Tuesday, June 28, 2011

Annulment in the offing? Here are you tax consequences


It is never too early to start planning for April 15, 2012. As we wind our way through 2011, we should be aware of the always-present income tax consequences affected by our actions on this journey.
Well, what happened to marital bliss? For whatever reason, you have decided to either annul the marriage, or legally separate or file for divorce. If not properly handled, taxes can become a terribly unanticipated problem.
First, we will explore annulment of the marriage. During this discussion we will only consider the legal and tax aspects of an annulment of a marriage.
A decree of annulment holds that no valid marriage ever existed. This results in the following:
You are considered an unmarried person for the whole year and your filing status has changed to Single, or if you meet certain requirements, Head of Household
You must file amended returns (Form 1040X, Amended U.S. Individual Income Tax Return) for all tax years affected by the annulment that are not closed by the statute of limitations.
On the amended return, you must change your filing status to Single, or if you meet certain requirements, Head of Household.
The statute of limitations generally does not end until 3 years after the due date of your original return.
An absolute decree of annulment ends the marital community in all community property states. Even though it holds that no valid marriage ever existed, the decree of annulment usually does not nullify community property rights arising during the “marriage.” You should check your state law for exceptions.
The general definition of community property is all property that has been acquired during the marriage, other than a gift or inheritance (commonly referred to as separate property).
Some basic housekeeping steps should also be acted upon as follows:
• Notify the Social Security Administration (SSA) of any name changes. This will update the records of the SSA to prevent problems when trying to claim Social Security benefits.
• Notify the IRS of any name change and/or change of address, if necessary.
• Review IRS Form W-4 and FTB Form DE-44, to adjust payroll tax withholding by your employer.
• Update all your financial accounts with name change and/or change of address where necessary. This is important because of the mailing of various tax information documents, particularly year end IRS Forms 1099, W-2’s, etc.
• Notify the Post Office of your change of address so you won’t miss getting your mail.
For more detailed information on this subject, refer to IRS Publication 504, Divorced or Separated Individuals and IRS Publication 555, Community Property, both of which can be found on www.IRS.gov.

Sunday, June 26, 2011

The tax law that could make your grandchildren super-rich


Sometimes Congress hands out a break that is so generous it seems it must be a mistake. This one’s a doozy: the ability to receive a tax-free inheritance of $400 million or more.
Thanks to two recent changes in the tax code, investors with huge 401(k) accounts have a way to turn them into tax-free income for their grandchildren’s lifetimes.
This is by far the biggest estate-planning break on record, created even as lawmakers debate over which tax giveaways should be killed to help shore up the federal budget.
“I call this tax break the government’s going-out-of business sale,” says IRA guru Ed Slott, who travels the country teaching advisers and accountants how to squeeze benefits out of the Roth IRA. “This is a tax break you could drive 10 Mack trucks through. It’s an incredible opportunity to do a totally tax-free transfer of wealth.”
This massive estate-tax break was created last year in two steps. First Congress lifted a $100,000 income restriction on who can convert a 401(k) or IRA to a Roth IRA, allowing even the wealthiest investors to convert. Then late in the year, it raised the generation-skipping transfer tax exemption (GST) to $5 million until 2013. The exemption was previously $3.5 million, and was scheduled to drop to $1 million this year before Congress stepped in.
Both of these provisions on their own create possibilities for significant tax savings. But used in combination, the results are exponentially greater.
The Roth IRA has always been on a different playing field compared with alternatives because it allows gains to be withdrawn tax free. Money taken out of a 401(k), regular IRA or other retirement accounts are subject to income-tax rates.
Also, the Roth doesn’t require that minimum distributions be taken after turning age 70½, as other plans do. So if you don’t need retirement plan assets to live on, the Roth preserves it best for heirs.
Not everyone jumps at the chance to convert to a Roth IRA because you have to pay income taxes on the assets moved into the account. So if you plan to live off of retirement account assets, a conversion might not make sense. But from an estate planning perspective, when there are decades of gains ahead, the tax bill can be a small price to pay for big benefits down the road.
With the new GST exemption, the estate planning benefits that can be wrung out of a Roth are eye-popping. Consider an extreme case: A wealthy individual converts a large 401(k) account to a Roth IRA and names a grandchild as the beneficiary. The grandchild, at age 1, inherits the Roth, whose assets have grown to $5 million. Because of the new $5 million GST, the Roth assets would not be subject to estate tax or generation-skipping transfer tax.
Under Roth rules, an heir must take required minimum distributions, but the distributions can be stretched over a lifetime, and assets left in the Roth can continue to grow tax free. Based on a 1-year-old’s life expectancy of 81.6-years, assuming an average annual return of 8 percent, Slott calculates that the grandchild’s lifetime income from the Roth would be $408 million — “completely free of estate, gift, income and capital gains taxes,” he says.
If both grandparents left a big Roth account to the same grandchild, the tax-free inheritance would be almost twice that amount, depending on the age of the grandchild when the second Roth is inherited.
You don’t have to have stratospheric wealth to get in on these great estate planning benefits. Consider: A $100,000 Roth inheritance would let a grandchild pocket more than $8 million, tax-free. This would have been possible even under the old GST tax exclusion, but the old Roth rules, which prohibited conversions from IRAs and 401(k)s for those with incomes above $100,000, would have prevented many from taking advantage of the opportunity.
With the new $5 million estate tax exemption, passed along with the GST exemption last year, the Roth has become a turbocharged, tax-favored inheritance tool for any generation. But the benefits are even more pronounced when the Roth income is spread over the long expected lifetime of a grandchild.
Grace Allison, senior vice president and tax strategist at Northern Trust, cautions that the upfront tax bill on Roth conversions can take the shine off of this strategy, so it’s critical to crunch the numbers. If you convert $5 million, at the highest tax rate of 35 percent, you’ll have to hand over about $1.7 million.
That kind of tax bill is mind-numbing for most people, but in the universe where ultra-wealthy people are trying to preserve their multimillions, $1.7 million may seem like a small amount, considering how much will be saved in taxes in the long run.
In the extreme example above, the total tax savings would be in the neighborhood of $100 million over the grandchild’s lifetime, probably much more
Did Congress intend for this big generational benefit? Although the government could surely use wealthy taxpayers to pay big upfront tax bills on Roth conversions right now, the amount it would forgo in taxes on inherited money over decades would be staggering.
Whether intentional or not, opportunities to combine the Roth with the GST exemption are limited: The exemption is scheduled to drop to $1 million in 2013.
And it’s always possible that tax reforms will rescind these tax breaks before that. Roberton Williams, senior fellow at the Urban Institute, says that if any drastic changes are made, it will be Congress’s mess to figure out how to honor previous tax breaks in Roth accounts. In the meantime, get ’em while you can.

Wednesday, June 8, 2011

Financial tips for teens with summer jobs


If your son or daughter has a summer job, here are some tips for maximizing income and instilling good financial habits:
This may be the first time the worker is faced with a W-4 form. If summer earnings, combined with any other income that is earned during the year, are not enough to incur income tax then he or she should claim exemption from withholding. This avoids having to wait until tax time to reclaim the tax that was withheld unnecessarily.
This is a great time to learn the value of saving. Part of each paycheck should be put into a savings account for the “future.” That could mean money for college, a car or some other goal that is down the road. Learning to have the patience to wait for the prize is important for young people. Saving is as easy as putting an agreed-upon percentage of pay or fixed dollar amount into a savings account each pay period. If possible, set up a direct deposit from the employer to the bank. Otherwise make a bank deposit as soon as the paycheck comes to reinforce the habit of saving first before spending the paycheck.
If total income for the year is going to be more than $8,500, such that your son or daughter may owe income tax, consider making an IRA contribution with some of the earnings. That will lower their tax bill and give them a great start towards retirement. If the worker is not going to have taxable income consider a Roth IRA contribution instead. Although contributions are not tax-deductible, Roth IRAs are an even more powerful retirement tool than traditional IRAs because all of the earnings are tax-free at withdrawal.

Saturday, June 4, 2011

Bill Would End Taxing Benefits for Domestic Partners


A bipartisan group of House lawmakers introduced a bill that would have health-care benefits for domestic partners treated in the same way as those for a married couple.
Legislation introduced late Thursday by Democratic Reps. Jim McDermott of Washington and Earl Blumenauer of Oregon, along with New York Republican Reps. Richard Hanna and Nan Hayworth, would stop health-care benefits from being considered income for tax purposes. As a result, a person with a domestic partner enrolled in his or her work-sponsored health-care plan no longer would incur a tax liability for those benefits.
"It's wrong to punish American companies for doing the right thing," Mr. McDermott said Friday. "As things stand, a company has to pay higher payroll taxes and the employee is hit with a huge tax penalty that their married co-workers are exempt from."
Under current law, someone whose spouse is on his or her employer-provided health-care plan doesn't pay income taxes on the value of the health-care benefits, while someone with a domestic partner does. On average, an employee with a domestic partner ends up paying an additional $1,700 each year in federal taxes on health-care benefits, according to think tank Third Way, citing a 2007 study conducted by the Williams Institute.
For example, a man with a salary of $50,000 whose wife is on his office health-care plan and receives $10,000 worth of health-care benefits still pays income taxes based only on that $50,000. Meanwhile, someone in a domestic partnership in the same situation would have to pay federal taxes on the full $60,000. A company then also owes more payroll taxes on the higher sum.
Mr. McDermott originally introduced the bill in 2001, but momentum has built since then as more companies have started allowing employees to add domestic partners to their health-care plans. On Tuesday, a coalition of 77 companies and trade associations—including Alcoa Inc., Microsoft Corp., Intel Corp., AT&T Inc. and Citigroup Inc.—sent the lawmaker a letter supporting the bill.
"Companies like ours in increasing numbers have made the business decision to provide health benefits to such beneficiaries," stated the letter from the Business Coalition for Benefits Tax Equity. "Unfortunately, federal tax law has not kept pace with corporate change in this area, and employers that offer such benefits and employees who receive them are taxed inequitably."
The bill would also provide equal tax treatment for health benefits given to nonspouse dependents, which can include adult children or grandchildren. A similar one is being written by a bipartisan group in the Senate.

Wednesday, June 1, 2011

Federal Income Tax Discharged in Bankruptcy Unless Non-payment was Intentional, Appeals Court Says


The U.S. Court of Appeals, Sixth Circuit, recently ruled that an Ohio doctor could discharge her federal income taxes in chapter 7, based upon the government’s inability to prove that her failure to pay the income taxes was intentional.  This case, Beneficial Mortgage Corp., et al. v. Storey, No. 09-3848 (6th Cir. May 16, 2011), involved the U.S. government’s attempt to obtain tax liens upon the doctor’s real estate after her chapter 7 case was discharged.
Tax returns the doctor filed for 1995, 1996, 1997, 2000, 2001, 2002, 2003, 2004, and 2005, showed taxes owed, but the taxes were not paid.  In 2002, the doctor filed chapter 7 and listed the IRS as a creditor.  The appeals court noted that the bankruptcy law’s section 507(a)(8) allows income taxes to be discharged if (1) a return is filed, (2) the taxes are more than three years old, and (3) the taxes were not assessed within 240 days before the chapter 7 was filed.
The appeals court also noted that section 507(a)(1) prevents the discharge of any income tax for which a fraudulent return was filed, or where the debtor “willfully attempted in any manner to evade or defeat the tax.”  The government argued that the simple facts that the doctor had filed tax returns showing that she owed income taxes, and had purchased real estate in 1994, and had earned income during the years in question, proved that she had willfully evaded her income taxes by failing to pay them.
The appeals court disagreed, holding that while non-payment of taxes is relevant evidence, standing alone it cannot constitute willfully evading income taxes.  “Mere nonpayment, without more, evidences not dishonesty but the defining characteristics of all debtors — honest and dishonest, alike — insufficient resources to honor all of one’s obligations,” said the court.  The non-payment had to be “knowing and deliberate” to constitute willfully evading or defeating income taxes within the meaning of bankruptcy code section 507(a)(1).
Accordingly, the appeals court ordered that the doctor’s income taxes were discharged for the years for which she otherwise qualified, 1994 through 1997.