Thursday, October 1, 2015

2015 year-end tax planning — what’s new


With another year-end tax planning season now upon us, a survey of some of the new developments that have taken place over the past year is often useful. Assessing income and deductions currently realized in 2015 and forecasting for the remainder of the year and into 2016 has become an ingrained part of year-end planning, in which tax brackets are balanced, and a variety of adjusted gross income ceilings and floors between years are manipulated to a taxpayer’s best advantage. This column, however, takes a look at some of what’s new so far in 2015 in generating ideas that may have an impact on year-end planning.

At the top of the list on Congress’ tax agenda for the fall is passage of must-do legislation to renew approximately 50 tax incentives, known as extenders. Tax changes may also appear in a multi-year highway bill and/or as stand-alone legislation before year-end 2015. So far this year, however, no major changes impact 2015 year-end tax planning.
1. Tax extenders. Once again, passage of a “tax extenders” package may prove to be a cliffhanger. At stake are over 50 provisions that officially expired at the end of 2014. The hope is not only to retroactively reinstate them, but also to extend them through 2016. High on the list of extenders impacting individuals are the state and local sales tax deduction, the exclusion of discharge of qualified principal residence indebtedness, the mortgage insurance premium deduction, and the teachers’ classroom expense deduction. Business extenders include, among many others, extension of Section 179 expensing, the research credit, transit benefits parity, and the Work Opportunity Credit.
2. Trade Act. President Obama on June 29 signed the Bipartisan Congressional Trade Priorities and Accountability Act of 2015 (HR 2146) and the Trade Preferences Extension Act of 2015 (HR 1295). The trade bills touch on several tax provisions that carry year-end planning implications:
The Health Coverage Tax Credit under Code Sec. 35, used to help offset the cost of health insurance by workers whose jobs have been outsourced, has been renewed. The revived HCTC is made retroactive to Jan. 1, 2014, and available for months beginning before Jan. 1, 2020.
The Defending Public Safety Employees’ Retirement Act, included in HR 2146, provides certain federal public safety officers with an exemption from the 10 percent penalty on early distributions from a qualified retirement plan. The provision applies to distributions made after Dec. 31, 2015, so affected taxpayers should postpone taking advantage of the new law until 2016.
The major tax change brought about by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (a.k.a., the Highway Bill) involves revised due dates of certain returns and extensions. For the most part, however, they only start to impact taxpayers in 2017. Likewise, enhanced mortgage reporting and estate tax valuation connected to stepped-up basis have effective dates that removed them from 2015 year-end planning consideration.

The Supreme Court’s 2015 Obergefell decision on same-sex marriage did little to change treatment on the federal tax level. Rev. Rul. 2013-17 had already determined that for federal tax purposes, the state of celebration would control whether a same-sex couple should file jointly and otherwise be treated as married. Nevertheless, a shake-out of strategies to take advantage of the changes brought about by the Supreme Court’s Windsor decision in 2013 continues to evolve.
Benefits have been one focal point. A few weeks after Obergefell, the Social Security Administration made a focused effort to encourage spouses, divorced spouses, and surviving spouses of a same-sex marriage to apply for benefits in light of the decision. The SSA also reported that it was working with the Department of Justice to analyze the decision and provide instructions for processing claims.

In a pro-taxpayer case brought by a same-sex unmarried couple but not necessarily confined in its application, the Ninth Circuit in Voss held that multiple owners of a single residence can claim home mortgage interest deduction in excess of the $1 million and $100,000 home equity indebtedness cap. In reversing the Tax Court, the appellate court said that the IRS’s interpretation of the ceiling was wrong and that the language that set the limits were not per residence, but rather per taxpayer (with a reduced limit imposed on married taxpayers filing separately).
This case, which in effect can double the ceiling to $2 million/$200,000 for two owners, might also work in connection with vacation property — say, for example, in a situation in which several members of the same extended family might purchase and jointly mortgage a family compound-like setup. Since only a single appellate circuit has signed on to this expansion of the mortgage interest deduction so far, however, taxpayers should move cautiously and expect continued IRS resistance.

Year-end strategies include the usual consideration of Roth IRA conversions, increasing contributions to 401(k) plans, and computing any required minimum distribution requirement, among others. Gone, however, is the free-wheeling option of withdrawing from multiple IRAs to consolidate or otherwise redistribute balances. Following Bobrow, TC Memo. 2014-21, the IRS ended a grace period and announced that, effective for rollover distributions received on or after Jan. 1, 2015, a taxpayer would be limited to one 60-day rollover per year for all IRA accounts, rather than one 60-day rollover per year for each IRA account. The penalty for ignoring this rule may be immediate recognition of the entire account balance in income, as well as imposition of a 10 percent early withdrawal penalty. Unlimited trustee-to-trustee transfers, however, are still allowed and therefore offer a workaround.

Although first authorized over 18 months ago by the Tax Increase Prevention Act of 2014, A Better Life Experience, or ABLE, accounts remain unavailable. To help jumpstart the process, the IRS in Notice 2015-18 assured states that may soon enact enabling legislation, before guidance is issued, that ABLE accounts may still qualify under Code Sec. 529A even though the legislation or the account documents do not fully comply with subsequent guidance. Later in 2015, the IRS released proposed reliance regs (IR-2015-91, NPRM REG-102837-15)), that provided additional details on the establishment, funding, distribution and reporting of ABLE Accounts.
Accounts may be set up for qualified individuals with disabilities for tax years beginning after Dec. 31, 2014. Contributions to an ABLE account are limited to the annual gift tax exclusion ($14,000 in 2015), which give ABLE contributions a year-end planning dimension. A major drawback to aggressive funding in many cases, however, is that amounts left over in an account after the beneficiary dies must be transferred to the state.

Adjusting capital gains and losses, and dividend income, has always been a year-end staple. With the erratic swings in the stock markets lately, those adjustments may prove even more challenging. Simply because markets are down, however, does not mean that the taxpayer should assume that there are losses. Cost basis may be low due to prior-year holdings as the result of the long-term bull market.
2015 is the third year in which the net investment income tax of 3.8 percent applies. Taxpayers are settling into the routine of computing NII in connection with timing capital gains and other NII-captured transactions and paying estimated tax on them. IRS statistics early in 2015 confirmed that recent run-ups in the financial markets, combined with the fact that the NII thresholds are not adjusted for inflation, have increased the need to implement strategies that can avoid or minimize the NII tax.

Year-end repairs and other expenses are generally more cost-effective if allowed to be written off immediately, rather than capitalized and depreciated. An increase in the de minimis safe harbor threshold amount under the final “repair regs” for taxpayers without an applicable financial statement is needed for small businesses, the American Institute of CPAs told the IRS in early 2015. It urged the IRS to significantly boost the threshold amount from $500 to as much as $2,500.
Currently, a de minimis safe harbor allows taxpayers to deduct certain items costing $5,000 or less (per item or invoice) and that are deductible in accordance with the company’s AFS. IRS regs also continue to provide a $500 de minimis safe harbor threshold for taxpayers without an AFS.
In July, the IRS released a much-anticipated draft version of Form 3115, Application for Change in Accounting Method. Slated for release in final form by December, the new forms will be used to process many more method changes than were required back in 2009 when the current form was issued. While the draft generally follows the basic format of the current form, it makes some significant changes. New instructions are expected to do most of the heavy lifting on navigating the growing complexity of the rules.
At a recent webinar, an IRS representative indicated that taxpayers will be permitted to continue using the current version of Form 3115 (revised December 2009) to file method changes for the 2014 tax year under the repair regs even after the final version is released. This will generally benefit filers who would not need to re-prepare forms on which work has begun, or otherwise change procedures in the preparation of the form at year’s end.

A new directive from the IRS Large Business and International Division provided guidance to examiners on whether certain activities qualify for the Sec. 199 domestic production activities deduction (LB&I 04-0315-001). To be eligible for the Sec. 199 deduction, a taxpayer must determine, among other requirements, if it had manufactured, produced, grown or extracted qualified property in whole or in significant part within the United States, the IRS reminded examiners.
The IRS also issued final, temporary and proposed regulations on the allocation of Sec. 199 wages in short tax years. Proposed regulations also clarify how to determine domestic production gross receipts, among other fine points. Those involved with the Sec. 199 deduction should review these regulations with respect to timing receipts and expenditures as a necessary adjunct to year-end planning.

The installment method of reporting gain has been a tried-and-true way to defer gain on a sale into subsequent tax years. Not all income from installment payments may be deferred pro-rata, however. In Mingo, CA-5, Dec. 9, 2014, for example, the Fifth Circuit denied installment method for gain from sale of partnership interest attributable to unrealized receivables. In that case, the Fifth Circuit Court of Appeals found that married taxpayers were not entitled to use the installment method to report income from unrealized receivables the wife received from the sale of her partnership interest in a consulting business. Since the proceeds did not arise from the sale of property, their installment method of accounting did not clearly reflect income.
Existing installment sale regulations (Reg. Sec. 1.453-9(c)(2)) provide the rule that gain is not recognized on a disposition of an installment obligation if another non-recognition provision applies. Subsequently, in Rev. Rul. 73-423, the IRS provided an exception to this non-recognition rule (thus requiring recognition of gain on the disposition) where the transferor of the obligation receives stock in satisfaction of the obligation. Proposed regs (NPRM REG-109187-11) now incorporate the holding of the revenue ruling and also apply it to the receipt of a partnership interest.

The IRS issued final regs (TD 9728) during this past summer under Sec. 706(d) to address how to allocate partnership items among partners whose interests in the partnership change during its tax year. Among its changes, the final regulations set forth an expanded scope of the varying interest rule, which requires that partners’ distributive shares of partnership tax items for a tax year must take into account the varying interests of the partners in the partnership during the tax year. This adds a certain degree of flexibility in determining a partner’s distributive share when interests change at year end or otherwise.

Rev. Proc. 2015-39 has provided a safe harbor under which accrual-basis taxpayers may treat economic performance as occurring on a ratable basis for ratable service contracts. The IRS also indicated that additional safe harbors may be developed. This new safe harbor should prove useful immediately for year-end strategies by accrual-basis taxpayers currently negotiating contracts for regular services that extend into 2016. Done right to fit under the definition of ratable service contracts, a full deduction in the current 2015 tax year may be taken for certain 2015 payments, even though services may not be performed until 2016.

Each year, year-end planning takes some new twists and turns, not only because client situations change from year to year, but also because the tax law is constantly evolving. 2015 is proving no exception to changes in the tax law that may change or enhance year-end strategies. And with 2015 not yet over, additional developments, including but certainly not limited to tax legislation, are sure to further challenge existing tax strategies as we head ever closer to Jan. 1, 2016. 

Wednesday, September 30, 2015

Year-End Tax-Planning Considerations for Those About to Get Married


As if the process of getting married isn’t complex and difficult enough, prospective spouses also need to take income tax considerations into account before tying the knot.
That’s particularly true for those who plan to marry late this year or early next year. From the federal income tax standpoint, those marrying next year may come out ahead by deferring or accelerating income, depending on their circumstances. Others may find it to their advantage to defer a year-end marriage until next year.
The timing issue—whether to marry this year or the next—may be particularly relevant for same-sex couples in light of the recent decisions by the Supreme Court. In Obergefell v. Hodges, the Supreme Court held in June that same-sex couples may now exercise the fundamental right to marry in all states. Previously, in the 2013 decision U.S. v. Windsor, et al, the Supreme Court struck down section 3 of the Defense of Marriage Act, which had required same-sex spouses to be treated as unmarried for purposes of federal law. The IRS subsequently issued guidance on this decision in which it determined that same-sex couples legally married in jurisdictions that recognize their marriages will be treated as married for federal tax purposes, regardless of whether their state of residence recognizes their marriage.
Background: The amount of income subject to the two lower tax brackets (10 percent and 15 percent) for married taxpayers filing jointly is exactly twice as large as the amount of such income for single taxpayers. However, the tax brackets above 15 percent cover a larger total amount of income for two single taxpayers than for two taxpayers who are married.
For example, in 2015, two unmarried taxpayers can each have $90,750 of taxable income before they hit the 28 percent bracket. On the other hand, if they are married, their combined taxable income over $151,200 will be taxed at a rate starting at 28 percent. Also, on a joint return, the 33 percent rate begins at $230,450, the 35 percent rate starts at $411,500, and the 39.6 percent rate starts at $464,850.
On the other hand, two unmarried taxpayers with substantially equal amounts of income can have as much as $378,600 ($189,300 × 2) of taxable income before being in the 33 percent bracket, $823,000 ($411,500 × 2) before being in the 35 percent bracket, and $826,400 ($413,200 × 2) before being in the 39.6 percent bracket.
Thus, there is a marriage penalty when, for example, married taxpayers’ combined income will cause part of their income to be taxed at a rate above 25 percent, when none of their income would be taxed at a rate above 25 percent if they filed as single individuals.
A taxpayer’s marital status for the entire year is determined as of Dec. 31. A taxpayer who gets married (or divorced) on that date is treated as if he were married (or single) all year long.
Marriage-penalty implications for year-end planning: Those eager to tie the knot as soon as possible should keep in mind that deferring the marriage until next year could save substantial tax dollars. And, where two unmarried taxpayers with substantially equal amounts of taxable income have solidified plans to marry next year, it may pay to accelerate income into this year rather than attempt to defer it until next year.
Illustration 1: John and Jess are planning to get married. Jess expects to have $300,000 of taxable income in 2015, and John expects to have $250,000. Their combined taxable income for 2015 will be $550,000. If they get married before 2016, and file a joint return for 2015, they will owe income taxes for 2015 of $163,715.90. If they delay their marriage until 2016, then for 2015, Jess will owe taxes of $82,606.25, and John will owe $66,106.25, for a combined tax of $148,712.50. This will be $15,003.40 less than they would owe if they married in 2015 and filed a joint return for 2015.
If John and Jess married in 2015 and filed separate income tax returns for 2015, John would owe income taxes of $71,957.95 on taxable income of $250,000, and Jess would owe income taxes of $91,757.95 on taxable income of $300,000. The combined amount they would owe would be $163,715.90, the same amount they would owe if they filed a joint return for 2015.
Marriage bonus implications for year-end planning: If only one of the prospective spouses has substantial income, marriage and the filing of a joint return will usually save taxes, thus resulting in a marriage bonus. In such a case, it will probably be better to defer income until next year if they will be married next year, or, if they are in the planning stage, to accelerate the marriage into this year if feasible.
Illustration 2: Same facts as in Illustration 1, except John expects to have taxable income of $25,000 in 2015, and Jess expects to have taxable income of $525,000. If they get married before 2016, and file a joint return for 2015, they will owe income taxes for 2015 of $163,715.90. If they delay their marriage until 2016, then John will owe income taxes of $3,288.75 for 2015, and Jess will owe income taxes of $164,269.05. Their combined income taxes will be $167,577.80 in 2015 if they file as single taxpayers, or $3,841.90 more than they would pay if they filed a joint return for 2015.
Depending on the taxpayers’ income, marriage and the filing of a joint return may not only result in a marriage bonus because of the tax-rate structure, but also produce tax savings in the form of bigger deductions based on adjusted gross income, or smaller AGI-based tax hikes. For example, for 2015:
• The AGI phaseout for making deductible contributions to traditional IRAs by taxpayers who are active participants in an employer-sponsored retirement plan begins at $98,000 of modified AGI (MAGI) for joint return filers and the deduction is phased out completely at $118,000 of MAGI. For single taxpayers, the phaseout begins at $61,000 of MAGI and is phased out completely at $71,000 of MAGI. And for a married taxpayer who is not an active plan participant but whose spouse is such a participant, the otherwise allowable deductible contribution phases out ratably for MAGI between $183,000 and $193,000.
• Individuals may take an above-the-line deduction for up to $2,500 of interest on qualified education loans, but the amount otherwise deductible is reduced ratably at modified AGI between $130,000 and $160,000 on joint returns, and between $65,000 and $80,000 on other returns.
• The 3.8 percent investment surtax applies to the lesser of (1) net investment income or (2) the excess of MAGI over the threshold amount of $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers.
• The additional 0.9 percent Medicare (hospital insurance) tax applies to individuals receiving wages with respect to employment in excess of $250,000 for married couples filing jointly, $125,000 for married couples filing separately, and $200,000 for other taxpayers.
Besides the above considerations, couples thinking of marrying should consider there are various tax rules that apply differently to related parties, and that, when one marries, his spouse becomes a related party. For example, there is a rule that doesn’t allow someone to recognize a loss on a sale to a related party. Using that example, a couple may want to consider having an intra-couple sale occur before the marriage takes place.

Tuesday, September 29, 2015

Alternative Minimum Tax: What Is It and Do You Need to Worry About It?


There are two ways the IRS can calculate your federal income tax liability each year -- the standard method of using deductions, exemptions, and credits to determine your marginal tax rate or tax bracket, and a completely separate method called the alternative minimum tax, or AMT. More and more middle-class households are blindsided by the alternative minimum tax each year, so here's what you need to know about the tax and who it applies to.
What is the alternative minimum tax?Basically, the alternative minimum tax is intended to ensure that high-income individuals can't use excessive deductions and exemptions to avoid paying their fair share of taxes. The tax has existed since 1969, and was originally aimed at top income earners who derived all of their income from tax-free bonds in order to avoid paying any taxes whatsoever.
At first, the tax made a lot of sense. It originally targeted people who earned over $200,000 per year, which was a massive income in 1969. Fast-forward 46 years, and the AMT thresholds now include many middle-income families.
Will you have to pay it?Whether or not you'll have to pay alternative minimum tax depends on a few factors. Of course, the primary factor is your income. And, while it seems that earners in the $200,000 to $500,000 income level are most vulnerable, it's possible to get hit with an alternative minimum tax with an income greater than $83,400 for married couples and $53,600 for single taxpayers.
Other than income, the main determining factor is how many exemptions and deductions you have. For instance, if you have a bunch of kids, high medical expenses, and you have lots of miscellaneous itemized deductions, it's entirely possible to earn a six-figure salary and have zero federal income tax liability under the standard calculations.
However, your tax will be calculated using both methods -- the standard formula as well as the alternative minimum tax. If the alternative minimum tax is more than the standard calculated tax, you're responsible for paying the difference.
How is it calculated?The calculation of alternative minimum tax is complicated (then again, what isn't complicated about the U.S. tax system?)
When calculating alternative minimum tax, a completely different set of exemptions and tax rates are used. The calculation starts with your regular taxable income, and then certain deductions are added back in. For wealthy taxpayers, deductions related to incentive stock options and tax-exempt interest from certain private activity bonds are added back, but there are many deductions commonly taken by middle-income taxpayers that are not allowed in the AMT calculation. Just to name a few examples of deductions that are not used when determining income for alternative minimum tax purposes:
  • Deductions for state and local taxes you paid
  • Miscellaneous itemized deductions -- this category includes deductions for unreimbursed employee expenses, tax preparation fees, and several other expenses.
  • Property taxes
  • Home equity loan interest, unless the loan funds were used exclusively for home improvements
Once the income subject to alternative minimum tax is calculated, an exemption amount is applied, which is $83,400 (married filing jointly) or $53,600 (single/head of household) for the 2015 tax year. The remaining amount is subject to tax rates of 26% or 28% depending on how much the income is, and if the income is high enough, the exemption amount begins to phase out. I know this sounds complicated.
f this still sounds complicated, don't worry. Few people actually calculate their AMT by hand. If you use a computer program to do your taxes, all of the major ones calculate the alternative minimum tax automatically. For the few people who prefer to do taxes by hand, the IRS provides an AMT assistant to help determine whether you should even fill out the AMT form.
Smart tips to reduce your alternative minimum taxThere may be a few ways to reduce the likelihood you'll get hit with the alternative minimum tax, or at least reduce the amount you'll have to pay. To get you started:
  • Increasing your 401(k) contributions can help reduce your taxable income, and you can choose to defer $18,000 of your paychecks into your account in 2015 ($24,000 if you're over 50).
  • Make sure your tax-free municipal bonds are AMT-exempt. Your financial advisor should be able to find this out quickly, and many bonds are actually advertised as "AMT free."
  • Maximize your business tax deductions. If you file a schedule C, the deductions you claim are not affected by the alternative minimum tax calculations.
The bottom lineThe alternative minimum tax has good intentions -- to make sure that loopholes don't allow the wealthy to avoid paying their fair share of federal income taxes. However, since the AMT thresholds are now in the realm of middle-class household incomes, it makes sense to familiarize yourself with the alternative minimum tax calculation process and whether it could affect you.

Monday, September 28, 2015

Capital losses can save on taxes

With the end of 2015 approaching, you may be assessing your personal income tax situation and looking for tax planning strategies that will work to your favor. Have you considered the potential for tax savings related to capital gains and losses?
Most taxpayers understand that their income levels and filing status determine their marginal (ordinary) tax bracket, with tax rates ranging from 10 percent to 39.6 percent. These tax rates apply to sources of ordinary income, such as salary, self-employment income, business income, interest income and certain sources of retirement income.
However, capital gain income may be subject to rates that are lower than ordinary tax rates. Capital assets commonly include property held for investment, such as stocks, bonds and mutual funds. The tax rate on long-term capital gains can range from zero percent to 20 percent, depending on your taxable income.
Awareness of the different tax rates and evaluating the nature of your capital gains can help you take advantage of the preferential capital gain tax rates, utilize capital losses to offset capital gains and provide an opportunity for tax savings.
 What are the different capital gains tax rates?
The long-term capital gains tax rate of zero percent applies to taxpayers with taxable income less than $74,900 for “Married Filing Joint” and less than $37,450 for single filers.
The long-term capital gains tax rate of 15 percent applies to taxpayers with taxable income between $74,901 and $464,850 for “Married Filing Joint” and between $37,451 and $413,200 for single filers.
The maximum long-term capital gains tax rate of 20 percent applies to taxpayers with taxable income over $464,851 for “Married Filing Joint” and over $413,201 for single filers.
 What is the difference between short-term and long-term capital gains and losses?
A capital gain or loss occurs upon the sale or exchange of property and equals the difference between the sales proceeds and your basis in the property, which typically is the amount you paid for it.
A capital gain or loss is categorized as short-term when the property is owned or held for one year or less before it is sold. Property held for more than one year is categorized as long-term. The holding period generally begins the day after the property is acquired and ends as of the day the property is sold.
It is important to know that net long-term capital gains qualify for the lower tax rates and net short-term capital gains are taxed at your ordinary tax rates. For this reason, if you are going to sell an investment at a gain, it may be beneficial to hold onto it for more than a year before selling so the gain can qualify for long-term treatment.
In order to determine the tax treatment of your capital gains, you will first need to net the gains and losses. Capital losses offset capital gains, but only up to $3,000 of net capital loss can be used to offset ordinary income in each year.
Excess losses are carried forward within the short-term or long-term category from which they originated to offset future capital gains until fully utilized.
Capital gains and losses are first netted against each other within their respective short-term or long-term categories. When there is both a net short-term gain and a net long-term gain, the short-term gain is taxed at ordinary rates and the long-term gain is taxed at capital gains rates.
An overall net short-term gain can result when net short-term gains exceed, or absorb, net long-term losses. An overall net long-term gain can result when net long-term gains exceed net short-term losses.
 How can losses help reduce my tax liability?
Capital losses offset your capital gains dollar for dollar. Capital gains are essentially tax-free when fully absorbed by capital losses.
You may want to consider whether your investment portfolio provides an opportunity to recognize capital losses to partially or fully offset gains. Also, since net capital gains are included in your taxable income, they factor into several tax deduction limitations and phase-outs that are based on income levels.
There are additional tax implications and variables to consider beyond the general concepts covered in this article. A detailed analysis may be necessary to determine the specific tax impact that will apply to your situation.

Saturday, September 26, 2015

5 Overlooked Variables in Retirement Planning


It wasn’t long ago that most Americans had a secure three-legged stool on which to rest their retirement concerns – a well-funded Social Security system, substantial corporate pensions with retiree health benefits and, ideally, a strong personal savings rate.
Nowadays, however, pensions aren’t what they used to be; they’ve been largely replaced by employer-sponsored plans such as a 401(k), 403(b) or 457, the reliability of which is yet to be proven. Social Security, which was never meant to be a sole income provider during retirement, is often said to be vulnerable for future generations.
Alarmingly, only 53 percent of the civilian workforce contributes to or participates in a retirement plan, according to the U.S. Bureau of Labor Statistics, with subsets like the private industry at just 48 percent. And, according to the Transamerica Center for Retirement Studies, 36 percent of baby boomers plan to rely on Social Security as their primary source of income.
“All is not lost; however, whether you’re retired, soon-to-be retired or planning on it a few decades in advance, your best move is to do something about it now,” says Marc Sarner, president of Wake Up Financial and Insurance Services Inc. (
While there are many clear factors to consider when planning for retirement – such as when to draw Social Security benefits and the possibility of long-term medical care – Sarner summarizes five variables you may be overlooking.
  • You may need a housing plan – or two. Between 2005 and 2007, U.S. home values spiked drastically in value, but shortly thereafter plummeted. Fluctuations in the housing market could impact your retirement income strategy. Your home may not provide the backup retirement income you have anticipated, Sarner says. Looking ahead, the rate of house appreciation is likely to revert closer to the long-term norms (pre-2006) of 0.75 to 1 percent per year over the rate of inflation – not double-digit annual increases, according to the Urban Land Institute.
  •  Consider the potential impact of inflation. Inflation can be experienced a little differently when you retire because you’ll likely spend money proportionately on different things. For retirees, the tendency is to spend money on things that experience a higher rate of inflation. For instance, health care, which has an inflation rate of about 8 percent – is currently two to three times greater than the overall inflation rate. 
  •  Reconsider your goals. The distribution of retirement income differs from accumulation because, once retired, you may no longer have the timeline to help you recover from the impact of a down market. You can’t control what the markets will do, or when they will do it, Sarner says. The occurrence of a market downturn, such as in the first few years of retirement, can have an impact on how long retirement assets may last. One helpful strategy is to combine growth opportunity with reliable income sources.
  •  Understand taxes in retirement. Many pre-retirees think that when they retire their taxes will be less because they are no longer working. However, many of my clients pay more taxes in retirement then while they were working.  Shocking? It’s true. The house is paid off, you have no dependents and have less write offs. Throw in your pension and Social Security income, plus RMD income from IRAs and 401ks, and now you have a real taxation problem. Proper planning can help elevate this future tax liability.
  •  Find your distribution strategy. Saving for retirement is like standing at the foot of a tall mountain and beginning the slow, steady climb towards your retirement savings goal. If you’re not prepared for a long and controlled descent, you could run out of an adequate supply of rope to make your journey safely. A distribution strategy is all about how to descend the mountain as steadily, carefully and securely as possible.
“These are summary explanations of lengthy considerations,” Sarner says. “Be sure to carefully review the many aspects of these retirement variables.”

Friday, September 25, 2015

Self-Employed? Don't Forget These Tax-Filing Tips

Calculating income taxes is a royal pain, even when your situation is uncomplicated enough that you can file a 1040EZ Form. And if you're self-employed, be prepared for extra layers of complexity. Not only must you file an annual return with numerous additional forms and schedules, you're also responsible for paying quarterly estimated taxes, which can mean having to write a pretty hefty check while waiting for your clients to pay their overdue bills.

Add in that you're also responsible for funding your own health insurance and retirement and you may start to miss having an employer manage a portion of your financial affairs. (Although many people go into business for themselves precisely to call their own shots.)

Here are a few things to remember when calculating your 2015 taxes:

First, some potentially good news for taxpayers who claim a home office deduction: You now may choose between the traditional method of calculating the business use of your home (which involves numerous calculations, filling out the onerous IRS Form 8829 and maintaining back-up records for years) and a new simplified option.

Under the new, so-called "safe harbor" method, you can simply claim a standard deduction of $5 per square foot for the portion of your home used regularly and exclusively for business, up to a maximum of 300 square feet – a $1,500 limit.

Contrast that with the traditional method where you must calculate actual expenses of your home office expressed as a percentage of the square footage your home office consumes. For example, if your office takes up 12 percent of your house, you can deduct 12 percent of your electricity bill.

A few additional details:

• You can choose either method from year to year; however, once you've elected a method for a given tax year it's irrevocable.

• Under the safe-harbor method you cannot depreciate the portion of your home used for business in that particular year.

• With the new method you can still claim allowable mortgage interest, real estate taxes and insurance losses as itemized deductions on Schedule A. These deductions don't have to be allocated between personal and business use, as under the traditional method.

You'll need to weigh whether the recordkeeping hours you save justify the potentially smaller deduction – especially if you have a large home office or considerable deductions. Suggestion: Look at last year's deduction and compare what it would have been using the $5 per square foot calculation, factoring in time spent doing the math.

A few other self-employment tax-filing considerations:

• In addition to the home office deduction, you generally can deduct many other business-related expenses, including: legal and accounting fees; professional dues and subscriptions; business insurance and licenses; professional training and education; professional equipment and software; maintenance/repairs; and business-related mileage, travel and entertainment.

• You can also deduct the full cost of medical, dental, vision and long-term care insurance premiums for you, your spouse and dependents, even if you don't itemize deductions.

• For more details on business expenses and deductions, see IRS Publication 535 ( Also visit the IRS' Self-Employed Individuals Tax Center.

Bottom line: Income taxes are often more complicated for self-employed people and good recordkeeping is essential. Unless you're an accounting whiz, consider hiring a tax professional or financial planner who specializes in self-employment issues. The penalties and fees they can help you avoid – and hidden deductions they can uncover – will probably more than pay for their fees.

Thursday, September 24, 2015

Retiring early? Plan ahead to avoid early withdrawal penalties

Imagine you have diligently saved over the years, accumulating a substantial amount of money for your retirement. If you could access your funds, you would be able to work part-time or even retire early. Unfortunately, you are younger than 59 ½ and your money is tied up in pre-tax or qualified plans. 

Retirement plans, such as IRAs, 401(k)s, SEP-IRAs or SIMPLE IRAs, allow you to save money pre-tax, thus lowering your taxable income during your working years. Some plans allow you to contribute after-tax money as well. The funds in these plans grow tax-deferred until retirement age. After 59 ½ , you can begin taking distributions, paying only ordinary income tax on the taxable portion of your withdrawals. If you choose to access your money early, the IRS imposes an early distribution penalty of 10 percent on the withdrawal in addition to the ordinary income tax due. Depending on your current tax bracket, an early distribution can cost you 40 to 50 percent of your withdrawal.

While you cannot avoid paying taxes on your distribution, there are ways you can avoid the early withdrawal penalty that is levied on the gross amount of your withdrawal prior to age 59 ½ . 

Roth IRAs are funded with after-tax money, so they are more flexible than other pre-tax retirement plans. You contribute money after-tax, and the earnings grow tax free for your retirement years. Direct contributions are always accessible, penalty- and tax-free, while earnings can be accessed penalty- and tax-free after age 59 ½ . However, to contribute to a Roth IRA, your adjusted gross income must be less than $131,000 for single or $193,000 for joint filers.

How do you access your retirement money early if either you don’t have or are ineligible for a Roth IRA? It takes a little planning and five years, but it is possible. The Tax Increase Prevention and Reconciliation Act of 2005 repealed the income limits on Roth conversions starting in 2010. Therefore, many investors who were above the income limits for contributions were able to convert money from pre-tax retirement savings plans into Roth IRAs. A conversion is a taxable event, but the true benefit to a conversion is the tax-free growth potential and tax-free withdrawals in retirement. However, Roth IRAs also allow you to withdraw converted money penalty- and tax-free after it has been in your Roth for five years. 

If you know you will want to pull money out early, you could begin converting a set dollar amount each year to a Roth, paying the tax due, with funds from outside of the pre-tax account, at the time of the conversion. Roth conversions are not an all-or-nothing deal. You can do it slowly over the years, only converting amounts which you can afford to pay the taxes on. Furthermore, each conversion amount has its own five-year time period. So with multiple conversions, there may be multiple five-year periods underway at once. Earnings on the converted funds should remain in the account until age 59 ½ . Otherwise, withdrawals of earnings will incur the 10 percent early withdrawal penalty.

While early withdrawal penalties will vanish at 59 ½ , you don’t always have to wait that long to access your retirement funds. Typically, the longer funds grow tax free in a Roth, the greater the benefit should become.