Monday, March 31, 2014

Tax Advantages of Being Single

 With three filing statuses that pertain to being single, choosing the right one can help taxpayers make the most of their financial situation.

Single filers can have an advantage over their married counterparts, because dual income married couples often pay more tax due to the marriage penalty.

A couple suffers a marriage penalty if its partners pay more income tax as a married couple than they would as two single individuals. Conversely, the couple receives a marriage bonus if its partners pay less income tax as a married couple than they would have as two single individuals.

Tax issues for single women are not unique by gender. There are differences in filing single versus filing married and even further married filing separate, but many considerations regarding filing status are not gender based.

More than 11 million households are single families, according to the U.S. Census Bureau.

Single women, single men and taxpayers in general need to watch for tax law changes but even more importantly life changes. Life changes may include marriage or divorce but more commonly relocation, moving and taking care of a new dependent.

Having children changes everything in more ways than one.

If you are single due to a spouse passing, widows who have dependent children are entitled to a special filing status for two subsequent years.

A single parent can usually claim head of household filing status if he or she is the only adult in the home; provides more than half the cost of rent, utilities and food; and has dependent children.

You can claim this too if you are supporting an elderly parent even if they don't live with you.

Filing under head of household status tends to provide a higher standard deduction and lower taxes than single status.

With divorces nearing 900,000 per year, it's important to know that if a divorce is final before midnight on December 31, 2013, you are considered a single taxpayer in 2014.

Divorced women are taxed on any alimony they receive but do not pay tax on any child support.

One of the most common family structures next to the single parent household is the blended family, which is a combination of two parents with children from previous relationships and/or from the current relationship.

If you are unmarried but living with a partner, be mindful of the deductions that you can split and the ones that you can't. Take best advantage of each deduction.

When parents remarry, they may file a married filing jointly return with their new spouse, claiming the children from their new relationship and any eligible children from previous relationships.

Consider all of the good works that you do. Women are very giving of their time and resources and often overlook the deduction for charitable miles or out of pocket expenses.

Marriage does have its privileges however when buying a home.

Singles only get a $250,000 exclusion on gain from the sale of their home while married individuals get twice that.

Sunday, March 30, 2014

Tax Day Could Bring Tax Surprises for Higher-Income Taxpayers

The Affordable Care Act contained more than 40 tax code changes. Some of the changes are resulting in increased tax bills for higher-income taxpayers, which could come as a surprise to many of them on Tax Day.

The phase-out of itemized deductions and personal exemptions, and the increase in Medicare taxes, as well as changes in tax rates on net investment income, lead the list of changes at the top.

Phase-out of itemized deductions and personal exemptions return for higher-income taxpayers

The phase-out of itemized deductions and personal exemptions have returned for those married filing jointly with adjusted gross income above $300,000 ($150,000 MFS) and $250,000 for all other filers.

From tax year 2012 to tax year 2013, a couple who earns $450,000 would see their itemized deductions reduced from $89,500 to $85,000 due to new limits preventing higher-income taxpayers from claiming a percentage of their total eligible itemized deductions. The reduction is based on income; as income over the threshold increases, allowable deductions decrease.

For 2012, before the phase-out of personal exemptions, a married couple filing jointly who earned $450,000 and had two dependent children was eligible to claim $15,200 in personal exemptions. For 2013, the same couple wouldn’t be eligible to claim personal exemptions because they exceeded the phase-out threshold.

Even if individual incomes don’t meet withholding threshold, married couples could still pay the additional Medicare tax

The additional Medicare tax increases the portion paid by employees by 0.9 percent, making it 2.35 percent. This is applied to wages, tips and some fringe benefits that exceed $250,000 for those married filing jointly ($125,000 MFS) and $200,000 for all other taxpayers.

For example, with this change a couple who earns $450,000 pays $1,575 for total additional Medicare taxes for 2013, while in 2012 they paid nothing because the law didn’t yet apply.

For many of these taxpayers the additional tax is automatically withheld from their regular paychecks. However, those who are self-employed or pay estimated income tax should be aware that they also are subject to the additional Medicare tax if the threshold is crossed. Married couples whose individual incomes are less than $200,001 (the point at which employers automatically start withholding for the tax) should investigate making adjustments to their Form W-4s if their combined income will exceed the $250,000 threshold.

Net investment income tax applies when adjusted gross income threshold is met

Net capital gains from the sale of stock, dividends, investments and other sources are subject to the new net investment income tax when adjusted gross income thresholds are met. This means a home sale could trigger the tax when the gain isn’t excluded from income under the special rules for sales of homes.

Taxpayers whose filing status is married filing jointly with modified adjusted gross income exceeding $250,000 ($125,000 MFS) and all other taxpayers whose income exceeds $200,000 could be subject to the tax. For example, a couple earning $450,000 who also has $25,000 in interest and dividends pays $950 for this tax in 2013, while in 2012 they paid nothing because the law didn’t yet apply.

Going forward, offsetting capital gains with capital losses could be beneficial; the tax only applies to net capital gain, which is the amount left when losses are subtracted from gain.

But, there is some good tax news for higher-income taxpayers. Among the other things permanently extended starting in 2013 is no estate tax if estate assets are less than $5.25 million. Plus, any unused estate tax exclusion can be transferred to a surviving spouse. Also, taxpayers may gift up to $14,000 per person to as many people as they want without paying gift tax. However, not understanding how changes in gift and estate tax provisions impact specific circumstances can be costly for individuals and families. For protection against financial surprises, take confusion out of the equation and talk to a tax professional.

Saturday, March 29, 2014

H&R Block Get Your Billion Dollars Back Tax Scam

You’ve probably seen the commercials. H&R Block has been running advertisements this year telling everyone that they can get to listen that American taxpayers are giving $1 billion to the IRS that’s really their money — and all because they’re doing their own taxes instead of letting H&R Block do their taxes for them. H&R Block wants you to “Get Your Billions Back” since you are leaving so much money on the table.

To emphasize that huge $1 billion amount which isn’t being claimed, they are running a number of different commercials to show how much money that $1 billion is. One is where they have a concessionaire placing $500 on every seat in every stadium in the US:

What both these commercials do is lead you to believe is that by doing your own taxes, you’re making huge mistakes that could be costing you hundreds, if not thousands of dollars that you would be yours if you just let H&R Block do your taxes instead. They are using your fears of losing money doing your own taxes to try and convince you to let them do your taxes. It’s a good strategy on their part that happens to be a con game to make you fear you’re losing a ton of money doing your own taxes when in reality you’re not.

While they are hoping that you make the assumption that you’re losing $500 or more (like the amount they place on the stadium seats), the truth is that it’s likely you aren’t losing any money doing your own taxes. If you are losing money, it’s a whole lot less than the commercials imply. How do we know? Simply run the numbers.

There are over 50 million families that do their own taxes. That means that if all the families that are doing their own returns aren’t claiming $1 billion worth of deductions that they could claim, each family is failing to claim a little less than $20 each on their returns. Yes, that’s right. If you are doing your own taxes, on average you’re failing to claim about $20. Why don’t they say this in their commercials? Because they know perfectly well if they did, nobody would go to H&R Block to get their taxes done.

Still, $20 is $20, so why not have H&R Block find you that extra $20? A good question until you realize how much they charge to do your tax return. In 2013, H&R Block charged the average person just under $200 ($198) to do their taxes. If you do the math, you might save $20 from the IRS, but you end up losing $178 out of your own pocket to H&R block. All of a sudden, it doesn’t sound like such a great deal.

It gets even worse. If you read the fine print in the commercials, it says that a study shows that H&R Block is able to find savings for about 1 in 5 people who do their own taxes. That’s right. You need to pay nearly $200 for a 20% chance of getting a bit of savings from them. On the other hand, if they are only finding 1 in 5 people that can get a greater refund, that means the refund for those that they can find it for increases from $20 to $100. Of course, since you are paying nearly $200 for them to do your taxes, you are still coming out $100 behind by letting them do your taxes.

What this all says is that the “Get Your Billion Back” commercials are an extremely deceptive advertising campaign to make you think you’re losing a lot of money by doing your own taxes when in reality, you’re not. All you need to do is run the numbers, and they will tell you that you’ll likely spend much more of your own money getting your taxes done by H&R Block than you would if you did them yourself.

Friday, March 28, 2014

Did Americans Really Overpay by $1 Billion at Tax Time?

I heard a statistic on a running commercial series that is so shocking that I don't want to believe it's true: H&R Block claims Americans overpaid by $1 billion in taxes last year. Apparently this is enough for a stack of five hundred dollars to be placed on every seat of every NFL stadium (one on each of 2 million seats in the thirty two professional football stadiums).

I tried to find the methodology for this statistic, but H&R Block isn't making it very easy to find on their website or elsewhere on the internet. On the plus side, they do have a lot of interesting statistics about a billion dollars. Did you know that if you stack up a billion dollar bills, the pile is 109,250 meters high? Apparently, this billion comes, at least in part, from the 56 million Americans who will do their taxes on their own this year, and H&R Block estimates 11 million of those could contain errors that left money on the table. (Their site claims that H&R Block professionals found more money for one in five people, with $460 per person, on average.) So the question is: should people try to do my taxes on my own?

That said, the amount of money you would be leaving money on the table is, by definition, an "unknown unknown." If I were aware of the error, I'd correct it. But I'm not (so I can't, and I won't, but...) Using H&R Block's statistics, you have a 20% chance leaving money on the table, and that average error would cost you $460. But the math says you should not pay the extra $206 to hire a professional, for a one-in-five chance of netting $460. (I would need a one in five chance to net over $1,000 for the odds to point to hiring a professional.)  This also means that, even though Americans might have left one billion on the the table by not using H&R Block, they'd be paying H&R Block several times more than that had each one of those do-it-yourself tax payers simply paid them $246.- the average H&R Block fee.

But these are all just gross averages: who knows where your individual situation fits in? And then there's the fact that doing taxes is kind of a chore.It's boring, and there are better ways to spend a weekend. Regardless of the money spent, this might be a case for outsourcing.

Thursday, March 27, 2014

Tax filing and planning tips for small business owners

With an April 15 tax deadline looming, businesses across the country are preparing to file their 2013 taxes. Tax season can be both an administrative and financial burden. New data reports that only 41 percent of small business owners feel very confident they are maximizing their tax benefits for the 2013 year, according to a recent Spark Business OmniPulse Survey conducted by Research Now. In fact, 22 percent of business owners plan to file for an extension this year. The survey also suggests small business owners are faced with a lack of resources and tools when it comes to filing their taxes.

Fortunately, there are a variety of ways to help prepare your business for tax season and minimize your tax burden. A few tips to help small business owners reduce stress and maximize tax benefits:

* Hire a professional. Meet with your accountant before you begin. Tax laws change every year, so a professional advisor or CPA can offer guidance on the latest legislation surrounding eligible tax deductions. Equip yourself with updated information at

* Organize (and digitize) your records. Computerizing your paperwork is a good way to streamline operations and find forms quickly. The IRS requires that you keep paperwork from the last seven years, which includes bank and credit card statements, transactions and expenses.

* Manage finances year-round. To help maximize deductions, keep a detailed log of expenses throughout the year to easily reference when tax time rolls around. Based on what you spend, your business can be eligible to write-off office supplies, equipment, furniture, software, travel expenses and more. Consider streamlining all expenses on a business credit card account to help simplify tracking and maximize rewards.

* File for an extension. You still need to pay your bill, but your business could be eligible for a six-month paperwork extension. Nearly 40 percent of business owners say they plan to file for an extension because they don’t have the necessary background information. If you do choose to extend, make sure you file the extension by April 15 or else you could be subject to costly fines.

* Do your research. There are other great ways to help relieve your tax burden, like setting up a low-cost 401(k) plan for you and your employees. Contributions are tax-deferred, plus a 401(k) plan can be a great tool for employee recruitment, retention and morale. ShareBuilder 401k offers intuitive tools along with market-efficient investments and model portfolios designed to make setting up and selecting the right plan quick, easy and affordable.

Wednesday, March 26, 2014

Biggest urban legend in taxation - the Gift Tax

What is the biggest urban legend in the area of taxation?
If you answered “the gift tax,” score one for the home team.
The most common phone call received by tax professionals involve inquiries from parents or grandparents about whether or not they will have to pay gift tax on their monetary gifts. Adult children and grandchildren call to ask about whether they will have to pay a tax on gifts received. [Lots of hand-wringing going on]
Like the urban legends that struck fear in many of us as youngsters, the dark, scary world of gift taxes does the same to adults. One person whispers a rumor of a gift tax nightmare that some other person experienced and the urban legend grows and grows.
People fear the gift tax simply because they don’t understand how it works.
Knowledge conquers fear: Demystifying the gift tax
The gift tax is a real tax. You don’t necessarily need to pay it, but there are a number of rules surrounding this inconvenient tax.
First, any person can gift any individual up to $14,000 in 2014 and have no obligation to report it to the IRS. So mom and dad can give a combined $28,000 to their favorite child without creating any new filing requirements for themselves. But, if mom and dad gift little Johnny anything above that amount – even $28,001 -- they will need to file a gift tax return with their annual tax return.
Filing a gift tax return does not mean that these generous parents will automatically have to pay a gift tax (yes, the IRS assesses the gift tax based on the giver’s financial circumstances), but they will have to file the return. In fact, an individual owes no gift tax until he or she gives away the lifetime exclusion amount.
So what’s the lifetime exclusion amount?
For 2014, the lifetime exclusion amount is quite generous at $5,340,000! If you give away more than that, then you will owe gift tax – assessed at the whopping rate of 40 percent. This means that for the average taxpayer, fear of having to pay a gift tax represents an unfounded worry. You don’t need to add unnecessary sources of stress to your life.
Every rule has its exception (or two)
In some situations, you may not have to file a gift tax return even if you give over the annual limit.
Let’s suppose your favorite Aunt Martha is very sick and out of the goodness of your heart, you decide to pay her medical bills. No gift tax return is required, even if the amount exceeds $14,000. However this exception comes with an important caveat – you must pay the medical provider directly. If you give Aunt Martha the money and she then chooses to use it to pay her medical bills, you’ll need to file a gift tax return if the amount exceeds $14,000.

Another exception involves gifting money for higher education costs (i.e. college tuition). So, let’s say you decide to pay little Scarlet’s university tuition. You won’t need to file a gift tax return, even if the amount exceeds $14,000. But just like the example with Aunt Martha above, you’ll need to pay the money directly to the university. If you write young Scarlett a check for her tuition and the amount exceeds $14,000, you’ll need to file a gift tax return. By making payment directly to the educational institution, you can gift an unlimited amount of money with no obligation to file a gift tax return, or pay gift tax on it in the future.
Now you know the facts, so stop living in fear and embrace your desire to gift money to your loved ones. Unless you are giving away more than $5,340,000 you will not owe any gift tax.
Even so, any time you plan to give away large amounts of money, it’s wise to consider sitting down with a qualified tax professional. He or she may know of some legal ways to avoid the 40 percent rate on taxable gifts.

Tuesday, March 25, 2014

Filing an Extension Can Ease Stress As Tax Deadline Approaches

The IRS expects to process 148 million tax returns this year. So far, they’ve received 75 million, which means, well, a lot of you still have some work to do. April 15th is around the corner, but before you pull an all-nighter, Bob Meighan of TurboTax says consider this alternative.

"If you can’t get it done or you decide that you want to procrastinate for a few more months, file an extension. It's called form 4868," says Meighan.

That form, which is also available on the IRS website, essentially buys you an extra six months, no harm, no foul, but here’s the catch.

"If you owe any tax, you have to pay Uncle Sam by April 15th, so an extension of time to file is not an extension of time to pay," says Meighan.

After the deadline passes, that’s when the penalties start to kick in, and those can really add up.

We’ll start with the failure-to-file penalty, because that one’s the biggie. Five percent of your unpaid taxes for every month that your return is late. Let’s say you owe $3,000. You're looking at a penalty of $150 a month until you pay it. Again, this can be easily avoided by filing for an extension. When you do, you’ll want to send some money with it, a good faith estimate of what you think you owe. Because extension or no, any money you owe the government after April 15th is subject to the failure-to-pay penalty. That’s one half of one percent of the amount you owe for every month you owe it. Plus interest, of course.

"Whatever the interest rate is at the time, you’ll also owe that. So taxpayers that end up owing tax at the end of the year, if they don’t pay it right away, are going to get hit with even a higher bill because of all of the penalties and interest that continue," says Peggy Riley, an IRS spokesperson.

If you absolutely can't pay your balance by April 15th, you can always apply for an installment agreement. There is a one time application fee and your payment plan has be approved.

"And in most cases, as long as it’s a reasonable amount that you’re offering to pay, and it’s going to be paid off in a reasonable amount of time, they’re usually approved. So I always encourage people not to ignore it. It’s not going to go away, it’s actually going to get worse, so work with us and set up something that’s convenient for both," says Riley.

Monday, March 24, 2014

Foreign Tax Credit: How to Get Money Back


Investing abroad can make you rich. But there are also traps for those who aren't familiar with the way international investing works. The foreign tax credit is one way that investors can get back money they have to pay to foreign governments in tax for their investment income.
Many countries have tax treaties that make owning foreign stocks similar to owning U.S. stocks for tax purposes. But other countries don't have those provisions in a tax treaty, and so shareholders in France's Total (NYSE: TOT  ) , Spain's Telefonica (NYSE: TEF  ) , and other dividend-paying stocks around the world need to know what they've paid and how to get it back. The IRS has made it easier to claim a foreign tax credit lately, no longer requiring Form 1116 if your tax-reporting 1099s from your broker include foreign tax amounts and meet all the necessary requirements. Even though foreign investing can be lucrative, it pays to know these rules to get the maximum tax break.

Sunday, March 23, 2014

Estate planners shift gears in new tax environment

Wealthy individuals aren't the only ones struggling to cope with higher income-tax rates and the new 3.8 percent investment income tax funding the president's health-care plan. The beneficiaries of trusts—wealthy or not—are also feeling the bite, and estate planners are trying to figure out ways to reduce it.

Trusts are separate legal entities created by a person or organization and managed by a trustee for the benefit of others—very often spouses or children of the trust creator. They allow a person to remove assets and property from their own estates, thereby avoiding the estate tax when they die, and enable them to control how and when assets are distributed to their beneficiaries.

The bigger tax hit

The variety of trusts and the rules that govern them are enormous. So-called simple trusts pay out all the income they produce to beneficiaries, who then don't face income taxes. With grantor trusts, the creator of the entity is deemed the owner and thus faces all tax liabilities stemming from its administration. However, for the rest of the universe of trusts—call them complex, nongrantor trusts—income taxes have become a much bigger deal.

The reason is that, for tax purposes, trusts are treated like wealthy individuals—only worse. While the new 39.6 percent marginal tax rate created by the American Taxpayer Relief Act applied to income over $400,000 for individuals last year, it kicked in at an income threshold of just $11,950 for trusts. The 3.8 percent Medicare surtax applied to the net investment income of individuals earning more than $200,000 also hit trusts starting at that lower threshold.

The upshot is significantly higher tax bills. Assuming no capital gains income, a trust holding $1 million in assets and making a 10 percent return last year paid income taxes of $34,868 and new Medicare taxes of $3,346. That's nearly $7,400 more than it would have paid in 2012 on the same income.

While minimizing taxes is certainly not the only, nor even the primary, objective of trusts, it is a major issue for trustees with a fiduciary responsibility.

"The objective is to maximize the amount of money that family members [or other beneficiaries] receive," said Ronni Davidowitz, head of the trusts and estates practice at legal firm Katten Muchin Rosenman. "Estate planners have to revisit some of their planning patterns of the past and reevaluate what makes sense now."

Dealing with the tax hit

One strategy to reduce the tax hit is to invest more of the trust's assets in tax-exempt securities, such as municipal bonds.

"The new investment income taxes have caused some clients to think about whether they can handle higher allocations to municipal bonds," said Lisa Whitcomb, director of wealth strategies at Glenmede, a privately owned trust company managing more than $25 billion in assets. However, the still-low yields on muni bonds—and the fact that tax-reform proposals from both political parties have proposed taxing muni bond interest—have made people wary, she added.

A more difficult decision is whether a trustee should consider making larger distributions to beneficiaries. If those beneficiaries are in a lower tax bracket and not subject to the new Obamacare taxes, the distribution can save a lot of money. "If it's in the discretion of a trustee to distribute assets, the additional level of tax is an aspect of what you have to look at," said Davidowitz.

It's still only one aspect, however. A bigger distribution may not be permissible under the trust's governing documents, and it may not make sense based on the circumstances of the beneficiaries. If their beneficiaries are minors or deemed not responsible enough to handle larger sums of money, trustees are likely wary of making the distributions, despite potentially positive tax consequences.
"Saving taxes is not the be-all and end-all of managing trusts," said Laura Twomey, a partner with law firm Simpson Thacher & Bartlett who specializes in estate planning. "There are a lot of non-tax issues involved in distributions to beneficiaries, and you have to be aware of the intentions of the creator of the trust."

Nevertheless, bigger distributions can make sense in some situations, said Whitcomb. According to her, while only two or three of the hundreds of trusts that Glenmede manages elected to make additional distributions for the 2013 tax year—the deadline for making them was March 5—it's the right thing to do in some cases, she said.

"Many trusts created years ago are in their third or fourth generation of beneficiaries, and those beneficiaries may be competent, normal adults who are not among the high-net-worth individuals who created the trust," said Whitcomb. "A bigger distribution might be a real boon for them."

With higher income taxes likely an ongoing issue, trustees may want to consider the option more closely.

Saturday, March 22, 2014

Weird Tax Rules and Deductions

Despite being in the industry for more than 30 years, every day I get asked a tax-related question that I find not only weird, but thought-provoking as well.
There are so many changes to and interpretations of our tax code, and everyone has a different financial situation, which creates a lot of grey areas when it comes to filing taxes.
For example, twice this week I was asked if time volunteered in a charitable activity was deductible. The answer, of course, is no. One person owned a nail salon and donates gift certificates for manicures and pedicures to local charities for silent auctions. I had to tell her that her time is an intangible and therefore has no value to the IRS. Sure, she would have likely made $50 for that hour of time, but in a sense she is already deducting it because she isn’t declaring the income. The other person drives a few hours a week for a charitable organization that provides meals to the elderly and disabled. She is a semi-retired attorney who makes $400 per hour when at work. She would like to deduct $1,200 a week for the three hours she drives for the charity. Not allowed.
Confusion also arises over the rules for medical deductions. You cannot deduct the cost for cosmetic surgery as a medical expense because the procedure is not medical in the sense of preventing disease, curing a disease or saving a life. The IRS considers the procedure optional.
The IRS will allow the deduction if it’s reconstructive surgery to correct a birth defect or to restore one’s physical anatomy after a loss from cancer, other illness or accident. So if a woman has breast cancer and then gets breast augmentation, she may deduct the expense. The procedures that actress Angelina Jolie went through to reduce her risk of contracting cancer would be considered a medical expense and would be deductible.
If a woman gets a breast enhancement just to improve her appearance, the IRS will disallow the expense. But, as with most tax-related rules, there are exceptions. A stripper deducted the cost of her breast enlargement in order to “improve her skills” for business. She fought for her deduction up to tax court level where it was disallowed as a medical expense, but was allowed as an ordinary and necessary business expense.
Intent is a primary factor in determining whether or not an expense is deductible – especially when deducting business expenses. For example, according to Ann-Margaret Carrozza, a tax and estate planning attorney from New York City, a professional body builder was allowed a deduction for body oil but denied a deduction for health supplements.
Business intent is confirmed in the purchase of the body oil simply because every body builder on TV or in competition is covered in oil. Health supplements however, are available and used by many taxpayers, but are not deductible as a medical expense. The IRS doesn’t deem this an ordinary and necessary business expense for body builders, although I can understand an argument in his favor.
Carrozza cites other interesting deductions and attempts at deductions:
  1. A gas station was allowed a deduction for giving his customers free beer. The agency considers it a promotional expense. But beer supplied at a Super Bowl party by another business owner was disallowed. The reason is likely that the party setting did not provide a venue for a substantial business discussion.
  2. The cost of a wedding gift purchased for the boss’s daughter was disallowed as a business expense. The taxpayer fought it all the way to tax court, but it was still found to be a personal expense despite his argument that he would never have even attended the wedding except to make a good impression on his boss (Wonder if he still works there).
  3. A business owner successfully deducted the cost of feeding feral cats because they kept the rodent population down in the store. Yet a business owner who was protecting his home office by using his dog as a burglar alarm was disallowed the deduction. I would imagine if the dog were trained as a vicious beast and were guarding a junk yard at night, the deduction would be allowed. Dogs are also deductible as herding animals and as therapy or service dogs. 

Friday, March 21, 2014

How Lowering Taxes Drove Paper Millionaires to the Poorhouse


Tax expert and advisor Less Antman on how trying too hard to minimize taxes can cost your clients in the end.
Many dot-com workers, afraid of higher taxes for selling company stock too early, failed to sell it before it crashed.For advisors, a little tax knowledge can be a dangerous thing.“Most people lose more money trying to reduce taxes than they save in taxes,” says advisor Less Antman, who founded the firm SimplyRich and taught prep courses for CPAs for 27 years.In an interview with ThinkAdvisor, he warned of the dangers of too much portfolio rebalancing, the limitations of tax-loss harvesting, and the unintended consequences now dogging investors who tried to dodge estate taxes in the '90s.Yet the lure of tax minimization is powerful and often destructive, for middle-class investors through the wealthiest.

Paper Millionaires Turned Paupers

Antman tells the story of a client in the late ’90s who sought his help to minimize taxes on incentive stock options that had amassed enormous built-in gains.“One of my earliest clients was working for a dot-com company that had given out incentive stock options, they had an enormous built-in gain, and they wanted to figure out the way to minimize taxes.”Tongue-in-cheek, he suggested holding onto the stock until it crashed and gains disappeared, eliminating the tax problem.

The client took the hint and exercised the options, then immediately sold enough stock to become financially independent for life.

In contrast, many of the client’s colleagues exercised options with a plan to hold the stock for a day and a year in order to convert higher-taxed ordinary income to more lightly taxed long-term capital gains.

The stock collapsed before that day was to arrive for most of the client’s colleagues, and their gains were wiped out.

But that is not all. Antman says that these once paper-rich techies, by exercising their options, became subject to the alternative minimum tax (AMT) on phantom gains for which they received gigantic tax bills at a 28% rate. They could only begin to claw back those payments the following year — with capital losses limited to just $3,000 a year.

To make this more comprehensible, Antman says these tax-minimizing dot-com-ers — on options worth $1 million — would have received a $280,000 AMT bill just for exercising, then after the crash have $1 million worth of capital loss deductions they could use at a rate of $3,000 a year, which has some utility for those living to the age of 340.

“To be fair, several years later Congress passed a limited measure to allow some people to recover old capital losses from the AMT, but they still had to pay the $280,000 on the nonexistent gain and then wait several years for the government to show some mercy." he says. "And that mercy rule has since expired, so we’re back to tax hell for such people the next time it happens.”

It is common, Antman adds, for particularly smart people to make such mistakes because they research tax-saving strategies and think they understand them without foreseeing the tax traps that lie within. That’s why people with incentive options need a tax-savvy advisor, Antman says, quoting Lord Thomas Dewar of Scottish whisky fame:
“Nothing hurts more than having to pay an income tax, unless it is not having to pay an income tax.”

Muni Bonds, Variable Annuities and Other Potential Tax Traps

Antman’s key tax insight for advisors, though, is to avoid the all-too-common mistake of seeking to minimize taxes rather than maximize after-tax returns.

“There’s a big difference: You can reduce taxes in ways that reduce your income even more,” he says, citing muni bonds as a classic example of reducing a tax bill by accepting lower returns at the outset.
Nobody not in the top tax bracket should even consider them, he says, yet it is common for middle-class investors to park their cash in muni-based money market funds.

Variable annuities are also not all they’re reputed to be, Antman says. They turn all income ordinary, even what would otherwise have been long-term capital gains; lose the stepped-up basis at death that applies to taxable account assets, restrict investment options severely, and typically add fees that far exceed the net benefit of deferring taxation on earnings.

Moreover, deferral is of little value if it is only for a small number of years, so the best case for a variable annuity would presumably be one intended to be held for decades. Yet money invested for decades belongs in equities, and deferral of equity taxation can be obtained by the use of index mutual funds or ETFs without any of the fees of variable annuities.

“There are lots of ways to cu
t your taxes that will cut your income even more,” he says.
Antman emphasizes that he does occasionally find a role for an annuity, but it isn’t to save taxes.
“The traditional role of an annuity was to pay a periodic income for life, and was essentially a form of protection against living too long. For those who either have no desire or no ability to consider the needs of heirs or charitable legacies, converting a lump sum into periodic payments for life is a reasonable bet to make with an insurance company.
“Of course, in such cases I will recommend either an inflation-adjusted annuity or an immediate variable annuity that pays for life but varies the payments based on the return of underlying investments, since a fixed annuity doesn’t really protect someone against the impact of long-term inflation. But the one topic that never comes up in a proper discussion of such annuities is taxes.


Thursday, March 20, 2014

Tax Time IRA Questions and Answers

Q. Can I do a conversion now for 2013?

A. No. In order to have a 2013 conversion, the funds must leave the IRA or plan account in 2013. They don’t have to be in the Roth IRA in 2013 since you can take a withdrawal in December, 2013 and have 60 days to complete a rollover (conversion) to the Roth IRA in January or February, 2014. But the funds must leave the traditional IRA or the employer plan by December 31, 2013.

 Q. I am contributing to my employer plan. Can I also make an IRA contribution?

 A. Yes. As long as you have earned income or compensation and will not be 70 ½ or older during the year, you can make an IRA contribution. If your income exceeds certain limits you may not be able to deduct the contribution. You can also make a Roth IRA contribution even if you are 70 ½ or over unless your income exceeds certain limits. You can find all of those limits at A contribution can also be made for a non-working or lower wage spouse based on your earnings subject to the income limits noted above (known as a spousal IRA contribution).

Q. I was told I can still set up a SEP IRA for 2013 and fund it up to October 15th. Is this right?

 A. Yes. As long as you meet the criteria for establishing an employer plan, you can establish and fund a SEP IRA up to the tax filing deadline, plus extensions, for your business. We examined that issue in more detail here. Keep in mind that if you have any employees, including your spouse, whatever contribution is made to your SEP must also be made for any eligible employees. You cannot fund just your own account.

Q. Someone died last year. She had earned income. Can we make a contribution to her IRA or Roth IRA account for last year?

 A. No. You can only make a contribution for someone who is alive. The theory behind this is that if someone dies during the tax year, they no longer have a need to save for retirement.

Wednesday, March 19, 2014

IRS Can Audit You Forever, But Key Steps Can Prevent It


Even a routine tax audit can be expensive and nerve-wracking. So if the IRS statute of limitations has expired, it can be a trump card. The IRS normally has three years to audit, measured from the return due date or filing date, whichever is later.
But watch out: the three years is doubled if you omitted 25% or more of your income. Even worse, the IRS has no time limit if you never file a return. What’s more, the IRS also has no time limit on fraud. As a result, you might think the IRS would always assert fraud to get unlimited time.
It’s a chicken or egg issue, since the IRS has to show you were fraudulent to keep the time limit open. Fortunately, though, the IRS has a high burden to show fraud. Here are other timing rules you should know.
Many people voluntarily give the IRS more time. Why would anyone do that? It works like this. The IRS contacts you (usually about two and a half years after you file), asking you to extend the statute. Most tax advisers say you should usually agree. If you say “no” or ignore the request, the IRS will assess extra taxes.
There are also time limits to amending a tax return. Do it within three years of your original. But here’s a timing trick. If your amended return has an increase in tax, and you submit the amended return within 60 days before the three-year statute runs, the IRS will only have 60 days after it receives the amended return to make an assessment.
An amended return that does not report a net increase in tax doesn’t extend the statute. Timing on refunds can be tricky too. If you have too much tax withheld but fail to file a return, you usually only have two years (not three) to get it back.
Statute of limitation issues come up frequently with partnerships, LLCs and S corporations. The partners or shareholders pay tax, but the return is filed by the entity. And the entity might agree to extend the statute. Also, a tax notice may be sent to a partnership, but not to partners. Professional advice may be needed to untangle it.
Also, watch for cases where the statute may be “tolled” (held in abeyance). That can occur with an IRS John Doe summons, even though you have no notice of it! For example, suppose a promoter sold you on a tax shelter. The IRS may issue the accountant a summons asking for the names of all his clients. While he fights turning those names over, the statute of limitations clock for his clients is stopped.
Finally, consider state taxes too. Some states have three- and six-year statutes like the IRS. But some states set their own time clocks, giving them even more time to assess taxes. In California, for example, the basic statute of limitations is four years. However, if the IRS adjusts your federal return you are obligated to file an amended return in California. If you don’t, the California statute never runs out.
Timing is everything in tax matters, and that’s certainly true with the statute of limitations. The statute usually begins to run when a return is filed, so keep certified mail or courier confirmation. If you file electronically, keep all the electronic data, plus a hard copy of your return. Monitor the timing carefully and know when you’re clear. It can mean the difference between winning and losing.

Tuesday, March 18, 2014

Traditional IRAs and Roth IRAs

Question Asked:

Should my wife and I contribute to a Roth IRA or a traditional IRA? We both participate in our respective employer's 401(k) plan. What if our income is too high?

Answer:  You are wise to augment your 401(k) retirement plans by saving additional retirement funds in your IRAs. After all, you are responsible to save for your own retirement. The extra $5,500 you contribute to an IRA every year may not seem like much now, but you will be surprised what compound growth can do over time.

If you and your wife save $11,000 at the beginning of every year in an IRA that grows at 7 percent per year, after 20 years your contributions of $220,000 will be worth more than $482,000. After 30 years, your contributions of $330,000 will be worth over $1.1 million. If that IRA is a Roth, your withdrawals will be tax-free.
Everyone with earned income is eligible to contribute to a traditional IRA. Income limitations only dictate how much is tax-deductible. Roth IRAs have different rules. If your income is too high, you can't contribute directly to a Roth. Contribution eligibility in 2014 begins to phase out for married couples when their adjusted gross income reaches $181,000, and eligibility ends at $191,000. The phase-out range for single taxpayers is $114,000 to $129,000.
If your income is higher than the above limits, there is a back door. IRS rules allow traditional IRA owners to convert their IRA to a Roth without regard to income. If you want to contribute to a Roth in 2014 but your income is too high, you can first contribute to a traditional IRA and then convert it to a Roth.
But be careful. No problem if you don't already have an IRA. But if you do, the IRS says you can't pick and choose which IRA you convert. You must prorate and pay tax on any previously untaxed amounts in all your IRAs.
Untaxed amounts include dollars you rolled over from a retirement plan and dollars that you contributed and deducted on your income tax return. Previously taxed amounts — your cost basis — equal the total of the non-deductible contributions you made.
Here's an example. Let's say you have a $50,000 rollover IRA from a former retirement account, a separate $50,000 traditional IRA that holds $25,000 of cost-basis (non-deductible) contributions and $25,000 of earnings, and a new $5,000 IRA with a $5,000 cost basis.
Your total IRA value is $105,000 and your total cost basis is $30,000. If you convert your new $5,000 traditional IRA to a Roth, you will owe tax on $3,572 (subtract $30,000 from $105,000, divide by $105,000, and multiply by $5,000).
High income earners without traditional or rollover IRAs can open an IRA, contribute $5,500 ($6,500 if age 50 or older), and then convert the whole $5,500 to a Roth with no tax consequence. If you are a high-income earner with IRA accounts you should check with your current 401(k) plan administrator and ask if the plan allows you to move your pre-tax IRA money into your 401(k). Some plans will allow this, and if so, you can move the pre-tax money to your 401(k) and convert the remaining non-deductible money and future annual traditional IRA contributions tax-free.

Monday, March 17, 2014

401(k) Moves to Ease Your Tax Time Blues


It's been a rough winter for most of the country. And, if you think Mother Nature hits hard, just wait a few weeks until Uncle Sam gets a crack at us. Millions will owe money to the government, but there's still time to help reduce your tax burden for this year and beyond. A good place to start is with your workplace 401(k) plan. While the 401(k) is designed to help you save more for retirement, it can also lessen your tax blow for 2014. Here's a look at what you need to know:
  • Try to increase or max out your contributions. Traditional 401(k) plans are funded with pre-tax dollars, which means your current taxable income is lowered. Making a significant contribution could bump you down into a lower tax bracket entirely, allowing you to keep even more of your pay. An Employee Benefit Research Institute report found that only 10% of participants were maxing out their contributions, so there is room to get more aggressive with your savings rate. *
  • Get extra credit. Based on your income and filing status, contributions to a qualified 401(k) plan may even further lower your tax bill through the saver's credit or retirement savings contributions credit. The credit was established in 2002 and directly reduces your taxable income by a percentage of the amount you put into your 401(k) plan. According to the IRS, those who meet eligibility requirements can take a credit of up to2,000, so it's definitely worth investigating.
  • Consider a Roth 401(k). A Roth 401(k) can offer a different kind of strategic tax planning opportunity. In a traditional 401(k) plan, contributions are made on a pre-tax basis and taxes are paid when you take distributions from the plan. In a Roth 401(k), contributions are made on an after-tax basis and distributions of any investment earnings are tax-free after you meet certain requirements.
  • Withdrawals are tax burdens. Any withdrawal from a 401(k) plan can carry significant tax consequences. How significant? If you take money out of your employer-sponsored retirement plan before the age of 59½, you'll likely face a 10% federal penalty. What's more, the government will take 20% of your withdrawal as an advance on your tax bill. Plus, some plans may freeze employees who have taken a withdrawal from contributing for the next six months, hurting retirement savings even further.
  • Avoid the loan. Borrowing from your 401(k) should be an absolute last resort. Loans from a 401(k) plan must be repaid with after-tax dollars, negating much of the tax benefits of a 401(k). And if you leave your job and are unable to repay the loan in full, the outstanding balance is treated like a withdrawal, triggering a tax bill and possibly a 10% penalty on top of the tax.

Sunday, March 16, 2014

Last-Minute Tax Tips Before April 15

We’re down to the last few weeks before April 15, the day more commonly known as “tax day,” among a few other colorful descriptions that are best not printed.

If you haven’t filed your tax return yet, chances are good that you’re not expecting a big refund. But it’s not too late to do a little last minute tax planning, and you might be surprised by how much a few tax tips can lower your tax bill or — hope springs eternal — actually secure a decent-sized refund.

Let’s take a look at some tax tips that can keep a little more cash in your pocket this April:

Contribute to an IRA or HSA Plan
I’ll start with one that is tried and true—contributing to an IRA or HSA plan.

For tax year 2013, you can contribute $5,500 to an IRA or Roth IRA and $6,500 to either if you are age 50 or older. The Roth IRA, as a general rule, is a better long-term financial planning vehicle. But if you’re looking to take a dent out of your tax bill today, you’ll want to contribute to a traditional IRA, as the Roth offers no tax break in the year of the contribution.

How much can you save by making a contribution? It depends on your tax bracket, but let’s consider an example. If you’re filing as a married couple with a combined income between $72,501 and $146,400, you fall in the 25% marginal tax bracket. Contributing $5,500 will mean $1,375 in tax savings. Contributing a combined $11,000 will save you $2,750.

The same goes for Health Savings Account (HSA) contributions. If you buy your own health insurance and it is HSA-compatible, an HSA can be thought of as something like a “spillover” retirement account if you have already maxed out your IRA or 401k. And unlike IRAs — in which your ability to take a deduction can be phased out or eliminated if you already contribute to an employer 401k plan — HSA accounts have so such conditions.

In 2013, an individual policyholder can contribute a maximum of $3,250 to an HSA, and a family can contribute $6,450.

Though hardly a revolutionary idea, parking cash in an IRA or HSA is a last-minute tax tip that works.

Investment Advisor Fees
Next on the list are investment advisor fees. If you manage your own investments exclusively, then there isn’t much you can do here. And if you use the services of a broker who charges a sales commission on the stocks or mutual funds you buy, those are not deductible (though they do affect your cost basis and thus have an effect on any capital gains taxes you pay down the road).

If you use a fee-based advisor, however, you might be in luck. Advisory fees paid to your financial advisor are indeed deductible.

There are a couple things to keep in mind though. In order to write off any investment advisory fees, you have to itemize. Often, if you have a home mortgage, you will pay enough in mortgage interest and other home-related expenses to surpass the standard deduction. In 2013, that amounts to $6,100 for an individual or $12,200 for a couple filing jointly. Additionally, your deductions here are generally limited to the amount of expenses over and above 2% of your adjusted gross income.

One major word of caution. While the deductibility of investment advisor fees is unquestionably deductible for taxable accounts, it gets a little murky with IRA accounts. Paying your investment advisor out of your IRA is not considered a taxable distribution. But you can’t claim the fees paid as a deduction. You can, however, claim the deduction if you pay your fees with outside money. In practice, this will mean either writing your advisor a check or having them deduct the fees for managing your IRA from a separate, taxable account.

If you subscribe to paid financial newsletters, newspapers, or magazines, these too can be considered “investment related expenses” as well if you can credibly say that you use the publications to generate investment income.

This won’t be a large deduction for most people. Most subscription services cost, at most, a couple hundred dollars. Still, there is no reason not to take advantage of the tax break if these are expenses you were going to make anyway. And for some avid investors with subscriptions to multiple publications and high-end advisory services, the deduction could conceivably be worth a couple thousand dollars.

Keep good records of your subscription purchases because, as a general rule, large itemized deductions make great audit targets for the IRS. And naturally, you should use common sense here. If you don’t feel you can credibly explain to an IRS auditor that you need a given publication—such as your Sunday newspaper—to make investment decisions, you should err on the side of caution and leave those expenses off your tax return.

Child Care Expenses
Next on this list of tax tips are child care expenses. If you have kids and you pay for daycare, mother’s day out or for the services of a nanny, tally up what you paid in 2013. It could give you a nice tax credit.

The Child and Dependent Care Credit can seem a little complicated at first, but I can sum it up like this. If you pay for childcare expenses so you can work outside the home, $3,000 in expenses for the first child (or a total of $6,000 in expenses for two or more children) can be used to calculate the credit. The $3,000 (or $6,000) is multiplied by a factor that varies by income. For example, if your household’s adjusted gross income is more than $43,000, the factor is 0.2. (Don’t worry, popular tax programs such as TurboTax will make these calculations for you.) The factor is greater the less your income is, meaning that lower-income families get a larger credit.

So, for a family with two or more dependent kids, the tax credit would be calculated as $6,000 * 0.2 = $1,200.

It’s not uncommon for parents to pay tens of thousands of dollars in child care expense, so it can be frustrating that the amount used in the credit calculation is capped at $6,000. Still, a $1,200 reduction in your tax bill is nothing to laugh off, particularly considering that you were going to be making these expenses anyway.

A few things to note: To qualify, your kids must be under age 13, and the expenses must legitimately be used to allow a parent to return to work. For example, if a family has a stay-at-home mom who is not gainfully employed, they would not be able to apply any preschool or early development classes to the credit.

Also, only expenses you pay for yourself are eligible for the credit. Employer-provider care actually reduces the credit, though it also reduces your taxable income. If you have any doubts, talk to your CPA.

Check for Donations
For one final last-minute tax tip, dig through your bank statements and receipts for any donations you made to charities last year. Whether it was a check you left in the offering plate on Sunday or a gift you gave to your university or the local homeless shelter, taken in total, they could amount to a good-sized deduction.

Remember: To write off any charitable contributions, you have to itemize. Often, if you have a home mortgage, you will pay enough in mortgage interest and other home-related expenses to surpass the standard deduction. In 2013, that amounts to $6,100 for an individual or $12,200 for a couple filing jointly.

It’s also important to keep good records. Larger charities will usually send you a statement at the end of the year summarizing your donations. But smaller charities often won’t, so you’ll want to keep a copy of your bank or credit card statement or a receipt.

Cash donations are pretty straightforward, as are donations of stock or other items with a listed market value. Donations of clothes or personal items can get a lot more complicated because the “value” of the items in question can be somewhat subjective. TurboTax and other mainstream tax programs will offer guidance, but as a note for the future, I recommend taking a photo of any clothes or personal items donated to keep for your records. In the event you are audited, they can add support to your estimated values.

Saturday, March 15, 2014

Preparing for tax crunch time

It’s almost crunch time. The deadline is one month away. Appointments with your CPA are filling up fast, and when you do get into see your CPA, things might be a little bit hurried. The more you are prepared for your meeting with your accountant, the more time you’ll have to explore every available deduction, decide on which income reporting method is more advantageous and discuss tax-planning issues that will affect you in the future.

Truthfully, you should have been preparing since January when your 1099s and W-2s began to trickle in. But all is not lost. You still have time to separate your records into income and expense categories. You may consider asking your CPA’s office if they have a tax organizer or questionnaire you could complete before your meeting. By design, these organizers are built to remind you of events and transactions that you may have forgotten about.

Items you should bring to your accountant’s attention include any foreign financial dealings. You may remember a few weeks ago, I highlighted the foreign tax credit. Your accountant needs to be aware of any special reporting requirements you may have.

To help your accountant, organize your paperwork by separating your income statements from the rest of your paperwork. This includes your employment W-2s, 1099s from banks, investment accounts and your prior year’s state refund; and K-1s from partnerships. It is extremely important to include the instructions for the K-1s. Keep in mind K-1s often arrive much later than your other income statements. In order for you to receive a K-1, the partnership must first file their tax return. It is very likely you may receive a K-1 after April 15th. Make a list of the K-1s you expect to receive. If you do not receive it by the time you are ready to file, you can file for an extension or complete your return without the K-1 and amend it later when you receive the statement. Your CPA should recommend the best course of action for your situation.

You should also pay close attention to transactions during the year that may require special treatment from your tax preparer. These include the sale of stocks or other property, gifted or inherited property, sale of a home, the refinance of your home mortgage, purchase of a home, a change in your filing status, the addition or loss of a dependent and any depreciation deductions you may be entitled to. If you are following a tax organizer provided by your CPA, it should walk you through documenting these records. If you do not have an organizer available to you, you can compare your collected documents to your prior year’s tax return.

Using organization and thoroughness in your tax records will enable you to be on the right track with your taxes. Do not miss any of the deductions you are entitled to take because your records are not organized. Because of the complexity involved in computing a tax return, attention to detail on your part can only enhance the value of your accounting professional’s advice. Tax minimization is a benefit of well-organized personal cash management.

Friday, March 14, 2014

8 Myths About College Financial Aid and What You Can Do To Get Aid

Paying for college is stressful, but knowing how financial aid is awarded can reduce parents’ anxiety and also make college more affordable. 

1. I’m not talented enough to get a scholarship.
You can get scholarships just for corresponding with the admissions office, or showing up for an interview, or filling out your FAFSA form correctly. One college in New York let this cat out of the bag.

2. I can’t afford an expensive college.
Expensive colleges inflate their prices in part to appear generous when they award scholarships. So apply to those private schools if you think you have the right grades and a chance of getting in.

3. My family has too much income to get financial aid.
Bill Gates qualifies for financial aid. All he would do is fill out a FAFSA form (Free Application For Student Aid) and his kids get a loan from the government starting at $5,500. Plus, merit aid is based on merit, not income.

4. Thousands of scholarships go unclaimed because they are too hard to find.
The internet is your desk-top resource for finding all kinds of scholarships. Don’t pay someone to find scholarship when you can do it yourself. There’s a lady in Michigan who found over $100,000 in scholarships for her son, and has a 33-page description of how she did it. Get it on Kindle for $10.00.

5. My high school grades are not good enough to get a scholarship.
Most financial aid is based, not on grades, but on need. To keep the aid you simply maintain a minimum GPA. Grades don’t count as much as you think: you can get aid based on your ethnicity, religion, your zip code, major, or evidence of a unique extracurricular activity.

6. Only athletes and minority groups get aid.
Colleges do award aid on this basis, but it’s only a small portion of the aid given.The FAFSA form, which determines how much aid you qualify for, doesn’t ask about your ethnicity or your athletic ability.

7. My grades are so good that I’m likely to get a “full ride” anywhere.
Sorry, but the competition for full ride scholarships is fierce, and colleges have a high bar for a full ride.

8. The paperwork is just too complicated.
In most cases all you have to do is fill out the FAFSA form. The form’s directions walk you through the process, and they even have an 800 number where you can stay on the phone as long as you need to get it right.

Thursday, March 13, 2014

Tax Returns: Do Them Yourself or Hire Help?

There are times it makes sense to actually hire a tax pro. Tax software is great and for millions of Americans, it’s a good solution, but there are times you need professional help.

It’s best to use a professional when you own your own business, you’ve gone through a major life change like marriage or divorce, you’ve bought or sold a home in the previous year, you own rental property or have a large investment portfolio. In other words, if your taxes are complicated for any reason, it pays to hire a professional. If you manage to pick an experienced accountant, you’ll find that he or she has probably prepared a return for someone in your exact situation. What’s more, if the IRS has issues with the filing, such as wanting more information, your professional will handle the exchange.

Picking a professional is a whole other kettle of fish. Certified public accountants are the gold standard having completed a four-part accounting exam. What’s more, they can represent you in front of the IRS (if it comes to that.) However, there are less expensive ways to get help. Enrolled agents who have passed a tax exam and/or actually worked at the IRS and are licensed to file taxes. You can find an enrolled agent at   Some certified financial planners also offer tax services. At a minimum, you want your CFP to be talking to whoever prepares your taxes. There are also accredited tax accountants and tax planning services. (I did say it was a whole kettle of fish, right?) Getting a preparer who is recommended by someone you know and trust is a good idea, too. Keep in mind, though, if there is an accountant that everybody in the office uses because he gets incredible refunds, I’d stay away. When a pro gets in trouble, the feds typically audit everyone he did a return for.

Truth is, tax software isn’t nearly as scary as you might think. You don’t do math. The software makes calculations for you. And, the way the packages work is that they have you fill out the form by asking you questions and prompting you for a response. Better yet, if you make a mistake using a software program, like entering the wrong Social Security number, the IRS will ask you to fix the issue, instead of sending you a bill.

For some of us, it comes down to a comfort level – do you want to handle it on your own, or do you want a pro to do it for you. Just make sure that however you get it done that you file electronically. Filing online is the most secure way of filing your taxes, and guarantees the quickest processing.

Wednesday, March 12, 2014


Here's a little-known secret for parents planning to send their children to college in the future: Some of the tax-saving moves you make now could hurt your student's chances for getting financial aid later.

It's because of the way the financial aid system treats different assets. Retirement plans and IRAs don't count for college aid purposes. You're not expected to break into these accounts to pay for tuition.

   Another Key Point:
The college aid formula requires 35 percent of the assets in your child's name to be used for college costs. But the government-mandated formula only expects about 5.6 percent of the money in the parent's name to be spent. So you're better off keeping accounts in your own name, especially during the last two years of high school, which is generally when you'll be asked to start providing tax returns.

Don't assume you're not eligible for assistance. With the high cost of college today, many schools now have programs available to relatively well-off families if they meet certain qualifications. For example, your child might be able to get a "merit award" based on high standardized test scores and superior grades.

The best strategy: If you expect to apply for financial aid, don't hold back placing money in your own retirement plan in order to put away savings in a college account in your child's name.

Contributions to retirement accounts are usually tax-deductible and the earnings are tax deferred until withdrawn. On top of these tax breaks, your family may also become eligible for more financial aid.

Remember that you can usually tap retirement accounts for college money. Many 401(k) plans allow loans to be taken. And thanks to a tax law that went into effect in 1998, you can generally withdraw a limited amount from your IRAs penalty-free to pay higher education costs for yourself, your children and grandchildren.

Tuesday, March 11, 2014

Net Investment Business Tax hits real estate businesses

The new federal Net Investment Income Tax became effective in 2013, making this the first year that we are seeing its effects on tax returns. It’s a 3.8 percent tax on net investment income, which is intended to help finance the federal Affordable Care Act.
The accounting profession has told people for a couple of years that this was coming, but it’s still generating confusion.
This tax kicks in for incomes greater than $250,000 for those who are married and filing a joint return. It is having the greatest impact on entrepreneurs and investors because it applies to gains from any kind of activity that is not related to their primary career.
For example, a company’s CEO may invest in a lawn care business, hiring others to do the work. This makes him a “passive investor” and his profit from that lawn care business will be subject to the 3.8 percent tax. Similarly, income or gains from the sale of rental property may also be subject to the Net Investment Income Tax.
The two areas where we are seeing the greatest impact of this new tax are real estate and family businesses.

Real estate
If you are married and have lived in the home you are selling for at least two of the last five years, there is no tax on gains less than $500,000. But if you sell a vacation home that is not your primary residence, that is a taxable gain and will more than likely be subject to the 3.8 percent tax.
This tax also kicks in at just $12,000 of income for real estate that is held in trusts, meaning it could lead to changes in how people pass on their assets to others.
To avoid paying this tax on gains from real estate investments, it is important to be declared a real estate professional. To be classified as such, you must be able to document that you’ve spent more than 700 hours during the year performing qualified real estate professional services such as property management, brokering, development, construction or even buying and flipping houses.
In addition, those 700 hours must equate to more than half of your service time. If you can meet both of these requirements, then none of your real estate income or gains on property sales will be subject to the new 3.8 percent tax.
Those who are in real estate full time will find it simple to meet this definition. But if you dabble in real estate on the side, it’s going to be difficult.
For example, if you work 2,000 hours in another full-time job, you would need to also perform 2,001 hours in the real estate business to qualify as a real estate professional. Reaching that level of service hours is unlikely. If you fall into this category, it becomes important to plan ahead to try and qualify as a real estate professional before you recognize large gains.

Family businesses
This new tax is affecting family businesses where children are allocated income through ownership in the company, yet aren’t actively involved with day-to-day operations. Even if every owner receives the same amount of income, those who are classified as passive business participants will be taxed the additional 3.8 percent, while those classified as material participants will be exempt from this new tax.
There are seven tests to see if you qualify as a material participant. The primary test states that you must have spent at least 500 hours actively involved in the business. That equates to 10 hours per week for 50 weeks. This can be difficult to document for most entrepreneurs as they typically don’t fill out time cards. So it becomes vitally important to maintain a calendar so that all time invested in the business can be substantiated.
Another win/win opportunity to avoid paying the 3.8 Net Investment Income Tax is to donate appreciated assets to charity. This way, you’ll also receive a tax deduction for your contribution.

Monday, March 10, 2014

Revisiting the myth of tax deferral

By Tom Sedoric

I’m puzzled why there are not more discussions and articles about tax efficiency and investments, particularly when it comes to the issue of tax deferral.

Of course, tax planning is far from “sexy.” The lead story in the most recent IMCA (Investment Management Consultants Association, ) research quarterly was titled,  “Increased Tax Rates and Investment Strategy.”

Like the remarkable underestimation of the potential long-term power of compound interest in creating one’s fortune, there are too few discussions about the potential shortcomings of tax deferral and the significance of tax-efficient investment strategies.

I’ve beaten this drum for a long time. It was nearly three decades ago, when the transition to 401(k) plans was taking off, that I wrote a column that drew the ire of many of my fellow advisers and friends in the accounting profession. The abridged version goes like this: beware the myth of tax deferral. My point was to take a hard look at the long-term implications of tax-deferral plans and to recognize the potentially serious drawbacks in the future.

The future is here for some. There is often confusion about the benefits and mathematics of tax deferral, as well as pretax savings, because sometimes a tax-deferred account or investment only defers one from paying potentially more down the road. This may not always be to an investor’s advantage.

Owning a tax-deferred asset, like the stock of a good company or fund, in a taxable account is often wiser than holding the same fund or company in a tax-deferred account like an IRA or 401(k). If held in an IRA, that growth company or fund will eventually be taxed as ordinary income.  Ordinary income tax rates could be twice the level if the stock or fund had been held in a taxable account, sold, and taxed as a long-term capital gain. Remember, in investing, it is not what you make, but what you keep that matters most.
A conscious choice
Automatic savings can occur if a 401(k) is in place and can be terrific for the investor taking control of their retirement security and very profitable for mutual fund companies and insurance vendors. I think trends and events over the past three decades have given us a clearer perspective of winners and losers in the tax-deferral arrangement.

One reality has become quite apparent: People who do not create diversified tax efficiencies and who relied too much on tax-deferred investments in their long-term plans may find themselves hit with much greater tax burdens than they expected or needed to pay in later years. Individual tax rates have been largely declining for three decades, while few experts believe tax rates will be lower in the future.

The issue of tax efficiencies remains elusive because it sounds dull, dry and formidable – better left to accountants. It is anything but formidable, and I believe the matter of tax efficiencies resides in the same category as compound interest. It is considered dull and unexciting when compared to the latest investment scheme.

In truth, tax efficiencies should be an integral part of any sound investment plan.
Here’s a frequent example of mine, and it has to do with my favorite hypothetical company, XYZ:
Investor A has a $1 million investment in company XYZ, with a zero cost basis, held in a tax-deferred IRA savings account. Investor A also has $1 million directly invested in company XYZ stock in their personal trust or investment account, also with a zero cost basis.
On paper, both assets are worth the same, except for the significant difference of future tax liability. And if the client dies with a significant IRA, the tax burden on future generations may even be higher.

The obligation of the tax-deferred IRA is set at the income tax rate, which could currently be over 40 percent, or higher if ordinary income tax rates increase again. The sales of stock in a taxable account would be subject to a much lower long-term capital gains tax of barely 20 percent for even the highest-income investor.

Assuming a zero cost basis for this hypothetical example, the IRA investment could have an after-tax value of an estimated $600,000 while the stock investment in a taxable account could be worth as much as $800,000 – a $200,000 difference.

Some would call this found money, but in reality it’s a conscious choice to weigh long-term risks and benefits – and naturally unique to every investor. If investors are blinded or distracted by the allure of tax deferrals, they may miss out on the opportunity to have greater flexibility for future earnings.
I don’t believe that tax-deferred plans are inherently unhealthy, though the late Sy Syms said, “An educated consumer is our best customer,” and the same may be true in the realm of tax deferral. After all, why should people pay more taxes than they need to?