Thursday, August 28, 2014

IT'S YOUR MONEY: Tax planning doesn't have to be last minute

It's not April (or even late March). Why should you be thinking about tax planning? Because now may be a good time of year to do some planning that isn't reactionary, and that may be less painful than last-minute tax work.

If you're going to take it on, make an appointment with a tax professional who does tax planning in addition to tax preparation. That will involve taking your 2013 tax return with you along with your year-to-date paystub showing what you've been paid and what your withholdings have been.

Also, think through how your financial life has changed this year. Perhaps you bought or sold a home. Maybe one of your children is out of college and living away from home. Changing jobs may impact your tax situation.

Make a list of these financial life changes and take pertinent documents with you to your appointment.

A good tax professional can take all this information and do some calculations that will estimate if you're going to owe taxes or get a refund. You can make adjustments to your payroll withholdings or just be better prepared for the outcome.

If your tax planning doesn't give you good news, there may be some things you can do to reduce the taxes you might owe. Charitable giving is often a good way to lower taxes if you itemize your deductions. You can donate items you don't need any more. Goodwill, ARC and other nonprofit thrift stores are happy to take your used clothing, toys, furniture and other items. Make sure you get a receipt. Ideally, take a photo of the items before you donate them and attach that to your receipt. You can't deduct what you paid for the item, but you can deduct what the thrift store would probably sell the item for. Some of the larger thrift stores will have a list of common items and the prices they generally fetch.

Contributing to your employer's retirement plan might also save you taxes. That's a winning idea for most people beyond the immediate tax breaks. You save for retirement and, in many plans, the employer will match some of what you contribute. In that situation, you lose money by not contributing. The tax savings is just a bonus!

Don't be fooled into thinking that getting a big refund is a good deal. If it looks like you've overpaid on taxes so far for the year, don't intentionally pay in more so you can have a big refund. Would you want an investment that has no growth potential and will only give you your money back at a specific time? That's what a tax refund is.

You might not always be able to control your tax situation, but you can be informed about it.

Wednesday, August 27, 2014

Tax Planning for 2015

This year's tax planning is going to be heavily focused on accelerating deductions and maximizing tax credits, according to Evan Stephens, a tax manager at the business consulting and accounting firm Sensiba San Filippo.
“However, taxpayers should be advised that a number of tax benefits available in 2013 are not yet available in 2014, as Congress has let some very popular provisions lapse for 2014 and has yet to reinstate them into law for 2014,” he said. “These include bonus deprecation, larger Section 179 deductions, and a number of tax credits, such as the Research and Development Credit.”

Stephens recommends practitioners consider the following tips for their clients:

• Pay your real estate taxes, personal property taxes and state income taxes before year end in order to push down your taxable income by increasing you itemized deductions. However, be aware that these deductions can phase out and/or be limited by alternative minimum tax.

• Reduce income by taking advantage of other tax-exempt investment vehicles, such as muni bonds, which are tax-free for federal purposes, and, in most states, home-state bonds are also state tax-exempt for state purposes. However, be wary that investing in municipal bonds that have a private activity element (bonds funding new sports stadiums, etc.), as they are still taxable for Alternative Minimum Tax purposes.

• Congress has not yet committed to reinstating the added benefits of bonus depreciation on fixed asset purchases for 2014. However, there is still a much smaller benefit through a Section 179 deduction of up to $25,000.

• A small blip in the code allows for a much larger, $500,000 Section 179 benefit, for non-calendar year taxpayers whose tax years begin in 2013, but end in 2014. This may benefit some taxpayers who do not carry a calendar year end.

• Congress has not yet reinstated the Research and Development credits or nonbusiness energy credits, but given these programs’ popularity will likely do so before year end. Taxpayers should be sure to keep up with the latest legislation, as some believe these will likely be extended into 2014 at some point in the coming year.

• The business energy credits remain. These credits are for taxpayers that install solar, geothermal, combined heat and power (CHP), geothermal heat pump, fuel cell, microturbine or transition energy property for use in their business. The credit can be as much as 30 percent of the cost of the property.

“Long-term capital gains still maintain their preferential rates, but are subject to the additional 3.8 percent Medicare investment tax,” Stephens said. “Short-term capital gains are subject to ordinary income rates and the 3.8 percent Medicare investment tax.”

He recommends considering tax deferral mechanisms for significant tax gains, such as Section 1031 like-kind exchanges for real property sales or structuring the sale as an installment sale. “An installment sale will spread the gain over several tax periods in order to minimize or entirely avoid the Medicare tax on investment income,” he noted.

“Taxpayers should also consider realizing losses on existing stock holdings while maintaining the investment position by selling at a loss and repurchasing at least 31 days later or swapping it out for a similar but not identical investment. This is often referred to as loss harvesting,” said Stephens. “However, if the 31-day repurchase is not adhered to, the sales are considered a wash sales transaction and the losses are disallowed.”

Finally, Stephens urges his clients to maximize contributions to their tax savings and retirement vehicles such as 401K, 403(b), 457 plans, 529 plans, Health Savings Accounts, SEPs, and Keogh plans.

“If self-employed, set up a self-employed retirement plan,” he said. “Revisit decisions to contribute to a traditional versus a Roth retirement plan. Distributions from Roth IRAs and 401(K)s are not subject to regular tax or the Medicare investment tax and, therefore, are a more attractive retirement savings vehicle for high net worth individuals. On the contrary, if a taxpayer is hovering around the threshold for the new Medicare tax, he or she should consider moving Roth contributions to a traditional retirement plan. Maximizing contributions to a traditional plan could reduce taxable income below the threshold and, therefore, avoid an additional 3.8 percent tax on investment income.”

Monday, August 25, 2014

The Best 529 College-Savings Plans


For most parents, saving for college feels like climbing to the summit of a very tall mountain. And it doesn’t help that the path keeps getting steeper; tuition hikes have far exceeded inflation over the past several decades. If your child is a newborn, expect a degree from a four-year, in-state public college to run about $222,000, assuming 5% annual growth in the cost of college; four years at a private school could be double that.

Luckily, tools are available to help you scale the heights. State-sponsored investment programs known as 529 plans, as well as other kinds of savings programs, can provide the momentum you need to reach your goal. And you probably won’t need to save the full amount. Most families get a discount in the form of grants, scholarships and education tax breaks and use loans to fill the gap—more than two-thirds of college seniors graduate with student debt.

A more realistic goal: Save about one-third of your expected college costs. When the time comes, current income, grants and loans can cover the rest. “Planning ahead is the key,” says Betty Lochner, of the College Savings Plans Network, which collects data on 529 plans. (To estimate what you’ll need to save under different scenarios, use the college-savings calculator by The College Board.)

The best place to save is in a 529 plan. Sponsored by 48 states and the District of Columbia (neither Washington State nor Wyoming offers a 529 savings plan), these investment accounts let your savings grow tax-free, and the earnings escape tax completely if the withdrawals are used for qualified college expenses, which include tuition, fees, and room and board. The appeal of 529 plans lies in their easy access as well as their tax benefits. The plans have no income limit and set a high cap on contributions. Two-thirds of the states and the District of Columbia give a tax deduction or credit for contributions. If your child skips college, you can make the recipient a sibling, grandchild, niece or nephew (or even yourself) without losing the tax break.

There are a few drawbacks. If you cash out for non-college purposes, you’ll owe income tax and a 10% penalty on earnings (but not on contributions). You may have to return any state tax deductions, too. Plus, you’re limited to the investment options in your plan. After you pick a portfolio, you must wait 12 months before you can change the investment mix or transfer the money to another plan.

Which plan?

Buy a 529 plan directly from your state if it offers a tax break. Most states offer two types of college-savings plans: a low-cost plan sold directly by the state and a higher-cost plan sold by a broker. The lower expenses of a direct-sold plan mean more of your money will go toward building your college fund. And in most cases, the state tax break will trump lower fees in an out-of-state program. (Go to the Vanguard 529 State Tax Deduction Calculator or's State Tax 529 Calculator to find out what your potential tax savings would be in your state plan.)

If your state doesn’t offer a tax break—or if you live in Arizona, Kansas, Maine, Missouri, Montana or Pennsylvania, which offer a tax break no matter where you invest—you can search for the best state plan that meets your goals. Figuring out which plan that is depends on what matters most to you. Low fees? An aggressive or conservative investment track? A plan with lots of investment options?

States generally offer an array of choices, including age-based port­folios, which adjust the mix of in­vestments automatically to become more conservative as your child ages; funds that focus on stocks or bonds (or both); and guaranteed-principal or principal-protected funds. But some plans offer better-performing funds and a more diversified mix of investments than others. And some plans charge lower maintenance fees, have funds with lower annual expense ratios, or both.

With the help of several databases—including research firm Morningstar’s 529 plan center, the College Savings Plans Network and, all of which you can access—we looked for direct-sold plans that excel in various categories. See our state-by-state guide to our 529 picks for more.

Best for hands-on investors: The solid funds in the Utah Educational Savings Plan are mostly index-based. They include 18 from Vanguard and 6 from Dimensional Fund Advisors. And UESP ranks among the lowest-cost 529 programs in the country. But here’s what we really like about Utah for do-it-yourselfers: customization. As with most 529 plans, you can handpick individual funds from Utah’s so-called static portfolios. But this plan also lets you create a tailor-made portfolio and have it automatically adjust at three-year intervals according to your preferences as your child nears his college years. No other state plan offers this feature in its age-based tracks.

Best for low fees: New York’s 529 College Savings Program uses Vanguard funds, so it should come as no surprise that it has low costs. The average expense ratio charged by its underlying funds (0.17%, according to Morningstar) is significantly lower than the 0.76% expense ratio charged by the typical U.S. stock index fund. Even better, the plan has no annual maintenance fee.

We also like that the plan offers three age-based tracks with different risk profiles: aggressive, moderate and conservative. The aggressive track starts at birth with 100% in stocks and ends with 0% in stocks at age 19 (it’s 25% in the last three years of high school). New York’s age-based portfolios don’t include an international stock fund. But the program’s assortment of individual funds does have a foreign-stock option: Vanguard Developed Markets Index fund.

Best age-based plan for aggressive investors: If an aggressive track with top-tier funds is what you seek, you’ll find it in the Maryland College Investment Plan. From birth through age 4, the portfolio holds 100% stocks—including stocks in developed and emerging countries. As your child ages, the track adjusts every three years, ticking down its stock investments to 40% when your child hits age 14 and 23% at age 18. By contrast, the average 529 plan’s age-based allocation to stocks is 80% in the early years and 10% at age 19.

What’s more, Maryland’s 529 plan is packed with good funds from T. Rowe Price, including Blue Chip Growth, Mid-Cap Growth, Small-Cap Stock and International Growth & Income. The lineup helped the age-based track targeted for 2030 post a 14.0% three-year annualized return (through June 30), two percentage points ahead of the typical age-based track for children between birth and 6 years old.

Best age-based plan for conservative investors: This one is tricky. Some conservative age-based tracks are simply too conservative. The conservative age-based track of New York’s 529 plan, for instance, sets out at birth with 50% invested in stocks and pares that to zero by age 11. But at that age, you still have six or seven years before your child matriculates, and stocks offer the best chance of increasing the size of your portfolio. That’s why we like Utah’s moderate and conservative tracks for conservative investors. In the early years, both tracks load up on stocks (80% in moderate; 60% in conservative), but the mix trickles down to 0% stocks by age 19 in the moderate trajectory, and it goes to 0% by age 13 in the conservative path.

Best for nervous Nellies: After 2008, many plans added savings options backed by the Federal Deposit Insurance Corp. to their investment lineups. You won’t lose money in these kinds of funds, but you certainly won’t keep up with the rate of college-tuition inflation. Still, says Scott Kahan, a certified financial planner based in New York City, “If you have a big lump sum—enough money to put away for college—and you want to be conservative, or your child is going to college next year,” these savings plans can make sense. Many state plans have a high-yield savings account among their investment options. For stand-alone plans, we like the bank-sponsored option offered through Virginia’s CollegeWealth plan with Union First Market Bank. It recently offered a 2% yield (2.25% for balances greater than $10,000).

Best if you want hand-holding: Rather have an adviser do all of the work? That can be okay. Some fee-only advisers, such as Gifford Lehman, a certified financial planner in Monterey, Calif., set their clients up in direct-sold plans. (Lehman’s favorite plan is Utah’s.)

But if your adviser puts you in an adviser-sold plan, consider yourself warned: You’ll pay for that. Funds in adviser-sold plans cost an average of 1.28% in annual expenses, more than double the 0.60% average expense ratio for funds in direct-sold plans, according to Morningstar.

If you think the hand-holding is worth the cost, go with Virginia’s College America plan. It holds many top-notch American Funds, such as International Growth and Income and New Economy, which charge an average of 1.19% in expenses. (There is a $10 annual maintenance fee per account.) If your broker or adviser doesn’t have access to CollegeAmerica, try ARKANSAS’S ISHARES 529 PLAN, which invests in thrifty exchange-traded funds. The average annual expense ratio of the funds in the iShares plan is a low 0.59%. There’s also a $10 annual fee per account.

Wednesday, August 20, 2014

Accessing Your Retirement Income: Sooner Or Later


Most business owners want to retire … eventually; some sooner than others. While some owners profess to never wanting to exit their businesses, we know that ultimately everyone must exit. A business owner who sold his business at age 54 never looked back. He’s living the good life, playing his guitar and enjoying his grandkids. In contrast, last month a business owner told me he has retired three times. He just keeps, “getting sucked back into the business world.” Even so, I know countless business owners who are doing well physically, mentally and financially; and are looking for ways to put off retirement. No matter where you stand in this continuum of desires, it’s wise to have a plan for how you can get at your retirement funds when you need them.     
Getting At Your Income SOONER
Successful business owners are more able to retire early than most employees. They have equity in their businesses, substantial control over their compensation and tax structures, and there is no upside limit to their earning ability. Early retirement — or at least a planned slowdown —is a payback for long hours worked and risks taken. There are a number of ways business owners can access retirement capital without having to necessarily sell their business. Consider these three popular approaches.    
  1. Qualified Money:  As a business owner you may have built up a sizeable qualified retirement plan, but are frustrated by the fact that you can’t get at those funds. Taxable withdrawals from qualified plans before a participant attains age 59 ½ are subject to an early 10% withdrawal penalty. There is, however, an exception if taxable withdrawals are taken in the form of “substantially equal periodic payments.” Commonly referred to as a “72(t) plan” or a “SEPP.” A 10% penalty tax will not apply to these pre-59 distributions as long as you follow the rules. The amounts must be distributed at least annually, be calculated as a life expectancy payout and continue for a minimum of 5 years or until age 59 ½ (whichever is later). There are three methods for designing these payouts, each with their own advantages and disadvantages. All, however, have the benefit of allowing you to start drawing down your qualified plan money early. 
  2. Life Insurance: Qualified plans are a great way to defer taxes on current income, but there are limits on how much you can put in a plan and distributions are generally taxed as ordinary income. There is a product you can add to your portfolio in which you pay your taxes now, are not limited in how much you put away, and can receive tax-free income in the future — cash value life insurance. Excess capital that has already been taxed can be used to fund a cash rich life insurance policy. The cash values will grow tax-deferred. Then, when you are ready to start taking an income, you can first withdraw your principal tax-free and then switch to loans against the policy’s death benefit. The remaining death benefit provides a source of income if you have a spouse or children to support in retirement. Since life insurance is subject to insurability, this is a tactic a business owner should address well before the need for retirement income is pressing.     
  3. Recapitalization:  There are ways of leveraging your business equity that fall short of actually selling your entire business. With an improved economy, recapitalizations (recaps) are back in vogue, even for smaller companies. Essentially with a recap you are exchanging your business equity for a combination of cash and a piece of the capital stock of a new entity intended to support the company’s future growth. The concept can be analogized to taking some of the chips off the table, but letting you stay in the game. There are many uses for recaps, but one is to monetize some of the owner’s equity. It’s a way to “liquify” your business without liquidating the operation. Plenty of investment banks, private equity firms and other financers are structured for privately-held businesses. 
Delaying Your Income Until LATER
I had helped my father set up an IRA many years ago. Eventually he retired and, when he came into his 70s, found out he had to start taking required minimum distributions (RMDs). He was furious about being forced to take taxable distributions when he didn’t need the money. Back then, there weren’t many ways to avoid RMDs. Nowadays, there are a number of ways to structure a portfolio to delay the receipt of taxable income. Consider these three ideas. 
  1. Backdoor Roth: The Roth IRA concept has proved disappointing to many business owners because of the income limits placed on who can contribute ($191,000 income for a married couple) and how much you can contribute ($5,500 per year). Still, there is an approach that can help business owners who, like my father, want to put off receiving RMDs: A so-called “backdoor Roth” allows high income earners to delay receiving retirement income. With a backdoor Roth, the high income earner contributes to a traditional IRA and then converts that IRA to a Roth IRA. It accomplishes the same thing as opening a Roth directly, but avoids the limits on contributions.  The conversion will be taxed, but the account then grows tax-deferred and will pay out tax-free.  Think of it as paying tax on the seed and not on the harvest. Best of all, Roths are not subject to RMD rules, thereby allowing you to push off taking an income into the future. 
  2. Deferred Income Annuities:  I recently discussed the trend towards using deferred income annuities (DIAs) as a safety net for retirement income. These contracts involve putting money away currently into a contract that will, later in life (say age 75 or 80), pay out an income you can’t outlive. For the business owner who wants to delay retirement and stay in the business, the DIA can be an effective way to lock in an income stream for the golden years. And, now you can use your qualified plan funds as the source of that income stream. On July 1 the Treasury issued final regulations amending RMD rules to allow annuity investors to start collecting later. If you want to delay receipt of qualified money, you can put some of the funds in a DIA, and thereby avoid being forced to receive taxable income in the form of RMDs. 
  3. Your Business:  Finally, don’t forget that your business ownership offers tremendous flexibility in retirement income planning. You can structure cash flows and tax events so as to exit on your own terms. There are too many tactics to address here, but let me offer an example. Accumulate that income in your business as a way to delay receiving a retirement income. If you are an S Corp or LLC, your business income will be taxed to you as it is earned, but that also means you’re building an account of after-tax income. When you want to start slowing down at work, you can reduce your taxable salary, and instead start taking out tax-free dividends.   
Business equity is a wonderful thing to have, but some day you may also want retirement income.  You don’t have to decide now when you’ll receive retirement income, but it makes sense to have a plan for how to receive that income so it’s there when you need it.

Tuesday, August 19, 2014

Quarterly Estimated Tax Filers’ Biggest Mistakes


Weeks ahead of the next quarterly deadline for filing estimated taxes (September 15) marks a good moment to look at what these filers often do wrong.

These clients, possibly a growing segment of your practice, given business startups and recent groundswells in employment structures, sometimes need a lot of help to keep up on taxes. “Poor planning is their biggest problem,” said Cheryl Morse, an EA with Emerging Business Partners in Wellesley, Mass. “Anything from letting their bookkeeping get behind to not having the money to pay their estimated tax.”

“Not making estimates at all and not anticipating what they’re going to earn by the end of the year,” said Jeffrey Schneider, an EA with Florida-based SFS Tax and Accounting Services.

Errors vary by type of returns, whether for a business requiring quarterly payroll returns or for individuals requiring quarterly estimates, said EA Roy Frick of Ocean City, Md.-based Fairway Services Ltd. and Frick Accountants Ltd.

“We call all our business clients each quarter as a reminder that they have payroll tax returns due,” Frick said. “Individual estimates are another situation. We provide them vouchers and envelopes with their returns and advise them that if situations change to contact us. In all cases, we try to prepare safe harbor estimates. If they had a large capital gain in the prior year, that can be a problem, so we need to make sure they are adjusted during the year.”

‘Just laziness?’

Misconceptions about estimated quarterly taxes run rampant among taxpayers – if newly self-employed taxpayers realize such taxes exist at all. “Every year, my tax return instruction letter to all my clients states that they need to call me once it is determined that their tax situation may have changed. Very few do,” Schneider said. “Is it because of potential fees? Because they don’t want to deal with taxes until April? Or is it just laziness? I’m sure it’s a combination. Whatever their reason, it can be a big dilemma if the client owes more than they anticipated come April 15.”

Self-employment taxes, a common feature of quarterly filing, are minefields for potential audits and penalties little understood by most affected taxpayers. “The failure-to-pay penalty is really interest on the monies the IRS did not receive by a certain date. In most cases, it is not a huge number,” Schneider added.

“For my business clients, their income tax withholdings (via wages) are enough to cover their W-2 wages. The pass-through number can cause the issue. When a client has a large K-1 income amount, they may owe tax with the return. Many of [my clients] believe that they can make better use of their money than the amount they have to pay in the penalty. It is when they underestimate that ultimate number that causes the highest anxiety,” he said. “That’s when they kill the messenger.”

Schedule and remind

“I emphasize the bookkeeping aspect, and make sure they have a clear understanding that knowing their financial condition at any moment in time affects pricing and hiring, not just taxes, and can’t be put on the back burner,” Morse said. “I really drive home that letting this get out of control kills many good businesses.”

“When April 15th comes around and they do not have the cash to pay, ‘File an extension.’ they say,” Schneider reported. “I explain that an extension is an extension to file, not to pay and that monies have to be paid with the extension. I have to explain that the IRS can void the extension and that late-paying penalties will be assessed on any outstanding balance, plus interest. Many clients file zero extensions and will deal with the aftermath later.”

“I advise clients to open another account at their bank and transfer 25 percent with every deposit,” said Mike Habib, an EA in Whittier, Calif. “This way, the account is funded when payment is due.”

Massachusetts EA Morse makes sure to schedule appointments for such clients two weeks before estimates come due and reminds them of those appointments – “often twice” – in the weeks just before the appointment.

“We also schedule the next appointment while they’re with me,” she added. “Scheduling the year in advance always seemed to lead to conflicts for one of us.”

Monday, August 18, 2014

How Obamacare could make filing taxes a nightmare

This tax season will be a messy one for most of Obamacare's 8 million enrollees.

Individuals and families who bought subsidized coverage have been receiving tax credits based on whatever amount they thought they would earn this year. Upon filing taxes, the IRS will reconcile the amount of subsidy received, based on expected income, with the person's actual income.

That's where things can get ugly.

If the person underestimated their income for the year — and got a higher subsidy than they actually deserved — they'll owe the government the difference. But if they overestimated their income, and received too small a subsidy, they'll see a bigger tax return.

How much of a problem is this?

Since most Obamacare enrollees are expected to have significant changes in their incomes, this could be a significant problem.

"Income volatility is much higher among those who were uninsured before reform than among those who had insurance," says George Brandes, vice president for health care programs at Jackson Hewitt Tax Service. "Many people with stable, salaried jobs already had health insurance through their employers."

In a 2013 Health Affairs paper, economists estimated that over 98 percent of enrollees on the California exchange would have some change in their income from one year to the next (they looked at 2018 and 2019).

Their analysis suggests that 38.4 percent of enrollees receiving subsidies would owe the government some kind of repayment if individuals never reported income changes to the exchange. Another 41 percent would receive tax refunds, because they would become eligible for bigger subsidies over the year. People can reduce these uncertainties by updating their information if and when their income changes.

The health law places limits on how much tax credit reconciliation could slam most enrollees. The limit ranges from $600 for low-income families up to $2,500 for those who earn more. Though capped, these sums still represent substantial financial shocks to low-income families.

"From Jackson Hewitt's perspective, the repayment liability caps do offer consumers some level of protection and predictability," Brandes said. "We have some sense of the order of magnitude that this is going to have on our customers."

But if income for the year was over 400 percent of the federal poverty line (about $95,000 for a family of four), the family is obligated to repay the subsidy in its entirety when filing taxes.

"One number in that study that really jumps out: 19 percent of households between 250 and 400 percent of the federal poverty line could wind up above that 400 percent threshold, which means the caps wouldn't apply to them. Then they're on the hook for the full face value of the tax credit," Brandes said. "That's one group where we're paying particular attention."

Perhaps softening the impact, repayments owed for overly-generous subsidies would take the form of lower tax refunds for many families.

"Having to repay a health insurance exchange subsidy might not necessarily mean that money will be owed to the IRS," the Health Affairs authors write. "Of the 132 million Americans who filed income tax returns in 2009, 83 percent received refunds, and 17 percent owed additional taxes."

Enrollees can help by updating their information when their income changes

"All of this illustrates how challenging it is to subsidize health insurance for low- and middle-income families through the tax system," said Larry Levitt, a vice president at the Kaiser Family Foundation.

The best thing for individuals and families to do is update their information within the health insurance exchange as soon as something changes. They have to do that through the actual exchange interface — which will have a section for changes in income or family circumstances — not through their insurer. Instructions for updating information on can be found here.

If people reported their income changes to insurers and had tax credits adjusted in a timely fashion, the number of people owing repayment would fall by 7 to 41 percent, and the size of the average repayment could be reduced by up to 61 percent, authors of the Health Affairs report found.

Enrollees can also take steps before the tax-filing process, especially if they're near the cutoff where the repayment caps no longer apply.

"There are things that can be done to change someone's modified adjusted gross income — you can make contributions to tax-preferred retirement vehicles, for example," Brandes said. "That can reduce your taxable income and push you back down into the tax credit range that allows you to benefit from the cap. There's a role for the tax-preparing industry here, not just in doing the reconciliation but also in terms of good tax-planning."

The key to smoothing these problems is education and outreach, but that's easier said than done. According to recent polling from the Kaiser Family Foundation, an estimated 40 percent of people receiving insurance subsidies don't actually realize the cost of their coverage is being offset by financial assistance from the federal government.

According to the same poll, over half of enrollees who did report receiving subsidies are concerned that their income will change and they will no longer be eligible for this financial help.

Sunday, August 17, 2014

Succession and Tax Planning: An overview to accomplish your goals before the end of 2014

As we approach the middle of the third quarter, the end of the year likely seems like an eternity away. However, the end of 2014 is quickly approaching and the window to implement proper succession and tax planning will be over sooner than you may think.  Therefore, this is the first in a three-part series that will focus on succession and tax planning techniques, particularly for owners of closely held businesses.

Many clients wish to eventually transfer their ownership in the family business to either their children or grandchildren. From a succession, income tax, and estate tax planning perspective, there is tremendous benefit in transferring a portion of a closely held business to the next generation during the owner's lifetime.  Ownership is transferred to the eventual successors, giving them a greater connection to the business, and appreciation in the value of the business is removed from the client's estate.

The most straightforward method of transferring ownership would be to make small gifts of the business over an extended period of time to the younger family members.  If the amount of the gift is less than the annual gift tax exclusion, there will not be any gift tax due.  Spouses may make tax-free gifts of $28,000 per donee per year.  Thus, over a period of time, a portion of the equity may be transferred to family members in a younger generation.

If the business will potentially appreciate rapidly within a short amount of time, then making small gifts every year is not a viable option because the majority of the appreciation would remain in the client's estate.  However, it is possible to transfer significant portions of the business and thereby the appreciation on a relatively efficient gift tax basis through the use of a grantor retained annuity trust ("GRAT") or through a sale to a trust for the benefit of the business owner's children and grandchildren.  If structured properly, the appreciation will be removed at marginal gift-tax cost.

In some situations, the successor will not be a member of the owner's family—say for instance the business is owned equally by two unrelated parties.  In these cases, it is vital that there be either a redemption agreement or cross-purchase agreement in place if the desire is for ownership to remain in the hands of those that are active in the business, as opposed to the deceased owner's heirs. Depending on the classification of the entity (i.e. a C corporation, S Corporation, or LLC taxed as a partnership), then different tax considerations will affect the form of the agreement.

Regardless of whether the goal is to transfer a business to family members in a younger generation or to unrelated persons, proper planning is essential to accomplish either of these goals in the most tax efficient manner.  In the next installment, we will discuss specific income tax issues and viable solutions for closely held businesses.

Saturday, August 16, 2014

Accountants vs. Accounting Software: Choosing The Best Fit For Your Business

Technology has given us the necessary tools to make our lives more convenient than ever before. In business, this covers many areas, including accounting software, which has made it easier for entrepreneurs to manage their business and finances. However, some still believe that no machine or equivalent can replace the work of an extraordinary accountant.

It has been an ongoing debate between the efficiency of a traditional bookkeeper versus accounting software. The modern advancements in technology have made it possible for businesses to manage most of their financial areas themselves. It’s an all-around tool which can maximize your business’ performance. On the other hand, accountants provide more value by offering financial advice when making key business decisions. Nothing beats the personal touch a financial advisor can give.

Accountants and accounting software have their own advantages and disadvantages. To understand these pros and cons, we have prepared a guide to help you make sound business decisions and avoid potential financial pitfalls.

Advantages and disadvantages of hiring a professional accountant:
Whether you are a business owner or an individual seeking help in filing taxes, nothing beats hiring a professional accountant. They can handle your financial work and even offer you advice. However, before you hire an accountant, checkout the advantages and disadvantages:

Advantage: personal touch
Professional accountants are like family doctors – you can build a relationship with them. Like doctors, they understand your financial situation and goals. Their advice can help reduce tax on capital gains or prepare for your future. A software program cannot anticipate these things. Nothing beats the human touch.

Disadvantage: it can be costly
Cost is the number one reason people turn to accounting software for help. On average, accountants can charge between $100 and $1,000 for their services. These may include simple tax returns, itemising and forms for declaring capital gains and losses. In addition, professional fees may also include hourly rates and processing fees, depending on your needs. It can definitely put a dent in your wallet.

Advantage: tax fees may be deductible
This is one of the main advantages of hiring a professional accountant. Since filing taxes can be complicated, some fees incurred while filing may be deducted from your tax return. These fees may include the following: – Advice on tax planning, – Legal counsel on tax issues, – Fees incurred during the tax preparation, and – Fees for representation in tax audits and collections. An accountant can guide you on how to avail of these possible tax deductions. They can help you itemize all deductions to claim tax breaks.

Disadvantage: be aware of people posing as “professional accountants
Before hiring a professional accountant, it is best to investigate their background. Check references and ensure that these are legitimate. You can also ask for feedback from previous clients, colleagues or business partners. Remember that you will be sharing personal and confidential information, which can be used against you. If you are not careful, you might lose more in the end.

Advantages & disadvantages of using accounting software
Accounting helps a business function and grow. The advent of accounting software has made it easier for entrepreneurs to manage and track their finances. It’s a cost-effective way of running a business. However, it also has its advantages and disadvantages. Let’s take a look at some of these examples:

Advantage: automation
Automation is one of the main advantages. Software removes all the time-consuming manual processes and streamlines everything. Aside from automated calculations and formulas, it can generate reports with a click of a mouse. Accounting software can also share information to other users through email or other electronic means. It makes everything seamless and organized.

Disadvantage: prone to fraud
Since data and information can be shared between users, it is now prone to fraud. Anyone can alter the stored data and use it for fraudulent activities. These can severely affect a business’ operations. To prevent this, extra layers of electronic security must be added to existing ones. In addition, a team of internal auditors may be needed to check for data inaccuracies. More security measures mean more costs.

Advantage: compatibility
Using accounting software makes it easier for businesses to share and integrate information. This is also crucial for companies on a merger. Instead of taking months to integrate all the financial and system data, it can be accomplished in less than a month. Compatibility is the key in making a process efficient and seamless.

Disadvantage: additional software & training needed
Accounting software requires constant updates to work properly. Some features, such as exporting data to an Excel spreadsheet or saving it as a PDF file may need to be purchased. You will need these to generate reports and for filing purposes. Purchasing these software add-ons may pose an additional expense to you. With the new software and updates installed, you also need to learn them. Although most modern accounting software is generally user-friendly, it still takes time to master their features. Paid training is the way to go to avoid costly errors in the end.

The bottom line
There is basically no difference between a traditional accountant and an electronic one. If you prefer doing your taxes and financial statements using software, go ahead. If you feel that a trained professional can help manage your finances, give it a spin. Both can help you maximize your business’ potential. As Steve Jobs once said, “technology is nothing.” Have faith in people and give them the tools they need. They will do wonders with it.

Friday, August 15, 2014

Tax Breaks, Pitfalls of Renting Your Second Home


Owning a vacation home can be a wonderful thing, providing you and your family a private getaway with all the comforts of home.

It also could net you some extra money if you rent it when you're not there.

But if you're not careful, it also could cause you some tax troubles.

"If you have a vacation home, it can make a tax difference as to whether it was used as personal residence or not used at all by the owners," says Mark Luscombe, principal federal tax analyst at CCH in Riverwoods, Illinois, a provider of tax information and services.

Basically, the amount of time you personally spend at your second home determines how much tax you might owe on rent, as well as deductions you can claim against the property.

There are three basic second-home tax situations.

You rent the property to others most of the year.
You rent the property to others for a very short time.
You use the property yourself and rent it when you're not there.
Here's a closer look at the tax implications of these scenarios.

Second Home as Full-Time Rental

You used to enjoy spending all your free time at your beach house, but now that the kids are grown and gone, you and your spouse have found other ways to vacation. So you've decided to lease out the vacation home more than you use it.

Of course, since taxes are involved, you must meet some specific requirements to take tax advantage of your rental vacation property. If you limit your personal use of your second home to 14 or fewer days, or 10 percent of the time it's rented, you've essentially turned your second home into an investment.

And for many, it's an investment that can pay off.

"Nearly half of the people who finance their vacation homes are able to cover 75 percent or more of their mortgage by renting it out to travelers," says Jon Gray, senior vice president, Americas, at HomeAway, an online vacation rental marketplace.

HomeAway's 2013 Customer Satisfaction Survey found that second-home owners rent their properties to travelers 18 weeks a year and bring in more than $28,000 in annual rental income. "That's not an insignificant amount of money," says Gray.

Of course, that rental income is taxable. But you also can deduct many costs associated with your rented second home.

Common Rental Expenses

The Internal Revenue Service says the most common rental expenses are:

Auto and travel expenses.
Cleaning and maintenance.
Legal and other professional fees.
Local transportation expenses.
Management fees.
Mortgage interest.
Property management fees.
Rental payments.
When your deductible rental expenses exceed your rental income, you could wipe out any possible taxable income and even record losses that could help additionally at tax time.

Passive activity pitfalls
Your rental losses, however, could be limited. The IRS usually considers rental real estate as a passive activity; that is, you get income mainly for the use of property rather than for services provided.

And the tax code's passive activity rules mean that generally you can only use passive losses to offset passive income, not ordinary income such as wages. Any excess passive losses are carried forward to the next tax year.

There is one way to get around passive activity rules. If you are an active participant in your rental vacation home, says Luscombe, up to $25,000 of the home's expenses beyond the rental income could be deductible. There are income restrictions and a phaseout of this amount. If you make more than $100,000 ($50,000 if married filing separately), your deductible allowance is limited.

What constitutes active participation? You're deemed to have materially participated in a rental property if you (or your spouse) were involved in its operations on a regular, continuous and substantial basis during the tax year. This includes such things as personally maintaining the property and lining up renters, says Luscombe.

Short-Term Rental Advantages

When you or your family spend time at your second-home retreat as well as rent it for part of the year, the tax rules change. But exactly how much depends on the precise breakdown of the days you and renters are in the house.

The best tax deal is for short-term rentals. These are situations where your property is rented for 14 or fewer days. Money received for two-week-or-less rentals is tax-free.

"This issue comes up every time there is a special event," says Luscombe. Residents head out of town to avoid the increased congestion caused by special events such as the Super Bowl or music festivals, lease their homes to visitors coming in for the festivities, and pocket the payments without any worry about reporting the income.

It doesn't matter if you got $20,000 for the week those football fans leased your condo near the stadium. The IRS isn't entitled to a cent.

Even better, this short-term rental income tax break isn't limited to second homes. If you rent your primary residence for two weeks or less, that income doesn't have to be reported on your tax return.

Hybrid Home Tax Calculations

Tax rules are a bit trickier when you use your vacation home yourself for more than two weeks and also rent it out for a substantial part of the year. As with everything tax, meticulous record keeping is key.

To reduce taxes on any rent you collect, you'll want to deduct eligible expenses. But because the home has shared personal and rental use, you must allocate the costs.

For example, you spent 60 days last year during ski season at your mountain cabin. The hillside hideaway was rented for 180 days the rest of the year. You can deduct 75 percent of your vacation home's qualifying rental expenses against rent you collect: 180 rental days divided by 240 total days of property use.

But you can't claim rental losses in this situation -- only zero out your rental income.

And you'll report the personal portion of your expenses, including mortgage interest and property taxes on your second home, as usual on your Schedule A itemized deductions.

Don't Forget Local Taxes

Finally, don't overlook any state and local taxes that might be assessed on the rental of your home, whether a primary residence or a second home.

"Generally, any short-term rentals, typically called transient rentals, even just for a weekend, have a state and local tax obligation," says Rob Stephens, co-founder of HotSpot Tax Services, a Greenwood Village, Colorado, company that files state and local sales and lodging taxes for owners of vacation rental properties.

In Texas, if you rent your home for fewer than 30 days, you're subject to the state's hotel occupancy tax. It's called the transient occupancy tax in California. Florida counties collect a tourist impact tax on all rentals.

"As a practical matter, it gets very difficult for local jurisdictions to track and monitor this type of rental, so historically, we've seen a pretty high level of noncompliance," says Stephens.

But with state and local governments seeking every possible penny, tax revenue from such rentals is getting more attention. And the same technology that helps folks find short-term vacation home occupants also offers tax collectors a view of who's making potentially taxable residential rental income.

Thursday, August 14, 2014

5 Tax Strategies to Pay for College Without Going Broke

Saving for college is not for the faint of heart. The cost of an education has been spiraling upward and although there are some fine 529 plans to help, the numbers can be mind-boggling.
For men and women who own their own businesses, there are a few tips that can help them create a “tax scholarship” for their children.
Owning your own business gave him the chance, he said, to take advantage of IRS rules to help pay the tuition bills.
There are also various tax credits, including the Lifetime Learning Credit, which allows parents to deduct $2,000 of educational expenses per year for dependent children.
Any strategy to help ease the tuition burden must be weighed against the tax consequences to the prospective student and the parents.
1. Hire Your Children
Giving the kids the chance to work is a good way to shift income. This helps because they probably won’t earn enough to owe taxes. The money can be set aside in an IRA or other investment vehicle. For example, if a child does office work or painting or lawn mowing on rental properties for, say $2,500 per year, the savings can build up over several years before high school graduation. Cummings says it’s important to document the job and ensure that the work is legitimate.

2. Stock Transfer

Putting stock owned by parents in the name of a child can save tax payments. Beware, Cummings says, of the so-called kiddie tax, though, that mandates children can make at most $2,000 per year in unearned income using this strategy. Anything above that is subject to the tax rate of the parents.

3. Tuition Reimbursement

Offering employees tuition reimbursement for taking college courses can lower costs because of the tax benefits associated with such programs. The IRS puts a cap of $5,250 on such a program. It’s important that all employees receive the same benefits. In other words, the children of the business owner can’t receive a benefit not available to other employees.

4. Gift or Leaseback

By making a gift of a piece of property to a child and then leasing it back, the money saved in lower tax payments can be put toward paying for college, as can any lease payments. Beware of the kiddie tax mentioned in No. 2, which applies up to age 24 unless the child is no longer a dependent of the parents.

5. Divorce Planning

For couples no longer married, but able to work on college strategies together, there are ways to maximize tax benefits. Generally, such planning involves deciding which parent claims a deduction for the child as a dependent, leaving the other free to take advantage of tax saving rules while avoiding the kiddie tax.

Wednesday, August 13, 2014

Mid-Year Tax Planning Checklist

All too often, taxpayers wait until after the close of the tax year to worry about their taxes and miss opportunities that could reduce their tax liability or financially assist them. Mid-year is the perfect time for tax planning. The following are some events that can affect your tax return; you may need to take steps to mitigate their impact and avoid unpleasant surprises after it is too late to address them.

Did you get married, divorced, or become widowed?
Did you change jobs or has your spouse started working?
Did you have a substantial increase or decrease in income?
Did you have a substantial gain from the sale of stocks or bonds?
Did you buy or sell a rental?
Did you start, acquire, or sell a business?
Did you buy or sell a home?
Did you retire this year?
Are you on track to withdraw the required amount from your IRA (age 70.5 or older)?
Did you refinance your home or take out a second home mortgage this year?
Were you the beneficiary of an inheritance this year?
Did you have a child? Time to consider a tax-advantaged savings plan!
Are you taking advantage of tax-advantaged retirement savings?
Have you made any significant equipment purchases for your business?
Are you planning to purchase a new business vehicle and dispose of the old one? It makes a significant difference whether you sell or trade-in the old vehicle.
Are your cash and non-cash charitable contributions adequately documented?
Are you keeping up with your estimated tax payments or do they need adjusting?
Did you purchase your health insurance through a government insurance exchange and qualify for an insurance subsidy? If your income subsequently increased, you may need to be prepared to repay some portion of the subsidy.
Do you have substantial investment income or gains from the sale of investment assets? If so, you may be hit with the 3.8% surtax on net investment income and need to adjust your advance tax payments.
Did you make any unplanned withdrawals from an IRA or pension plan?
Have you stayed abreast of every new tax law change?

If you anticipate or have already encountered any of the above events or conditions, it may be appropriate to consult with this office, preferably before the event, and definitely before the end of the year.

Tuesday, August 12, 2014

Understanding the Alternative Minimum Tax

 I’d like to switch gears and discuss AMT, or the Alternative Minimum Tax. Originally enacted in 1969 and aimed at addressing the fact that approximately 200 Americans found a way not to pay income tax, this piece of legislation has grown more complex and is focused on ensuring that all Americans pay a minimum amount of federal income tax. In essence, it sets a floor on total tax liability.

The number of taxpayers affected by AMT liability has grown from about 20,000 in 1970 to an estimated 3.9 million in 2013 and is projected to be more than 6 million by 2023. Without proper planning, you could find yourself paying this additional tax.

AMT is calculated from AMTI (AMT Income), which equals AGI (adjusted gross income) minus itemized deductions plus AMT preference items. The list of preference items is too long to fit into this column, so one planning piece when considering making investments is to ask yourself or your financial professional whether the gains and/or income on the investment is subject to AMTI.

You may be asking yourself “How do I know if I’m subject to AMT?” The most straight-forward way to answer that question is this: if you’re AMTI is above $82,100 and you file “married filing jointly” or it’s above $52,800 as a single taxpayer, you’ll have to go through the calculation process to determine IF you owe MORE taxes than you’ve already paid through the traditional tax calculation process. After calculation, if your AMT liability is more than your regular tax liability, your “AMT tax” will be the difference between the numbers.

To find out if you paid AMT taxes, you’ll want to look on page two of your Form 1040 and look at Line 45.

Tax law affects the investment environment, your investment decisions, and can have a profound effect on the long-term success of your financial success. Ensuring that your assets and financial strategies are working as tax-efficient as possible is imperative to maximizing your potential returns.

Monday, August 11, 2014

Tax Planning Strategies for Today

Procrastinators beware: Tax planning isn’t just something you have to deal with at the end of the year and then again in April.

While it’s tempting to pay your taxes and forget about them until next year, a mid-year review can ensure you aren’t overpaying Uncle Sam.

“People should look at their tax exposure mid-year because those that do tend to pay less in taxes than people who do not,” says David McKelvey, partner at accounting firm Friedman. “There are moves that taxpayers can make, but the real value is the ability to plan out actions for the balance of the year.”

Mid-year tax planning can also make life less stressful when April 15 rolls around, especially for those that change tax brackets and might be facing a bigger-than-normal bill.

“Often, individuals will put off tax planning until the end because it is much easier to summarize and estimate finances for the remainder of the year when they are already three-quarters of the way done,” says Megan McManus, CPA and tax manager at accounting and business consulting firm Sensiba San Filippo. “However, for some tax rules and exemptions, there is a limited window of opportunity to take advantage of the rules.”

To help reduce any surprises come tax season and take full advantage of all eligible breaks and credits, experts offer the following tips:

Look at Your Tax Bracket

People with taxable income of more than $400,000 for individuals and $450,000 for couples are subject to the highest income tax rate, which according to McKelvey, currently stands at 39.6%. If you expect to fall into the top tax bracket this year, he says now is the time to create strategies to reduce your taxable income.

For instance, he says you can take steps to defer income or accelerate deductible expenses to get into a lower bracket. Even if you aren’t a high earner, any moves to reduce your taxable income means less money you’ll owe Uncle Sam. “If you find you may be close to jumping into the higher bracket, steps can be taken to reduce income,” he says.  “Increase retirement contributions, harvest losses from investment accounts, look at non-taxable investments and gifts to charities.”

Max Out Your Tax Advantaged Retirement Account

Many employers offer their workers some form of a retirement savings plan that often includes a match offering, and experts say the middle of the year is a great time to make sure you are taking full advantage of your benefits package.

Increasing your retirement contributions can help build your nest egg quicker, but it can also help you pay less taxes, says Sarah Deierlein, an enrolled agent at Tax Defense Network.

"Most people have their highest taxable income during their working years. Therefore, by maximizing your savings and reducing your taxable income now, you will be able to pay tax on the income when you are retired and your taxable income is lower each year," says Deierlein. She noted 401(k) accounts allow for up to $17,500 in contributions or $23,000 if you are 50 or older, and IRAs allow for $5,500 in contributions or $6,500 if you are over 50.

Consider Your Investment Gains and Losses

If you are lucky enough to realize (or plan for) significant capital gains from investments this year, now is an ideal time to sell some underperforming investments to generate losses to help offset your gains.

This move is extremely important if you are a high earner because the capital gains for taxpayers in the top bracket is 20% this year, says McKelvey. He says you may even be able to repurchase those underperformers as long as you wait at least 31 days after selling them.

Check Up on Your Medical Expenses

If you have a lot of out of pocket medical expenses, experts recommend looking into enrolling in a flexible spending account or a health savings account.

These accounts let you cover medical expenses with tax-free dollars and reduce your taxable income for the year. According to McKelvey, you can contribute up to $3,300 per year for individuals and $6,550 per family.

“One thing to note is that the use-it or lose-it policy been amended by The Affordable Health Care Act, meaning that an employee can now have up to $500 from their Healthcare FSA rollover into the next year without losing any funds,” notes McManus.

Sunday, August 10, 2014

Investments and Tax Planning: They Go Hand-in-Hand

When it comes to investments, tax planning should play a major role.

Many changes to the tax code at the beginning of 2013 affects investors, which is why how and when you invest can significantly alter your tax bill. At the start of 2013, the capital gains tax rate rose to 20% from 15%. The addition of the Affordable Care Act Surtax of 3.8% increases the amount of capital gains tax on incomes greater than $200,000 to 23.8%. The increase to the maximum ordinary income tax rate to 39.6% affects most investors.

Waiting until the end of the year to address any tax issues could result in paying more in taxes to Uncle Sam come April 15. It is better to create an investing plan that takes taxes into consideration early in the year and update that plan in response to changing market conditions and tax law.

“The market may have moved against them and there is a much smaller window of time to create a strategy to minimize tax liabilities," warns Robert Weiss, global head of J.P. Morgan Private Bank’s Advice Lab

But Congress makes planning hard as it has gotten in the habit of not acting on pending tax issues until the final bell has sounded for the year. It is then that we are visited with new laws retroactive to the beginning of the year.  This could put a monkey wrench in tax planning, but Weiss advises people to work with whatever level of certainty available.

“…create a pro forma that encompasses existing alternative minimum tax, capital gain tax, capital loss treatments, and regular income tax.”

To get your taxes in order, it’s a good idea to have a solid foundation then work with potential contingencies to determine your course.  Here’s where to start:

Retirement Planning

Tax planning should also encompass retirement issues and the deferral aspects of retirement plans. For 2014, you can tuck away $17,500 if under age 50 and $23,000 if 50 and over into a 401(k) plan tax free. This move reduces your taxable income and can lower your tax bill.

Where you live in retirement plays a major role in determining how much you pay in taxes. If you retire to a high tax jurisdiction, such as New York or California, you may wish to consider a ROTH IRA plan, the distributions of which are not taxable.

Track Deductions

Maximizing the impact of deductions is another tax planning tool. For example, if you are subject to the alternative minimum tax (AMT), you should know that there are certain deductions, such as state income tax, excess medical, and property taxes that are not deductible for AMT purposes. It may be more beneficial to defer these deductions to another tax year.  This requires professional analysis to determine the best route.

Another potentially overlooked deduction is the interest cost for mortgages.  If a homeowner has a mortgage greater than $1.1 million, any interest on the portion of the loan above that amount may not be deductible.

Because tax law is so complex and every taxpayer’s situation is unique, it’s important to be savvy about tax laws but equally important to create a plan with a qualified tax professional and a qualified investment advisor to determine the course suitable for your particular needs.

Saturday, August 9, 2014

Staying in the 15% Tax Bracket for Life

Retirees often are blindsided by high tax bills. Retirees are the targets of many of tax increases, though they aren’t explicitly named. Instead, Congress enacts stealth taxes that quietly drain cash from retirees.

Fortunately, you can fight back. Retirees have more control over their tax burden and more flexibility than most taxpayers, especially when you start planning before retirement. Even if you wait, there still are steps to take.

The key to keeping your tax burden low is to reduce your adjusted gross income. That’s the number at the bottom of the first page of the standard Form 1040. AGI is critical, because most of the stealth taxes are based on it instead of taxable income, which is calculated on the second page of the 1040. Taxable income is lower than AGI because of the personal exemptions and either the standard deduction or itemized deductions. Even those are reduced or phased out if your AGI is too high.

The stealth taxes are numerous: phaseouts of personal exemptions and itemized expenses, the 3.8% tax on net investment income, inclusion of some Social Security benefits in gross income, the Medicare surtax, and more. You beat these stealth taxes primarily by reducing AGI. When you can’t reduce AGI, you still reduce the overall tax burden by controlling the types of income you receive.

Retirees often can choose how and when they receive income. By carefully paying attention to the sources of income and the amount of AGI, they have more control over their tax burden. In fact, you can almost determine the tax rate you want to pay. Some planners refer to this as tax bracket management. In this visit, you’ll learn how to keep your tax bracket as low as possible year after year.

Diversify income sources. The key to tax bracket management is tax diversification. Tax diversification recognizes that different types of income are taxed differently. The tax law and your situation can change, so you don’t want only one type of income or tax break. During the working years, most income tends to be ordinary income, whether it is salary or business profits. But in retirement you often can diversify income sources.

Tax diversification is achieved by having your investments in different types of accounts: traditional IRAs and 401(k)s, Roth IRAs and 401(k)s, taxable accounts, annuities, and any others available to you. You’ll also have other sources of income, such as Social Security and perhaps some form of pension. Having different income sources allows you to use all the available strategies.

Reduce or convert traditional IRAs. One of the greatest obstacles to tax bracket management is having too much of your nest egg in traditional IRAs or 401(k)s. Most people don’t realize this until it is too late.

Traditional IRAs (and other forms of tax deferral) are great during the accumulation years. Yet, they create two problems during the distribution years. One problem is that all distributions are taxed as ordinary income, facing your highest tax rate. The other is that after age 70½, minimum distributions are required. As you age, the required distributions increase, and many people in their late 70s and beyond complain that the required distributions far exceed their cash needs and increase taxes.

There are a couple of strategies. One is to take IRA distributions before you need the money. Over time or in a lump sum take money out of the IRA, pay the taxes, and put the rest of the distribution in a taxable account. When you spend the principal in the future it won’t be taxed. You’ll also be able to invest the money so future income and gains receive favorable tax rates, as we’ll discuss.

The other strategy is to convert all or part of the traditional IRA to a Roth IRA. You pay taxes on the converted amount, but future distributions to you and your heirs are tax free.

Most people don’t want to prepay taxes. It goes against one of the longstanding principles of tax planning. But when taxes will be higher in the future, especially when you’ll be faced with an array of stealth taxes, paying taxes now can make sense. In 2010 favorable tax treatment was offered to those who converted traditional IRAs to Roth IRAs that year. The IRS recently reported the results. Conversions increased by nine times over the previous year. Among taxpayers with $1 million or more of income, more than 10% did conversions. That means the taxpayers who receive the most sophisticated advice decided paying taxes early was a good idea when it converted future ordinary income into tax-favored or tax-free income.

An advantage of a Roth IRA is that distributions from it, no matter how large, aren’t included in AGI. That is a big help in avoiding the stealth taxes triggered by higher AGI.

Time IRA distributions and conversions. Consider more than immediate cash needs when deciding how much to distribute from a traditional IRA or 401(k) or how much to convert to a Roth IRA. Consider the rest of your tax picture. Increase distributions or conversions in a year when your tax rate is lower. Perhaps you have high deductible medical expenses, a business loss, earned less income, or have other factors that reduce your tax bill. That would be a good year to increase IRA distributions or conversions, because you’ll be in a lower tax bracket or have deductions to offset the taxes on the IRA transactions.

Delay Social Security. You need to consider a number of factors before deciding when to take Social Security, but income taxes are a reason to defer benefits. Social Security benefits are tax free or mostly tax free unless your AGI is above $44,000. Since delaying benefits increases your benefit, it also increases your potentially tax-advantaged income.

Seek tax-advantaged income. Your taxable accounts should seek tax-exempt income, qualified dividend income, and long-term capital gains. Investments that generate ordinary income, such as interest, should be in other types of accounts or annuities whenever possible. It also is wasteful to take short-term capital gains in taxable accounts without a compelling reason.

There’s a catch with tax-exempt interest. It generally is excluded from gross income and therefore AGI. But some of the stealth taxes, such as the Medicare premium surtax and the tax on Social Security benefits, use modified AGI. Modified AGI is regular AGI plus tax-exempt interest and foreign earned income that was excluded from income. So, if your AGI is near stealth tax thresholds, tax-exempt interest might not help.

Use tax-wise investment strategies. Taxable accounts need to be managed with both taxes and investment returns in mind, resulting in higher after-tax returns.

Loss harvesting is an important strategy. When investments decline below the purchase price, sell them and book the loss. In most cases you can buy them back after waiting more than 30 days or immediately buy another investment that isn’t substantially similar. The losses offset capital gains earned during the year. Losses that exceed your gains can be deducted up to $3,000 annually to reduce taxes on other income. When losses for the year exceed gains plus $3,000, you can carry the excess amount to future years to use in the same way.

You also want to avoid owning in your taxable accounts mutual funds that distribute a lot of their gains each year, forcing you to include them in gross income. Look for mutual funds with low turnover ratios or for tax-favored investments such as master limited partnerships.

Avoid selling investments at a gain if you held them for one year or less, unless there is a compelling nontax reason. You want to earn long-term capital gains instead of ordinary income or short-term gains.

Manage your tax bracket annually. When you have tax diversification and the other strategies in place, you are in position to manage your tax bracket, keeping it around 15% to 20% annually.

You’ll have a base automatic income from Social Security and perhaps some annuities and pensions. After age 70½ you’ll also have required minimum distributions from traditional IRAs and 401(k)s. Your taxable accounts might generate qualified dividends, tax-exempt interest, mutual fund distributions, and other income that’s outside your control.

But you have flexibility beyond that you can use to minimize your tax burden while meeting spending needs. You want to focus on keeping AGI as low as possible and minimizing ordinary income.

To meet spending needs that exceed the automatic income, carefully choose the sources. You might sell some assets in taxable accounts at long-term capital gains to raise cash. Or if AGI is too high for the year, consider Roth IRA distributions to avoid triggering a higher tax bracket or stealth taxes. In a year when AGI is low or you have deductions to offset ordinary income, consider taking extra distributions from traditional IRAs or annuities.

With tax diversification and tax bracket management, you can generate substantial cash flow each year while keeping your tax rate at 20% or even less. Many retirees avoid the higher ordinary income tax brackets despite substantial cash flow. You can avoid the stealth taxes and other burdens Congress aims at you.

Friday, August 8, 2014

Understanding Net Investment Income Tax

As part of the controversial Affordable Care Act, known by most as Obamacare, several new taxes were enacted to help fund the program.

Among these new taxes is one that became effective on Jan. 1, 2013, the Net Investment Income Tax. This regulation imposes a 3.8 percent surtax on the net investment income of certain individuals, estates and trusts that have income above the statutory threshold amounts. The key consideration, however, is what constitutes net investment income and which taxpayers are affected.

The threshold amount for individuals is based on filing status and is not indexed for inflation.

The threshold amount is $125,000 for taxpayers filing married filing separately; $200,000 for taxpayers filing as single or head of household; and $250,000 for those with a filing status of married filing jointly or qualifying widow(er) with a dependent child.

Individuals will owe the additional net investment income tax if their modified adjusted gross income exceeds these figures. Modified adjusted gross is defined as adjusted gross income plus foreign earned income less deductions and exclusions related that foreign earned income.  

In general, investment income includes, but is not limited to the following: interest income, dividend income, capital gains income, rental and royalty income, income from non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the tax payer. Gains from the sale of stocks, bonds and mutual funds are subject to this tax.

In addition, capital gain distributions from mutual funds as well as gains from the sale of investment real estate including gains from the sale of a second home that is not a primary residence are also subject to this tax. Gains from the sales of interests in partnerships and S corporations in which the owner is not materially participation are also subject to this tax.

To determine net investment income, investment income from these categories is reduced by investment expenses such as early-withdrawal penalties, interest expense, adviser fees, directly related rental and royalty expenses, and state and local taxes allocable to items included in investment income.

Items such as wages, unemployment, social security benefits, alimony, tax-exempt interest income, self-employment income and retirement income are all examples of income exempted from this net investment income tax.  

In addition to these exemptions for income which are not investment related, the Code Section 1411 excludes non-passive trade or business income from this net investment tax.

As a result, there are renewed discussions on the definition of material participation.

In other words, dividends received from a business where you are actively involved and meet the IRS definition of material participation would be exempted from this net investment income tax. Dividends received from a company where you are an investor and do not meet the definition of material participation will be subject to the tax.

Form 8960 is used to report the net investment income tax. This form is a separate schedule that ultimately flows up into the individual income tax return, the estate return, or the trust return as applicable. The corresponding tax is paid for individuals as part of their 1040 Form, while estates and trusts include this Form 8960 as part of their 1041 return.

Many taxpayers may not be impacted by these new taxes on net investment income.

However, all taxpayers should be aware of the continuing complexity that is placed in our tax code and the tax preparation process.

Despite the ongoing rhetoric from Congress on the need for tax simplification, virtually all legislation in the area of taxes continues to be in the opposite direction.

Thursday, August 7, 2014

What is the new investment surtax and how can we avoid some or all of it?

The Problem – New Investment Surtax Can Cost You 3.8%. Effective Jan. 1, 2013, you may pay an additional 3.8% surtax on your investment income. The Net Investment Income Tax (NIIT), or investment surtax, is imposed by section 1411 of the Internal Revenue Code. If you file your taxes as a single person and your adjusted gross income (AGI) is $200,000 or greater or if you file your taxes jointly and your AGI is $250,000 then you are the target of this new tax. As it applies to the new rules, investment income includes: dividends, rents, royalties, interest, short term and long term capital gains and taxable annuity payments. The surtax applies to the income above $200,000 or $250,000, respectively.

Although 3.8% may not seem like a large additional tax it is important to know what the current tax rate is on some of the most common sources of income being impacted. Specifically, the tax rate on most dividends and long term capital gains is 15.0%. The surtax translates to an over 25% (3.8% / 15.0%) increase in the actual taxes paid on the impacted income.

Although the following items may increase your AGI and increase the amount of surtax you may pay they are not subject to the surtax: wages, self-employment income; distributions from IRAs, Roth IRAs and company retirement plans, municipal bond interest, death benefit proceeds from life insurance policies, veterans’ benefits and Social Security income.

The Solution – Reduce Your Adjusted Gross Income (AGI) and Increase Your Retirement Savings. One of the easiest ways to avoid the 3.8% surtax on investment income is to reduce your adjusted gross income (AGI) to $250,000 for joint filers ($200,000 for single filers). No, I am not suggesting you compromise your income simply to avoid taxes on your income. I am suggesting you take advantage of your employer sponsored retirement plan to reduce your AGI. A potentially greater benefit of reducing your AGI is the reduction in income taxes. Let’s look at three examples.

Example 1 – Single Person Age 50 Working at a Company
When you contribute $23,000 ($17,500 if under age 50) to your 401(k) you reduce your AGI by $23,000. This contribution reduces your AGI from $223,000 to $200,000 and eliminates the surtax.

Example 2 – Husband and Wife Each Age 50 Working at Companies
When you each contribute $23,000 ($17,500 if under age 50) to your 401(k) you reduce your combined AGI by $46,000. These contributions reduce your AGI from $296,000 to $250,000 and eliminate the surtax.

Example 3 – Husband and Wife Each Age 50 Working at Public Schools
When you each contribute $23,000 ($17,500 if under age 50) to your 403(b) you reduce your combined AGI by $46,000. When you each simultaneously contribute $23,000 ($17,500 if under age 50) to your 457(b) you reduce your combined AGI by another $46,000. These contributions reduce your AGI from $342,000 to $250,000 and eliminate the surtax.

Although retirement account withdrawals are not subject to the surtax, they could be subject to income taxes. Fortunately, there are additional estate planning and financial planning strategies to avoid required minimum distributions (RMDs). As a result, these strategies avoid income taxes and the surtax.

Often Overlooked. Another way of reducing your AGI, avoiding the surtax and creating a tax free savings account to pay medical costs and long term care insurance premiums is to contribute to your employer sponsored Health Savings Account (HSA).

Action Step – Avoid the New Investment Surtax. When you contribute to your employer sponsored retirement account you can accomplish two goals simultaneously – create a healthy retirement nest egg and avoid the surtax.

Saturday, August 2, 2014

5 Questions to Ask Before Making Gifts for Medicaid or Tax Planning

Many seniors consider transferring assets for estate and long-term care planning purposes, or just to help out children and grandchildren. Gifts and transfers to a trust often make a lot of sense. They can save money in taxes and long-term care expenditures, and they can help out family members in need and serve as expressions of love and caring.
But some gifts can cause problems, for both the generous donor and the recipient. Following are a few questions to ask yourself before writing the check:
  1. Why are you making the gift? Is it simply an expression of love on a birthday or big event, such as a graduation or wedding? Or is it for tax planning or long-term care planning purposes? If the latter, make sure that there's really a benefit to the transfer. If the value of your assets totals less than the estate tax threshold in your state, your estate will pay no tax in any case. For federal purposes the threshold is $5.34 million (in 2014). Gifts can also cause up to five years of ineligibility for Medicaid, which you may need to help pay long-term care costs.
  2. Are you keeping enough money? If you're making small gifts, you might not need to worry about this question. But before making any large gifts, it makes sense to do some budgeting to make sure that you will not run short of funds for your basic needs, activities you enjoy -- whether that's traveling, taking courses or going out to eat -- and emergencies such as the need for care for yourself or to assist someone in financial trouble.
  3. Is it really a gift (part one)? Are you expecting the money to be paid back or for the recipient to perform some task for you? In either case, make sure that the beneficiary of your generosity is on the same page as you. The best way to do this is in writing, with a promissory note in the case of a loan or an agreement if you have an expectation that certain tasks will be performed.
  4. Is it really a gift (part two)? Another way a gift may not really be a gift is if you expect the recipient to hold the funds for you (or for someone else, such as a disabled child) or to let you live in or use a house that you have transferred. These are gifts with strings attached, at least in theory. But if you don't use a trust or, in the case of real estate, a life estate, legally there are no strings attached. Your expectations may not pan out if the recipient doesn't do what you want or runs into circumstances -- bankruptcy, a lawsuit, divorce, illness -- that no one anticipated. If the idea is to make the gifts with strings attached, it's best to attach those strings legally through a trust or life estate.
  5. Is the gift good for the recipient? If the recipient has special needs, the funds could make her ineligible for various public benefits, such as Medicaid, Supplemental Security Income or subsidized housing. If you make many gifts to the same person, you may help create a dependency that interferes with the recipient learning to stand on his own two feet. If the recipient has issues with drugs or alcohol, he may use the gifted funds to further the habit. You may need to permit the individual to hit bottom in order to learn to live on his own (i.e., don't be an "enabler").
If after you've answered all of these questions, you still want to make a gift, please go ahead. But unless the gift is for a nominal amount, it is advisable to check with your attorney to make sure you are aware of the Medicaid, tax and other possible implications of your generosity.