Saturday, January 24, 2015

Seriously, start planning for 2015 tax returns now

Did you mail out those checks to charities before year-end? Did the beneficiaries of your annual tax-free gifts cash their checks? Did you sell those energy stocks and use the losses to offset gains elsewhere in your portfolio?

There are plenty of tax-smart strategies that required action before the end of the year, but it's never too early to think about managing your taxes and minimizing the hit to income. In a low-yield environment, tax-efficient investing and sensible tax planning is all the more valuable. Financial advisors are always on the lookout to save their clients money on their tax bill.

Here are some things to consider when it comes to taxes in 2015.

Know your income thresholds:
Much of tax planning over the last two years has been about adjusting to the changes resulting from the American Taxpayer Relief Act of 2012 and the Affordable Care Act. The first created a new top marginal tax rate of 39.6 percent for taxpayers earning more than $400,000 ($450,000 for married couples) in 2013. It also increased the capital gains tax rate for those taxpayers from 15 percent to 20 percent. The brackets are indexed for inflation, meaning the top rate now applies to income over $413,200 for 2015.
The higher tax rate likely applies to about 1 percent of the population. However, the new 3.8 percent investment income tax and additional 0.9 percent surtax on income that is helping to finance the President's health-care plan hits a lot more people.

The taxes apply to individuals making more than $200,000 ($250,000 for married couples) annually, and that threshold is not indexed for inflation.

"It's going to get tougher every year, and it's going to hit more and more people," said Jim Heitman a certified financial planner and owner of Compass Financial Planning.

Carol Kroch, managing director of wealth and philanthropic planning at Wilmington Trust, predominantly advises ultra-high-net-worth clients who are far beyond the new tax thresholds. However, for clients at or near those thresholds, she suggests they pay attention to details that can save them taxes.
"People can do some nipping and tucking to their advantage," Kroch said. "It's not a huge tax, but over time it has an impact, and some taxpayers can time a number of things to avoid higher taxes."

Timing gains and losses
One opportunity available every year is timing the gains and losses in your investment portfolio.
For example, if your income is close to the $200,000 Obamacare threshold or the higher figure for the top tax bracket, consider waiting until next year to sell positions that will push you over the threshold. There is market risk to the strategy, but it's worth considering.
Harvesting tax losses on investments is another option. While there haven't been a lot of opportunities on that front in the last several years, the recent uptick in volatility in the stock market and turmoil in the energy sector specifically presents some chances.

"It's been hard to find losses over the last several years, but the recent pop in volatility has allowed us to capture some losses," Heitman said. Investors can offset capital gains with losses and up to $3,000 in ordinary income as well.
Other timing opportunities for taxpayers, depending on their expectations for income this year versus future years, include accelerating an interest payment on a mortgage or paying real estate taxes for the first quarter of 2016 in December.
"If you're expecting higher income this year [versus next], accelerate your January interest payment into this year," said David Plotts, director of financial planning at Glenmede. 

Gifts that give
Charitable gifts are also a means to lower your income and possibly avoid higher marginal rates. Cash gifts are fully deductible by taxpayers up to 50 percent of their adjusted gross income. Gifts of appreciated stock are deductible up to 30 percent of AGI, with the added benefit of avoiding capital gains taxes on the shares.

Another opportunity that both Plotts and Kroch recommend to their clients is to take advantage of the $14,000 that taxpayers can annually gift to another individual tax-free. There is no carry-forward of the exemption, so if taxpayers don't use it, they lose it.

"A married couple with $10 million in assets who have 10 grandchildren can transfer $280,000 tax-free from their estate to them without using up any of their lifetime exemption," Kroch said. "It can add up to a lot."

The estate-planning uncertainty was largely resolved by the American Taxpayer Relief Act, which pegged the exemption at $5 million (indexed for inflation) per individual and set the tax rate on estates above that threshold at 40 percent.

Many wealthy Americans set up expensive trust structures in 2012, expecting that the exemption would drop significantly. It didn't. "There was a rush of estate planning at the end of 2012, and I think there was some buyer's remorse," Plotts said.

Trusts generating significant income face the highest marginal tax rate on income just over $12,300, as well as the investment income taxes.

Plotts is recommending clients revisit the planning strategies and structures put in place at the end of 2012. With interest rates still low, grantor-retained annuity trusts remain very good ideas for wealthy people, he suggested.

GRATs are fairly simple low-cost vehicles, as far as trusts go. They are set up as an annuity to the donor for a fixed term, with the donated principal expected to earn a rate of return determined by the Internal Revenue Service.

If the assets in the trust earn more than the theoretical rate of return, the remainder goes to the beneficiary tax-free. The applicable rate is currently 2 percent, meaning there's a high probability that the assets will earn more than that and the beneficiary will get a sizable benefit tax-free.

"GRATs are still a top play," Plotts said. "With a rate increase likely on the horizon, it's a good time to get them in place."

Friday, January 23, 2015

Private College 529 Plan May Be a Smart Choice

What if there were a guaranteed way to lock-in today's tuition rates at a diverse group of more than 275 private colleges across the country, for up to 30 years?

This could end up being a very significant benefit. According to data compiled by the College Board, the cost of attending a private, nonprofit, four-year college has been escalating rapidly. The 10-year percentage change in inflation-adjusted tuition and fees, from the 2003–2004 academic year to the 2013–2014 academic year, range from a low of 14 percent to a high of 48 percent, depending on the location of the college. The highest difference in cost was for colleges located in the Southwest. Schools located in the West had the lowest difference.

Assume today's tuition cost at the university of your choice is $35,000. If tuition rises at 5 percent a year, the cost of tuition at that school will be $57,011 in a decade. If you contributed $35,000 to a plan that guaranteed today’s tuition, your tax-free savings at the end of 10 years would be $22,011.

There is a way to protect yourself against these escalating costs. You can do so with a much underutilized and underpublicized plan called the Private College 529 Plan. It’s structured as a prepurchase of tuition and not as an investment. You won’t need to select investment options or be concerned about market volatility. The colleges and universities participating in the plan take the market risk and guarantee the plan’s obligations.

You can find a list of participating schools here. They include Stanford University, George Washington University, Emory University, Wesleyan University and Duke University. My alma mater, Johns Hopkins University, is also a participant. You can use accumulated prepaid tuition at any college that subsequently joins the plan.

The Private College 529 Plan has the same tax benefits as other 529 plans. As long as the money you contribute is used to pay tuition and mandatory fees at member schools, schools that don't have to be designated until the time of enrollment, there are no federal tax consequences. If you live in a state that offers a tax benefit for contributions made to any 529 plan, check with a tax professional to see if your contribution to the Private College 529 Plan can claim the same consideration.

Another significant benefit of the Private College 529 Plan is that 100 percent of your contributions go toward tuition. There are no entry fees, annual fees, service fees or exit fees. Although the Private College 529 Plan has many advantages, it does share the disadvantages attributable to all 529 plans. If you don't use the money contributed for tuition at a participating school, you'll be subject to a 10 percent penalty upon withdrawal. The penalty also applies if you contribute more funds than you end up using. You will be hit with the penalty when you redeem the excess funds.

This penalty can be particularly onerous if you need to withdraw the contributed funds due to an emergency, such as a health crisis. Contributing to any 529 plan decreases your liquidity. In addition, you are losing the opportunity to invest this money and possibly earn returns that may exceed the benefit you are gaining from participating in the plan.

Also, depending on where you live, your contribution to the plan may not qualify for any in-state tax benefits. Having assets in a 529 plan can affect the ability of your child to obtain other financial aid. However, for federal financial aid, 529 savings are considered parental assets, which are assessed in the formula for granting aid at a much lower rate. If your child applies for school-specific funding, the amount otherwise granted could be reduced if prepaid tuition credits are taken into consideration.

Although 529 plans permit changing the beneficiary without tax consequences if the new beneficiary is a "member of the family" as defined by the Internal Revenue Code, be sure any change you make qualifies. Otherwise, you could incur adverse tax consequences.

Finally, the Private College 529 Plan may limit the flexibility of the beneficiary to transfer from a college that is a participant in the plan to one that isn't. On balance, the Private College 529 Plan offers significant benefits for those who intend to attend a participating school. It should be seriously considered as part of your financial planning process.

Thursday, January 22, 2015

Dependency Exemption for Children of Divorced Parents

The income tax results of this topic are often overlooked during the divorce process, especially considering the personal and emotional toll incurred at the time. But, it is also could be a time for tax planning.
The rules for claiming a child are set in stone, and are not ambiguous. First, one or both parents must provide more half the cost of the child’s support. That is, a grandparent can’t be providing more than half of the child’s support and the parents expect to claim the child.
Second, the default rule is that the exemption automatically goes to the parent having custody of the child. However, the custodial parent can release his or her claim to the exemption on Form 8332. The parents can decide between themselves who will claim the exemption. This issue is often negotiated between the parents, and made part of the divorce or separation agreement. The exemption can even alternate between the parents on a year-by-year basis, if they like, provided Form 8332 is prepared and signed by the other parent.
If each parent has custody for part of the year, the custodial parent is considered to be the one who has custody for the greater portion of the year. “Joint custody” is a common term in separation and divorce agreement and for legal purposes, the spouses may be considered to have the child 50% of the time each. The Tax Code for dependency exemptions does not marry to this definition. The dependency exemption will go to the parent with the greater physical custody for that year. Where the custody is supposed to be 50/50, it will be extremely difficult to determine who has the most physical custody during the year. The relief for this is simply for the spouses to prepare and sign Form 8332 for each year. Consider it an insurance policy in the event of an audit. The completed form must be attached to the parent’s tax return who is claiming the child’s dependency exemption.
As for tax planning, the spouse who will benefit most from deducting the exemption should take it. That is, arrange for the parent who will save the most tax from the exemption. Then, the tax savings from the exemption can be shared. However, if the situation is less than cordial, it might be difficult to agree who gets what, so we have suggested just putting the tax savings into the child’s college fund or bank account.
The worst case scenario we run across is were both spouses claim the child’s dependency exemption. This not only throws a monkey wrench into the E-File process, but now the IRS will get involved on a very personal level in an attempt to solve the question. That situation is time consuming and expensive and should be avoided if possible.
For anyone going through a divorce or separation, it is a tumultuous time. But, it is important that you and your legal counsel are familiar with, and consider the economic effects of your child’s dependency exemption.

Wednesday, January 21, 2015

New Roth 401(k) Rollovers Maximize After-Tax Contribution Value

As 2015 opens, clients are beginning to focus on retirement income savings strategies for the year—and many are concentrating on newly available options for maximizing the value of employer-sponsored retirement accounts. 
While the non-Roth after-tax contribution option offered wealthy clients a way to increase their 401(k) account values in the past, it did little to mitigate the current or future tax bite. The increasingly widespread availability of in-plan Roth 401(k) rollovers, however, has changed the retirement income planning landscape, creating new opportunities for higher income clients who wish to truly maximize their 401(k) contributions using after-tax dollars. 
Despite this, the rules can prove tricky, and small business and individual clients alike should be advised as to the potential impact of using this nontraditional 401(k) savings strategy. 
401(k) Deferral Options
Many clients are unaware that 401(k) contribution options spread much further than the ability to defer the traditional annual pre-tax contribution limit ($18,000 in 2015, or $24,000 for clients age 50 and over). While deferring wages up to this contribution limit is the goal for some clients, in order to truly maximize the 401(k) option, others have sought to take advantage of the non-Roth after-tax contribution limit, which allows the client to defer more than the annual pre-tax limit (for a total of up to $53,000 or 100% of compensation in 2015).
Until recently, however, the non-Roth after-tax contribution was a much less viable option even for wealthy clients because these contributions did not reduce current tax liability and, unlike the currently taxable Roth contribution, earnings on the non-Roth after-tax contribution are also taxable. 
Small business clients today, however, have the option of allowing in-plan Roth rollovers that can maximize the value of the non-Roth after-tax contribution. To maximize the value of the non-Roth after-tax contribution, the client can contribute after-tax dollars to his or her 401(k), but then quickly convert those dollars to a Roth 401(k)—where earnings can grow tax-free.  No early distribution penalties apply to the in-plan Roth rollover as long as the funds remain in the Roth for at least five years.
Further, for clients who have not immediately converted non-Roth after-tax contributions to a Roth 401(k), new IRS rules have simplified the splitting of pre and after-tax contributions into separate accounts. The new IRS rules allow a 401(k) distribution to be treated as a single distribution even if it contains both pre-tax and after-tax contributions, and even if those contributions are rolled over into separate accounts, as long as the amounts are scheduled to be distributed at the same time.
The guidance now allows the taxpayer to allocate pre-tax and after-tax contributions among different types of accounts in order to maximize their future earnings potential—even upon exiting the 401(k) plan.  
Practical Considerations for the Small Business Client
In order to maximize the value of non-Roth after-tax 401(k) contributions, however, the small business client who controls the 401(k) plan must permit in-plan Roth rollovers. The plan itself can dictate how often a participant is entitled to make an in-plan Roth rollover—and while it might be preferable for participants to have the ability to convert at any time, the small business client must consider the administrative burdens that frequent rollovers could create.
Further, because non-Roth after-tax contributions can be distributed at any time, a rollover notice may be required each time a participant makes an in-plan Roth rollover. As a result, many small business clients should choose to limit the number of rollovers that a participant may make each year in order to make the option administratively feasible. 
It’s also important that the plan participants understand the potential ramifications of conversion.  Though quickly converting non-Roth after-tax contributions into a Roth can minimize taxable earnings, it is still possible that some additional tax liability may result if the account has generated earnings between contribution and conversion. 
Further, the converted amounts become subject to distribution requirements—for example, amounts can only be distributed penalty-free upon the occurrence of certain specified events, such as reaching age 59 ½ or separation from service.
The in-plan Roth rollover rules, combined with the liberalized IRS guidance regarding the separation of pre and after-tax contributions, have created an opportunity for clients to maximize the value of non-Roth after-tax 401(k) contributions—stretching the value of 401(k) accounts to ensure sufficient retirement income later in life.

Tuesday, January 20, 2015

Due-diligence considerations for 2014 individual income tax returns


Laws and guidance on some new issues in the “virtual” and “sharing” economy, in the new health care law, and changes to foreign reporting rules are interesting on many fronts, including whether practitioners should modify the questions they ask clients to ensure proper compliance. This article suggests which questions to ask to ensure due diligence.

1. Do you own or use any virtual currency?

Virtual or digital currency, such as bitcoin, has been around for a few years. What is new is Notice 2014-21, where the IRS states that this convertible currency should be treated as property for tax purposes (rather than as a currency). The notice also provides that “mining” a virtual currency (which is the process for obtaining the virtual currency by solving mathematical problems) produces income upon receipt using the fair market value (FMV) at that time. Treatment of virtual currency as property means that when it is used, such as to buy goods, its basis and FMV must be determined to measure the resulting gain or loss. The holding period of the asset and character of the income (ordinary or capital) must also be determined. Practitioners will need to find out whether and how clients are using virtual currency, if the clients’ records are sufficient, and the tax effects of these transactions.

2. Do you rent out property, such as through an online exchange?

Web-based accommodation businesses, such as Airbnb, make it relatively easy (and enticing) for property owners to become landlords. These new landlords may not understand the tax consequences of short-term rentals. Thus, a conversation about rental rules (Sec. 280A and Sec. 469, both of which may limit deducting losses) is warranted. Beyond federal and state income tax considerations, clients may need guidance regarding possible obligations for local taxes, such as business license and transient occupancy taxes.

3. Did you receive a Form 1095-A?

Form 1095-A, Health Insurance Marketplace Statement, is a new form for 2014, and is related to the new health care law. Clients who receive this form for the first time might not know to provide it to their tax preparer. Individuals who enrolled in a federal or state exchange to obtain health insurance will receive this form, which provides information for determining the Sec. 36B premium tax credit for the individual and his or her family. Individuals eligible to claim the premium tax credit on their returns or who received it in advance (through reduced monthly premiums) will need to complete new Form 8962, Premium Tax Credit (PTC), and attach it to their Form 1040, U.S. Individual Income Tax Return, or 1040A, U.S. Individual Income Tax Return. (The credit cannot be claimed on Form 1040-EZ, Income Tax Return for Single and Joint Filers With No Dependents.) Clients who received Form 1095-A are likely to want an explanation of the credit and its effect on their federal tax liability, as these health care rules are new for 2014.

4. Did you and everyone in your family have health care coverage for every month of 2014?

Another new health care rule that first applies for 2014 is the individual shared-responsibility payment (Sec. 5000A). This provision, which affects all individuals, requires individuals to have “minimum essential coverage.” To implement this rule, there is a new line on the 2014 tax form (line 61 on Form 1040; line 38 on Form 1040A; and line 11 on Form 1040EZ), which will require the preparer to find out who is in a client’s “shared responsibility family” (Regs. Sec. 1.5000A-1) and whether they had minimum essential coverage for each month of the year.

If anyone did not have coverage for any month, the next question is whether an exemption applies. If an exemption does not apply to all or some of the noncoverage months, the shared-responsibility payment must be computed. Exemptions are claimed on Form 8965, Health Coverage Exemptions. Worksheets in the Form 8965 instructions assist with calculating the payment, which is reported on line 61 of Form 1040 (or equivalent line on the other 1040 forms).

Preparers will need to determine what questions to ask clients and when they will want to obtain additional documentation or have a conversation with the client. The number of questions needed may vary depending on the client.

Example 1: Gail is single, age 75. It is likely that Gail is on Medicare Part A, which is considered minimum essential coverage. The preparer asks all clients what type of health coverage they had for each month of 2014. Gail responds that she had Medicare Part A. Given that this is a reasonable answer, the preparer should not have to ask other questions.

Example 2: Tom and Jane have two dependent children under age 18. Both Tom and Jane work full time for large employers and have each been at the same place of employment for several years. Their Forms W-2, Wage and Tax Statement, for 2014 have figures in Box 12 with code “DD” indicating that the employers provide health coverage. The preparer asks all clients what type of health coverage they had for everyone in their family for each month of 2014. Tom and Jane indicate that Tom was covered by his employer’s insurance, and Jane and the children were covered by insurance from Jane’s employer. Given that this is a reasonable answer, further supported by information on the W-2s, the preparer should not have to ask other questions.

Example 3: Jerry is single, age 32. He changed jobs during 2014 and had a period of unemployment. The preparer asks all clients what type of health coverage they had for each month of 2014. Jerry answers that he is not sure. The preparer will need to follow up with Jerry to discuss what minimum essential coverage means (perhaps using the IRS chart). For any months for which Jerry did not have coverage, questions must be asked about exemptions. Using the IRS chart should be a good starting point. The preparer might also want to use IRS Publication 5156, Facts About the Individual Shared Responsibility Provision, to help the client in answering the coverage and exemption questions.

Preparers should consider how they want to ask the questions necessary to complete line 61. They may want to create a worksheet (see the sample worksheet below) as a starting point. To best ensure that the answers are reliable, clients likely need to be educated about the shared-responsibility payment to understand its purpose and when it does and does not apply. Some IRS resources may be useful to include in this background explanation:

IRS Individual Shared Responsibility Provision webpage with additional links; and
IRS Publication 5187, Health Care Law: What’s New for Individuals & Families, on the premium tax credit and the individual shared-responsibility payment.
The IRS also has health reform resources for tax professionals, including best practice guides for the credit and payment.

Preparers will also want to determine when they want to obtain documentation, such as a health insurance card, beyond what they may already have (such as Form 1095-A or W-2). For the 2015 tax year, clients are likely to have more documentation about their coverage, such as Form 1095-B, Health Coverage, and/or Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, than they do for 2014.

5. Do you have foreign assets?

For many years, a standard question for clients has been whether they have a foreign bank account. Today, that question is too narrow. The Foreign Account Tax Compliance Act (FATCA), P.L. 111-147, added a new reporting requirement under Sec. 6038D using Form 8938, Statement of Specified Foreign Financial Assets. In addition, reporting for FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), has expanded to require more than information on a directly owned account at a foreign bank. Preparers should review the instructions for these forms to be sure the questions clients are asked are sufficiently comprehensive to fully address these reporting obligations.

Also, a 2014 court case held that an individual’s online gambling accounts held by a foreign casino were required to be reported on the FBAR (Hom, No. C 13-03721 WHA (N.D. Cal. 6/4/14)). The rationale was that the accounts functioned as banks. A similar rationale might hold for other types of accounts. For example, virtual currency an individual holds through an account or “wallet” set up by a foreign entity might be reportable on the FBAR.

Standard questions

The five questions above concern issues that are new or different for 2014. This 2014 tax update should also remind practitioners of the importance of long-standing due-diligence areas, such as for charitable contributions and mortgage interest. Court cases continue to hold that charitable contribution deductions are denied if the required documentation is lacking or incomplete or the valuations are incorrect (see, e.g., Chandler, 142 T.C. No. 16 (2014), and Smith, T.C. Memo. 2014-203). Thus, questions need to be asked to determine that documentation and valuations are valid.

Mortgage interest due-diligence questions include whether the Sec. 163(h) dollar limits were exceeded and whether debt is properly secured by the house. A 2014 case found that a note from a relative to purchase a home did not produce qualified residence interest because the note was not recorded and, thus, was not secured (Dong, T.C. Summ. 2014-4).

Monday, January 19, 2015

Retirement Plans for Young People: Know Your Choices

A primary concern of a young person starting to save for retirement is the ability to access his or her retirement savings, if needed, for other purposes. It's nice to have a retirement nest egg, but when you are in your 20s, 30s, and 40s, you predictably will need money for other stuff, too, such as buying a house and educating your children. But the Tax Code puts a block on most retirement plan withdrawals in the form of an extra 10% tax on income-taxable distributions taken prior to age 59 1/2 (sometimes called the "premature distributions penalty"). So when you have a choice, it's wise to save for retirement in a way that minimizes exposure to that penalty.

Of course, if you participate in an employer-sponsored plan that is entirely funded by the employer, you have no choice about participating...and even if you can't access that money until many years from now, it's nice to have such a plan! But beyond the totally-employer-funded plan, you do have choices:
The first choice to consider is an employer-sponsored cash-or-deferred plan (such as a401(k) plan) where the employer matches some or all of the employee's contribution. Even if the employee's contributions are going to be out of the employee's reach for many years, it is considered advisable to take advantage of that match and contribute to the 401(k) plan as much as needed to secure the matching contribution. Otherwise you're giving up "free" money.

Once that's done, where should you put the rest of your retirement savings contribution for the year? The next best retirement plan for younger people is undoubtedly the Roth IRA. With a Roth IRA, the individual can always withdraw his or her own annual contributions tax-free and penalty-free. Only the earnings that hopefully will accrue on those contributions are subject to income tax and the premature distributions penalty, but you don't need to worry about that unless you have to withdraw more than what you contributed. So the Roth IRA contributor is not putting that money out of his or her reach, which is a very nice feature when you are looking at several decades ahead before you attain retirement age. Even though a traditional IRA contribution is sometimes tax deductible (see below), it may be worth giving up an immediate tax deduction (depending on how much money it actually saves you) to go for a Roth IRA rather than a traditional IRA if you are eligible to contribute to a Roth IRA (see below for that, too).        

The second-best type of plan from this perspective is the employer-sponsored 401(k) plan. Though distributions from these plans are generally subject to income tax and the 10% penalty, it is possible under some employer plans for the employee to borrow from his own plan account. A loan would not be subject to income tax or penalty, provided various rules are followed and the loan is timely repaid. The maximum loan is generally 50% of the employee's vested account balance (a higher percentage if the vested account balance is under $20,000), but never more than $50,000. Though borrowing is not a helpful solution for desperately needed funds you know you can't repay, it is helpful for getting a downpayment on a house or funding some other capital-type need you expect you can repay gradually. Your interest payments go right back into your own pocket (inside the retirement plan). Borrowing from your own plan account is neverpossible with any type of IRA, including an employer-sponsored SEP-IRA.

In the employer plan, the question may arise: Should the employee direct his contributions to a "regular" 401(k) account (employee's contributions excluded from employee's income for income tax purposes) or to a "designated Roth account" (DRAC), if the plan offers DRACs? This would involve an exercise in number crunching. How much current income tax does the traditional 401(k) contribution save (usually a lot) vs. how much will be saved later when taking tax-free distributions from the DRAC. Although the rules are not as favorable as for Roth IRAs, DRAC contributions withdrawn prior to age 59 1/2 would not be subject to the 10% penalty.

The worst type of plan for the young person is the traditional IRA. Even if your contributions to the plan are not tax-deductible, once they go into the IRA, you cannot withdraw them (with one exception--you can change your mind and withdraw an IRA contribution tax-free for a limited time after making it). Rather, every withdrawal you make from a traditional IRA will "carry out" with it proportionate amounts of taxable income (i.e., the deductible contributions you made plus all the accrued earnings on all your contributions) and the after-tax money (i.e., your nondeductible contributions, if you made any). Further, the calculation will not just consider the particular account you withdraw from, but all your IRAs collectively if you have more than one--even rollover IRAs! Generally you can view money in a traditional IRA as "trapped" until you reach age 59 1/2...unless you do a Roth conversion or find an escape hatch.

So consider carefully the choice between contributing to a traditional IRA and a Roth IRA, if you have a choice. The deadline for 2014 IRA contributions of any type is April 15, 2015. Here are your choices:

The young individual generally can contribute $5,500 a year from his/her compensation to either a traditional IRA or a Roth IRA, but:
An individual cannot contribute to a Roth IRA for 2014 if his/her adjusted gross income (AGI) exceeds $129,000 (single) or the spouses' combined income exceeds $191,000 (married filing jointly). For 2015, these limits increase to $131,000 and $193,000, respectively.
A 2014 contribution to a traditional IRA will be tax-deductible if the individual is unmarried and either (1) does not participate in an employer-sponsored retirement plan (such as a 401(k)), or (2) does participate in such a plan but has AGI of less than $70,000. The contribution to a traditional IRA will be tax-deductible if the individual is married and either (1) neither spouse participates in an employer-sponsored retirement plan, or (2) one or both of them do participate in such a plan but they jointly have AGI of less than $116,000. For 2015 these limits will increase to $71,000 and $118,000, respectively.

If high income prevents the individual from directly contributing to a Roth IRA, he or she can still contribute to a traditional IRA, then later convert that IRA to a Roth IRA. The tax on the conversion may be low enough to make this worthwhile. The tax on the conversion would be zero, if the traditional IRA contribution that was converted was nondeductible, has not appreciated since it was contributed, and the individual does not have any other pretax money in this or any other traditional IRA. A low- or no-tax Roth IRA conversion would be a good investment because it creates the possibility of years of tax-free future earnings and the possibility of a later tax-free and penalty-free withdrawal of that conversion contribution if the individual does need to take money out before age 59 1/2.

Note, however, that if a young person does a taxable Roth conversion, then withdraws the conversion contribution less than five years later, the withdrawal would be income tax-free but it would be subject to the 10% penalty. In other words, taxable Roth conversions can be a good long-term investment for the young person but are not a way to get fast penalty-free access to IRA funds

Sunday, January 18, 2015

Tax season is here again

Fire up the calculator. Starting Tuesday, you can officially file your federal income taxes for 2014.

It’s the first time in two years that the IRS has opened its tax-filing season on time. Given recent IRS hiring cuts and new federal tax law changes, opening promptly is a “stunning achievement,” said IRS Commissioner John Koskinen, in a conference call last week with reporters.

This year, the IRS expects about 150 million taxpayers will file a federal return. If you’re among them, there are some changes and tips worth noting:

Health care compliance

One of the biggest changes this year is that all U.S. taxpayers and their dependents must declare that they had 2014 health care coverage, as required under the federal Affordable Care Act.

“Most people – more than 80 percent – will only be required to just check a box and file as normal,” Koskinen said.

There are three possible scenarios:

▪ If you have health care coverage, check the “full year coverage” box, which is on Line 61 of the regular Form 1040.

▪ If you’re not covered, you must request an exemption, generally limited to those who are incarcerated, are Native Americans, of certain religious faiths or have other special circumstances. (See IRS Form 8965 for details.)

▪ For each month that someone in your household did not have health care coverage, you’ll be required to make a “shared responsibility payment,” part of the penalties designed to encourage more Americans to get health care coverage. For 2014, that annual payment is $95 per adult and $47.50 per child, capped at a family maximum of $285.

▪ If you bought ACA health care coverage for the first time, such as through a marketplace like Covered California, and received a tax credit to subsidize your premiums, you’ll need to report that at tax time. Some taxpayers received advance payments of their tax credit, which typically went directly to their health care provider to reduce their monthly premiums.

In those cases, you’ll be receiving a new IRS Form 1095-A in the mail. Use it to reconcile what was received in premium assistance with annual income. You might owe more; you might be due a refund.

Don’t file any tax return until you’ve received the new Form 1095-A from your health care marketplace, such as Covered California, the IRS commissioner urged last week. Otherwise, your tax return could be inaccurate and you might face penalties or have to file an amended return.

Surf, don’t call

The IRS is blunt this year in urging taxpayers to get federal tax help online, rather than picking up the phone.

“We expect our phones to be extremely busy, and there will frequently be extensive wait times of a half-hour or more, so I would caution taxpayers to use our phone lines only as a last resort,” Koskinen said. Instead, he said, consumers should use the IRS website,, to get answers to basic questions, request forms and find free tax-preparation help.

Also, starting in February, there will be more than 12,000 sites across the country where seniors and those earning less than $53,000 a year can get free help in preparing their federal tax returns. (See box.)

This year the IRS has 14 companies offering Free File, the no-cost tax preparation and e-filing program for those earning $60,000 or less. About 70 percent of all taxpayers qualify to use Free File, the IRS says.

Avoid the audit

Despite budget and staffing cuts, Koskinen said the IRS still expects to conduct about 1 million audits of taxpayer returns. The best way to avoid being one of them, he said, is to file as accurately as possible.

“The roulette wheel spins and you don’t want the white ball to land on you,” he said. If you’re making a conscious decision to cheat on your taxes, “We’re not going to be happy with you.”

Faster refunds?

The IRS says 90 percent of tax refunds will be issued in less than 21 days. “The best way to ensure a quick refund is to e-file your return,” said Koskinen. “That’s because we expect processing delays for paper returns as a result of our budget constraints.”

To receive a refund promptly, request “direct deposit” into a savings or checking account, rather than a paper check that’s mailed.