Passage of the Tax Cuts and Jobs Act (TCJA) in December 2017 has led to confusion over some longstanding deductions. In response, the IRS recently issued a statement clarifying that the interest on home equity loans, home equity lines of credit and second mortgages will, in many cases, remain deductible.
How it used to be
Under prior tax law, a taxpayer could deduct “qualified residence interest” on a loan of up to $1 million secured by a qualified residence, plus interest on a home equity loan (other than debt used to acquire a home) up to $100,000. The home equity debt couldn’t exceed the fair market value of the home reduced by the debt used to acquire the home.
For tax purposes, a qualified residence is the taxpayer’s principal residence and a second residence, which can be a house, condominium, cooperative, mobile home, house trailer or boat. The principal residence is where the taxpayer resides most of the time; the second residence is any other residence the taxpayer owns and treats as a second home. Taxpayers aren’t required to use the second home during the year to claim the deduction. If the second home is rented to others, though, the taxpayer also must use it as a home during the year for the greater of 14 days or 10% of the number of days it’s rented.
In the past, interest on qualifying home equity debt was deductible regardless of how the loan proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles and other personal expenses and still claim the itemized interest deduction.
What’s deductible now
The TCJA limits the amount of the mortgage interest deduction for taxpayers who itemize through 2025. Beginning in 2018, for new home purchases, a taxpayer can deduct interest only on acquisition mortgage debt of $750,000.
On February 21, the IRS issued a release (IR 2018-32) explaining that the law suspends the deduction only for interest on home equity loans and lines of credit that aren’t used to buy, build or substantially improve the taxpayer’s home that secures the loan. In other words, the interest isn’t deductible if the loan proceeds are used for certain personal expenses, but it is deductible if the proceeds go toward, for example, a new roof on the home that secures the loan. The IRS further stated that the deduction limits apply to the combined amount of mortgage and home equity acquisition loans — home equity debt is no longer capped at $100,000 for purposes of the deduction.
As a relatively comprehensive new tax law, the TCJA will likely be subject to a variety of clarifications before it settles in. Please contact our firm for help better understanding this provision or any other.
Around this time of year, many people have filed and forgotten about their 2017 tax returns. But you could get an abrupt reminder in the form of an IRS penalty. Here are three common types and how you might seek relief:
1. Failure-to-file and failure-to-pay. The IRS will consider any reason that establishes that you were unable to meet your federal tax obligations despite using “all ordinary business care and prudence” to do so. Frequently cited reasons include fire, casualty, natural disaster or other disturbances. The agency may also accept death, serious illness, incapacitation or unavoidable absence of the taxpayer or an immediate family member.
If you don’t have a good reason for filing or paying late, you may be able to apply for a first-time penalty abatement (FTA) waiver. To qualify for relief, you must have: 1) received no penalties (other than estimated tax penalties) for the three tax years preceding the tax year in which you received a penalty, 2) filed all required returns or filed a valid extension of time to file, and 3) paid, or arranged to pay, any tax due. Despite the expression “first-time,” you can receive FTA relief more than once, so long as at least three years have elapsed.
2. Estimated tax miscalculation. It’s possible, but unlikely, to obtain relief from estimated tax penalties on grounds of casualty, disaster or other unusual circumstances. You’re more likely to get these penalties abated if you can prove that the IRS made an error, such as crediting a payment to the wrong tax period, or that calculating the penalty using a different method (such as the annualized income installment method) would reduce or eliminate the penalty.
3. Tax-filing inaccuracy. These penalties may be imposed, for example, if the IRS finds that your return was prepared negligently or that there’s a substantial understatement of tax. You can obtain relief from these penalties if you can demonstrate that you properly disclosed your tax position in your return and that you had a reasonable basis for taking that position.
Generally, you have a reasonable basis if your chances of withstanding an IRS challenge are greater than 50%. Reliance on a competent tax advisor greatly improves your odds of obtaining penalty relief. Other possible grounds for relief include computational errors and reliance on an inaccurate W-2, 1099 or other information statement.
Each year, millions of taxpayers claim an income tax refund. To be sure, receiving a payment from the IRS for a few thousand dollars can be a pleasant influx of cash. But it means you were essentially giving the government an interest-free loan for close to a year, which isn’t the best use of your money.
Fortunately, there’s a way to begin collecting your 2018 refund now: You can review the amounts you’re having withheld and/or what estimated tax payments you’re making, and adjust them to keep more money in your pocket during the year.
Choosing to adjust
It’s particularly important to check your withholding and/or estimated tax payments if:
Even if you haven’t encountered any major life changes during the past year, changes in the tax law may affect withholding levels, making it worthwhile to double-check your withholding or estimated tax payments.
Making a change
You can modify your withholding at any time during the year, or even more than once within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically will go into effect several weeks after the new Form W-4 is submitted. For estimated tax payments, you can make adjustments each time quarterly payments are due.
While reducing withholdings or estimated tax payments will, indeed, put more money in your pocket now, you also need to be careful that you don’t reduce them too much. If you don’t pay enough tax throughout the year on a timely basis, you could end up owing interest and penalties when you file your return, even if you pay your outstanding tax liability by the April 2019 deadline.
One timely reason to consider adjusting your withholding is the passage of the Tax Cuts and Jobs Act late last year. In fact, the IRS had to revise its withholding tables to account for the increase to the standard deduction, suspension of personal exemptions, and changes in tax rates and brackets. If you’d like help determining what your withholding or estimated tax payments should be for the rest of the year, please contact us.
In an increasingly globalized society, many people choose to open offshore accounts to deposit a portion of their wealth. When doing so, it’s important to follow the IRS’s strict foreign accounts reporting requirements. In a nutshell, if you have a financial interest in or signature authority over any foreign accounts, including bank accounts, brokerage accounts, mutual funds or trusts, you must disclose those accounts to the IRS and you may have additional reporting requirements.
To do so, your tax preparer will check the box on line 7a of Schedule B (“Interest and Ordinary Dividends”) of Form 1040 — regardless of the account value. If the total value of your foreign financial assets exceeds $50,000 ($100,000 for joint filers) at the end of the tax year or exceeds $75,000 ($150,000 for joint filers) at any time during the tax year, you must provide account details on Form 8938 (“Statement of Specified Foreign Financial Assets”) and attach it to your tax return.
Finally, if the aggregate value of your foreign accounts is $10,000 or more during the calendar year, file FinCEN (Financial Crimes Enforcement Network) Form 114 — “Report of Foreign Bank and Financial Accounts (FBAR).” The current deadline for filing the form electronically with FinCEN is April 15, 2018, with an automatic extension to October 15.
Failure to disclose an offshore account could result in substantial IRS penalties, including collecting three to six years’ worth of back taxes, interest, a 20% to 40% accuracy-related penalty and, in some cases, a 75% fraud penalty. For further information, contact us.
The child credit has long been a valuable tax break. But, with the passage of the Tax Cuts and Jobs Act (TCJA) late last year, it’s now even better — at least for a while. Here are some details that every family should know.
Amount and limitations
For the 2017 tax year, the child credit may help reduce federal income tax liability dollar-for-dollar by up to $1,000 for each qualifying child under age 17. So if you haven’t yet filed your personal return or you might consider amending it, bear this in mind.
The credit is, however, subject to income limitations that may reduce or even eliminate eligibility for it depending on your filing status and modified adjusted gross income (MAGI). For 2017, the limits are $110,000 for married couples filing jointly, and $55,000 for married taxpayers filing separately. (Singles, heads of households, and qualifying widows and widowers are limited to $75,000 in MAGI.)
Now the good news: Under the TCJA, the credit will double to $2,000 per child under age 17 starting in 2018. The maximum amount refundable (because a taxpayer’s credits exceed his or her tax liability) will be limited to $1,400 per child.
The TCJA also makes the child credit available to more families than in the past. That’s because, beginning in 2018, the credit won’t begin to phase out until MAGI exceeds $400,000 for married couples or $200,000 for all other filers, compared with the 2017 phaseouts of $110,000 and $75,000. The phaseout thresholds won’t be indexed for inflation, though, meaning the credit will lose value over time.
In addition, the TCJA includes (starting in 2018) a $500 nonrefundable credit for qualifying dependents other than qualifying children (for example, a taxpayer’s 17-year-old child, parent, sibling, niece or nephew, or aunt or uncle). Importantly, these provisions expire after 2025.
Qualifications to consider
Along with the income limitations, there are other qualification requirements for claiming the child credit. As you might have noticed, a qualifying child must be under the age of 17 at the end of the tax year in question. But the child also must be a U.S. citizen, national or resident alien, and a dependent claimed on the parents’ federal tax return who’s their own legal son, daughter, stepchild, foster child or adoptee. (A qualifying child may also include a grandchild, niece or nephew.)
As a child gets older, other circumstances may affect a family’s ability to claim the credit. For instance, the child needs to have lived with his or her parents for more than half of the tax year.
Tax credits can serve as powerful tools to help you manage your tax liability. So if you may qualify for the child credit in 2017, or in years ahead, please contact our firm to discuss the full details of how to go about claiming it properly.
Years and years ago, the notion of having a company cafeteria or regularly catered meals was generally feasible for only the biggest of businesses. But, more recently, employers providing meals to employees has become somewhat common for many midsize to large companies. A recent tax law change, however, may curtail the practice.
As you’re likely aware, in late December 2017 Congress passed and the President signed the Tax Cuts and Jobs Act. The law will phase in a wide variety of changes to the way businesses calculate their tax liabilities — some beneficial, some detrimental. Revisions to the treatment of employee meals and entertainment expenses fall in the latter category.
Before the Tax Cuts and Jobs Act, taxpayers generally could deduct 50% of expenses for business-related meals and entertainment. But meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.
Under the new law, for amounts paid or incurred after December 31, 2017, deductions for business-related entertainment expenses are disallowed. Meal expenses incurred while traveling on business are still 50% deductible, but the 50% disallowance rule now also applies to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises will be completely nondeductible.
If your business regularly provides meals to employees, let us assist you in anticipating the changing tax impact.
The Tax Cuts and Jobs Act (TCJA), signed into law this past December, affects more than just income taxes. It’s brought great changes to estate planning and, in doing so, bolstered the potential value of dynasty trusts.
Let’s start with the TCJA. It doesn’t repeal the estate tax, as had been discussed before its passage. The tax was retained in the final version of the law. For the estates of persons dying, and gifts made, after December 31, 2017, and before January 1, 2026, the gift and estate tax exemption and the generation-skipping transfer tax exemption amounts have been increased to an inflation-adjusted $10 million, or $20 million for married couples (expected to be $11.2 million and $22.4 million, respectively, for 2018).
Absent further congressional action, the exemptions will revert to their 2017 levels (adjusted for inflation) beginning January 1, 2026. The marginal tax rate for all three taxes remains at 40%.
Now let’s turn to dynasty trusts. These irrevocable arrangements allow substantial amounts of wealth to grow free of federal gift, estate and generation-skipping transfer (GST) taxes, largely because of their lengthy terms. The specific longevity of a dynasty trust depends on the law of the state in which it’s established. Some states allow trusts to last for hundreds of years or even in perpetuity.
Where the TCJA and dynasty trusts come together is in the potential to avoid the GST tax. It levies an additional 40% tax on transfers to grandchildren or others that skip a generation, potentially consuming substantial amounts of wealth. The key to avoiding the tax is to leverage your GST tax exemption, which, under the TCJA, will be higher than ever starting in 2018.
Assuming you haven’t yet used any of your gift and estate tax exemption, you can transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, plus future appreciation, are removed from your taxable estate.
Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.
Naturally, setting up a dynasty trust is neither simple nor quick. You’ll need to choose a structure, allocate assets (such as securities, real estate, life insurance policies and business interests), and name a trustee. Our firm can work with your attorney to maximize the tax benefits and help ensure the trust is in the best interests of your estate.
Sidebar: Nontax reasons to set up a dynasty trust
Regardless of the tax implications, there are valid nontax reasons to set up a dynasty trust. First, you can designate the beneficiaries of the trust assets spanning multiple generations. Typically, you might provide for the assets to follow a line of descendants, such as children, grandchildren, great-grandchildren, etc. You can also impose certain restrictions, such as limiting access to funds until a beneficiary earns a college degree.
Second, by placing assets in a properly structured trust, those assets can be protected from the reach of a beneficiary’s creditors, including claims based on divorce, a failed business or traffic accidents.
Every company needs to upgrade its assets occasionally, whether desks and chairs or a huge piece of complex machinery. But before you go shopping this year, be sure to brush up on the enhanced bonus depreciation tax breaks created under the Tax Cuts and Jobs Act (TCJA) passed late last year.
Qualified new — not used — assets that your business placed in service before September 28, 2017, fall under pre-TCJA law. For these items, you can claim a 50% first-year bonus depreciation deduction. This tax break is available for the cost of new computer systems, purchased software, vehicles, machinery, equipment, office furniture and so forth.
In addition, 50% bonus depreciation can be claimed for qualified improvement property, which means any qualified improvement to the interior portion of a nonresidential building if the improvement is placed in service after the date the building is placed in service. But qualified improvement costs don’t include expenditures for the enlargement of a building, an elevator or escalator, or the internal structural framework of a building.
Bonus depreciation improves significantly under the TCJA. For qualified property placed in service from September 28, 2017, through December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100%. In addition, the 100% deduction is allowed for both new and used qualifying property.
The new law also allows 100% bonus depreciation for qualified film, television and live theatrical productions placed in service on or after September 28, 2017. Productions are considered placed in service at the time of the initial release, broadcast or live commercial performance.
In later years, bonus depreciation is scheduled to be reduced to 80% for property placed in service in 2023, 60% for property placed in service in 2024, 40% for property placed in service in 2025 and 20% for property placed in service in 2026.
Important: For certain property with longer production periods, the preceding reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.
If bonus depreciation isn’t available to your company, a similar tax break — the Section 179 deduction — may be able to provide comparable benefits. Please contact our firm for more details on how either might help your business.
The clock is ticking down to the tax filing deadline. The good news is that you still may be able to save on your impending 2017 tax bill by making contributions to certain retirement plans.
For example, if you qualify, you can make a deductible contribution to a traditional IRA right up until the April 17, 2018, filing date and still benefit from the resulting tax savings on your 2017 return. You also have until April 17 to make a contribution to a Roth IRA.
And if you happen to be a small business owner, you can set up and contribute to a Simplified Employee Pension (SEP) plan up until the due date for your company’s tax return, including extensions.
Deadlines and limits
Let’s look at some specifics. For IRA and Roth IRA contributions, the maximum regular contribution is $5,500. Plus, if you were at least age 50 on December 31, 2017, you are eligible for an additional $1,000 “catch-up” contribution.
There are also age limits. You must have been under age 70½ on December 31, 2017, to contribute to a traditional IRA. Contributions to a Roth can be made regardless of age, if you meet the other requirements.
For a SEP, the maximum contribution is $54,000, and must be made by the April 17th date, or by the extended due date (up to Monday, October 15, 2018) if you file a valid extension. (There’s no SEP catch-up amount.)
If not covered by an employer’s retirement plan, your contributions to a traditional IRA are not affected by your modified adjusted gross income (MAGI). Otherwise, when you (or a spouse, if married) are active in an employer’s plan, available contributions begin to phase out within certain MAGI ranges.
For married couples filing jointly, the MAGI range is $99,000 to $119,000. For singles or heads of household, it’s $62,000 to $72,000. For those married but filing separately, the MAGI range is $0 to $10,000, if you lived with your spouse at any time during the year. A phase-out occurs between AGI of $186,000 and $196,000 if a spouse participates in an employer-sponsored plan.
Contributions to Roth IRAs phase out at mostly different ranges. For married couples filing jointly, the MAGI range is $186,000 to $196,000. For singles or heads of household, it’s $118,000 to $133,000. But for those married but filing separately, the phase-out range is the same: $0 to $10,000, if you lived with your spouse at any time during the year.
Saving for retirement is essential for financial security. What’s more, the federal government provides tax incentives for doing so. Best of all, as mentioned, you still have time to contribute to an IRA, Roth IRA or SEP plan for the 2017 tax year. Please contact our firm for further details and a personalized approach to determining how to best contribute to your retirement plan or plans.
It’s not uncommon for adult children to help support their aging parents. If you’re in this position, you might qualify for an adult-dependent exemption to deduct up to $4,050 for each person claimed on your 2017 return.
For you to qualify for the adult-dependent exemption, in most cases your parent must have less gross income for the tax year than the exemption amount. (Exceptions may apply if your parent is permanently and totally disabled.) Social Security is generally excluded, but payments from dividends, interest and retirement plans are included.
In addition, you must have contributed more than 50% of your parent’s financial support. If you shared caregiving duties with one or more siblings and your combined support exceeded 50%, the exemption can be claimed even though no one individually provided more than 50%. However, only one of you can claim the exemption in this situation.
Although Social Security payments can usually be excluded from the adult dependent’s income, they can still affect your ability to qualify. Why? If your parent is using Social Security money to pay for medicine or other expenses, you may find that you aren’t meeting the 50% test.
Also, if your parent lives with you, the amount of support you claim under the 50% test can include the fair market rental value of part of your residence. If the parent lives elsewhere — in his or her own residence or in an assisted-living facility or nursing home — any amount of financial support you contribute to that housing expense counts toward the 50% test.
Easing the burden
An adult-dependent exemption is just one tax break that you may be able to employ on your 2017 tax return to ease the burden of caring for an elderly parent. Contact us for more information on qualifying for this break or others.
The new tax reform law, commonly called the “Tax Cuts and Jobs Act” (TCJA), is the biggest federal tax law overhaul in 31 years, and it has both good and bad news for taxpayers.
Below are highlights of some of the most significant changes affecting individual and business taxpayers. Except where noted, these changes are effective for tax years beginning after December 31, 2017.
More to consider
This is just a brief overview of some of the most significant TCJA provisions. There are additional rules and limits that apply, and the law includes many additional provisions. Contact your tax advisor to learn more about how these and other tax law changes will affect you in 2018 and beyond.
If you’re like many Americans, you might not start thinking about filing your tax return until close to this year’s April 17 deadline. You might even want to file for an extension so you don’t have to send your return to the IRS until October 15.
But there’s another date you should keep in mind: the day the IRS begins accepting 2017 returns (usually in late January). Filing as close to this date as possible could protect you from tax identity theft.
Why it helps
In an increasingly common scam, thieves use victims’ personal information to file fraudulent tax returns electronically and claim bogus refunds. This is usually done early in the tax filing season. When the real taxpayers file, they’re notified that they’re attempting to file duplicate returns.
A victim typically discovers the fraud after he or she files a tax return and is informed by the IRS that the return has been rejected because one with the same Social Security number has already been filed for the same tax year. The IRS then must determine who the legitimate taxpayer is.
Tax identity theft can cause major complications to straighten out and significantly delay legitimate refunds. But if you file first, it will be the tax return filed by a potential thief that will be rejected — not yours.
What to look for
Of course, in order to file your tax return, you’ll need to have your W-2s and 1099s. So another key date to be aware of is January 31 — the deadline for employers to issue 2017 W-2s to employees and, generally, for businesses to issue 1099s to recipients of any 2017 interest, dividend or reportable miscellaneous income payments. So be sure to keep an eye on your mailbox or your employer’s internal website.
An additional bonus: If you’ll be getting a refund, filing early will generally enable you to receive and enjoy that money sooner. (Bear in mind, however, that a law requires the IRS to hold until mid-February refunds on returns claiming the earned income tax credit or additional child tax credit.) Let us know if you have questions about tax identity theft or would like help filing your 2017 return early.
Given the astronomical cost of college, even well-off parents should consider applying for financial aid. A single misstep, however, can harm your child’s eligibility. Here are five common mistakes to avoid:
1. Presuming you don’t qualify. It’s difficult to predict whether you’ll qualify for aid, so apply even if you think your net worth is too high. Keep in mind that, generally, the value of your principal residence or any qualified retirement assets isn’t included in your net worth for financial aid purposes.
2. Filing the wrong forms. Most colleges and universities, and many states, require you to submit the Free Application for Federal Student Aid (FAFSA) for need-based aid. Some schools also require it for merit-based aid. In addition, a number of institutions require the CSS/Financial Aid PROFILE®, and specific types of aid may have their own paperwork requirements.
3. Missing deadlines. Filing deadlines vary by state and institution, so note the requirements for each school to which your child applies. Some schools provide financial aid to eligible students on a first-come, first-served basis until funding runs out, so the earlier you apply, the better. This may require you to complete your income tax return early.
4. Failing to list schools properly. The FAFSA allows you to designate up to 10 schools with which your application will be shared. The order in which you list the schools doesn't matter when applying for federal student aid. But if you're also applying for state aid, it's important to know that different rules may apply. For example, some states require you to list schools in a specified order.
5. Mistaking who’s responsible. If you’re divorced or separated, the FAFSA should be completed by the parent with whom your child lived for the majority of the 12-month period ending on the date the application is filed. This is true regardless of which parent claims the child as a dependent on his or her tax return.
The rule provides a significant planning opportunity if one spouse is substantially wealthier than the other. For example, if the child lives with the less affluent spouse for 183 days and with the other spouse for 182 days, the less affluent spouse would file the FAFSA, improving eligibility for financial aid.
These are just a few examples of financial aid pitfalls. Let us help you navigate the process and explore other ways to finance college.
Many people make donations at the end of the year. To be deductible on your 2017 return, a charitable donation must be made by December 31, 2017. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” But what does this mean?
Is it the date you write a check or charge an online gift to your credit card? Or is it the date the charity actually receives the funds? In practice, the delivery date depends in part on what you donate and how you donate it. Here are a few common examples:
Checks. The date you mail it.
Credit cards. The date you make the charge.
Pay-by-phone accounts. The date the financial institution pays the amount.
Stock certificates. The date you mail the properly endorsed stock certificate to the charity.
To be deductible, a donation must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions. The IRS’s online search tool, “Exempt Organizations (EO) Select Check,” can help you more easily find out whether an organization is eligible to receive tax-deductible charitable contributions. You can access it at https://www.irs.gov/charities-non-profits/exempt-organizations-select-check. Information about organizations eligible to receive deductible contributions is updated monthly.
Many additional rules apply to the charitable donation deduction, so please contact us if you have questions about the deductibility of a gift you’ve made or are considering making. But act soon — you don’t have much time left to make donations that will reduce your 2017 tax bill.
Many people overlook taxes when planning their mutual fund investments. But you’ve got to handle these valuable assets with care. Here are some tips to consider.
Avoid year-end investments
Typically, mutual funds distribute accumulated dividends and capital gains toward the end of the year. But don’t fall for the common misconception that investing in a fund just before a distribution date is like getting “free money.”
True, you’ll receive a year’s worth of income right after you invest. But the value of your shares will immediately drop by the same amount, so you won’t be any better off. Plus, you’ll be liable for taxes on the distribution as if you had owned your shares all year.
You can get a general idea of when a particular fund anticipates making a distribution by checking its website periodically. Also make a note of the “record date” — investors who own fund shares on that date will participate in the distribution.
Invest in tax-efficient funds
Actively managed funds tend to be less tax efficient. They buy and sell securities more frequently, generating a greater amount of capital gain, much of it short-term gain taxable at ordinary income rates rather than the lower, long-term capital gains rates.
Consider investing in tax-efficient funds instead. For example, index funds generally have lower turnover rates. And “passively managed” funds (sometimes described as “tax managed” funds) are designed to minimize taxable distributions.
Another option is exchange-traded funds (ETFs). Unlike mutual funds, which generally redeem shares by selling securities, ETFs are often able to redeem securities “in kind” — that is, to swap them for other securities. This limits an ETF’s recognition of capital gains, making it more tax efficient.
This isn’t to say that tax-inefficient funds don’t have a place in your portfolio. In some cases, actively managed funds may offer benefits, such as above-market returns, that outweigh their tax costs.
Watch out for reinvested distributions
Many investors elect to have their distributions automatically reinvested in their funds. Be aware that those distributions are taxable regardless of whether they’re reinvested or paid out in cash.
Reinvested distributions increase your tax basis in a fund, so track your basis carefully. If you fail to account for these distributions, you’ll end up paying tax on them twice — once when they’re paid and again when you sell your shares in the fund.
Fortunately, under current rules, mutual fund companies are required to track your basis for you. But you still may need to track your basis in funds you owned before 2012 when this requirement took effect, or if you purchased units in the fund outside of the current broker holding your units.
Do your due
Tax considerations should never be the primary driver of your investment decisions. Yet it’s important to do your due diligence on the potential tax consequences of funds you’re considering — particularly for your taxable accounts.
Sidebar: Directing tax-inefficient funds into nontaxable accounts
If you invest in actively managed or other tax-inefficient funds, ideally you should put these holdings in nontaxable accounts, such as a traditional IRA or 401(k). Because earnings in these accounts are tax-deferred, distributions from funds they hold won’t have any tax consequences until you withdraw them. And if the funds are held in a Roth account, those distributions will escape taxation altogether.
If you recently redeemed frequent flyer miles to treat the family to a fun summer vacation or to take your spouse on a romantic getaway, you might assume that there are no tax implications involved. And you’re probably right — but there is a chance your miles could be taxable.
Generally, miles awarded by airlines for flying with them are considered nontaxable rebates, as are miles awarded for using a credit or debit card. The IRS even addressed the issue in Announcement 2002-18, where it said:
Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.
There are, however, some types of miles awards the IRS might view as taxable. Examples include miles awarded as a prize in a sweepstakes and miles awarded as a promotion.
For instance, in the 2014 case of Shankar v. Commissioner, the U.S. Tax Court sided with the IRS in finding that airline miles awarded in conjunction with opening a bank account were indeed taxable. Part of the evidence of taxability was the fact that the bank had issued Forms 1099 MISC to customers who’d redeemed rewards points to buy airline tickets.
The value of the miles for tax purposes generally is their estimated retail value. If you’re concerned you’ve received miles awards that could be taxable, please contact us.
Well-crafted, up-to-date estate planning documents are an imperative for everyone. They also can help ease the burdens on your family during a difficult time. Two important examples: wills and living trusts.
A will is a legal document that arranges for the distribution of your property after you die and allows you to designate a guardian for minor children or other dependents. It should name the executor or personal representative who’ll be responsible for overseeing your estate as it goes through probate. (Probate is the court-supervised process of paying any debts and taxes and distributing your property after you die.) To be valid, a will must meet the legal requirements in your state.
If you die without a will (that is, “intestate”), the state will appoint an administrator to determine how to distribute your property based on state law. The administrator also will decide who will assume guardianship of any minor children or other dependents. Bottom line? Your assets may be distributed — and your dependents provided for — in ways that differ from what you would have wanted.
The living trust
Because probate can be time-consuming, expensive and public, you may prefer to avoid it. A living trust can help. It’s a legal entity to which you, as the grantor, transfer title to your property. During your life, you can act as the trustee, maintaining control over the property in the trust. On your death, the person (such as a family member or advisor) or institution (such as a bank or trust company) you’ve named as the successor trustee distributes the trust assets to the beneficiaries you’ve named.
Assets held in a living trust avoid probate — with very limited exceptions. Another benefit is that the successor trustee can take over management of the trust assets should you become incapacitated.
Having a living trust doesn’t eliminate the need for a will. For example, you can’t name a guardian for minor children or other dependents in a trust. However, a “pour over” will can direct that assets you own outside the living trust be transferred to it on your death.
There are other documents that can complement a will and living trust. A “letter of instruction,” for example, provides information that your family will need after your death. In it, you can express your desires for the memorial service, as well as the contact information for your employer, accountant and any other important advisors. (Note: It’s not a legal document.)
Also consider powers of attorney. A durable power of attorney for property allows you to appoint someone to act on your behalf on financial matters should you become incapacitated. A power of attorney for health care covers medical decisions and also takes effect if you become incapacitated. The person to whom you’ve transferred this power — your health care agent — can make medical decisions on your behalf.
These are just a few of the foundational elements of a strong estate plan. We can work with you and your attorney to address the tax issues involved.
In today’s economy, many individuals are self-employed. Others generate income from interest, rent or dividends. If these circumstances sound familiar, you might be at risk of penalties if you don’t pay enough tax during the year through estimated tax payments and withholding. Here are three strategies to help avoid underpayment penalties:
1. Know the minimum payment rules. For you to avoid penalties, your estimated payments and withholding must equal at least:
2. Use the annualized income installment method. This method often benefits taxpayers who have large variability in income by month due to bonuses, investment gains and losses, or seasonal income — especially if it’s skewed toward year end. Annualizing calculates the tax due based on income, gains, losses and deductions through each “quarterly” estimated tax period.
3. Estimate your tax liability and increase withholding. If, as year end approaches, you determine you’ve underpaid, consider having the tax shortfall withheld from your salary or year-end bonus by December 31. Because withholding is considered to have been paid ratably throughout the year, this is often a better strategy than making up the difference with an increased quarterly tax payment, which may trigger penalties for earlier quarters.
Finally, beware that you also could incur interest and penalties if you’re subject to the additional 0.9% Medicare tax and it isn’t withheld from your pay and you don’t make sufficient estimated tax payments. Please contact us for help with this tricky tax task.
Health care costs continue to be in the news and on everyone’s mind. As a result, tax-friendly ways to pay for these expenses are very much in play for many people. The three primary players, so to speak, are Health Savings Accounts (HSAs), Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs).
All provide opportunities for tax-advantaged funding of health care expenses. But what’s the difference between these three types of accounts? Here’s an overview of each one:
HSAs. If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored HSA — or make deductible contributions to an HSA you set up yourself — up to $3,400 for self-only coverage and $6,750 for family coverage for 2017. Plus, if you’re age 55 or older, you may contribute an additional $1,000.
You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.
FSAs. Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored FSA up to an employer-determined limit — not to exceed $2,600 in 2017. The plan pays or reimburses you for qualified medical expenses.
What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a 2½-month grace period to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.
HRAs. An HRA is an employer-sponsored arrangement that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year. And there’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.
Please bear in mind that these plans could be affected by health care or tax legislation. Contact our firm for the latest information, as well as to discuss these and other ways to save taxes in relation to your health care expenses.
Disaster planning is usually associated with businesses. But individuals need to prepare for worst-case scenarios, as well. Unfortunately, the topic can seem a little overwhelming. To help simplify matters, here are five keys to disaster planning that everyone should consider:
1. Insurance. Start with your homeowners’ coverage. Make sure your policy covers flood, wind and other damage possible in your region and that its dollar amount is adequate to cover replacement costs. Also review your life and disability insurance.
2. Asset documentation. Create a list of your bank accounts, titles, deeds, mortgages, home equity loans, investments and tax records. Inventory physical assets not only in writing (including brand names and model and serial numbers), but also by photographing or videoing them.
3. Document storage. Keep copies of financial and personal documents somewhere other than your home, such as a safe deposit box or the distant home of a trusted friend or relative. Also consider “cloud computing” — storing digital files with a secure Web-based provider.
4. Cash. You may not receive insurance money right away. A good rule of thumb is to set aside three to six months’ worth of living expenses in a savings or money market account. Also maintain a cash reserve in your home in a durable, fireproof safe.
5. An emergency plan. Establish a family emergency plan that includes evacuation routes, methods of getting in touch and a safe place to meet. Because a disaster might require you to stay in your home, stock a supply kit with water, nonperishable food, batteries and a first aid kit.
Are you a highly compensated employee (HCE) approaching retirement? If so, and you have a 401(k), you should consider a potentially useful tax-efficient IRA rollover technique. The IRS has specific rules about how participants such as you can allocate accumulated 401(k) plan assets based on pretax and after-tax employee contributions between standard IRAs and Roth IRAs.
In 2017, the top pretax contribution that participants can make to a 401(k) is $18,000 ($24,000 for those 50 and older). Plans that permit after-tax contributions (several do) allow participants to contribute a total of $54,000 ($36,000 above the $18,000 pretax contribution limit). While some highly compensated supersavers may have significant accumulations of after-tax contributions in their 401(k) accounts, the tax law income caps block the highest paid HCEs from opening a Roth IRA.
However, under IRS rules, these participants can roll dollars representing their after-tax 401(k) contributions directly into a new Roth IRA when they retire or no longer work for the companies. Thus, they’ll ultimately be able to withdraw the dollars representing the original after-tax contributions — and subsequent earnings on those dollars — tax-free.
Participants can contribute rollover dollars to conventional and Roth IRAs on a pro-rata basis. For example, suppose a retiring participant had $1 million in his 401(k) plan account, $600,000 of which represents contributions. Suppose further that 70% of that $600,000 represents pretax contributions, and 30% is from after-tax contributions. IRS guidance clarifies that the participant can roll $700,000 (70% of the $1 million) into a conventional IRA, and $300,000 (30% of the $1 million) into a Roth IRA.
The IRS rules allow the retiree to roll over not only the after-tax contributions, but the earnings on those after-tax contributions (40% of the $300,000, or $120,000) to the Roth IRA provided that the $120,000 will be taxable for the year of the rollover.
Alternatively, the IRS rules allow the retiree to delay taxation on the earnings attributable to the after-tax contributions ($120,000) until the money is distributed by contributing that amount to a conventional IRA, and the remaining $180,000 to the Roth IRA.
Under each approach, the subsequent growth in the Roth IRA will be tax-free when withdrawn. Partial rollovers can also be made, and the same principles apply.
Golden years ahead
HCEs face some complex decisions when it comes to retirement planning. Let our firm help you make the right moves now for your golden years ahead.
If you’re an investor looking to save tax dollars, your kids might be able to help you out. Giving appreciated stock or other investments to your children can minimize the impact of capital gains taxes.
For this strategy to work best, however, your child must not be subject to the “kiddie tax.” This tax applies your marginal rate to unearned income in excess of a specified threshold ($2,100 in 2017) received by your child who at the end of the tax year was either: 1) under 18, 2) 18 (but not older) and whose earned income didn’t exceed one-half of his or her own support for the year (excluding scholarships if a full-time student), or 3) a full-time student age 19 to 23 who had earned income that didn’t exceed half of his or her own support (excluding scholarships).
Here’s how it works: Say Bill, who’s in the top tax bracket, wants to help his daughter, Molly, buy a new car. Molly is 22 years old, just out of college, and currently looking for a job — and, for purposes of the example, won’t be considered a dependent for 2017.
Even if she finds a job soon, she’ll likely be in the 10% or 15% tax bracket this year. To finance the car, Bill plans to sell $20,000 of stock that he originally purchased for $2,000. If he sells the stock, he’ll have to pay $3,600 in capital gains tax (20% of $18,000), plus the 3.8% net investment income tax, leaving $15,716 for Molly. But if Bill gives the stock to Molly, she can sell it tax-free and use the entire $20,000 to buy a car. (The capital gains rate for the two lowest tax brackets is generally 0%.)
Few purchases during your lifetime will be as expensive as buying a home. Whether it’s your primary residence, a vacation home or an investment property, how you choose to pay for it can have a significant impact on your financial situation over time. If you’re considering a mortgage loan, understanding the main categories of mortgages — fixed-rate and adjustable-rate — and the situations they’re best designed for will help you match the right type for your needs.
Fixed-rate loans offer stability
A fixed-rate mortgage, as its name suggests, is a loan whose interest rate remains constant for the life of the loan — typically 15 or 30 years. One of the primary benefits of a fixed-rate loan is that it provides a measure of certainty about one of the biggest expenses in your monthly budget. With interest rates likely to rise after an extended period of historically low rates, you won’t have to worry about potentially higher payments in the future if you select a fixed-rate loan.
That said, if interest rates were to fall again, your fixed-rate loan would leave you unable to take advantage of the shift unless you refinance, which might involve fees. You’re also paying a premium for the stability offered by a fixed-rate mortgage. You could consider a 15-year fixed-rate loan, which would charge a lower rate than a 30-year loan, but the tradeoff will be higher monthly payments.
ARMs provide flexibility
Adjustable-rate mortgages (ARMs) typically offer a fixed interest rate for an initial period of years. This rate, which is usually lower than that of a comparable fixed-rate mortgage, resets periodically based on a benchmark interest rate. For example, a 5/1 ARM means that your interest rate is fixed for the first five years and then will adjust every year after that.
Paying less interest in the beginning frees your cash for other investments. You might also take advantage of an ARM if you’re confident that you’ll have more money in the future than you do today, or if you plan on selling your house before or soon after the initial fixed-rate period expires. When considering an ARM, you’ll need to assess your ability to keep up with potentially higher payments — say, if the initial period expires, your rate goes up and you’re unable to sell the home, or if your income changes.
The best for you
The right loan type depends, naturally, on your financial position. But whether you’re buying a primary residence, vacation home or investment property also plays a role. Regardless of which type of home you’re purchasing, having a basic knowledge of the loan types can help ease the buying process. Let our firm assist you in evaluating the best mortgage for your needs.
A royal flush can be quite a rush. But the IRS casts a wide net when defining gambling income. It includes winnings from casinos, horse races, lotteries and raffles, as well as any cash or prizes (appraised at fair market value) from contests. If you participate in any of these activities, you must report such winnings as income on your federal return.
If you’re a casual gambler, report your winnings as “Other income” on Form 1040. You may also take an itemized deduction for gambling losses, but the deduction is limited to the amount of winnings.
In some cases, casinos and other payers provide IRS Form W-2G, “Certain Gambling Winnings” — particularly if the entity in question withholds federal income tax from winnings. The information from these forms needs to be included on your tax return.
If you gamble often and actively, you might qualify as a professional gambler, which comes with tax benefits: It allows you to deduct not only losses, but also wagering-related business expenses — such as transportation, meals and entertainment, tournament and casino admissions, and applicable website and magazine subscriptions.
To qualify as a professional, you must be able to demonstrate to the IRS that a “profit motive” exists. The agency looks at a list of nonexclusive factors when making this determination, including:
But don’t “go pro” for the tax benefits, since doing so is a major financial risk. If you enjoy the occasional game of chance, or particularly if you’re considering gambling as a profession, please contact our firm. We can help you manage the tax impact.
From time to time, a business may find that its operating expenses and other deductions for a particular year exceed its income. This is known as incurring a net operating loss (NOL).
In such cases, companies (or their owners) may be able to snatch some tax relief from this revenue defeat. Under the Internal Revenue Code, a corporation or individual may deduct an NOL from its income.
3 ways to play
Generally, you take an NOL deduction in one of three ways:
1. Deducting the loss in previous years, called a “carryback,” which creates a refund,
2. Deducting the loss in future years, called a “carryforward,” which lowers your future tax liability, or
3. Doing a little bit of both.
A corporation or individual must carry back an NOL to the two years before the year it incurred the loss. But the carryback period may be increased to three years if a casualty or theft causes the NOL, or if you have a qualified small business and the loss is in a presidentially declared disaster area. The carryforward period is a maximum of 20 years.
Direction of travel
You must first carry back losses to the earliest tax year for which you qualify, depending on which carryback period applies. This can produce an immediate refund of taxes paid in the carryback years. From there, you may carry forward any remaining losses year by year up to the 20-year maximum.
You may, however, elect to forgo the carryback period and instead immediately carry forward a loss if you believe doing so will provide a greater tax benefit. But you’ll need to compare your marginal tax rate — that is, the tax rate of the last income dollar in the previous two years — with your expected marginal tax rates in future years.
For example, say your marginal tax rate was relatively low over the last two years, but you expect big profits next year. In this case, your increased income might put you in a higher marginal tax bracket. So you’d be smarter to waive the carryback period and carry forward the NOL to years in which you can use it to reduce income that otherwise would be taxed at the higher rate.
Then again, as of this writing, efforts are underway to pass tax law reform. So, if tax rates go down, it might be more beneficial to carry back an NOL as far as allowed before carrying it forward.
Whatever the reason
Many circumstances can create an NOL. Whatever the reason, the rules are complex. Let us help you work through the process.
Sidebar: AMT effect
One tricky aspect of navigating the net operating loss (NOL) rules is the impact of the alternative minimum tax (AMT). Many business owners wonder whether they can offset AMT liability with NOLs just as they can offset regular tax liability.
The answer is “yes” — you can deduct your AMT NOLs from your AMT income in generally the same manner as for regular NOLs. The excess of deductions allowed over the income recognized for AMT purposes is essentially the AMT NOL. But beware that different rules for deductions, exclusions and preferences apply to the AMT. (These rules apply to both individuals and corporations.)
When buying a vacation home, the primary objective is usually to provide a place for many years of happy memories. But you might also view the property as an income-producing investment and choose to rent it out when you’re not using it. Let’s take a look at how the IRS generally treats income and expenses associated with a vacation home.
Mostly personal use
You can generally deduct interest up to $1 million in combined acquisition debt on your main residence and a second residence, such as a vacation home. In addition, you can also deduct property taxes on any number of residences.
If you (or your immediate family) use the home for more than 14 days and rent it out for less than 15 days during the year, the IRS will consider the property a “pure” personal residence, and you don’t have to report the rental income. But any expenses associated with the rental — such as advertising or cleaning — aren’t deductible.
More rental use
If you rent out the home for more than 14 days and you (or your immediate family) occupy the home for more than 14 days or 10% of the days you rent the property — whichever is greater — the IRS will still classify the home as a personal residence (in other words, vacation home), but you will have to report the rental income.
In this situation, you can deduct the personal portion of mortgage interest, property taxes and casualty losses as itemized deductions. In addition, the rental portion of your expenses is deductible up to the amount of rental income. If your rental expenses are greater than your rental income, you may not deduct the loss against other income.
If you (or your immediate family) use the vacation home for 14 days or less, or under 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a rental property. In this instance, while the personal portion of mortgage interest isn’t deductible, you may report as an itemized deduction the personal portion of property taxes. You must report the rental income and may deduct all rental expenses, including depreciation, subject to the passive activity loss rules.
This has been just a brief examination of some of the tax issues related to a vacation home. Please contact our firm for a comprehensive assessment of your situation.
Once a relatively obscure concept, income in respect of a decedent (IRD) can create a surprisingly high tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there are ways to minimize or even eliminate the IRD tax bite.
How it works
Most inherited property is free from income taxes, but IRD assets are an exception. IRD is income a person was entitled to but hadn’t yet received at the time of his or her death. It includes:
IRD isn’t reported on the deceased’s final income tax return, but it’s included in his or her taxable estate, which may generate estate tax liability if the deceased’s estate exceeds the $5.49 million (for 2017) estate tax exemption, less any gift tax exemption used during life. (Be aware that President Trump and congressional Republicans have proposed an estate tax repeal. It hasn’t been passed as of this writing, but check back with us for the latest information.)
Then it’s taxed — potentially a second time — as income to the beneficiaries who receive it. This income retains the character it would have had in the deceased’s hands. So, for example, income the deceased would have reported as long-term capital gains is taxed to the beneficiary as long-term capital gains.
What can be done
When IRD generates estate tax liability, the combination of estate and income taxes can devour an inheritance. The tax code alleviates this double taxation by allowing beneficiaries to claim an itemized deduction for estate taxes attributable to amounts reported as IRD. (The deduction isn’t subject to the 2% floor for miscellaneous itemized deductions.)
The estate tax attributable to IRD is equal to the difference between the actual estate tax paid by the estate and the estate tax that would have been payable if the IRD’s net value had been excluded from the estate.
Suppose, for instance, that you’re the beneficiary of an estate that includes a taxable IRA. If the estate tax is $150,000 with the retirement account and $100,000 without, the estate tax attributable to the IRD income is $50,000. But be careful, because any deductions in respect of a decedent must also be included when calculating the estate tax impact.
When multiple IRD assets and multiple beneficiaries are involved, complex calculations are necessary to properly allocate the income and deductions. Similarly, when a beneficiary receives IRD over a period of years — IRA distributions, for example — the deduction must be prorated based on the amounts distributed each year.
We can help
If you inherit property that could be considered IRD, please consult our firm for assistance in managing the tax consequences. With proper planning, you can keep the cost to a minimum.
Married couples don’t always agree — and taxes are no exception. In certain cases, an “innocent” spouse can apply for relief from the responsibility of paying tax, interest and penalties arising from a spouse’s (or former spouse’s) improperly handled tax return. Although it isn’t easy to qualify, potentially affected taxpayers should review the rules.
Applicants may qualify for various forms of relief if they can meet the applicable IRS conditions. One factor that’s considered is whether the applicant received any significant direct or indirect benefit from the tax understatement. For instance, an applicant’s case could be weakened if he or she had used unreported income to pay extraordinary household expenses.
The IRS will also look at the distinctive aspects of the case. The fact that a spouse applying for relief has already divorced his or her partner is significant. Whether the applicant was abused physically or mentally will also play a role, as will whether he or she was in poor mental or physical health when the return(s) in question was signed. In addition, the IRS will consider whether the applicant would experience economic hardship without relief from a significant tax debt.
Generally, an applicant must request innocent spouse relief no later than two years after the date the IRS first attempted to collect the tax. But other forms of relief may still be available thereafter. Please contact our firm for more information.
The Achieving a Better Life Experience (ABLE) Act of 2014 created a tax-advantaged savings account for people who have a qualifying disability (or are blind) before age 26. Modeled after the well-known Section 529 college savings plan, ABLE accounts offer many benefits. But it’s important to understand their limitations.
Tax and funding benefits
Like Section 529 plans, state-sponsored ABLE accounts allow parents and other family and friends to make substantial cash contributions. Contributions aren’t tax deductible, but accounts can grow tax-free, and earnings may be withdrawn free of federal income tax if they’re used to pay qualified expenses. ABLE accounts can be established under any state ABLE program, regardless of where you or the disabled account beneficiary live.
In the case of a Section 529 plan, qualified expenses include college tuition, room and board, and certain other higher education expenses. For ABLE accounts, “qualified disability expenses” include a broad range of costs, such as health care, education, housing, transportation, employment training, assistive technology, personal support services, financial management, legal expenses, and funeral and burial expenses.
An ABLE account generally won’t jeopardize the beneficiary’s eligibility for means-tested government benefits, such as Medicaid or Supplemental Security Income (SSI). To qualify for these benefits, a person’s resources must be limited to no more than $2,000 in “countable assets.”
Assets in an ABLE account aren’t counted, with two exceptions: 1) Distributions used for housing expenses count, and 2) if the account balance exceeds $100,000, the beneficiary’s eligibility for SSI is suspended so long as the excess amount remains in the account.
ABLE accounts offer some attractive benefits, but they’re far less generous than those offered by Sec. 529 plans. Maximum contributions to 529 plans vary from state to state, but they often reach as high as $350,000 or more. The same maximum contribution limits generally apply to ABLE accounts, but practically speaking they’re limited to $100,000, given the impact on SSI benefits.
Like a 529 plan, an ABLE account allows investment changes only twice a year. But ABLE accounts also impose an annual limit on contributions equal to the annual gift tax exclusion (currently $14,000). There’s no annual limit on contributions to Sec. 529 plans.
ABLE accounts have other limitations and disadvantages as well. Unlike a Sec. 529 plan, an ABLE account doesn’t allow the person who sets up the account to be the owner. Rather, the account’s beneficiary is the owner.
However, a person with signature authority — such as a parent, legal guardian or power of attorney holder — can manage the account if the beneficiary is a minor or otherwise unable to manage the account. Nevertheless, contributions are irrevocable and the account’s funders may not make withdrawals. The beneficiary can be changed to another disabled individual who’s a family member of the designated beneficiary.
Finally, be aware that, when an ABLE account beneficiary dies, the state may claim reimbursement of its net Medicaid expenditures from any remaining balance.
If you have a child or relative with a disability in existence before age 26, it’s worth exploring the feasibility of an ABLE account. Please contact our firm for more details.
Like many people, you probably feel a great sense of relief wash over you after your tax return is completed and filed. Unfortunately, even professionally prepared and accurate returns may sometimes be subject to an IRS audit.
The good news? Chances are slim that it will actually happen. Only a small percentage of returns go through the full audit process. Still, you’re better off informed than taken completely by surprise should your number come up.
A variety of red flags can trigger an audit. Your return may be selected because the IRS received information from a third party — say, the W-2 submitted by your employer — that differs from the information reported on your return. This is often the employer’s mistake or occurs following a merger or acquisition.
In addition, the IRS scores all returns through its Discriminant Inventory Function System (DIF). A higher DIF score may increase your audit chances. While the formula for determining a DIF score is a well-guarded IRS secret, it’s generally understood that certain things may increase the likelihood of an audit, such as:
Bear in mind, though, that no single item will cause an audit. And, as mentioned, a relatively low percentage of returns are examined. This is particularly true as the IRS grapples with its own budget issues.
Finally, some returns are randomly chosen as part of the IRS’s National Research Program. Through this program, the agency studies returns to improve and update its audit selection techniques.
If you receive an audit notice, the first rule is: Don’t panic! Most are correspondence audits completed via mail. The IRS may ask for documentation on, for instance, your income or your purchase or sale of a piece of real estate.
Read the notice through carefully. The pages should indicate the items to be examined, as well as a deadline for responding. A timely response is important because it conveys that you’re organized and, thus, less likely to overlook important details. It also indicates that you didn’t need to spend extra time pulling together a story.
Your response (and ours)
Should an IRS notice appear in your mail, please contact our office. We can fully explain what the agency is looking for and help you prepare your response. If the IRS requests an in-person interview regarding the audit, we can accompany you — or even appear in your place if you provide authorization.
For many years, business owners had to ask themselves one question when it came to facing taxation in another state: Do we have “nexus”? This term indicates a business presence in a given state that’s substantial enough to trigger the state’s tax rules and obligations.
Well, the question still stands. And if you’re considering operating your business in multiple states, or are already doing so, it’s worth reviewing the concept of nexus and its tax impact on your company.
Precisely what activates nexus in a given state depends on that state’s chosen criteria. Triggers can vary but common criteria include:
Then again, one generally can’t say that nexus has a “hair trigger”. A minimal amount of business activity in a given state probably won’t create tax liability there.
For example, an HVAC company that makes a few tech calls a year across state lines probably wouldn’t be taxed in that state. Or let’s say you ask a salesperson to travel to another state to establish relationships or gauge interest. As long as he or she doesn’t close any sales, and you have no other activity in the state, you likely won’t have nexus.
As with many tax issues, the totality of facts and circumstances will determine whether you have nexus in a state. So it’s important to make assumptions either way. The tax impact could be significant, and its specifics will vary widely depending on just how the state in question approaches taxation.
For starters, strongly consider conducting a nexus study. This is a systematic approach to identifying the out-of-state taxes to which your business activities may expose you. The results of a nexus study may not necessarily be negative. You may find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state by, say, setting up a small office there. If all goes well, you may be able to allocate some income to that state and lower your tax bill.
Taxation and profitability
“The grass is always greener on the other side of the fence”, so the saying goes. If profitability beckons in another state, please contact our firm for help projecting how setting up shop there might affect your tax liability.
Sidebar: Service companies, beware of market-based sourcing
Nexus has been and remains the primary focus of companies considering whether and how they’d be taxed across state lines. (See main article.) But, recently, many states have established “market-based sourcing” for determining the tax liability of service companies that operate within their borders.
Under this approach, if the benefits of a service occur and will be used in another state, that state will tax the revenue gained from said service. “Service revenue” generally is defined as revenue from intangible assets — not the sales of tangible personal property.
Thus, in market-based sourcing states, the destination state of a service is the relevant taxation factor rather than the state in which the income-producing activity is performed (also known as the “cost of performance” method).
Individuals may want to donate artwork so it can be enjoyed by a wider audience or available for scholarly study or simply to make room for new artwork in their home. Here are four tips for donating artwork with an eye toward tax savings:
1. Get an appraisal. Donations of artwork valued at over $5,000 require a “qualified appraisal” by a “qualified appraiser”. IRS rules detail the requirements. In addition, auditors are required to refer all gifts of art valued at $20,000 or more to the agency’s Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.
2. Donate to a public charity. Donations to a qualified public charity (such as a museum or university) potentially entitle you to deduct the artwork’s full fair market value. If you donate to a private foundation, your deduction will be limited to your cost. The total amount of charitable donations you may deduct in a given year is limited to a percentage of your adjusted gross income (50% for public charities, 30% for private foundations) with the excess carried forward for up to five years.
3. Beware the related-use rule. To qualify for a full fair-market-value deduction, the charity’s use of the artwork must be related to its tax-exempt purpose. Even if the related-use rule is satisfied initially, you may lose some or all of your deductions if the artwork is worth more than $5,000 and the charity sells or otherwise disposes of it within three years of receipt. If that happens, you may be able to preserve your tax benefits via a certification process. (For further details, please contact us.)
4. Consider a fractional donation. Donating a fractional interest allows you to save tax dollars without completely giving up the artwork. Say you donate a 25% interest in your art collection to a museum for it to display for three months annually. You could then deduct 25% of the collection’s fair market value and continue displaying the art in your home or business for most of the year.
The rules for fractional donations, and charitable contributions of artwork in general, can be tricky. Plus, tax law changes affecting deductions may occur in the coming year. Contact our firm for help.
Today’s technology makes self-employment easier than ever. But if you work for yourself, you’ll face some distinctive challenges when it comes to your taxes. Here are some important steps to take:
Learn your liability. Self-employed individuals are liable for self-employment tax, which means they must pay both the employee and employer portions of FICA taxes. The good news is that you may deduct the employer portion of these taxes. Plus, you might be able to make significantly larger retirement contributions than you would as an employee.
However, you’ll likely be required to make quarterly estimated tax payments, because income taxes aren’t withheld from your self-employment income as they are from wages. If you fail to fully make these payments, you could face an unexpectedly high tax bill and underpayment penalties.
Distinguish what’s deductible. Under IRS rules, deductible business expenses for the self-employed must be “ordinary” and “necessary.” Basically, these are costs that are commonly incurred by businesses similar to yours and readily justifiable as needed to run your operations.
The tax agency stipulates, “An expense does not have to be indispensable to be considered necessary.” But pushing this grey area too far can trigger an audit. Common examples of deductible business expenses for the self-employed include licenses, accounting fees, equipment, supplies, legal expenses and business-related software.
Don’t forget your home office! You may deduct many direct expenses (such as business-only phone and data lines, as well as office supplies) and indirect expenses (such as real estate taxes and maintenance) associated with your home office. The tax break for indirect expenses is based on just how much of your home is used for business purposes, which you can generally determine by either measuring the square footage of your workspace as a percentage of the home’s total area or using a fraction based on the number of rooms.
The IRS typically looks at two questions to determine whether a taxpayer qualifies for the home office deduction:
1. Is the specific area of the home that’s used for business purposes used only for business purposes, not personal ones?
2. Is the space used regularly and continuously for business?
If you can answer in the affirmative to these questions, you’ll likely qualify. But please contact our firm for specific assistance with the home office deduction or any other aspect of filing your taxes as a self-employed individual.
As tax-filing season gets into full swing, there are many details to remember. One subject to keep in mind — especially if you’ve seen your income rise recently — is whether you’ll be able to reap the full value of tax breaks that you’ve claimed previously.
What could change? If your adjusted gross income (AGI) exceeds the applicable threshold, your personal exemptions will begin to be phased out and your itemized deductions reduced. For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (joint filer) and $155,650 (married filing separately). These are up from the 2015 thresholds, which were $258,250 (single), $284,050 (head of household), $309,900 (joint filer) and $154,950 (married filing separately).
The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately). Meanwhile, the itemized deduction limitation reduces otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). It doesn’t apply, however, to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.
If your AGI is close to the threshold, AGI-reduction strategies (such as making retirement plan and Health Savings Account contributions) may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate or defer deductible expenses. Please contact our firm for specific strategies tailored to your situation.
If you're planning to make significant charitable donations in the coming year, consider a donor-advised fund (DAF). These accounts allow you to take a charitable income tax deduction immediately, while deferring decisions about how much to give — and to whom — until the time is right.
A DAF is a tax-advantaged investment account administered by a not-for-profit "sponsoring organization", such as a community foundation or the charitable arm of a financial services firm. Contributions are treated as gifts to a Section 501(c)(3) public charity, which are deductible up to 50% of adjusted gross income (AGI) for cash contributions and up to 30% of AGI for contributions of appreciated property (such as stock). Unused deductions may be carried forward for up to five years, and funds grow tax-free until distributed.
Although contributions are irrevocable, you're allowed to give the account a name and recommend how the funds will be invested (among the options offered by the DAF) and distributed to charities over time. You can even name a successor advisor, or prepare written instructions, to recommend investments and charitable gifts after your death.
Technically, a DAF isn't bound to follow your recommendations. But in practice, DAFs almost always respect donors' wishes. Generally, the only time a fund will refuse a donor's request is if the intended recipient isn't a qualified charity.
As mentioned, DAF owners can immediately deduct contributions but make gifts to charities later. Consider this scenario: Rhonda typically earns around $150,000 in AGI each year. In 2017, however, she sells her business, lifting her income to $5 million for the year.
Rhonda decides to donate $500,000 to charity, but she wants to take some time to investigate charities and spend her charitable dollars wisely. By placing $500,000 in a DAF this year, she can deduct the full amount immediately and decide how to distribute the funds in the coming years. If she waits until next year to make charitable donations, her deduction will be limited to $75,000 per year (50% of her AGI).
Even if you have a particular charity in mind, spreading your donations over several years can be a good strategy. It gives you time to evaluate whether the charity is using the funds responsibly before you make additional gifts. A DAF allows you to adopt this strategy without losing the ability to deduct the full amount in the year when it will do you the most good.
Another key advantage is capital gains avoidance. An effective charitable-giving strategy is to donate appreciated assets — such as securities or real estate. You're entitled to deduct the property's fair market value, and you can avoid the capital gains taxes you would have owed had you sold the property.
But not all charities are equipped to accept and manage this type of donation. Many DAFs, however, have the resources to accept contributions of appreciated assets, liquidate them and then reinvest the proceeds.
Requirements and fees
A DAF can also help you streamline your estate plan and donate to a charity anonymously. Requirements and fees vary from fund to fund, however. Please contact our firm for help finding one that meets your needs.
If your company owns real property, or you do so individually, you may not always be able to dispose of it as quickly as you'd like. One avenue for perhaps finding a buyer a little sooner is an installment sale.
Benefits and risks
An installment sale occurs when you transfer property in exchange for a promissory note and receive at least one payment after the tax year of the sale. Doing so allows you to receive interest on the full amount of the promissory note, often at a higher rate than you could earn from other investments, while deferring taxes and improving cash flow.
But there may be some disadvantages for sellers. For instance, the buyer may not make all payments and you may have to deal with foreclosure.
You generally must report an installment sale on your tax return under the "installment method." Each installment payment typically consists of interest income, return of your adjusted basis in the property and gain on the sale. For every taxable year in which you receive an installment payment, you must report as income the interest and gain components.
Calculating taxable gain involves multiplying the amount of payments, excluding interest, received in the taxable year by the gross profit ratio for the sale. The gross profit ratio is equal to the gross profit (the selling price less your adjusted basis) divided by the total contract price (the selling price less any qualifying indebtedness — mortgages, debts and other liabilities assumed or taken by the buyer — that doesn't exceed your basis).
The selling price includes the money and the fair market value of any other property you received for the sale of the property, selling expenses paid by the buyer and existing debt encumbering the property (regardless of whether the buyer assumes personal liability for it).
You may be considered to have received a taxable payment even if the buyer doesn't pay you directly. If the buyer assumes or pays any of your debts or expenses, it could be deemed a payment in the year of the sale. In many cases, though, the buyer's assumption of your debt is treated as a recovery of your basis, rather than a payment.
The rules of installment sales are complex. Please contact us to discuss this strategy further.
Where did the time go? The year is quickly drawing to a close, but there’s still time to take steps to reduce your 2016 tax liability. Here are seven last-minute tax-saving tips to consider — you just must act by December 31:
1. Pay your 2016 property tax bill that’s due in early 2017.
2. Pay your fourth quarter state income tax estimated payment that’s due in January 2017.
3. Incur deductible medical expenses (if your deductible medical expenses for the year already exceed the applicable floor).
4. Pay tuition for academic periods that will begin in January, February or March of 2017 (if it will make you eligible for a tax deduction or credit).
5. Donate to your favorite charities.
6. Sell investments at a loss to offset capital gains you’ve recognized this year.
7. Ask your employer if your bonus can be deferred until January.
Keep in mind, however, that in certain situations these strategies might not make sense. For example, if you’ll be subject to the alternative minimum tax this year or be in a higher tax bracket next year, taking some of these steps could have undesirable results.
To make absolutely sure which of these tips are right for you, and learn whether there are other beneficial last-minute moves you might make, please contact our firm. We can help you maximize your tax savings for 2016.
Are you in your 50s or 60s and thinking more about retirement? If so, and you’re still not completely comfortable with the size of your nest egg, don’t forget about “catch-up” contributions. These are additional amounts beyond the regular annual limits that workers age 50 or older can contribute to certain retirement accounts.
Catch-up contributions give you the chance to take maximum advantage of the potential for tax-deferred or, in the case of Roth accounts, tax-free growth.
Under 2016 401(k) limits, if you’re age 50 or older, after you’ve reached the $18,000 maximum limit for all employees, you can contribute an extra $6,000, for a total of $24,000. If your employer offers a Savings Incentive Match Plan for Employees (SIMPLE) instead, your regular contribution maxes out at $12,500 in 2016. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $15,500 in total for the year.
But, check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do.
Another way to save more after age 50 is through a traditional IRA or a Roth IRA. With either plan, those 50 or older generally can contribute another $1,000 above the $5,500 limit for 2016. Plus, you can make 2016 IRA contributions as late as April 18, 2017.
The benefits of making the additional contribution differ depending on which account you’re considering. With a traditional IRA, contributions may be tax deductible, providing you with immediate tax savings. (The deductibility phases out at higher income levels if you or your spouse is covered by an employer retirement plan.)
Roth contributions are made with after-tax dollars, but qualified withdrawals are tax-free. By contributing to a Roth IRA and taking the tax hit up front, you won’t lose any of the income to taxes at withdrawal, provided you’re at least 59½ and have held a Roth IRA at least five years. However, be aware that the ability to contribute to a Roth IRA is phased out based on income level.
Another option if you’d like to enjoy tax-free withdrawals is to convert some or all of your traditional IRA to a Roth IRA — but you’ll also take an up-front tax hit.
If you’re self-employed, retirement plans such as an individual 401(k) — or solo 401(k) — also allow catch-up contributions. A solo 401(k) is a plan for those with no other employees. You can defer 100% of your self-employment income or compensation, up to the regular yearly deferral limit of $18,000, plus a $6,000 catch-up contribution in 2016. But that’s just the employee salary deferral portion of the contribution.
You can also make an “employer” contribution of up to 20% of self-employment income or 25% of compensation. The total combined employee-employer contribution is limited to $53,000, plus the $6,000 catch-up contribution.
The year’s almost over, but you still have time to squirrel away a few extra dollars.
When many people think about charitable giving, they picture writing a check or dropping off a cardboard box of nonperishable food items at a designated location. But giving to charity can take many different forms. One that you may not be aware of is a gift of appreciated stock. Yes, donating part of your portfolio is not only possible, but it also can be a great way to boost the tax benefits of your charitable giving.
No pain from gains
Many charitable organizations are more than happy to receive appreciated stock as a gift. It’s not unusual for these entities to maintain stock portfolios, and they’re also free to sell donated stock.
As a donor, contributing appreciated stock can entitle you to a tax deduction equal to the securities’ fair market value — just as if you had sold the stock and contributed the cash. But neither you nor the charity receiving the stock will owe capital gains tax on the appreciation. So you not only get the deduction, but also avoid a capital gains hit.
The key word here is “appreciated”. The strategy doesn’t work with stock that’s declined in value. If you have securities that have taken a loss, you’ll be better off selling the stock and donating the proceeds. This way, you can take two deductions (up to applicable limits): one for the capital loss and one for the charitable donation.
Inevitably, there are restrictions on deductions for donating appreciated stock. Annually you may deduct appreciated stock contributions to public charities only up to 30% of your adjusted gross income (AGI). For donations to nonoperating private foundations, the limit is 20% of AGI. Any excess can be carried forward up to five years.
So, for example, if you contribute $50,000 of appreciated stock to a public charity and have an AGI of $100,000, you can deduct just $30,000 this year. You can carry forward the unused $20,000 to next year. Whatever amount (if any) you can’t use next year can be carried forward until used up or you hit the five-year mark, whichever occurs first.
Moreover, you must have owned the security for at least one year to deduct the fair market value. Otherwise, the deduction is limited to your tax basis (generally what you paid for the stock). Also, the charity must be a 501(c)(3) organization.
Last, these rules apply only to appreciated stock. If you donate a different form of appreciated property, such as artwork or jewelry, different requirements apply.
A donation of appreciated stock may not be the simplest way to give to charity. But, for the savvy investor looking to make a positive difference and manage capital gains tax liability, it can be a powerful strategy. Please contact our firm for help deciding whether it’s right for you and, if so, how to properly execute the donation.
As the year winds down, many people begin to wonder whether they should put off until next year purchases they were considering for this year. One interesting wrinkle to consider from a tax perspective is the sales tax deduction.
Making the choice
This tax break allows taxpayers to take an itemized deduction for state and local sales taxes in lieu of state and local income taxes. It was permanently extended by the Protecting Americans from Tax Hikes Act of 2015.
The deduction is obviously valuable to those who reside in states with no or low income tax. But it can also substantially benefit taxpayers in other states who buy a major item, such as a car or boat.
Considering the break
Because the break is now permanent, there’s no urgency to make a large purchase this year to take advantage of it. Nonetheless, the tax impact of the deduction is worth considering.
For example, let’s say you buy a new car in 2016, your state and local income tax liability for the year is $3,000, and the sales tax on the car is also $3,000. This may sound like a wash, but bear in mind that, if you elect to deduct sales tax, you can deduct all of the sales tax you’ve paid during the year — not just the tax on the car purchase.
Picking an approach
To claim the deduction, you need not keep receipts and track all of the sales tax you’ve paid this year. You can simply use an IRS sales tax calculator that will base the deduction on your income and the sales tax rates in your locale, plus the tax you actually pay on certain major purchases.
Then again, if you retain documentation for your purchases, you might enjoy a larger deduction. The “actual receipt” approach could result in a sizable deduction if you’ve made a number of notable purchases in the past year that don’t qualify to be added on to the sales tax calculator amount. Examples include furnishing a new home, investing in high-value electronics or software, or purchasing expensive jewelry (such as engagement and wedding rings).
Saving while buying
The sales tax deduction offers an opportunity to save tax dollars while buying the items you want or need. Let us help you determine whether it’s right for you.
Appraisals can inspire anxiety for many business owners. And it’s understandable why. You’re obviously not short on things to do, and valuations cost time and money. Nonetheless, there are some legitimate reasons to obtain an appraisal regularly or, at the very least, to familiarize yourself with the process so you’re ready when the time comes.
Perhaps the most common purpose of a valuation is a prospective ownership transfer. Yet strategic investments (such as a new product or service line) can also greatly benefit from an accurate appraisal. As growth opportunities arise, business owners have only limited resources to pursue chosen strategies. A valuation can help plot the most likely route to success.
But hold on — you might say, why not simply rely on our tried-and-true projected financial statements for strategic planning? One reason is that projections ignore the time value of money because, by definition, they describe what’s going to happen given a set of circumstances. Thus, it can be difficult to compare detailed projections against other investments under consideration.
Valuators, however, can convert your financial statement projections into cash flow projections and then incorporate the time value of money into your decision making. For instance, in a net present value (NPV) analysis, an appraiser projects each alternative investment’s expected cash flows. Then he or she discounts each period’s projected cash flow to its present value, using a discount rate proportionate to its risk.
If the sum of these present values — the NPV — is greater than zero, the investment is likely worthwhile. When comparing alternatives, a higher NPV is generally better.
3 pillars of the process
Many business owners just don’t know what to expect from a valuation. To simplify matters, let’s look at three basic “pillars” of the appraisal process:
1. Purpose. There’s no such thing as a recreational valuation. Each one needs to have a specific purpose. This could be as clear-cut as an impending sale. Or perhaps an owner is divorcing his spouse and needs to determine the value of the business interest that’s includable in the marital estate.
In other cases, an appraisal may be driven by strategic planning. Have I grown the business enough to cash out now? Or how much further could we grow based on our current estimated value? The valuation’s purpose strongly affects how an appraiser will proceed.
2. Standard of value. Generally, business valuations are based on “fair market value” — the price at which property would change hands in a hypothetical transaction involving informed buyers and sellers not under duress to buy or sell. But some assignments call for a different standard of value.
For example, say you’re contemplating selling to a competitor. In this case, you might be best off getting an appraisal for the “strategic value” of your company — that is, the value to a particular investor, including buyer-specific synergies.
3. Basis of value. Private business interests typically are designated as either “controlling” or “minority” (nonmarketable). In other words, do you truly control your company or are you a noncontrolling owner?
Defining the appropriate basis of value isn’t always straightforward. Suppose a business is split equally between two partners. Because each owner has some control, stalemates could impair decision-making. An appraiser will need to definitively establish basis of value when selecting a valuation methodology and applying valuation discounts.
Often, we all find it difficult to be objective about the things we hold close. There are few better examples of this than business owners and their companies. But a valuation can provide you with an unbiased, up-to-date perspective on your business that can help you make better decisions about its future.
The traditional pension may seem like a thing of the past. But many workers are still counting on payouts from one of these “defined benefit” plans in retirement. If you’re among this group, it’s important to start thinking now about how you’ll receive the money from your pension.
Making a choice
Some defined benefit plans give retirees a choice between receiving payouts in the form of a lump sum or an annuity. Taking a lump sum distribution allows you to invest the money as you please. Plus, if you manage and invest the funds wisely, you may be able to achieve better returns than those provided by an annuity.
On the other hand, if you’re concerned about the risks associated with investing your pension benefits (you could lose principal) — or don’t want the responsibility — an annuity offers guaranteed income for life. (Bear in mind that guarantees are subject to the claims-paying ability of the issuing company.)
Choosing yet again
If you choose to receive your pension benefits in the form of an annuity — or if your plan doesn’t offer a lump sum option — your plan likely will require you to choose between a single-life or joint-life annuity. A single-life annuity provides you with monthly benefits for life. The joint-life option (also referred to as “joint and survivor”) provides a smaller monthly benefit, but the payments continue over the joint lifetimes of both you and your spouse.
Deciding between the two annuity options requires some educated guesswork. To determine the option that will provide the greatest overall financial benefit, you’ll need to consider several factors — including your and your spouse’s actuarial life expectancies as well as factors that may affect your actual life expectancies, such as current health conditions and family medical histories.
You might choose the single-life option, for example, if you and your spouse have comparable life expectancies or if you expect to live longer. Under those circumstances, the higher monthly payment will maximize your overall benefits.
But there’s a risk, too: Because the payments will stop at your death, if you die prematurely and your spouse outlives you, the overall financial benefit may be smaller than if you’d chosen the joint-life option. The difference could be substantial if your spouse outlives you by many years.
Your overall financial situation — that is, your expenses and your other assets and income sources — also play a major role. Even if you expect a joint-life annuity to yield the greatest total benefit over time, you may want to consider a single-life annuity if you need additional liquidity in the short term.
Managing this asset
Although increasingly uncommon, these defined benefit plans can be a highly valuable asset. Please contact us for help managing yours appropriately.
When it comes to tax planning, you’ve got to be ready for anything. For example, do you know whether you’re likely to be subject to the alternative minimum tax (AMT) when you file your 2016 return? If not, you need to find out now so that you can consider taking steps before year end to minimize potential liability.
The AMT was established to ensure that high-income individuals pay at least a minimum tax, even if they have many large deductions that significantly reduce their “regular” income tax. If your AMT liability is greater than your regular income tax liability, you must pay the difference as AMT, in addition to the regular tax.
AMT rates begin at 26% and rise to 28% at higher income levels. The maximum rate is lower than the maximum income tax rate of 39.6%, but far fewer deductions are allowed, so the AMT could end up taking a bigger tax bite.
For instance, you can’t deduct state and local income or sales taxes, property taxes, miscellaneous itemized deductions subject to the 2% floor, or home equity loan interest on debt not used for home improvements. You also can’t take personal exemptions for yourself or your dependents, or the standard deduction if you don’t itemize your deductions.
Steps to consider
Fortunately, you may be able to take steps to minimize your AMT liability, including:
Timing capital gains. The AMT exemption (an amount you can deduct in calculating AMT liability) phases out based on income, so realizing capital gains could cause you to lose part or all of the exemption. If it looks like you could be subject to the AMT this year, you might want to delay sales of highly appreciated assets until next year (if you don’t expect to be subject to the AMT then) or use an installment sale to spread the gains (and potential AMT liability) over multiple years.
Timing deductible expenses. Try to time the payment of expenses that are deductible for regular tax purposes but not AMT purposes for years in which you don’t anticipate AMT liability. Otherwise, you’ll gain no tax benefit from those deductions. If you’re on the threshold of AMT liability this year, you might want to consider delaying state tax payments, as long as the late-payment penalty won’t exceed the tax savings from staying under the AMT threshold.
Investing in the “right” bonds. Interest on tax-exempt bonds issued for public activities (for example, schools and roads) is exempt from the AMT. You may want to convert bonds issued for private activities (for example, sports stadiums), which generally don’t enjoy the AMT interest exemption.
Failing to plan for the AMT can lead to unexpected — and undesirable — tax consequences. Please contact us for help assessing your risk and, if necessary, implementing the appropriate strategies for your situation.
Sidebar: Does this sound familiar?
High-income earners are typically most susceptible to the alternative minimum tax. But liability may also be triggered by:
When 529 plans first hit the scene, circa 1996, they were big news. Nowadays, they’re a common part of the college-funding landscape. But don’t forget about them — 529 plans remain a valid means of saving for the rising cost of tuition and more.
Flexibility is king
529 plans are generally sponsored by states, though private institutions can sponsor 529 prepaid tuition plans. Just about anyone can open a 529 plan. And you can name anyone, including a child, grandchild, friend, or even yourself, as the beneficiary.
Investment options for 529 savings plans typically include stock and bond mutual funds, as well as money market funds. Some plans offer age-based portfolios that automatically shift to more conservative investments as the beneficiaries near college age.
Earnings in 529 savings plans typically aren’t subject to federal tax, so long as the funds are used for the beneficiary’s qualified educational expenses. This can include tuition, room and board, books, fees, and computer technology at most accredited two- and four-year colleges and universities, vocational schools, and eligible foreign institutions.
Many states offer full or partial state income tax deductions or other tax incentives to residents making 529 plan contributions, at least if the contributions are made to a plan sponsored by that state.
You’re not limited to participating in your own state’s plan. You may find you’re better off with another state’s plan that offers a wider range of investments or lower fees.
While 529 plans can help save taxes, they have some downsides. Amounts not used for qualified educational expenses may be subject to taxes and penalties. A 529 plan also might reduce a student’s ability to get need-based financial aid, because money in the plan isn’t an “exempt” asset. That said, 529 plan money is generally treated more favorably than, for instance, assets in a custodial account in the student’s name.
Just like other investments, those within 529s can fluctuate with the stock market. And some plans charge enrollment and asset management fees.
Finally, in the case of prepaid tuition plans, there may be some uncertainty as to how the benefits will be applied if the student goes to a different school.
Work with a pro
The tax rules governing 529 savings plans can be complex. So please give us a call. We can help you determine whether a 529 plan is right for you.
With summer headed toward its inevitable close, you may be tempted to splurge on a pricey “last hurrah” trip. Or perhaps you’d like to buy a brand new convertible to feel the warm breeze in your hair. Whatever the temptation may be, if you’ve pondered dipping into your 401(k) account for the money, make sure you’re aware of the consequences before you take out the loan.
Pros and cons
Many 401(k) plans allow participants to borrow as much as 50% of their vested account balances, up to $50,000. These loans are attractive because:
Yet, despite their appeal, 401(k) loans present significant risks. Although you pay the interest to yourself, you lose the benefits of tax-deferred compounding on the money you borrow.
You may have to reduce or eliminate 401(k) contributions during the loan term, either because you can’t afford to contribute or because your plan prohibits contributions while a loan is outstanding. Either way, you lose any future earnings and employer matches you would have enjoyed on those contributions.
Loans, unless used for a personal residence, must be repaid within five years. Generally, the loan terms must include level amortization, which consists of principal and interest, and payments must be made no less frequently than quarterly.
Additionally, if you’re laid off, you’ll have to pay the outstanding balance quickly — typically within 30 to 90 days. Otherwise, the amount you owe will be treated as a distribution subject to income taxes and, if you’re under age 59½, a 10% early withdrawal penalty.
If you need the money for emergency purposes, rather than recreational ones, determine whether your plan offers a hardship withdrawal. Some plans allow these to pay certain expenses related to medical care, college, funerals and home ownership — such as first-time home purchase costs and expenses necessary to avoid eviction or mortgage foreclosure.
Even if your plan allows such withdrawals, you may have to show that you’ve exhausted all other resources. Also, the amounts you withdraw will be subject to income taxes and, except for certain medical expenses or if you’re over age 59½, a 10% early withdrawal penalty.
Like plan loans, hardship withdrawals are costly. In addition to owing taxes and possibly penalties, you lose future tax-deferred earnings on the withdrawn amounts. But, unlike a loan, hardship withdrawals need not be paid back. And you won’t risk any unpleasant tax surprises should you lose your job.
The right move
Generally, you should borrow or take hardship withdrawals from a 401(k) only in emergencies or when no other financing options exist (and your job is secure). For help deciding whether such a loan would be right for you, please call us.
When they’re old enough to understand the concepts, some children start investing in the markets. If you’re helping a child learn the risks and benefits of investments, be sure you learn about the tax impact first.
For the 2016 tax year, if a child’s interest, dividends and other unearned income total more than $2,100, part of that income is taxed based on the parent’s tax rate. This is a critical point because, as joint filers, many married couples’ tax rate is much higher than the rate at which the child would be taxed.
Generally, a child’s $1,050 standard deduction for unearned income eliminates liability on the first half of that $2,100. Then, unearned income between $1,050 and $2,100 is taxed at the child’s lower rate.
But it’s here that potential danger sets in. A child’s unearned income exceeding $2,100 may be taxed at the parent’s higher tax rate if the child is under age 19 or a full-time student age 19–23, but not if the child is over age 17 and has earned income exceeding half of his support. (Other stipulations may apply.)
In many cases, parents take a simplified approach to their child’s investment income. They choose to include their son’s or daughter’s investment income on their own return rather than have him or her file a return of their own.
Basically, if a child’s interest and dividend income (including capital gains distributions) total more than $1,500 and less than $10,500, parents may make this election. But a variety of other requirements apply. For example, the unearned income in question must come from only interest and dividends.
Investing can teach kids about the time value of money, the importance of patience, and the rise and fall of business success. But it can also deliver a harsh lesson to parents who aren’t fully prepared for the tax impact. We can help you determine how your child’s investment activities apply to your specific situation.
One of the great things about setting up a home office is that you can make it as comfy as possible. Assuming you’ve done that, another good idea is getting comfortable with the home office deduction.
To qualify for the deduction, you generally must maintain a specific area in your home that you use regularly and exclusively in connection with your business. What’s more, you must use the area as your principal place of business or, if you also conduct business elsewhere, use the area to regularly conduct business, such as meeting clients and handling management and administrative functions. If you’re an employee, your use of the home office must be for your employer’s benefit.
The only option to calculate this tax break used to be the actual expense method. With this method, you deduct a percentage (proportionate to the percentage of square footage used for the home office) of indirect home office expenses, including mortgage interest, property taxes, association fees, insurance premiums, utilities (if you don’t have a separate hookup), security system costs and depreciation (generally over a 39-year period). In addition, you deduct direct expenses, including business-only phone and fax lines, utilities (if you have a separate hookup), office supplies, painting and repairs, and depreciation on office furniture.
But now there’s an easier way to claim the deduction. Under the simplified method, you multiply the square footage of your home office (up to a maximum of 300 square feet) by a fixed rate of $5 per square foot. You can claim up to $1,500 per year using this method. Of course, if your deduction will be larger using the actual expense method, that will save you more tax. Questions? Please give us a call.
Many families hire people to work in their homes, such as nannies, housekeepers, cooks, gardeners and health care workers. If you employ a domestic worker, make sure you know the tax rules.
Not everyone who works at your home is considered a household employee for tax purposes. To understand your obligations, determine whether your workers are employees or independent contractors. Independent contractors are responsible for their own employment taxes, while household employers and employees share the responsibility.
Workers are generally considered employees if you control what they do and how they do it. It makes no difference whether you employ them full time or part time, or pay them a salary or an hourly wage.
Social Security and Medicare taxes
If a household worker’s cash wages exceed the domestic employee coverage threshold of $2,000 in 2016, you must pay Social Security and Medicare taxes — 15.3% of wages, which you can either pay entirely or split with the worker. (If you and the worker share the expense, you must withhold his or her share.) But don’t count wages you pay to:
The domestic employee coverage threshold is adjusted annually for inflation, and there’s a wage limit on Social Security tax ($118,500 for 2016, adjusted annually for inflation).
Social Security and Medicare taxes apply only to cash wages, which don’t include the value of food, clothing, lodging and other noncash benefits you provide to household employees. You can also exclude reimbursements to employees for certain parking or commuting costs. One way to provide a valuable benefit to household workers while minimizing employment taxes is to provide them with health insurance.
Unemployment and federal income taxes
If you pay total cash wages to household employees of $1,000 or more in any calendar quarter in the current or preceding calendar year, you must pay federal unemployment tax (FUTA). Wages you pay to your spouse, children under age 21 and parents are excluded.
The tax is 6% of each household employee’s cash wages up to $7,000 per year. You may also owe state unemployment contributions, but you’re entitled to a FUTA credit for those contributions, up to 5.4% of wages.
You don’t have to withhold federal income tax or, usually, state income tax unless the worker requests it and you agree. In these instances, you must withhold federal income taxes on both cash and noncash wages, except for meals you provide employees for your convenience, lodging you provide in your home for your convenience and as a condition of employment, and certain reimbursed commuting and parking costs (including transit passes, tokens, fare cards, qualifying vanpool transportation and qualified parking at or near the workplace).
As an employer, you have a variety of tax and other legal obligations. This includes obtaining a federal Employer Identification Number (EIN) and having each household employee complete Forms W-4 (for withholding) and I-9 (which documents that he or she is eligible to work in the United States).
After year end, you must file Form W-2 for each household employee to whom you paid more than $2,000 in Social Security and Medicare wages or for whom you withheld federal income tax. And you must comply with federal and state minimum wage and overtime requirements. In some states, you may also have to provide workers’ compensation or disability coverage and fulfill other tax, insurance and reporting requirements.
Having a household employee can make family life easier. Unfortunately, it can also make your tax return a bit more complicated. Let us help you with the details.
With tax time long over and midyear officially here, it’s a great time to organize your financial records. And the key word here is indeed “organize.” Throwing all your important documents into a drawer won’t help much when an emergency occurs and you (or a family member) need to find a certain piece of paper.
Make a list
Of course, emergencies aren’t the only reason to organize your records. For example, you may need to be able to access relevant personal records if you’re ever audited or a victim of theft. Or your home could be damaged in a storm or fire. Or you may need proof to cash in investments or claim insurance benefits.
To get started, make a list of important records. These include items related to:
Grouping the items into broad categories such as these will make them easier to file and find later.
Establish your approach
With your list in hand, it’s time to start organizing and storing your records. Here are some tips for streamlining the process:
Create a central filing system. The ideal storage medium for personal documents is a fire-, water- and impact-resistant security cabinet or safe. Create a master list of the cabinet contents and provide a copy of the key to your executor or a trusted family member.
Designate a second storage location. Maintain a duplicate set of the records in another location, such as a bank safety deposit box, and provide access to a trusted individual (preferably not the same individual with access to the original documents). Consider keeping originals of your important legal documents, such as your will, with your attorney.
Back up records electronically. It also makes sense to store copies of records electronically. Simply scan your documents and save them to a trustworthy external storage device. If opting for a cloud-based backup system, choose your provider carefully to ensure its security measures are as stringent as possible.
Follow the ritual
Make organizing your records an annual ritual and not just a one-time event. Need assistance? We can help you identify the specific documents pertinent to your situation and organize them appropriately.
Sidebar: Create an emergency checklist to cope with calamity
Having an emergency checklist of important personal records handy is essential in the event you must evacuate your home. In a crisis, you’ll likely be able to take only what you can easily carry with you. That means storing the bare essentials in a portable container. Include these items:
Also set up an “In Case of Emergency” (ICE) directory in your cell phone. In your phone directory, simply type in “ICE” before each contact (ICE-1 Jane Smith, ICE-2 Dr. John Smith, etc.). Also consider storing and carrying electronic copies of key personal records on a USB flash drive.
The coming and going of Memorial Day marks the beginning of summer in the minds of many Americans. Although the kids might still be in school for another week or two, summer day camp is rapidly approaching for many families. If yours is among them, did you know that sending your child to day camp might make you eligible for a tax break?
Day camp is a qualified expense under the child and dependent care credit. This tax break is worth 20% of qualifying expenses, subject to a cap — and could be worth even more if your adjusted gross income is less than $43,000. For 2016, the maximum expenses allowed for the credit are $3,000 for one qualifying child and $6,000 for two or more.
Be aware, however, that overnight camp costs don’t qualify for the credit, nor do expenses related to summer school tutoring. In addition, certain types of child care are ineligible. These include care provided by a spouse and care provided by a child who’s under age 19 at the end of the year.
A variety of additional rules may apply. For example, eligible costs for care must be work-related. In other words, parents need to pay for the care so that they can work (or look for work). If you think you might qualify for the child and dependent care credit, please contact us. We can help you determine whether you’re eligible and then properly claim this potentially valuable tax break.
Preserving and managing family wealth requires addressing a number of major issues. These include saving for your children’s education and funding your own retirement. Juggling these competing demands is no trick. Rather, it requires a carefully devised and maintained family wealth management plan.
Start with the basics
First, a good estate plan can help ensure that, in the event of your death, your children will be taken care of and, if your estate is large, that they won’t lose a substantial portion of their inheritances to estate taxes. It can also guarantee that your assets will be passed along to your heirs according to your wishes.
Second, life insurance is essential. The right coverage can provide the liquidity needed to repay debts, support your children and others who depend on you financially, and pay estate taxes.
Prepare for the challenge
Most families face two long-term wealth management challenges: funding retirement and paying for college education. While both issues can be daunting, don’t sacrifice saving for your own retirement to finance your child’s education. Scholarships, grants, loans and work-study may help pay for college — but only you can fund your retirement.
Uncle Sam has provided several education incentives that are worth checking out, including tax credits and deductions for qualifying expenses and tax-advantaged savings opportunities such as 529 plans and Education Savings Accounts (ESAs). Because of income limits and phaseouts, many higher-income families won’t benefit from some of these tax breaks. But, your children (or your parents, in the case of contributing to an ESA) may be able to take advantage of them.
Give assets wisely
Giving money, investments or other assets to your children or other family members can save future income tax and be a sound estate planning strategy as well. You can currently give up to $14,000 per year per individual ($28,000 if married) without incurring gift tax or using your lifetime gift tax exemption. Depending on the number of children and grandchildren you have, and how many years you continue this gifting program, it can really add up.
By gifting assets that produce income or that you expect to appreciate, you not only remove assets from your taxable estate, but also shift income and future appreciation to people who may be in lower tax brackets.
Also consider using trusts to facilitate your gifting plan. The benefit of trusts is that they can ensure funds are used in the manner you intended and can protect the assets from your loved ones’ creditors.
Overcome the complexities
Creating a comprehensive plan for family wealth management and following through with it may not be simple — but you owe it to yourself and your family. We can help you overcome the complexities and manage your tax burden.
Sidebar: Charitable giving’s place in family wealth management
Do charitable gifts have a place in family wealth management? Absolutely. Properly made gifts can avoid gift and estate taxes, while possibly qualifying for an income tax deduction. Consider a charitable trust that allows you to give income-producing assets to charity, but keep the income for life — or for the charity to receive the earnings and the assets to later pass to your heirs. These are just two examples; there are more ways to use trusts to accomplish your charitable goals.
Like many taxpayers, you probably feel a sense of relief after filing your tax return. But that feeling can change if, soon after, you realize you’ve overlooked a key detail or received additional information that should have been considered. In such instances, you may want (or need) to amend your return.
Typically, an amended return — Form 1040X, to be exact — must be filed within three years from the date you filed the original tax return or within two years of the date the applicable tax was paid (whichever is later). Your choice of timing should depend on whether you expect a refund or a bill.
If claiming an additional refund, you should typically wait until you’ve received your original refund. Then cash or deposit the first refund check while waiting for the second. If you owe additional dollars, file the amended return and pay the tax immediately to minimize interest and penalties.
Bear in mind that, as of this writing, the IRS doesn’t offer amended returns via e-file. You can, however, track your amended return electronically. The IRS now offers an automated status-tracking tool called “Where’s My Amended Return?” at https://www.irs.gov/Filing/Individuals/Amended-Returns-(Form-1040-X)/Wheres-My-Amended-Return-1.
If you think an amended return is needed or warranted, please give us a call. We will be glad to help.
Many people want to do something, however small, to contribute to a healthier environment. There are many ways to do so and, for some of them, you can even save a few tax dollars for your efforts.
Indeed, with the passage of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) late last year, a couple of specific ways to go green and claim a tax break have been made permanent or extended. Let’s take a closer look at each.
Not driving for dollars
Air pollution is a problem in many areas of the country. Among the biggest contributors are vehicle emissions. So it follows that cutting down on the number of vehicles on the road can, in turn, diminish air pollution.
To help accomplish this, many people choose to commute to work via van pools or using public transportation. And, helpfully, the PATH Act is doing its part as well. The law made permanent the requirement that limits on the amounts that can be excluded from an employee’s wages for income and payroll tax purposes be the same for both parking benefits and van pooling / mass transit benefits.
Before the PATH Act’s parity provision, the monthly limit for 2015 was only $130 for van pooling / mass transit benefits. But, because of the new law, the 2015 monthly limit for these benefits was boosted to the $250 parking benefit limit and the 2016 limit is $255.
Sprucing up the homestead
Energy consumption can also have a negative impact on the environment and use up limited natural resources. Many homeowners want to reduce their energy consumption for environmental reasons or simply to cut their utility bills.
The PATH Act lends a helping hand here, too, by extending through 2016 the credit for purchases of residential energy property. This includes items such as:
The provision allows a credit of 10% of eligible costs for energy-efficient insulation, windows and doors. A credit is also available for 100% of eligible costs for energy-efficient heating and cooling equipment and water heaters, up to a lifetime limit of $500 (with no more than $200 from windows and skylights).
Doing it all
Going green and saving some green on your tax bill? Yes, you can do both. Van pooling or taking public transportation and improving your home’s energy efficiency are two prime examples. Please contact us for more information about how to claim these tax breaks or identify other ways to save this year.
Restructuring debt has become a common approach to personal financial management. But many people fail to realize that there’s often a tax impact to debt relief. And if you don’t anticipate it, a winning tax return may turn into a losing one.
Less debt, more income
Income tax applies to all forms of income — including what’s referred to as “cancellation-of-debt” (COD) income. Think of it this way: If a creditor forgives a debt, you avoid the expense of making the payments, which increases your net income.
Debt forgiveness isn’t the only way to generate a tax liability, though. You can have COD income if a creditor reduces the interest rate or gives you more time to pay. Calculating the amount of income can be complex but, essentially, by making it easier for you to repay the debt, the creditor confers a taxable economic benefit.
You can also have COD income in connection with a mortgage foreclosure, including a short sale or deed in lieu of foreclosure. Here, the tax consequences depend on which of the following two categories the mortgage falls into:
1. Nonrecourse. Here the lender’s sole remedy in the event of default is to take possession of the home. In other words, you’re not personally liable if the foreclosure proceeds are less than your outstanding loan balance. Foreclosure on a nonrecourse mortgage doesn’t produce COD income.
2. Recourse. This type of foreclosure can trigger COD tax liability if the lender forgives the portion of the loan that’s not satisfied. In a short sale, the lender permits you to sell the property for less than the amount you owe and accepts the sale proceeds in satisfaction of your mortgage. A deed in lieu of foreclosure means you convey the property to the lender in satisfaction of your debt. In either case, if the lender agrees to cancel the excess debt, the transaction is treated like a foreclosure for tax purposes — that is, a recourse mortgage may generate COD income.
Keep in mind that COD income is taxable as ordinary income, even if the debt is related to long-term capital gains property. And, in some cases, foreclosure can trigger both COD income and a capital gain or loss (depending on your tax basis in the property and the property’s market value).
Exceptions vs. exclusions
Several types of canceled debt are considered nontaxable “exceptions” — for example, debt cancellation that’s considered a gift (such as forgiveness of a family loan). Certain student loans are also considered exceptions — as long as they’re canceled in exchange for the recipient’s commitment to public service.
Other types of canceled debt qualify as “exclusions.” For instance, homeowners can exclude up to $2 million in COD income in connection with qualified principal residence indebtedness. A recent tax law change extended this exclusion through 2016, modifying it to apply to mortgage forgiveness that occurs in 2017 as long as it’s granted pursuant to a written agreement entered into in 2016. Other exclusions include certain canceled debts relating to bankruptcy and insolvency.
The rules applying to COD income are complex. So if you’re planning to restructure your debt this year, let us help you manage the tax impact.
Like many taxpayers, you may have been expecting to encounter a few roadblocks while traversing your preferred tax-saving avenues. If so, tax extenders legislation signed into law this past December may make your journey a little easier. Let’s walk through a few highlights of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act).
Of interest to individuals
If you’re a homeowner, the PATH Act allows you to treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction through 2016. However, this deduction is phased out for higher income taxpayers. The law likewise extends through 2016 the exclusion from gross income for mortgage loan forgiveness.
Those living in a state with low or no income taxes (or who make large purchases, such as a car or boat) will be pleased that the itemized deduction for state and local sales taxes, instead of state and local income taxes, is now permanent. Your deduction can be determined easily by using an IRS calculator and adding the tax you actually paid on certain major purchases.
Investors should note that the PATH Act makes permanent the exclusion of 100% of the gain on the sale of qualified small business stock acquired and held for more than five years (if acquired after September 27, 2010). The law also permanently extends the rule that eliminates qualified small business stock gain as a preference item for alternative minimum tax (AMT) purposes.
Breaks for businesses
The PATH Act gives business owners much to think about as well. First, there’s the enhanced Section 179 expensing election. Now permanent (and indexed for inflation beginning in 2016) is the ability for companies to immediately deduct, rather than depreciate, up to $500,000 in qualified new or used assets. The deduction phases out, dollar for dollar, to the extent qualified asset purchases for the year exceeded $2 million.
The 50% bonus depreciation break is also back, albeit temporarily. It’s generally available for new (not used) tangible assets with a recovery period of 20 years or less, and certain other assets. The 50% amount will drop to 40% for 2018 and 30% for 2019, however.
In addition, the PATH Act addresses two important tax credits. First, the research credit has been permanently extended, with some specialized provisions for smaller businesses and start-ups. Second, the Work Opportunity credit for employers that hire members of a “target group” has been extended through 2019.
Does your company provide transit benefits? If so, note that the law makes permanent equal limits for the amounts that can be excluded from an employee’s wages for income and payroll tax purposes for parking fringe benefits and van-pooling / mass transit benefits.
Much, much more
Whether you’re filing as an individual or on behalf of a business, the PATH Act could have a substantial effect on your 2015 tax return. We’ve covered only a few of its many provisions here. Please contact us to discuss these and other provisions that may affect your situation.
Sidebar: Good news for generous IRA owners
The recent tax extenders law makes permanent the provision allowing taxpayers age 70½ or older to make direct contributions from their IRA to qualified charities up to $100,000 per tax year. The transfer can count toward the IRA owner’s required minimum distribution. Many rules apply so, if you’re interested, let us help with this charitable giving opportunity.
There are virtually countless charitable organizations to which you might donate. You may choose to give cash or to contribute noncash items such as books, sporting goods, or computers or other tech gear. In either case, once you do the good deed, you owe it to yourself to properly claim a tax deduction.
No matter what you donate, you’ll need documentation. And precisely what you’ll need depends on the type and value of your donation. Here are five things to know:
1. Cash contributions of less than $250 are the easiest to substantiate. A canceled check or credit card statement is sufficient. Alternatively, you can obtain a receipt from the recipient organization showing its name, as well as the date, place and amount of the contribution. Bear in mind that unsubstantiated contributions aren’t deductible anymore. So you must have a receipt or bank record.
2. Noncash donations of less than $250 require a bit more. You’ll need a receipt from the charity. Plus, you typically must estimate a reasonable value for the donated item(s). Organizations that regularly accept noncash donations typically will provide you a form for doing so. Keep in mind that, for donations of clothing and household items to be deductible, the items generally must be in at least good condition.
3. Bigger cash donations mean more paperwork. If you donate $250 or more in cash, a canceled check or credit card statement won’t be sufficient. You’ll need a contemporaneous written acknowledgment from the recipient organization that meets IRS guidelines.
Among other things, a contemporaneous written acknowledgment must be received on or before the earlier of the date you file your return for the year in which you made the donation or the due date (including an extension) for filing the return. In addition, it must include a disclosure of whether the charity provided anything in exchange. If it did, the organization must provide a description and good-faith estimate of the exchanged item or service. You can deduct only the difference between the amount donated and the value of the item or service.
4. Noncash donations valued at $250 or more and up to $5,000 require still more. You must get a contemporaneous written acknowledgment plus written evidence that supports the item’s acquisition date, cost and fair market value. The written acknowledgment also must include a description of the item.
5. Noncash donations valued at more than $5,000 are the most complicated. Generally, both a contemporaneous written acknowledgment and a qualified appraisal are required — unless the donation is publicly traded securities. In some cases additional requirements might apply, so be sure to contact us if you’ve made or are planning to make a substantial noncash donation. We can verify the documentation of any type of donation, but contributions of this size are particularly important to document properly.
If you’ve looked into retirement planning, you’ve probably heard about the Roth IRA. Maybe in the past you decided against one of these arrangements, or perhaps you just decided to sleep on it. Whatever the case may be, now’s a good time to reacquaint yourself with the Roth IRA and its potential benefits, because you have until April 18, 2016, to make a 2015 Roth IRA contribution.
With a Roth IRA, you give up the deductibility of contributions for the freedom to make tax-free qualified withdrawals. This differs from a traditional IRA, where contributions may be deductible and earnings grow on a tax-deferred basis, but withdrawals (less any prorated nondeductible contributions) are subject to ordinary income taxes — plus a 10% penalty if you’re under age 59½ at the time of the distribution.
With a Roth IRA, you can withdraw your contributions tax-free and penalty-free anytime. Withdrawals of account earnings (considered made only after all your contributions are withdrawn) are tax-free if you make them after you’ve had the Roth IRA for five years and you’re age 59½ or older. Earnings withdrawn before this time are subject to ordinary income taxes, as well as a 10% penalty (with certain exceptions) if withdrawn before you are age 59½.
On the plus side, you can leave funds in your Roth IRA as long as you want. This differs from the required minimum distributions starting after age 70½ for traditional IRAs.
For 2016, the annual Roth IRA contribution limit is $5,500 ($6,500 for taxpayers age 50 or older), reduced by any contributions made to traditional IRAs. Your modified adjusted gross income (MAGI) may also affect your ability to contribute, however.
In 2016, the contribution limit phases out for married couples filing jointly with MAGIs between $184,000 and $194,000. The 2016 phaseout range for single and head-of-household filers is $117,000 to $132,000.
Regardless of MAGI, anyone may convert a traditional IRA into a Roth to turn future tax-deferred potential growth into tax-free potential growth. From an income tax perspective, whether a conversion makes sense depends on whether you’re better off paying tax now or later.
When you do a Roth conversion, you have to pay taxes on the amount you convert. So if you expect your tax rate to be higher in retirement than it is now, converting to a Roth may be advantageous — provided you can afford to pay the tax using funds from outside an IRA. If you expect your tax rate to be lower in retirement, however, it may make more sense to leave your savings in a traditional IRA or employer-sponsored plan.
Roth IRAs have become a fundamental part of retirement planning. Even if you’re not ready for one just yet, be sure to keep the idea of opening one on your radar.
Some married couples assume they have to file their tax returns jointly. Others may know they have a choice but not want to rock the boat by filing separately. The truth is that there’s no harm in at least considering your options every year.
Granted, married taxpayers who file jointly can take advantage of certain credits not available to separate filers. They’re also more likely to be able to make deductible IRA contributions and less likely to be subject to the alternative minimum tax.
But there are circumstances under which filing separately may be a good idea. For example, filing separately can save tax when one spouse’s income is much higher than the others, and the spouse with lower income has miscellaneous itemized deductions exceeding 2% of his or her adjusted gross income (AGI) or medical expenses exceeding 10% of his or her AGI — but jointly the couple’s expenses wouldn’t exceed the applicable floor for their joint AGI. However, in community property states, income and expenses generally must be split equally unless they’re attributable to separate funds.
Many factors play into the joint vs. separate filing decision. If you’re interested in learning more, please give us a call.
Tax-related fraud isn’t a new crime, but tax preparation software, e-filing and increased availability of personal data have made tax-related identity theft increasingly easy to perpetrate. The IRS is taking steps to reduce such fraud, but taxpayers must play their part, too.
How they do it
Criminals perpetrate tax identity theft by using stolen Social Security numbers and other personal information to file tax returns in their victims’ names. Naturally, the fake returns claim that the filer is owed a refund — and the bigger, the better.
To ensure they’re a step ahead of taxpayers filing legitimate returns and employers submitting W-2 and 1099 forms, the thieves file early in the tax season. They usually request that refunds be made to debit cards, which are hard for the IRS to trace once they’re distributed.
IRS takes action
The increasing rate of tax-related fraud — not to mention the well-publicized 2015 IRS data breach — has spurred government agencies and private sector businesses to act. This past June, a coalition made up of the IRS, state tax administrators, tax preparation services and payroll and tax product processors announced a new program with five initiatives:
1. Taxpayer identification. Coalition members will review transmission data such as Internet Protocol numbers.
2. Fraud identification. Members will share fraud leads and aggregated tax return information.
3. Information assessment. The Refund Fraud Information Sharing and Assessment Center will help public and private sector members share information.
4. Cybersecurity framework. Members will be required to adopt the National Institute of Standards and Technology cybersecurity framework.
5. Taxpayer awareness and communication. Members will increase efforts to inform the public about identity theft and protecting personal data.
Your role in preventing fraud
But the IRS and tax preparation professionals can’t fight fraud without your help. Be sure to keep your Social Security card secure, and if businesses (including financial institutions and medical providers) request your Social Security number, ensure they need it for a legitimate purpose and have taken precautions to keep your data safe. Also regularly review your credit report. You can obtain free copies from all three credit bureaus once a year.
If you’ve accumulated many bank, investment and other financial accounts over the years, you might consider consolidating some of them. Having multiple accounts requires you to spend more time tracking and reconciling financial activities and can make it harder to keep a handle on how much you have and whether your money is being invested advantageously.
Start by identifying the accounts that offer you the best combination of excellent customer service, convenience, lower fees and higher returns. Hold on to these and consider closing the rest, keeping in mind the bank account amounts you’ll be consolidating. The Federal Deposit Insurance Corporation generally insures $250,000 per depositor, per insured bank. So if consolidation means that your balance might exceed that amount, it’s better to keep multiple accounts. You should also keep accounts with different beneficiaries separate.
When closing accounts, make sure you stop automatic payments or deposits and destroy checks and cards associated with them. To prevent any future disputes, obtain letters from the financial institutions stating that your accounts have been closed. Closing an account generally takes several weeks.
When you sell a capital asset, the sale results in a capital gain or loss. A capital asset includes most property you own for personal use (such as your home or car) or own as an investment (such as stocks and bonds). Here are some facts that you should know about capital gains and losses:
• Gains and losses. A capital gain or loss is the difference between your basis and the amount you get when you sell an asset. Your basis is usually what you paid for the asset.
• Net investment income tax (NIIT). You must include all capital gains in your income, and you may be subject to the NIIT. The NIIT applies to certain net investment income of individuals who have income above statutory threshold amounts: $200,000 if you are unmarried, $250,000 if you are a married joint-filer, or $125,000 if you use married filing separate status. The rate of this tax is 3.8%.
• Deductible losses. You can deduct capital losses on the sale of investment property. You cannot deduct losses on the sale of property that you hold for personal use.
• Long- and short-term. Capital gains and losses are either long-term or short-term, depending on how long you held the property. If you held the property for more than one year, your gain or loss is long-term. If you held it one year or less, the gain or loss is short-term.
• Net capital gain. If your long-term gains are more than your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your net short-term capital loss, you have a net capital gain.
• Tax rate. The capital gains tax rate, which applies to long-term capital gains, usually depends on your taxable income. For 2015, the capital gains rate is zero to the extent your taxable income (including long-term capital gains) does not exceed $74,900 for married joint-filing couples ($37,450 for singles). The maximum capital gains rate of 20% applies if your taxable income (including long-term capital gains) is $464,850 or more for married joint-filing couples ($413,200 for singles); otherwise a 15% rate applies. However, a 25% or 28% tax rate can also apply to certain types of long-term capital gains. Short-term capital gains are taxed at ordinary income tax rates.
• Limit on losses. If your capital losses are more than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year, or $1,500 if you are married and file a separate return.
• Carryover losses. If your total net capital loss is more than the limit you can deduct, you can carry over the losses you are not able to deduct to next year's tax return. You will treat those losses as if they happened in that next year.
Yes, that is too good to be true, but we got your attention. As you are painfully aware, it is extremely difficult to earn much, if any, interest on savings, money market funds, or CDs these days. So, what are we to do? Well, one way to improve the earnings on those idle funds is to pay down debt. Paying off a home loan having an interest rate of 5% with your excess liquid assets is just like earning 5% on those funds. The same goes for car loans and other installment debt. But, the best return will more likely come from paying off credit card debt! We are not suggesting you reduce liquid assets to an unsafe level, but examine the possibility of paying off some of your present debt load with your liquid funds. Paying down $100,000 on a 5% home loan is like making more than $400 per month on those funds.
Your health insurance company may request that you provide the Social Security Numbers (SSNs) for you, your spouse, and your children covered by your policy. This is because the Affordable Care Act requires every provider of minimum essential coverage to report that coverage by filing an information return with the IRS and furnishing a statement to covered individuals. The information is used by the IRS to administer — and by individuals to show compliance with — the health care law.
Health coverage providers will file an information return (Form 1095-B, “Health Coverage”) with the IRS and will furnish statements to you in 2016 to report coverage information from calendar year 2015. The law requires coverage providers to list SSNs on this form. If you don’t provide your SSN and the SSNs of all covered individuals to the sponsor of the coverage, the IRS may not be able to match the Form 1095-B with the individuals to determine that they have complied with the individual shared responsibility provision.
Your health insurance company may mail you a letter that discusses these new rules and requests SSNs for all family members covered under your policy. The IRS has not designated a specific form for your health insurance company to request this information. However, it should be a written request that is mailed to you through the U.S. Postal Service, not emailed to you. If you receive an email request, it could be a phishing attempt by a hacker who is aware of this requirement, so be cautious and take precautions to protect yourself. Don’t respond directly to the email. Instead, call the insurance company at its main number (not any number contained in the email) or go directly to the insurance company’s website (not from the link or to an address contained in the email) to verify the request.
The Form 1095-B will provide information for your income tax return that shows you, your spouse, and individuals you claim as dependents had qualifying health coverage for some or all months during the year. You do not have to attach Form 1095-B to your tax return. However, it is important to keep it with your other important tax documents.
Anyone on your return who does not have minimum essential coverage, and who does not qualify for an exemption, may be liable for the individual shared responsibility payment.
The information received by the IRS will be used to verify information on your individual income tax return. If you refuse to provide this information to your health insurance company, the IRS cannot verify the information you provide on your tax return, and you may receive an inquiry from the IRS. You also may receive a notice from the IRS indicating that you are liable for the individual shared responsibility payment.
Continuing to work while receiving Social Security benefits may cause the benefit to be reduced below the anticipated amount. If you are under the full retirement age (currently 66), an earnings test determines whether your Social Security retirement benefits will be reduced because you earned more from a job or business than an annual exempt amount.
As a general rule, the earnings test is based on income earned during the year as a whole, without regard to the amount you earned each month. However, in the first year, benefits you receive are not reduced for any month in which you earn less than one-twelfth of the annual exempt amount.
For 2015, Social Security beneficiaries under the full benefit retirement age who have earnings in excess of the annual exempt amount are subject to a $1 reduction in benefits for each $2 earned over the exempt amount ($15,720 in 2015) for each year before the year during which they reach the full benefit retirement age. However, in the year beneficiaries reach their full benefit retirement age, earnings above a different annual exempt amount ($41,880 in 2015) are subject to a $1 reduction in benefits for each $3 earned over the exempt amount. Social Security benefits are not affected by earned income beginning with the month the beneficiary reaches full benefit retirement age.
The federal income tax rates for 2015 are the same as last year: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. However, the rate bracket beginning and ending points are increased slightly to account for inflation. For 2015, the maximum 39.6% bracket affects singles with taxable income above $413,200, married joint-filing couples with income above $464,850, heads of households with income above $439,000, and married individuals who file separate returns with income above $232,425. Higher-income individuals can also get hit by the 0.9% additional Medicare tax on wages and self-employment income and the 3.8% net investment income tax (NIIT), which can both result in a higher-than-advertised marginal federal income tax rate for 2015.
What we’ve listed below are a few money-saving ideas to get you started that you may want to put in action before the end of 2015:
• For 2015, the standard deduction is $12,600 for married taxpayers filing joint returns. For single taxpayers, the amount is $6,300. If your total itemized deductions each year are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions, such as charitable contributions and property taxes, in every other year. This allows you to time your itemized deductions so they are high in one year and low in the next. However, the alternative minimum tax (AMT), discussed later in this article, should be considered when using this strategy.
• If you or a family member own traditional IRAs and reached age 70½ this year, consider whether it’s better to take the first required minimum distribution in 2015 or by April 1 of next year.
• If your employer offers a Flexible Spending Account arrangement for your out-of-pocket medical or child care expenses, make sure you’re maximizing the tax benefits during the upcoming enrollment period for 2016.
• If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate with the maximum amount the company will match.
• If it looks like you are going to owe income taxes for 2015, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year.
• Between now and year end, review your securities portfolio for any losers that can be sold before year end to offset gains you have already recognized this year or to get you to the $3,000 ($1,500 married filing separately) net capital loss that’s deductible each year.
• If you own any securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year.
• Don’t overlook estate planning. For 2015, the unified federal gift and estate tax exemption is a generous $5.43 million, and the federal estate tax rate is a historically reasonable 40%. Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Also, you may need to make some changes that have nothing to do with taxes.
• If you are self-employed, consider employing your child. Doing so shifts income (which is not subject to the “kiddie tax”) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings and the ability to contribute to an IRA for the child.
• If you own an interest in a partnership or S corporation that you expect to generate a loss this year, you may want to make a capital contribution (or in the case of an S corporation, loan it additional funds) before year end to ensure you have sufficient basis to claim a full deduction.
Remember that effective tax planning requires considering at least this year and next year. Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2015 return won’t backfire and cost additional money in the future.
And finally, watch out for the AMT in all of your planning, because what may be a great move for regular tax purposes may create or increase an AMT problem. There’s a good chance you’ll be hit with AMT if you deduct a significant amount of state and local taxes, claim multiple dependents, exercise incentive stock options, or recognize a large capital gain this year.
Again, these are just a few suggestions to get you thinking. If you’d like to know more about them or want to discuss other ideas, please feel free to call us.
Adult children may be able to acquire a more expensive home than they might otherwise afford by using a shared equity financing arrangement, under which parents or other relatives share in the purchase and cost of maintaining a house used by the children as a principal residence. The nonresident owner rents his or her portion of the home to the resident owner and obtains the annual tax benefits of renting real estate if the statutory requirements are satisfied. Since the child does not own 100% of the home, he or she is the relative’s tenant as to the portion of the home not owned and rents that interest from the relative at a fair market rate.
A shared equity financing arrangement is an agreement by which two or more persons acquire qualified home ownership interests in a dwelling unit and the person (or persons) holding one of the interests is entitled to occupy the dwelling as his or her principal residence, and is required to pay rent to the other person(s) owning qualified ownership interests.
Under the vacation home rules, personal use of the home by a child or other relative of the property’s owner is normally attributed to the owner. However, an exception to the general rule exists when the dwelling is rented to a tenant for a fair market rent and serves as the renter’s principal residence. When the tenant owns an interest in the property, this exception to the general rule applies only if the rental qualifies as a shared equity financing arrangement.
Example: Shared equity financing arrangement facilitates child’s home ownership.
Mike and Laura have agreed to help their son, Bob, purchase his first home. The total purchase price is $100,000, consisting of a $20,000 down payment and a mortgage of $80,000. Mike and Laura pay half of the down payment and make half of the mortgage payment pursuant to a shared equity financing agreement with Bob. Bob pays them a fair rental for using 50% of the property, determined when the agreement was entered into.
Under this arrangement, Bob treats the property as his personal residence for tax purposes, deducting his 50% share of the mortgage interest and property taxes. Because his use is not attributed to his parents, Mike and Laura, they treat the property as rental. They must report the rent they receive from Bob, but can deduct their 50% share of the mortgage interest and taxes, the maintenance expenses they pay, and depreciation based on 50% of the property’s depreciable basis. If the property generates a tax loss, it is subject to, and its deductibility is limited by, the passive loss rules.
One drawback to shared equity arrangements is that the nonresident owners will not qualify for the gain exclusion upon the sale of the residence. The result will be a taxable gain for the portion of the gain related to the deemed rental. The gain may also be subject to the 3.8% net investment income tax (NIIT). Parents should consider guaranteeing or cosigning the mortgage, instead of outright joint ownership, if excluding potential future gain is a major consideration.
If it is anticipated that the resident owner will ultimately purchase the equity of the nonresident owner and the rental will generate losses suspended under the passive loss rules, special care must be taken when the lease terms are agreed to, because suspended passive losses normally allowed at disposition are not allowed when the interest is sold to a related party. This problem can be minimized by making a larger down payment that decreases mortgage interest expense, or by charging a rent at the higher end of the reasonable range for the value of the interest being rented to the resident owner.
The net investment income tax, or NIIT, is a 3.8% surtax on investment income collected from higher-income individuals. It first took effect in 2013. After filing your 2014 return, you may have been hit with this extra tax for two years, and you may now be ready to get proactive by taking some steps to stop, or at least slow, the bleeding for this year and beyond.
NIIT Basics. The NIIT can affect higher-income individuals who have investment income. While the NIIT mainly hits folks who consistently have high income, it can also strike anyone who has a big one-time shot of income or gain this year or any other year. For example, if you sell some company stock for a big gain, get a big bonus, or even sell a home for a big profit, you could be a victim. The types of income and gain (net of related deductions) included in the definition of net investment income and, therefore, exposed to the NIIT, include—
• Gains from selling investment assets (such as gains from stocks and securities held in taxable brokerage firm accounts) and capital gain distributions from mutual funds.
• Real estate gains, including the taxable portion of a big gain from selling your principal residence or a taxable gain from selling a vacation home or rental property.
• Dividends, taxable interest, and the taxable portion of annuity payments.
• Income and gains from passive business activities (meaning activities in which you don’t spend a significant amount of time) and gains from selling passive partnership interests and S corporation stock (meaning you don’t spend much time in the partnership or S corporation business activity).
• Rents and royalties.
Are You Exposed? Thankfully, you are only exposed to the NIIT if your Modified Adjusted Gross Income (MAGI) exceeds $200,000 if you are unmarried, $250,000 if you are a married joint-filer, or $125,000 if you use married filing separate status. However, these thresholds are not all that high, so many individuals will be exposed. The amount that is actually hit with the NIIT is the lesser of: (1) net investment income or (2) the amount by which your MAGI exceeds the applicable threshold. MAGI is your “regular” Adjusted Gross Income (AGI) shown on the last line on page 1 of your Form 1040 plus certain excluded foreign-source income net of certain deductions and exclusions (most people are not affected by this add-back).
Planning Considerations. As we just explained, the NIIT hits the lesser of: (1) net investment income or (2) the amount by which MAGI exceeds the applicable threshold. Therefore, planning strategies must be aimed at the proper target to have the desired effect of avoiding or minimizing your exposure to the tax.
• If your net investment income amount is less than your excess MAGI amount, your exposure to the NIIT mainly depends on your net investment income. You should focus first on strategies that reduce net investment income. Of course, some strategies that reduce net investment income will also reduce MAGI. If so, that cannot possibly hurt.
• If your excess MAGI amount is less than your net investment income amount, your exposure to the tax mainly depends on your MAGI. You should focus first on strategies that reduce MAGI. Of course, some strategies that reduce MAGI will also reduce net investment income. If so, that cannot possibly hurt.
Perhaps the most obvious way to reduce exposure to the NIIT is to invest in tax-exempt bonds via direct ownership or a mutual find. There are other ways, too. Contact us to identify strategies that will work in your specific situation.
Since the Supreme Court's 2013 Windsor decision, same-sex couples who are legally married under state or foreign laws are treated as married for federal tax purposes just like any other married couple. The Supreme Court's Obergefell decision (issued in late June) now requires all states to license and recognize marriages between same-sex couples. Specifically, the decision states that same-sex couples can exercise the fundamental right to marry in all states and that there is no lawful basis for a state to refuse to recognize a lawful same-sex marriage performed in another state.
Therefore, same-sex couples who are legally married in any state are now allowed to file joint state income tax returns wherever they reside. They are also entitled to the same inheritance and property rights and rules of intestate succession that apply to other legally married couples. Therefore, same-sex couples should now be able to amend previously filed state income, gift, and inheritance tax returns for open years to reflect married status and claim refunds. Furthermore, these couples likely need to rethink their estate and gift tax plans.
Before the Obergefell decision, members of married same-sex couples who live in states that did not previously recognize same-sex marriages had to file state income, gift, and inheritance tax returns as unmarried individuals. This caused additional complexity and expense in filing state returns.
Other implications of an individual's marital status include spousal privilege in the law of evidence; hospital access; medical decision-making authority; adoption rights; the rights and benefits of survivors; birth and death certificates; professional ethics rules; campaign finance restrictions; workers' compensation benefits; health insurance; and child custody, support, and visitation rights.
Note: The ruling does not apply to individuals in registered domestic partnerships, civil unions, or similar formal relationships recognized under state law, but not denominated as a marriage under the laws of that state. These individuals are considered unmarried for federal and state purposes. However, these state-law “marriage substitutes” might be eliminated now that all states must allow same-sex marriages. Individuals in these relationships can now obtain marriage licenses, get married, and thereby qualify as married individuals for both state and federal tax purposes.
Most of us have more than enough to do. We're on the go from early in the morning until well into the evening — six or seven days a week. Thus, it's no surprise that we may let some important things slide. We know we need to get to them, but it seems like they can just as easily wait until tomorrow, the next day, or whenever.
A U.S. Supreme Court decision reminds us that sometimes "whenever" never gets here and the results can be tragic. The case involved a $400,000 employer-sponsored retirement account, owned by William, who had named his wife, Liv, as his beneficiary in 1974 shortly after they married. The couple divorced 20 years later. As part of the divorce decree, Liv waived her rights to benefits under William's employer-sponsored retirement plans. However, William never got around to changing his beneficiary designation form with his employer.
When William died, Liv was still listed as his beneficiary. So, the plan paid the $400,000 to Liv. William's estate sued the plan, saying that because of Liv's waiver in the divorce decree, the funds should have been paid to the estate. The Court disagreed, ruling that the plan documents (which called for the beneficiary to be designated and changed in a specific way) trumped the divorce decree. William's designation of Liv as his beneficiary was done in the way the plan required; Liv's waiver was not. Thus, the plan rightfully paid $400,000 to Liv.
The tragic outcome of this case was largely controlled by its unique facts. If the facts had been slightly different (such as the plan allowing a beneficiary to be designated on a document other than the plan's beneficiary form), the outcome could have been quite different and much less tragic. However, it still would have taken a lot of effort and expense to get there. This leads us to a couple of important points.
If you want to change the beneficiary for a life insurance policy, retirement plan, IRA, or other benefit, use the plan's official beneficiary form rather than depending on an indirect method, such as a will or divorce decree.
It's important to keep your beneficiary designations up to date. Whether it is because of divorce or some other life-changing event, beneficiary designations made years ago can easily become outdated.
One final thought regarding beneficiary designations: While you're verifying that all of your beneficiary designations are current, make sure you've also designated secondary beneficiaries where appropriate. This is especially important with assets such as IRAs, where naming both a primary and secondary beneficiary can potentially allow payouts from the account to be stretched out over a longer period and maximize the time available for the tax deferral benefits to accrue.
A Health Savings Account (HSA) represents an opportunity for eligible individuals to lower their out-of-pocket health care costs and federal tax bill. Since most of us would like to take advantage of every available tax break, now might be a good time to consider an HSA, if eligible.
An HSA operates somewhat like a Flexible Spending Account (FSA) that employers offer to their eligible employees. An FSA permits eligible employees to defer a portion of their pay, on a pretax basis, which is used later to reimburse out-of-pocket medical expenses. However, unlike an FSA, whatever remains in the HSA at year end can be carried over to the next year and beyond. In addition, there are no income phaseout rules, so HSAs are available to high-earners and low-earners alike.
Naturally, there are a few requirements for obtaining the benefits of an HSA. The most significant requirement is that an HSA is only available to an individual who carries health insurance coverage with a relatively high annual deductible. For 2015, the individual's health insurance coverage must come with at least a $1,300 deductible for single coverage or $2,600 for family coverage. For many self-employed individuals, small business owners, and employees of small and large companies alike, these thresholds won't be a problem. In addition, it's okay if the insurance plan doesn't impose any deductible for preventive care (such as annual checkups). Other requirements for setting up an HSA are that an individual can't be eligible for Medicare benefits or claimed as a dependent on another person's tax return.
Individuals who meet these requirements can make tax-deductible HSA contributions in 2015 of up to $3,350 for single coverage or $6,650 for family coverage. The contribution for a particular tax year can be made as late as April 15 of the following year. The deduction is claimed in arriving at adjusted gross income (the number at the bottom of page 1 on your return). Thus, eligible individuals can benefit whether they itemize or not. Unfortunately, however, the deduction doesn't reduce a self-employed person's self-employment tax bill.
When an employer contributes to an employee's HSA, the contributions are exempt from federal income, Social Security, Medicare, and unemployment taxes.
An account beneficiary who is age 55 or older by the end of the tax year for which the HSA contribution is made may make a larger deductible (or excludible) contribution. Specifically, the annual tax-deductible contribution limit is increased by $1,000.
An HSA can generally be set up at a bank, insurance company, or other institution the IRS deems suitable. The HSA must be established exclusively for the purpose of paying the account beneficiary's qualified medical expenses. These include uninsured medical costs incurred for the account beneficiary, spouse, and dependents. However, for HSA purposes, health insurance premiums don't qualify.
You may be tempted to forget all about your taxes once you've filed your tax return, but that's not a good idea. If you start your tax planning now, you may avoid a tax surprise when you file next year. Also, now is a good time to set up a system so you can keep your tax records safe and easy to find. Here are some tips to give you a leg up on next year's taxes:
Take action when life changes occur. Some life events (such as marriage, divorce, or the birth of a child) can change the amount of tax you pay. When they happen, you may need to change the amount of tax withheld from your pay. To do that, file a new Form W-4 (“Employee's Withholding Allowance Certificate”) with your employer. If you make estimated payments, those may need to be changed as well.
Keep records safe. Put your 2014 tax return and supporting records in a safe place. If you ever need your tax return or records, it will be easy for you to get them. You'll need your supporting documents if you are ever audited by the IRS. You may need a copy of your tax return if you apply for a home loan or financial aid.
Stay organized. Make tax time easier. Have your family put tax records in the same place during the year. That way you won't have to search for misplaced records when you file next year.
If you are self-employed, here are a couple of additional tax tips to consider:
Employ your child. Doing so shifts income (which is not subject to the “kiddie tax”) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings; plus, the earnings can enable the child to contribute to an IRA. However, the wages paid must be reasonable given the child's age and work skills. Also, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student's need-based financial aid eligibility.
Avoid the hobby loss rules. A lot of businesses that are just starting out or have hit a bump in the road may wind up showing a loss for the year. The last thing the business owner wants in this situation is for the IRS to come knocking on the door arguing the business's losses aren't deductible because the activity is just a hobby for the owner. If your business is expecting a loss this year, we should talk as soon as possible to make sure you do everything possible to maximize the tax benefit of the loss and minimize its economic impact.
If you go on a business trip within the U.S. and add on some vacation days, you know you can deduct some of your expenses. The question is how much.
First, let’s cover just the pure transportation expenses. Transportation costs to and from the scene of your business activity are 100% deductible as long as the primary reason for the trip is business rather than pleasure. On the other hand, if vacation is the primary reason for your travel, then generally none of your transportation expenses are deductible. Transportation costs include travel to and from your departure airport, the airfare itself, baggage fees and tips, cabs, and so forth. Costs for rail travel or driving your personal car also fit into this category.
The number of days spent on business vs. pleasure is the key factor in determining if the primary reason for domestic travel is business. Your travel days count as business days, as do weekends and holidays if they fall between days devoted to business, and it would be impractical to return home. Standby days (days when your physical presence is required) also count as business days, even if you are not called upon to work on those days. Any other day principally devoted to business activities during normal business hours is also counted as a business day, and so are days when you intended to work, but could not due to reasons beyond your control (local transportation difficulties, power failure, etc.).
You should be able to claim business was the primary reason for a domestic trip whenever the business days exceed the personal days. Be sure to accumulate proof and keep it with your tax records. For example, if your trip is made to attend client meetings, log everything on your daily planner and copy the pages for your tax file. If you attend a convention or training seminar, keep the program and take some notes to show you attended the sessions.
Once at the destination, your out-of-pocket expenses for business days are fully deductible. Out-of-pocket expenses include lodging, hotel tips, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days are nondeductible.
In its efforts to combat identity theft, the IRS is stopping suspicious tax returns that have indications of being identity theft, but contain a real taxpayer’s name and/or Social Security number, and sending out Letter 5071C to request that the taxpayer verify his or her identity.
Letter 5071C is mailed through the U.S. Postal Service to the address on the return. It asks taxpayers to verify their identities in order for the IRS to complete processing of the returns if the taxpayers did file it or reject the returns if the taxpayers did not file it.
It is important to understand that the IRS does not request such information via e-mail; nor will the IRS call you directly to ask this information without first sending you a Letter 5071C. The letter number can be found in the upper corner of the page.
Letter 5071C gives you two options to contact the IRS and confirm whether or not you filed the return: You can (1) use the www.idverify.irs.gov site or (2) call a toll-free number on the letter. However, the IRS says that, because of the high volume on its toll-free numbers, the IRS-sponsored website, www.idverify.irs.gov, is the safest, fastest option for taxpayers with Web access.
Before accessing the website, be sure to have your prior-year and current-year tax returns available, including supporting documents, such as Forms W-2 and 1099. You will be asked a series of questions that only the real taxpayer can answer.
Once your identity is verified, you can confirm whether or not you filed the return in question. If you did not file the return, the IRS will take steps at that time to assist you. If you did file the return, it will take approximately six weeks to process it and issue a refund.
You should always be aware of tax scams, efforts to solicit personally identifiable information, and IRS impersonations. However, www.idverify.irs.gov is a secure, IRS-supported site that allows taxpayers to verify their identities quickly and safely. IRS.gov is the official IRS website. Always look for a URL ending with “.gov” — not “.com,” “.org,” “.net,” or other nongovernmental URLs.
A number of charities now ask their donors to consider donating life insurance policies rather than (or in addition to) cash in order to make substantially larger gifts than would otherwise be possible. The advantage to donors is that they can make a sizable gift with relatively little up-front cash (or even no cash, if an existing policy is donated). The fact that a charity may have to wait many years before receiving a payoff from the gift is typically not a problem, because charities normally earmark such gifts for their endowment or long-term building funds.
Of course, good reasons may exist for keeping the policy in force (such as to provide liquidity for a taxable estate or to meet the continuing needs of a surviving spouse or disabled child). Still, for individuals with both excess life insurance and a charitable intent, the donation of a life insurance policy may make sense.
If handled correctly, a life insurance policy donation can net the donor a charitable deduction for the value of the policy. A charitable deduction is also available for any cash contributed in future years to continue paying the premiums on a policy that was not fully paid up at the time it was donated. However, if handled incorrectly, no deduction is allowed. For this reason, we encourage you to contact us if you are considering donating a life insurance policy. We can help ensure that you receive the expected income tax deduction and that the contribution works as planned.