Friday, January 31, 2014

Planning for Social Security

Social Security recently announced its new figures for 2014.

Benefits for the 57 million monthly receipts will increase 1.5 per cent. The average check will be $1,294 per month.
People who receive the maximum benefit will receive $2,642 per month. These are people who paid in the maximum for 35 years.
People who receive disability payments will get an average of $1,294 per month. Cost-of-living increases are based on the consumer price index from the third quarter of 2012 through the third quarter of 2013. In the last 25 years, they have averaged 2.74 percent.

The maximum amount that can be taxed on Social Security will increase up to $117,000. That means that a worker at the top level will pay about $205 more this year. You must continue to pay the Medicare premium even above this level. In addition to that, people earning more than $200,000 have to pay an extra Obamacare tax of 0.9 percent.

Many people do not realize that you must give up some of your Social Security income if you start collecting before full retirement age.
For 2014, the figure is $15,480. For every $2 you earn above this amount, you must re-pay Social Security $1. There is a special rule for the year until you reach full retirement age. That year only, you can earn up to $41,400 and then you must give back one dollar for every three you earn. This only applies until the month of your birthday when you reach full retirement age.
After full retirement age you can earn any amount of income without a penalty. People often do not take this into consideration when they start Social Security at age 62.

Remember, every day 10,000 people reach retirement age. Because of all of this volume, Social Security is moving more functions online.

Many middle class taxpayers might get hit with the alternative minimum tax. This was created in 1969 to make sure that everyone paid taxes. Originally it got the very rich who maybe only owned tax-free investments such as muni-bonds. Today the rich are paying a lot more regular income taxes so that is often more than the alternative minimum. You have to pay whichever is higher. Low-income taxpayers do not earn enough to worry about the alternative minimum. This year it is estimated that some 3.9 million people or 4.2 percent will get hit with AMT. The average for individuals is $6,600. For a couple filing jointly the limit could be $80,800 and for individuals $51,900.

Whether you will be affected depends on your particular deductions. People at the most risk live in states with high local taxes, exercise stock options, report large investment options, have lots of children, use home equity loans, have many miscellaneous deductions or are claiming business depreciation.
People with extensive municipal bond holding also could be at risk.
If you are subject to this tax, you need to do substantial tax planning. Congress finally indexed the levels for exposure to this tax last year. That should make planning possible. Tax planning is important for all of your investment whether you are subject to this tax or not.

Thursday, January 30, 2014

Form 1099 Questions on Tax Forms Continue to Plague Preparers


The 2013 Forms 1065, 1120, 1120S, and 1040, Schedules C, E, and F, all contain questions asking if the taxpayer made any payments in 2013 that would require the taxpayer to file Form(s) 1099. If the answer is "yes," then the IRS wants to know if the taxpayer did, or will, file the required Forms 1099. The questions first showed up in 2011 and coincided with an increase in the penalties for failing to file correct information returns and payee statements. Practitioners immediately expressed concern that their clients may not be focused enough on the ramifications of not correctly reporting Form 1099 income and on their own liability for checking these boxes. If a client reports that all Form 1099s were filed when they were not, the client may be perjuring himself or herself. If the client reports that not all Form 1099s were filed, then that's a red flag for an audit.

If a taxpayer has a business that uses sporadic labor, the Form 1099 questions can present a dilemma in certain situations. For example, how does a taxpayer who intermittently employs workers by picking them up at places where such workers congregate, answer the questions? If any of these workers are used several times during the year in the taxpayer's business, the amounts paid to that worker will most likely exceed $600 so that the contractor is responsible for issuing a Form 1099-MISC to that individual. What if the workers will accept only cash. Without proper documentation, how does the taxpayer prove that no one individual was paid more than $600?

Form 1099-MISC
Generally, any person, including a corporation, partnership, individual, estate, and trust, that makes reportable transactions during the calendar year must file information returns to report those transactions to the IRS. However, a payer does not need to file Form 1099-MISC for payments not made in the course of the payer's trade or business. Thus, personal payments are not reportable. A payer is engaged in a trade or business if it operates for gain or profit. Nonprofit organizations are considered to be engaged in a trade or business and are subject to the reporting requirements. For other exceptions to filing a Form 1099-MISC, see ¶252,565.
The type of reportable transaction determines the Form 1099 that must be filed. Most of the issues revolving around the filing of Forms 1099, involve Form 1099-MISC and the reporting of non-employee compensation. In general, a payer must file Form 1099-MISC, Miscellaneous Income, for each person to whom the payer has paid during the year:
(1) at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest;
(2) at least $600 in rents, services (including parts and materials), prizes and awards, other income payments, medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) purchased from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate;
(3) any fishing boat proceeds; or
(4) gross proceeds to an attorney.
In addition, Form 1099-MISC must be filed to report direct sales of at least $5,000 of consumer products made to a buyer for resale anywhere other than a permanent retail establishment. Form 1099-MISC must also be filed for each person from whom a taxpayer has withheld any federal income tax under the backup withholding requirement (discussed below), regardless of the amount of the payment.
Compliance Tip: The deadline for filing paper Forms 1099-MISC is generally the last day of February following the calendar year for which the filing is made. The due date is extended until the last day of March for payers who file electronically. If the regular due date falls on a Saturday, Sunday, or legal holiday, Form 1099-MISC is due the next business day.

Backup-Withholding Requirement
There is a backup withholding requirement that applies to a reportable payment if the payee does not furnish a taxpayer identification number (TIN). The backup withholding rate is equal to 28 percent of the amount paid. The backup withholding requirement does not apply to payments made to tax-exempt, governmental, or international organizations.
In determining whether a payee has failed to provide a TIN, a payer is required to process the TIN within 30 days after receiving it from the payee or in certain cases, from a broker. Thus, the payer may take up to 30 days to treat the TIN as having been received.

Penalties for Failing to File Correct Information Returns
If a payer fails to file a correct information return by the due date and cannot show reasonable cause for failing to do so, the payer may be subject to a penalty. The penalty applies if the person fails to file timely, fails to include all information required to be shown on a return, or includes incorrect information on a return. The penalty also applies if a person files on paper when required to file electronically, reports an incorrect taxpayer identification number (TIN) or fails to report a TIN, or fails to file paper forms that are machine readable. The amount of the penalty is based on when the correct information return is filed. For returns required to be filed for the 2013 tax year, the penalty is:
$30 per information return for returns filed correctly within 30 days after the due date (by March 30 if the due date is February 28), with a maximum penalty of $250,000 a year ($75,000 for certain small businesses);
$60 per information return for returns filed more than 30 days after the due date but by August 1, with a maximum penalty of $500,000 a year ($200,000 for certain small businesses); and
$100 per information return for returns filed after August 1 or not filed at all, with a maximum penalty of $1,500,000 a year for most businesses but $500,000 for certain small businesses.
For purposes of the lower penalty, a business is a small business for any calendar year if its average annual gross receipts for the most recent three tax years (or for the period it was in existence, if shorter) ending before the calendar year do not exceed $5 million.
Persons who are required to file information returns electronically but who fail to do so (without an approved waiver) are treated as having failed to file the return, and are therefore subject to a penalty of up to $100 per return unless the person shows reasonable cause for the failure. However, they can file up to 250 returns on paper; those returns will not be subject to a penalty for failure to file electronically. The penalty applies separately to original returns and corrected returns.
OBSERVATION: For each fifth calendar year beginning after 2012, each of the dollar amounts described above is subject to indexing for inflation.
The penalty for failure to include the correct information on a return does not apply to a de minimis number of information returns with such failures if the failures are corrected by August 1 of the calendar year in which the due date occurs. The number of returns to which this exception applies cannot be more than the greater of 10 returns or 0.5 percent of the total number of information returns required to be filed for the year.
The penalty for a failure to include the correct information on a return does not apply to inconsequential errors or omissions. If a failure to file a correct information return is due to an intentional disregard of one of the requirements (i.e., it is a knowing or willing failure), the penalty is the greater of $250 per return or the statutory percentage of the aggregate dollar amount of the items required to be reported (the statutory percentage depends on the type of information return at issue). In addition, in the case of intentional disregard of the requirements, the $1,500,000 limitation does not apply.

Can IRS Limit Deductions to $600 Where No Form 1099 Is Filed?
Some practitioners have questioned whether or not the IRS can limit a compensation deduction to $599, the cutoff for not reporting nonemployee compensation, where a Form 1099-MISC is not filed. While there is nothing in the Code or regulations on this, nor is there any case law on point, some practitioner have reported IRS agents telling them that if they had not produced Form 1099s for compensation deductions taken on a return, the nonemployee compensation deduction would be limited to an amount not required to be reported on Form 1099-MISC.

What Constitutes a Trade or Business That Requires Reporting on Form 1099?
The characterization of an activity as a "trade or business" took on a new importance in 2013 with the implementation of the net investment income tax. Effective for tax years beginning after December 31, 2012, individuals are subject to a 3.8 percent tax on the lesser of net investment income or the excess of modified adjusted gross income over a threshold amount. Generally, income from a trade or business (with the exception of certain commodities trading income) is exempt from the net investment income tax.

As previously mentioned, taxpayers not in a trade or business aren't required to file Form 1099s. Whether a taxpayer is considered to be in a trade or business has become a hot topic because of the net investment income tax. As a result, taxpayers may be claiming that their activity is not subject to the net investment income tax because it rises to the level of a trade or business without considering the impact that will have on their Form 1099 filing requirements and the associated penalties if such forms aren't filed.

Practitioners should advise their clients to have non-employee workers or workers complete a Form W-9 if they believe payments to any individual might add up to $600 or more for the year. To the extent anyone is paid more than $600, a Form 1099-MISC should then be issued at the end of the year. Practitioners should also document in their files that they've had this discussion with clients and may want to consider revising their engagement letter to reflect the documentation a client will need in order to take certain deductions on the return. Similarly, practitioners may want to warn their clients about the trade-offs for claiming they are in a trade or business in an effort to escape the net investment income tax and their responsibility for filing Form 1099s when they are in a trade or business.

Wednesday, January 29, 2014

IRS Audit Targets


While many taxpayers look forward to filing season as the time they can get “free money” in the form of their tax refund, those with more complex returns are focused as well on avoiding situations that might lead to an audit.

“Things are different today than they used to be on audits,” observed Bradford Hall, managing director of Hall & Company CPAs. “They used to select returns based on various items on returns. They would review for anomalies, such as high charitable deductions which they would pick out of the crowd. Now it’s more of a matching process—‘Here’s what we have on you from these 1099s or 1098s, or medical deductions.’ They have information in their computer bank and they can compare it with your return.”

Of course, those whose annual earnings top $1 million are likely to be selected for audit approximately once every 10 years, Hall noted.

“But for those making less than a couple of hundred thousand, we’ve found that most audits are targeted to particular deductions or areas on the tax return,” he said. “The IRS doesn’t always tell us what it was that kicked our clients into an audit situation. But basically, they target specific areas such as auto expenses, home mortgage interest, property tax deductions or Schedule C income. Lots of times they will compare your W-2 with your bank deposits. If there are large deposits without the income to back them up, it will raise a red flag. It can be a problem for some people to remember where their deposits came from.”

“When Form 1099s come in, taxpayers need to realize that they will not get every Form 1099 that is reported to the IRS,” Hall observed. “There is a misunderstanding among taxpayers that they are only required to report amounts from the 1099s that they receive. Of course, everyone is required to report the amount of income they received throughout the year, whether they get a Form 1099 or not.”
“For every client that has a business, they’re doing at least a 14-month cash receipts test,” Hall said. “They do this for sole proprietorships, LLCs, small corporations, S corporations and general partnerships—any kind of business.”

One thing to watch out for is where a business changes its form, and receives a new federal ID number, Hall noted.

“The IRS has started to compare credit card sales to business income,” he said. “We’ve had a number of businesses where the credit card process had originally been set for a sole proprietor. The sole proprietor subsequently incorporated with a different federal ID number, and didn’t contact the credit card company to let them know that the ID number had changed. That triggered an audit, because the credit card company reported income that wasn’t on the individual tax return in the right area. Very few businesses remember to contact the credit card company and their vendors to let them know they have changed to a different entity.”

“The key to having a properly done tax return is to spend time and effort on it,” Hall said. “Most people don’t want to put in the time and the effort, and that leaves them at high risk for an audit. They should know that to the degree they spend time with their CPA the more accurate the tax return will be, and they will be able to sleep better at night knowing it’s been done properly.”

Tuesday, January 28, 2014

11 Questions To Ask When Hiring A Tax Preparer


I’m constantly asked if I can recommend the perfect tax preparer. The truth is that I can’t. You’re the only one who can find the perfect tax preparer for your taxes: there’s no one size fits all in this business. I can, however, offer you a few tips to help you figure out how to find the best tax preparer for you. The key, as with hiring any professional, is to ask questions. Lots of questions. And not just about pricing. Here’s a list of 11 questions that I recommend you ask a potential tax preparer:
  1. Do you have a PTIN (preparer tax identification number)?This should be your first question. Anyone who prepares federal tax returns for compensation must have a valid 2014 PTIN before preparing returns. Without a PTIN, the preparer is not allowed to prepare your return – this isn’t something you want to find out at the end.
  2. Have you prepared a tax return before for (fill in the blank)?Remember when I said that there’s no one size fits all in this business? That’s because tax returns are not all the same. Some tax preparers can do forms 1040-EZ in their sleep. Others are fluent in Schedules C (business) and/or E (rentals). Some may focus on pass-through entities, tax exempt organizations or fiduciary returns. Tax preparers may focus on international taxpayers or small businesses. There are as many variations as there are schedules and forms. It’s not uncommon for tax preparers – especially those that have been around for awhile – to have a pretty wide scope of knowledge. But nobody can do it all and don’t trust anyone who tells you otherwise. If you have special circumstances because of your investments, occupation or residency status, find a tax preparer who has experience with your specific situation.
  3. Do you know the requirements of the states and localities where I am required to file? Yes, federal income taxes know no boundaries – those rules don’t change from one state to the next. But that’s not true when it comes to states and localities. Your state or locality may have quirky filing requirements, especially for business owners. It can get even more complicated if you’ve moved from state to state during the year or if you live in one state and work in another. You may also need special guidance if you own a business or real estate in a state outside of your residency or if you are the beneficiary of a trust or estate in another state. Make sure that your preparer knows – and can handle – all of those filing requirements.
  4. What records and other documentation will you need from me? While you shouldn’t be expected to haul in the contents of your entire home office, a reputable preparer should insist that you provide your forms W-2, 1099, 1098 and other verification of income and expenses in order to prepare a proper return. You shouldn’t use a preparer willing to e-file your return just by using a pay stub (that’s against IRS rules). A tax preparer should be able to explain what will be needed for special schedules, forms or circumstances. If a preparer isn’t inclined to do the necessary due diligence (especially for something like the Earned Income Tax Credit) in the beginning, it should give you pause about what other corners the preparer might be willing to cut later – at your expense.
  5. How do you determine your fees? Note the wording on this one. I didn’t say ask how much the fees would be, rather I said ask how the fees are determined. Prices may vary based on the complexity of your return, whether you require additional schedules (such as dividend and interest on Schedule B, business information on Schedule C, capital gains and losses on Schedule D and/or rental income and losses on Schedule E); supporting forms (such as those for the child tax credit or additional charitable donation information); or whether your return has “out of the ordinary” line items (like Roth IRA conversions or homebuyer credit repayment). Avoid preparers who base their fee on a percentage of your anticipated refund: they have a financial incentive to encourage inappropriate credits and deductions.
  6. Can I file electronically? More than 1 billion individual tax returns have been processed since the debut of electronic filing in 1990. It’s the fastest way to get your refund and tends to result in fewer math errors. It may also be required: a paid preparer who prepares and files more than ten client returns must file electronically unless the client opts out.
  7. Who will sign my return? This is a biggie. Remember that your preparer must have a PTIN (see again #1). The PTIN and the preparer’s signature need to appear on your tax return. Don’t trust a preparer who refuses to sign a return. And be wary of any preparer or service who won’t tell you in advance who will actually be preparing the return.
  8. When will I receive a copy of my return? It’s not unreasonable to leave your preparer’s office without a copy of your completed return; assembly may be required. However, you should receive a complete copy of your return within a reasonable amount of time following your appointment. If your preparer can’t offer a window of time to expect the copy, it might be indicative of a time management problem. If your preparer can’t promise you a copy at all, run, don’t walk away: you will need a copy for your own records.
  9. How do I find you if I have a question or a problem after tax season is over? I’m not a fan of those tax preparation shops that pop up on street corners during tax season and then go missing for half the year. Clients often receive requests from taxing authorities for additional information in October or November and can no longer locate their tax preparer. Make sure that you know how to contact the tax preparer after your return has been filed. If your tax preparer won’t be around, consider taking your business elsewhere.
  10. What happens if I get audited? Nobody wants to think about an audit when filing a return. But you need to ask about it now so that you don’t end up in a pickle later. Find out how the tax preparer handles audits or examinations from IRS: will he or she respond to those questions? Represent you in front of IRS or Tax Court? (Remember that not all tax preparers are allowed to represent clients before the IRS or in court.) And what about the cost to fix any mistakes? How is that calculated?
I know. It looks like a long list. But most of these questions require pretty simple answers. And better to ask now than later, right? Choosing a good tax preparer does require a little bit of research and effort on your part but it’s worth it. And admit it: you asked at least these many questions when finding a hair dresser or a pediatrician. Just as you stick with other professionals from year to year, the goal here isn’t just to fill out a form but to create a relationship. A good tax preparer won’t mind answering your questions.

Monday, January 27, 2014

7 Crippling Mistakes With Form 1099 That Cost Big.


It’s Form 1099 season, and companies big and small are churning them out. If
you’re in business–even as a sole proprietor–you need to pay attention to
issuing them or face penalties. The burden on businesses seems to grow each
year. Even cost basis is now required on some Forms 1099.
But the real prize is receiving them. Since the IRS gets a copy of every single
one, they are key pieces of information that can cost you big. You may not like
the little forms, but here are 7 key traps.

1. Don’t Forget to Watch Your Mail. People always seem careful with
Forms W-2 since they are traditionally attached to tax returns showing wages
as well as taxes withheld. But I’m often surprised by how careless people are
about Forms 1099. Watch for each Form 1099! They are matched to your
Social Security Number, and you’re almost guaranteed an audit if you fail to
report one.

2. Don’t Forget Changes of Address. Even if the issuer of the form has
your old address, the information will be reported to the IRS (and your
state tax authority) based on your Social Security number. Make sure payers
have your correct address so you get a copy. Update your address directly with
payers, as well as putting a forwarding order in with the U.S. Post Office. You’ll
want to see any forms the IRS sees.
It’s a good idea to file a change of address Form 8822. The IRS explains how
and why at Topic 157 – Change of Address–How to Notify IRS.

3. Beware Errors. The normal deadline is January 31 for mailing 1099s to
taxpayers. Then, the payer has until the end of February to send copies to the
IRS. Some payers send forms to taxpayers and the IRS simultaneously, but
most use the 30 day delay. That delay means you may have the chance to
correct errors. Don’t just put arriving Forms 1099 in a pile; open them
Suppose you get a 1099-MISC on January 31 reporting $8,000 of consulting
pay, when you know you received only $800? Inform the payer immediately
in writing and by phone. There may be time for the payer to correct it before
sending it to the IRS. That’s better for you. If the payer has already sent an
incorrect form to the IRS, ask them to send a corrected form. There’s a box to
show it is correcting a prior 1099 so the IRS doesn’t add the amounts together.

4. Don’t Lose Them. Open the envelope and check the form. And keep the
forms in a safe place. You’ll need them if you do your own return. If you have
a paid preparer, you should give copies of each form to your return preparer.

5. Beware Timing. Don’t be too anxious to file your return if you haven’t
received all your Forms 1099. Some 1099s may come as late as March or April,
despite the normal deadline that they are supposed to be mailed to you no
later than January 31.

6. Missing One? Don’t Ask! Keeping payers advised of your current
address is a good idea, but if you don’t receive a Form 1099 you expect, I
wouldn’t request it. If you are expecting a Form 1099, you know about the
income and the amount. Just report it on your tax return. Reporting more
income doesn’t trigger a mismatch on IRS computers.
In contrast, if you fail to report something on your return that is reported on
a Form 1099, that is a mismatch. But why not request a Form 1099 you
If you call or write and ask for a Form 1099, the payer may issue the Form
1099 incorrectly. Or, you could end up with two, one issued originally (even if
it never got to you) and one issued because you inquired. The IRS computer
may think you had twice the income you did.

7. Report Them, Don’t Attach Them. I see clients fighting tax bills every
year that probably could have avoided problems entirely by more careful
reporting. You can’t ignore 1099s. Sure, you may disagree that something is
income (say, an injury lawsuit recovery). You may say money is capital gain
not ordinary income. It might even be recovery of basis and not income at all.
But you have to explain. Don’t ignore the form. And don’t attach it. Even in
paper filing days, copies of Form 1099 didn’t go on tax returns. Just keep them
with a copy of your tax return. You may need them in an audit.

Sunday, January 26, 2014

How to choose your tax professional

If you are planning to file your income taxes this year but aren't sure how to choose your tax preparer, we have some tips for you.

It may be tough to choose between a major franchise that guarantees quick filing with large returns, a private tax professional, or a popular online do-it-yourself program.

If you want to use a company, make sure you do your homework first. Find out how much they will charge and if there are any hidden fees.

You should choose someone who is knowledgeable.

"CPA firms, personal accountants, they're always a good choice. A CPA firm they have certified public accountants, which means they've gone through years of accounting schools and they have to do continuing education every year. A big myth is that they're more expensive when they're really not," says Rice.

If you decide to use an online-based program you should know how to do your taxes yourself. Most programs guide you through the process buy you are still on your own. However, there are many free filing options online and in person.

Be wary of places that promise large refunds. Every situation is unique and there is no way to guarantee a large refund.

Avoid places that are only open during tax season. The preparer should be available all year long just in case the IRS gets involved.

Also avoid places that offer quick refunds or say they can file before Jan. 31. No one can file before then, and an electronically-filed tax return with a direct deposit takes seven to ten days to return.

"When you go to look for your tax preparer, it's always good to look for reviews. You can check the Better Business Bureau, you can use paid sites such as Angie's List. There are free review sites everywhere. They're even on Facebook now," says Rice.

The IRS recommends you always check a preparer's qualifications. All tax return preparers should have a preparer tax identification number. Check their history and make sure they haven't had any trouble with the state board. Also ask about their service fees and find out how much they charge.

Saturday, January 25, 2014

How to Fund Your 401(k) and Still Have Spending Money


Consistent funding of your employer's 401(k) plan is a great way to save for retirement while paying less in income taxes, but not everyone is aware of the benefits. If you are among those who feel you can't afford to contribute to a company-sponsored 401(k) plan, you are missing an opportunity to get additional money from your employer in the form of matching funds based on how much you contribute.
Financial planners and other money experts advise people who are working in a full-time job that offers a 401(k) plan to research its rules and cut back on other spending in order to contribute. "Take advantage of the company match," says David Bendix, president of Bendix Financial Group. "I call it free money."
The 2012 Survey of Income and Program Participation from the U.S. Census Bureau shows that 61 percent of all workers have access to a company-sponsored pension or retirement plan, up from 59 percent in 2009. Yet, less than half participate. Participation increased to 46 percent in 2012, up from 45 percent in 2009, but is less than in 2003, when 48 percent participated, according to the Employee Benefit Research Institute.

How much you'll be able to contribute depends on your individual financial situation. Typically, Americans fall into three situations, according to David Jones, president of the Association of Independent Consumer Credit Counseling Agencies: Those who are "just barely making it," Jones says, those who have a little disposable income and those with a considerable amount of disposable income. Most people can identify with one of these groups, and your status doesn't necessarily have to do with how much money you make. It depends on your assets (how much you earn from various sources), and your liabilities (how much money you spend). Most people, Jones says, have a good picture of their assets but underestimate how much they spend. Even if they draw up a budget, he says, they tend to leave out items such as insurance costs and lunches they buy every day.
Employees can contribute up to $17,500 to a 401(k) plan in 2014. If you are 50 or older, the catch-up contribution limit is $5,500 for 2014. Each employer-sponsored plan has its own rules as to what percentage it matches, the amount of the match and how long you have to be with the company before you are vested and eligible to take the matching funds when you leave the employer.
Here are strategies for each scenario:
If you are living on the edge: If you are living from paycheck-to-paycheck, and believe you cannot contribute to a company 401(k) plan, it's time to "change your lifestyle," Jones says.
Look at the things you might be able to change, and free up enough money so you can pay into your 401(k) plan. "The closer you are to retirement, the more important it is to do that," he adds. Money that is automatically deducted from your paycheck and put into a 401(k) plan means you'll pay less in annual income taxes.
For example, if you earn a salary of $50,000, and you contribute $2,000 to a 401(k) plan, through "forced savings," you'll pay less taxes and have your money working for you in some type of investment. Most likely, if the amount is small enough at the beginning, you won't miss it. "Pretend you're making $48,000 instead of $50,000," Bendix says. The earlier you start this habit, the better. You get immediate tax savings now and the "compounding effect" from the dollars you put away, he says.
If you have credit card debt, student loan debt and other expenses, you'll have to pay these debts as well, so your 401(k) contributions will be limited at first. You might only be able to have 3 percent of your paycheck deducted this year, but you can increase the amount by another percent next year, says Mary Hunt, author of the book, "The Smart Woman's Guide to Planning for Retirement."

If you have minimal disposable income: If you're feeling pinched when it comes to funding your 401(k) plan, assess where you stand by writing down all your assets and all your liabilities including items you pay for with your credit card, those you pay for with cash or a debit card and those that are automatically deducted from your checking account. In this way, you can determine areas in which you can spend less, and use that money to fund your 401(k) at a larger percentage. It's advisable to look at expenses as "essential" and "optional," Hunt says. A lifestyle that uses up all of your income or a large portion of your income means you will be unable to save for the future, she adds
She advises moving some expenses to the "optional column" as a way to eliminate the expense from your daily routine or from your life altogether. For example, add up the cost of having two vehicles to see how much you are actually spending on transportation, Hunt says. While everyone isn't able to share a car, other options are to use public transportation, to buy a used car, eliminating a car payment or to rent a car when you need one.

Another option is to buy a $500,000 house instead of an $800,000 one, Bendix says, as the costs of home ownership include real estate taxes and maintenance on the house as well as any mortgage you may have.

If you have a considerable amount of disposable income: These people tend to have "plenty of money," Jones says. They tend to live a lifestyle that is beyond their means. When money is easy to come by it doesn't have the same value to the earner, he adds. "Outdoing your neighbor is very common in this group," Jones says. He advises people with a lot of disposable income to use it to plan for the future by funding their 401(k) plan, and to be prepared in case there is a stock market "correction," even though growth in the stock market has recently "affected 401(k)s in a positive way." Finally, Jones notes there is "some instability in the market itself," so it's advisable to save money through a 401(k).

For those who haven't taken advantage of an employer-sponsored 401(k) plan, it's time to evaluate how much expendable income you have, and find ways to create more of it. "If you make the adjustments in your lifestyle, you can increase the percent you can contribute," Jones says.

Funding your 401(k) is a way to save for the future, get matching funds from your employer and reduce your tax bill.

Friday, January 24, 2014

The scariest part of college applications: figuring out how to pay


Seventeen-year-old Megan Grossi of Malden has filled out her college applications, applied early action, and received acceptance letters from all four of her chosen schools. And now the hard part — figuring out how to pay for it all.

Grossi, a senior at Mystic Valley Regional Charter School, has received a commitment for an academic scholarship at her top choice, and is scouring for local and national scholarships.

Up next, she said, is filing the dreaded financial aid form that all students must complete to be considered for any federal aid such as grants, scholarships, loans, and work study. This year’s version of the Free Application for Federal Financial Aid was made available Jan. 1.

“Finances are huge for us,’’ said her mother, Carol Ann Desiderio-Grossi. “That’s why she applied to schools she really wanted and also state colleges. We aren’t quite sure how the finances are going to work out.’’

Grossi’s top choice, Ohio Wesleyan University, has already offered her a scholarship covering 60 percent of the $51,000 annual cost. Desiderio-Grossi said while the aid sounds like a lot, it still leaves a gap of nearly $100,000 over four years.

‘Finances are huge for us. . . . We aren’t quite sure how the finances are going to work out.’

That’s why they will be among the many families filling out the FAFSA over the next few weeks.

Martha Savery, a spokeswoman for the Massachusetts Educational Financing Authority, said all families should take the time to fill out the FAFSA even if they don’t think they will qualify. Not only could a family’s financial situation change, she said, but the form is necessary for federal student loans, which are available to any student regardless of need. And it’s free.

“We always recommend that a family take the time to file a FAFSA,’’ Savery said. “It’s not to say it’s a breeze, but it’s not as difficult as some people believe it is once they get into the process.’’

Like college applications, deadlines for applying for financial aid vary from school to school, officials said, which means families must take careful note of the earliest date by which the form must be filed.

“Families really need to be on the ball to start the process,’’ said Savery.

Deadlines typically range from mid-January to March.

Megan Grossi, 17, a Mystic Valley Regional Charter School senior, and her mother, Carol Ann Desiderio-Grossi.

Megan Grossi, 17, a Mystic Valley Regional Charter School senior, and her mother, Carol Ann Desiderio-Grossi.

The other key is having all paperwork together before starting the process, Savery said. To start the form, families will need a FAFSA PIN, which serves as an electronic signature. This is available at Parents and students will need to have Social Security numbers, driver’s license numbers, their most recent federal tax returns, the most recent W-2 or year-end pay stubs, untaxed income records, bank statements, and business and investment records.

“Being organized and having all the information there is really what makes it a simpler process,” Savery said.

She said it takes most families about an hour to complete the form if they have all their records together.

Savery said there are many resources available to help students and parents prepare and file the form.

In addition to resources online at and, families can receive personal assistance from financial aid experts at upcoming events organized by the state agency.

The resources help families answer questions about a variety of topics including assets, what records are needed, and how to link updated tax information. There are also answers to complicated family situations such as divorce, noncitizens, and emancipated minors.

The Massachusetts Educational Financing Authority helps organize FAFSA Day Massachusetts, a volunteer program in its 10th year providing free assistance to students and families seeking to complete the form. More than 20 FAFSA Day events will be held throughout the state, most on this Sunday or on Feb. 23, though the dates and times vary by location. A list of all locations is available at

“It’s scary for families, but the more they know and can learn about the process, the easier it becomes,’’ said Mary Beth Courtright, the director of financial aid at Massasoit Community College in Brockton. “The folks that help out are all there because they want to be there. They want to help families through the process and make it as easy as possible.’’

Massasoit will host a FAFSA Day event on Feb. 10 at 6:30 p.m. This is the second year Massasoit has hosted the event, which was previously held at Brockton High School. About 200 parents and students typically attend, Courtright said.

Elizabeth Hennessy, the director of counseling at Blackstone Valley Regional Vocational Technical High School in Upton, said families can walk into a FAFSA Day event not knowing where to start and leave having the form completed and filed. “It’s really streamlined,’’ Hennessy said.

“We have lots of volunteers because it takes an army. We have students move people around the building and triage them based on their need.’’

Blackstone Valley’s event will be held Sunday at 1 p.m.

When families arrive, they will be asked questions such as whether they need an interpreter, have they started the form, or do they just have a few questions. Families just starting will get a brief overview and then can sit down at a computer and complete the entire form. If they want to finish later, they can save the information, Hennessy said.

Families with a question or two can go to FAFSA Express, where they meet individually with experts and leave when they are ready. Hennessy said the financial experts come from all over the state, which means families don’t need to worry about sharing personal information with people they know in their community.

“You can walk in with nothing done and leave with it done,’’ she said. “The thing that families like is that it’s free, they get access to financial aid experts, and it doesn’t leave that day. You can leave with resources so you can continue on.’’

Once families get a confirmation that the form has been completed, they will wait to hear from the colleges about award letters, which typically arrive in March, Savery said.

Until then, families like Grossi’s will search for ways to help pay for the hefty bills that start next year.

Desiderio-Grossi said between savings, loans, scholarships, and financial aid, she hopes to have enough money so her daughter can attend her dream school.

“It’s like putting together a puzzle,’’ Desiderio-Grossi said. “You piece it together until you get the whole picture. Once the FAFSA comes through, then we’ll know where we really are.’’

Thursday, January 23, 2014

7 tax mistakes you don't know you're making


Tax season is here, and while there is no escaping taxes in general, you may be paying more than your fair share.
Unfortunately, some of the errors that cost you money at tax time may be hard to detect. Read what three finance professionals say are the most common -- though not necessarily most obvious -- mistakes that taxpayers make.

Mistake No. 1: Missing opportunities for tax savings

"One thing I would say off the bat is a lot of people need to start thinking about their taxes in December," says Bob Wheeler, a CPA in Santa Monica, Calif. and author of "The Money Nerve."
For those who have more than a basic return, Wheeler says there are plenty of opportunities to maximize deductions or claim credits. However, taxpayers typically must take action before the end of the calendar year.
Steve Warren, the Director of Taxation at Lehrman, Flom & Co. in Minneapolis, Minn. takes it one step further. He says taxpayers should be communicating with their CPA throughout the year and prior to major life events such as getting married, divorced, having children, changing jobs or receiving an inheritance. 
"Some good opportunities to save our clients some money have been lost," says Warren of those who wait until tax season to tell their CPA about life changes from the previous year.

Mistake No. 2: Failing to negotiate for exemptions in a divorce decree

If people communicated more with their CPAs, they might be able to avoid a mistake Patrick McGonigle says he sees frequently. Namely, during a divorce, some parents neglect to negotiate for their ability to take tax exemptions for their children.
McGonigle, a CFP with CJM Wealth Advisers in Fairfax, Va., notes that tax exemptions can be shared between parents, but if the divorce decree doesn't address the issue, the exemptions automatically fall to the parent with whom the children live most often. He offers the following example of just how much a parent stands to lose if they don't negotiate for a share of the exemptions.
Joe and Mary get a divorce in 2012 and have two children. Suppose Mary is awarded custody of the children and the divorce decree does not specify which parent is entitled to claim the children. Mary, as the custodial parent, would claim them since the children live with her. Joe has boxed himself out of $7,800 per year of exemptions. Now let's also assume the children are young. The value of $7,800 of exemptions over 20 years is $156,000, or an additional $39,000 of tax paid if Joe is in the 25 percent income tax bracket.
In addition, only that parent who claims the child as a dependent is entitled to receive the $1,000 child tax credit, the Lifetime Learning Credit or the American Opportunity Credit.

Mistake No. 3: Keeping poor records

Both Wheeler and Warren say another common mistake taxpayers make is not staying organized throughout the year.
For example, Wheeler says he often has clients -- particularly contract workers -- who do not track their income. Then, at tax time, they may not realize they are missing a W-2 or 1099 and fail to claim that income. Unfortunately, the IRS usually doesn't miss those little details, which can result in serious penalties and fines later.

Mistake No. 4: Forgetting to deduct unamortized points when refinancing

Another common mistake Warren sees is failing to claim deductible unamortized points whenrefinancing or selling a home with a mortgage.
For example, let's say you pay $1,000 in points when you refinance a mortgage. Typically, you must amortize the points over the life of the loan and can only deduct a portion of the points each year. However, if you refinance and still have $900 in unamortized points left on the original mortgage, you can deduct that entire amount in the year of the refinancing. 
"The points are fully deductible in the year of the home purchase or refinancing when the loan proceeds are used entirely to acquire or improve the home," Warren says.

Mistake No. 5: Overlooking important tax credits

Many lower-income families might miss out on lucrative tax credits by simply failing to file.
"A lot of times, people don't understand that just because you don't owe taxes doesn't mean you don't want to file a return," says Wheeler.
For example, families not filing could miss out on refundable tax credits such as the Earned Income Credit and the American Opportunity Credit. Although not refundable, Wheeler says the Saver's Tax Credit is another commonly missed credit that targets lower-income households.

Mistake No. 6: Improperly calculating the basis for investments

For those with investments, failing to consider reinvested dividends or capital gains could result in taxpayers using an incorrect basis for the purpose of calculating capital gains and losses on a sale.
"They are either reporting too much in capital gains or too little in capital loss and, either way, paying too much in tax," says Warren.

Mistake No. 7: Skipping itemized deductions

Finally, taxpayers who automatically take the standard deduction may be doing themselves a disservice.
"You hear about something being tax deductible, but it may not be deductible to you," says Warren. "Some tax breaks are only available as itemized deductions and will not reduce your tax bill if you are using the standard deduction."
Expenses that can be itemized include medical expenses in excess of 10 percent of your adjusted gross income, charitable contributions, property taxes, car registration fees based upon a vehicle's value, tax preparation fees and mortgage interest. Wheeler also advises unemployed individuals to be aware that expenses related to their job hunt could be deductible.
Taxes may be inevitable, but there is no reason to pay more than you have to. With a little preparation, you can make 2014 the year you get organized and see just how low your tax bill can go.

Wednesday, January 22, 2014

Tax-Smart Ways To Help Your Kids/Grandkids Pay For College


Many people say that a home is the largest single investment you’ll ever make, but consider this: The national median existing-home price was $199,500 in October of this year. That’s less than the estimated $210,388 it will cost to send your two-year-old to an in-state, public college for four years. Thinking about a private college? That’s going to run $465,516 by the time your toddler is ready for higher education.

College costs are increasing at about two times the rate of inflation each year – a trend that is expected to continue indefinitely. Here’s what you can expect to pay for each year of tuition, fees, and room and board by the time your kids (or grandkids) are ready to head off to college (assuming a steady 6% college cost inflation rate):

Keep in mind, these numbers represent a single year of costs; the number of years your child attends college will depend on the degree(s) he or she is seeking. While many students will qualify for financial aid, scholarships and grants to help cover college costs, there are still a number of ways to further reduce college costs. One of the easiest ways is to invest the money you’ve set aside for your child or grandchild’s college years in tax-smart investment vehicles. These plans and accounts allow you to efficiently save for your child or grandchild’s education while shielding the savings from the U.S. Internal Revenue Service as much as possible.

529 Plans

“One of the best ways to help a child financially while limiting your own tax liability is the use of 529 college plans,” says Sam Davis, Partner/Financial Advisor with TBH Global Asset Management. A 529 plan is a tax-advantaged investment plan that lets families save for the future college costs of a beneficiary. Plans have high limits on contributions, which are made with after-tax dollars. You can contribute up to the annual exclusion amount, currently $14,000, each year (the "annual exclusion" is the maximum amount you can transfer by gift - in the form of cash or other assets - to as many people as you wish, without incurring a gift tax). All withdrawals from the 529 are free from federal income tax as long as they are used for qualified education expenses (most states offer tax-free withdrawals, as well). There are two types of 529 plans:

  • 529 Savings Plans  These plans work like other investment plans such as 410(k)sand Individual Retirement Accounts (IRAs), in that your contributions are invested in mutual funds or other investment products. Account earnings are based on the market performance of the underlying investments, and most plans offer age-based investment options that become more conservative as the beneficiary nears college-age. 529 savings plans can only be administered by states.
  • 529 Prepaid Tuition Plans – Prepaid tuition plans (also called guaranteed savings plans) allow families to lock in today’s tuition rate by pre-purchasing tuition. The program pays out at the future cost to any of the state's eligible institutions when the beneficiary is in college. If the beneficiary ends up going to an out-of-state or private school, you can transfer the value of the account or get a refund. Prepaid tuition plans can be administered by states and higher education institutions.
“I strongly advise my clients to fund 529 plans for the unsurpassed income tax breaks,” Davis says. “Although the contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions to pay for the beneficiary's college costs come out federally tax-free.”

Traditional and Roth IRAs

An IRA is a tax-advantaged savings account where you keep investments such as stocks, bonds and mutual funds. You get to choose the investments in the account, and can adjust the investments as your needs and goals change. In general, if you withdraw from your IRA before you are 59.5 years old, you will owe a 10% additional tax on the early distribution.

However, you can withdraw money from your traditional or Roth IRA before reaching age 59.5 without paying the 10% additional tax to pay for qualified education expenses for yourself, your spouse, or your children or grandchildren in the year the withdrawal is made. The waiver applies to the 10% penalty only, and should not be confused with avoidance of income taxes.

Using your retirement funds to pay for your child or grandchild’s college tuition does come with a couple drawbacks. First, it takes money out of your retirement fund – money that can’t be put back in – so you need to make sure you are well-funded for retirement outside of the IRA. Second, IRA distributions can be counted as income on the following year’s financial aid application, which can affect eligibility for need-based financial aid.

To avoid dipping into your own retirement, you can set up a Roth IRA in your child or grandchild’s name. If your child is a minor (defined as being younger than 18 or 21 years old, depending on the state you live), many banks, brokers and mutual funds will let you set up a custodial or guardian IRA. As the custodian, you (the adult) control the assets in the custodial IRA until your child reaches age 18 (or 21 in some states), at which point the assets are turned over to the child. Your child (not you) must have earned income from a job during the year for which a contribution is made, but you can fund his or her annual contribution, up to the maximum amount. The IRS doesn’t care where the money comes from as long as it does not exceed the amount your child earned. For example, if your child earns $500 from a summer job, you can make the $500 contribution to the Roth IRA with your own money, and your child can do something else with his or her earnings. 


Coverdell education savings account (ESA) can be set up at a bank or brokerage firm to help pay the qualified education expenses of your child or grandchild. Like 529 plans, Coverdells allow money to grow tax-deferred, and withdrawals are tax-free at the federal level (and in most cases the state level) when used for qualifying education expenses. Coverdell benefits apply to higher education expenses, as well as elementary and secondary education expenses. If the money is used for nonqualified expenses, you will owe tax and a 10% penalty on earnings.

Coverdell contributions are not deductible, and contributions must be made before the beneficiary reaches age 18 (unless he or she is a special needs beneficiary, as defined by the IRS). While more than one Coverdell can be set up for a single beneficiary, the maximum contribution per beneficiary per year is limited to $2,000. To contribute to a Coverdell, your modified adjusted gross income (MAGI) must be less than $110,000 as a single filer (or $220,000 as a married couple filing jointly).

Custodial Accounts

Uniform Gifts to Minors Act (UGMAs) and Uniform Transfers to Minors Act (UTMAs) are custodial accounts that allow you to put money and/or assets in trust for a minor child or grandchild. As the trustee, you manage the account until the child reaches the age of majority, which is between 18 and 21 years of age, depending on your state. Once the child reaches that age, he or she owns the account and can use the money in any manner. That means he or she doesn't have to use the money for educational expenses.

Although there are no limits on contributions, parents and grandparents can cap individual annual contributions at $14,000 to avoid triggering the gift tax. One thing to be aware of is that custodial accounts count as students' assets (rather than parents’), so large balances can limit eligibility for financial aid. The federal financial-aid formula expects students to contribute 20% of savings, versus only 5.6% of savings for the parents.


The annual exclusion allows you to give $14,000 (for 2013 and 2014) in cash or other assets each year to as many people as you want. Spouses can combine annual exclusions to give $28,000 to as many individuals as they like – tax free. As a parent or grandparent, you can gift a child up to the annual exclusion each year to help him or her pay for college costs. Gifts that exceed the annual exclusion count against the lifetime exclusion, which is currently $5.25 million.

Concerned about the lifetime exclusion? As a grandparent, you can help your grandchild pay for college, while limiting your own tax liability, by making a payment directly to his or her higher-education institution. As Joanna Foster, MBA, CPA explains, “Grandparents can pay directly to the provider the educational expense, and that does not count against the annual exclusion of $14,000.” So, even if you send $20,000 a year to your grandchild’s college, the amount over $14,000 ($6,000 in this case) would not count against the lifetime exclusion.

The Bottom Line

Many people approach saving for college the same way they approach retirement: they do nothing because the financial obligations seem insurmountable. Many people say their retirement plan is to never retire at all (not a real plan, by the way). Similarly, parents might joke (or assume) that the only way their kids are going to college is if they get a full scholarship. Aside from the obvious flaw with this plan, it’s a back-seat approach to a situation that really needs a front-seat driver. Even if you can save only a small amount of money in a 529 or Coverdell plan, it’s going to help. For most families, paying for college is not as simple as writing a check each quarter. Instead, it’s an amalgamation of financial aid, scholarships, grants and money that the child has earned and money that parents and grandparents have contributed to tax-smart college savings vehicles.

Tuesday, January 21, 2014

Kids and Money: Tips, tricks to filing FAFSA

If you're turning your attention this month to filling out the Free Application for Federal Student Aid, you'll notice your information can be sent to up to 10 colleges at a time.

But what you may not realize is that the order in which you list the schools could influence the amount of financial aid you receive or in some cases, even admission.

That's one of the valuable takeaways from a new book by Mark Kantrowitz and David Levy, financial aid experts with, which operates a group of websites devoted to planning and paying for college.

Their book, Filing the FAFSA: The Edvisors Guide to Completing the Free Application for Federal Student Aid, provides a detailed reference for parents and students seeking financial assistance to pay for college.

For most families, that process starts with the FAFSA, although some mostly private colleges and universities also require additional financial-aid paperwork.

If anybody fits the definition of financial aid experts, it's the authors. Kantrowitz, the senior vice president and publisher of, has written several books on student loans and scholarships and has frequently testified before Congress. Levy directed college financial aid programs for 30 years before becoming Edvisors' associate editor.

Their new book offers especially useful tips on how to avoid FAFSA minefields and increase your financial aid eligibility.

Take the task of listing colleges to receive your financial information. Why is the order such a big deal?

Many schools — outside of the most highly selective — pay attention to how schools are ordered and use the information as a form of "competitive intelligence," the authors said. In some instances, a school at the top of the list might offer a smaller aid package because they think the student will attend regardless of the bottom-line cost, the author said.

To counter, Kantrowitz and Levy suggest students list their second-choice school first, and their top choice second or third. The first three positions matter the most. A caveat: The order in which schools are listed does not affect federal aid, but it can influence state aid and funding from the institution itself, the authors said.

In another scenario, if a second-choice school sees several more selective institutions listed on the FAFSA, the school might reject the applicant altogether in order to increase the percentage of students who accept its admissions offer. That measurement can help a school improve its ranking in the widely followed lists of top colleges.

"So this leads to strange circumstances where a student is admitted to an Ivy League institution and rejected by less selective institutions," the authors wrote.

Confused by all the gamesmanship? The point is to be aware that it goes on.

Some of the authors' other FAFSA suggestions:

■ Don't wait until your student has been accepted at a school or federal tax returns for this year have been filed to submit the FAFSA. Some schools have deadlines for state funds as early as Feb. 1. Other schools award aid on a first-come, first-served basis. Once you're organized, it takes about one hour to complete the online version of the FAFSA. There's also a paper version.

■ Don't assume your income is too high to qualify for aid. The FAFSA determines eligibility for unsubsidized federal Stafford and PLUS loans, which are available regardless of financial need. "Even wealthy students and parents can get these low-cost loans," the authors wrote.

■ Double-check your data. For example, transposing two digits in your student's Social Security number is one of the most common mistakes

Monday, January 20, 2014

IRS Releases Long-Awaited Draft Instructions To Form 8960: Computing New 3.8% Tax On Net Investment Income


Well, our long national nightmare is finally over. This morning, the IRS
released 20-page DRAFT instructions to go with the previously issued DRAFT
Form 8960. Note, the previously issued Form 8960, which you can find here,
was not changed at all. The IRS merely issued instructions to aid in the
population of the 33 total lines found on the draft form.

I read through the instructions this morning, and while they align perfectly
with the content of the final regulations, I have a couple of thoughts and

Don’t rely on the software.

As I just said, the instructions are very thorough, and clearly implement the
overwhelming majority of the principles found in the final regulations,
including the exclusions from net investment income for certain self-rental
income, self-charged interest, and rental income of real estate professionals
who meet the 500-hour safe harbor. There’s just one problem: this means
that you have to understand the final regulations.

That is my big takeaway from the instructions – there’s no faking it. When we
saw that this new, complex area of the law would ultimately be computed on a
one-page form, we anticipated that the meat of the computation would be
done off-form in worksheets provided by the instructions. And that’s exactly
what happened. But that shifts the onus back to us as tax advisors to
sure our inputs are correct, which means we must understand the nuances of
the final regulations.

Based on my review of the instructions, it will be virtually impossible for a tax
advisor to accurately compute, for example, the Net Gains and Losses
worksheet without a solid understanding of the types of gains and losses the
final regulations contemplate being included in and excluded from net
investment income. Perhaps I’m wrong, and the software will be idiot-proof,
but I wouldn’t count on it.

Real estate professionals
The final regulations provided a major boon to real estate professionals by
providing a safe-harbor whereby the taxpayer’s rental activity will be deemed
to rise to the level of a trade or business. Meeting the safe-harbor is vital,
because it effectively excludes the rental income from net investment income
because the income is rendered nonpassive – by virtue of the taxpayer’s real
estate professional status – and is deemed to be earned in a trade or business
by virtue of the safe harbor. You can read about it here.

Be warned, however – in the discussion on the safe harbor for real estate
professionals in the draft instructions, you will find the following language:
You qualify for the safe harbor if you are a real estate professional for
purposes of section 469 and you: Participate in each rental real estate activity
for more than 500 hours during the tax year, or Participated in a rental real estate activity for more than 500 hours in any 5 tax years (whether or not consecutive) during the 10 tax years immediately
prior to this tax year.

I underlined the text above because it would seem to indicate that a real estate
professional with 10 rentals must spend more than 500 hours on each rental
to enjoy the benefit of the safe-harbor. Remember, however, that a taxpayer is
permitted by Reg. Section 1.469-9 to elect to group all of his or her rental
activities together for purposes of meeting the real estate professional tests of
Section 469(c)(7). The final Section 1411 regulations make it clear that if this
election is made, the taxpayer need only spend 500 hours on the grouped
rental activities in order to satisfy the safe harbor. This is not made clear in the
draft instructions, but it is in fact the case. This greatly expands the reach of
the safe-harbor for taxpayers with multiple rentals.

Use of excess losses to of set other net investment income
Perhaps the most material change in the final regulations is the expansion of
the definition of “properly allocable deductions” to include any net losses from
the sale of property – or what I call “excess three little i losses” – to the extent
those losses are used in the current year to reduce the taxpayer’s taxable
income. This effectively permits certain excess losses from the disposition of
property to reduce other forms of net investment income like interest,
dividends, or passive income.

My first concern was mentioned above. The computation of the taxpayer’s net
gain or loss is driven by the completion of an off-form worksheet that will
require the taxpayer to be well versed in the concepts found in Reg. Section
1.1411-4. You can read about those concepts here.

Next, because the final regulations treat the excess losses as “properly
allocable deductions,” you may have expected to see those amounts appear in
Part II of the draft form alongside other allocable deductions like investment
interest expense or state and local taxes. Instead, the Form 8960 simply
allows Line 5d – the total of gains or losses included in net investment income
– to be negative.

Pre 2013 installment sales of S corporation stock or partnership
Under newly published proposed regulations, a taxpayer who materially
participates in a trade or business conducted by an S corporation or
partnership will not include in net investment income any gain from the sale
of a membership interest in the corporation or partnership unless a deemed
sale of the assets of the entity would have yielded gain that would be included
in the taxpayer’s net investment income.

Also under those regulations, a taxpayer who sells the membership interest
on the installment basis must compute the amount of the gain to be included
in net investment income in the year of sale. Any amount of the gain that is
excluded from net investment income is added to the taxpayer’s basis in the
membership interest for purposes of computing the gross profit percentage
and resulting gain in subsequent years for purposes of determining net
investment income.

Assume A sells S Co. stock with a basis of $10,000 for $100,000, to be paid
$20,000 in the year of sale and in each of the next four years. Assume A opts
not to use the simplified method, and determines under the deemed asset sale
steps that $50,000 of the gain must be included in net investment income.
This means the “excluded gain” is $40,000 ($90,000 gain less $50,000
included in net investment income.)
A must increase his basis in the S Co. stock of $10,000 by the $40,000 of
excluded gain, bringing his basis to $50,000. This brings A’s basis for
purposes of the net investment income tax to $50,000, and his gross profit
percentage is 50%.
Each year, when A receives $20,000 on the installment note, for chapter 1
purposes he will recognize $18,000 of gain (gross profit percentage of 90% *
$20,000 cash). The amount included in net investment income, however,
would be only $10,000 (gross profit percentage of 50% * $20,000 cash).
Thus, over the five years, A would include $50,000 in net investment income,
and $40,000 would be excluded from net investment income.

Many tax advisors have wondered how this will impact taxpayers who sold a
membership interest prior to 2013, because Section 1411 was not in place at
that time. Did this mean that taxpayers were resigned to including the entire
amount of gain from per-2013 sales that is recognized in 2013 and beyond in
net investment income?
The regulations seemed to indicate that this was not the case, and the draft
instructions confirm this conclusion, providing:
If you disposed of a partnership interest or S corporation stock in an
installment sale transaction to which section 453 applies, you need to
calculate your adjustment to net gain in the year of the disposition, even if the
disposition occurred prior to 2013. The dif erence between the amount
reported for regular tax and NIIT will be taken into account when each
payment is received.

The instructions go on to explain that if you sold the membership interest
prior to 2013, in the first year you are subject to the net investment income tax
you are required to attach to your return a statement explaining your
computation of the excluded amount, as well as other required disclosures. In
addition, the worksheet on page 9 will walk you through a computation
whereby you first include in net investment income the current year gain
recognized under the installment method for income tax purposes before
backing out the amount excluded from net investment income as determined
in my example above.