successful new product or service that increases sales and revenue. In contrast, a negative scenario could be a sudden economic downturn or change in consumer behavior that reduces demand for your products or services. 

Manage inventory

Too much inventory can tie up working capital, while too little inventory can lead to stockouts and lost sales. Implement inventory management systems to optimize inventory levels, reduce carrying costs, and improve cash flow.

Improve collections

Monitor your accounts receivable aging report and follow up with customers who have overdue payments. Implement efficient invoicing and payment processes, such as offering discounts for early payment or implementing an automated billing system. Finally, review your process for extending credit to customers; a high DOS (Days Sales Outstanding) ratio may be due to your customer’s ability to pay their bills.

Manage accounts payable

Negotiate favorable payment terms with suppliers to maximize payment flexibility and reduce the risk of late payment penalties. For instance, you might negotiate discounts or longer payment periods, potentially shifting 30-day payment terms to 60 or 90-day terms. Take advantage of early payment discounts and consider using electronic payment systems to streamline payment processing.

Right-size your expenses

One way to improve working capital is to increase profitability. Reassess all expenses to identify those that can be reduced or cut altogether.   

Review available credit

Banks are more willing to extend credit when you don’t need it. Therefore, plan ahead and secure a line of credit or other available credit before needing it.  

Seek professional advice

Effectively managing working capital can be intricate and demanding. This article is meant to provide an overview of working capital management and is not a substitute for speaking with one of our expert advisors. Consider seeking advice from one of our advisors, who can help you identify opportunities for working capital improvement and provide guidance on best practices. Please contact our office to discuss your unique situation.