Friday, January 30, 2015

Will You Have to Pay an Obamacare Fine?

If you are self-employed, and/or have fewer than 100 employees, you will not have to provide your employees health insurance. But there is a key part of Obamacare that will likely impact your pocketbook: the individual mandate. This means that you must get qualified health insurance for your family or pay an annual penalty (the law calls this the "individual shared responsibility payment").

OK, what does it amount to? For the current year, the penalty is the greater of $95 per adult and $47.50 per child, limited to a family maximum of $285; or 1 percent of your household income above your tax filing threshold (this is the amount for determining if you must file a tax return).

But the total penalty is capped at the national average for a bronze plan, which is roughly $2,448 per person with a maximum of $12,240 for a family with five or more members.

Kind of confusing? Well, to get a better idea of how this works, let’s take an example: Suppose you are married and have two children. Your household income is $70,000 and the filing threshold is $20,300.

2 adults X $95 + 2 children X $47.50 = $285
$49,700 (the $70,000 household income - $20,300 filing threshold) X 1% = $497
1% X $49,700 = $497
You will have to pay $497 since it is the higher amount (you can also check out this Obamacare calculator). You will list the penalty amount on your 1040 form.

Now, if you do not pay it, the IRS will not have the typical collection powers, such as with placing liens on your home or other property. However, the agency can deduct the penalty from any tax refunds.

If you do not get qualified insurance for 2015, then the penalty will be even steeper. It will be the greater of $325 per adult and $162.50 per child, limited to a family maximum of $975; or 2 percent of household income.

There are exceptions to the penalty. Some of the notable ones include:

You are already covered by a qualified employer plan.
You have coverage from a qualified off-exchange plan.
You have coverage under Medicare, Medicaid, The Children’s Health Insurance Program (CHIP), TRICARE (insurance for active members in the military) or Veterans Administration plans.
You are a member of a qualified Native American tribe.
Your income is too low for the filing of a tax return.
You qualify for a hardship exemption (this is broad, covering situations such as bankruptcy, foreclosure, eviction, homelessness, shut off from a utility, fire/flood, a victim of domestic violence and so on).
For many of these exemptions, you will need to apply for approval with the marketplace. This can take a month or two.

If you get an exemption, you will then receive an exemption certificate number or ECN. You include this on your tax return with form 8965.

But if an exemption does not apply and you do not get qualified health insurance, then you will be completely on the hook for your medical bills. Unfortunately, this could mean facing bankruptcy if you have a catastrophic medical event (although there are some limited health insurance policies that can potentially help). Besides, Obamacare does provide for subsidies that can greatly reduce the monthly premium payments on an insurance plan.

So if anything, it’s a good idea to check out the options from your state exchange or (if you state does not have an exchange). But you will have until Feb. 15 to enroll in a plan.

Thursday, January 29, 2015

Put Estate Planning on Your Bucket List


When the time comes for checking your financial to-do list, estate planning is most likely  the last item you’ll get to—if you get around to it at all.  It is estimated 120 million Americans lack an up-do-date estate plan.

Business owners also need to add succession planning to their checklist to ensure an effective transition following the founder’s retirement or death.

The New Year is a great time to organize your assets to avoid family fights and prevent a majority of your estate from going to the government.

Tom Jones, shareholder and chair of the corporate practice group at Chamberlain Hrdlicka (Atlanta), discussed the following essential  considerations for estate and succession planning:

Boomer:  What are the limitations of my will? Do I need a trust?

Jones:  In many cases, a will alone is sufficient and separate trusts are not necessary to provide a fully functional estate plan. Also, many wills contain trusts within the will document itself for tax planning and family protection purposes.

In larger estates, however, there will almost always be a need for one or more trusts in addition to the will. For example, it is very common to establish a separate trust to hold life insurance policies in a manner that will remove the policy proceeds from the estate of the individual insured for estate tax purposes.

Boomer:  What of my estate assets will be taxed?

Jones:  Generally speaking, all of the property and assets of a U.S. citizen or resident, of whatever nature and wherever located, will be subject to U.S. estate tax at death. In fact, some property interests that one might not expect to be counted as the property of the deceased person will be included in their taxable estate, such as property not actually owned by them but over which they have legal control.

As part of the estate planning process, it is important to develop a full inventory of all such property and property interests in order to project likely estate tax obligations at death.

Boomer:  How can I prepare my heirs to receive their inheritance?

Jones:  This will vary from family to family. In some cases, it is possible, indeed healthy, to have full, frank and open discussions with children about the nature of the estate that they are likely to inherit in the future. In other situations, due to family discord or particular issues with one or more of the beneficiaries, such dialogue may not be useful and may even be counterproductive.

Boomer:  What is business succession planning and how do I know if I need this advance planning?

Jones:  Business succession planning typically refers to the process of transition when the owner of a closely-held business retires or dies. Every business owner should have such a plan, whether it involves transitioning ownership and/or management of the business to employees or family members or potentially selling the business to a third-party. It is never too early to begin considering these transition issues.

Boomer  What are some of the choices available to a business owner to plan his or her estate and transfer interest in a family business?

Jones:  One type of plan that is frequently utilized involves giving voting control of the business to the “heir apparent” who is actively involved in management of the business while providing non-voting shares of the company to the other children who are not actively involved in management. Transition plans involving non-family employees often include the purchase of shares in the business over time.

In some cases, an ESOP, or employee stock ownership plan, may be a very effective transition tool.

In all cases, the business owner and his or her advisors should devote careful analysis to the legal, tax and human factors that will ultimately determine whether the plan succeeds or fails.

Wednesday, January 28, 2015



Early last year, a New York-based freelancer—let’s call him Henry—had to travel for a project. The job required him to be gone for a few months, so, in order to offset the cost of his room in the East Village, Henry fired up Airbnb, snapped a few pictures, wrote a short description, and listed his space for rent.

Things went well enough. Apparently, there were enough takers to cover the cost of rent and utilities for the time he would be away; he even ended up making a modest profit. Then, a couple of months later in January, he got hit with something in the mailbox that he wasn’t expecting: A 1099-K tax form.

"Airbnb reported the money I made off the site, and I got a tax bill for the full amount," Henry, who asked that his identity remain hidden because he didn't want to be associated with Airbnb, explained in an email. "I didn't really turn a profit from my Airbnb-ing so it wasn't a problem for me, but I know that it could become a very big problem for people that rely on the site as a source of supplemental income." Henry assumed that income taxes were taken out automatically whenever Airbnb paid him, which wasn’t the case. That it leaves for you to handle.

It was an honest oversight on Henry's part, sure. But his confusion speaks to one of the little understood realities that come with the quote-unquote "sharing economy," or when ordinary people offer up space in their cars, their bicycles, and in Airbnb’s case, the place where they sleep (or perhaps don’t), for additional income.

"People get woken up because they get sent a 1099-K, which is just this amorphous form at this point," says Russell Garofalo, founder of Brass Taxes in Brooklyn, which specializes in doing taxes for freelancers, artists, and other creative types. "It’s indicated that the IRS knows about this money, but you don’t know what to do about it. And you’re like, 'What the fuck is this?'"

Garofalo says he isn’t fond of the term the "sharing economy" because it leaves you with "a bunch of contractors with no rights" and "no price protections or benefits." Yet he says he has observed a sharp uptick in clients leveraging their rooms for additional cash since Airbnb debuted five years ago. And many of his customers are unsure of how they are being taxed.

Wait, What's A 1099?

As nice as it would be to keep what you earned from Uncle Sam, not reporting your income when tax season rolls around is both against the law, and easily traceable. At face value, 1099 self-employment forms aren’t very complicated: All they contain are your name, your address, your Social Security number, and the amount of money that the company reported to the IRS. Receiving one essentially means no taxes were taken out whenever you were cut a check. You're basically an entrepreneur. Congrats!

Furthermore, everyone from Amazon to Airbnb uses them, leaving it up to you to report your income. And if you weren’t saving funds as you went along, for example, the taxes you incur can be hefty. Chris Schultz, the CEO of Kung Fu, an upstart information broker designed to help independent contractors and companies understands worker’s rights, tells me that, assuming a 25% tax bracket and 15.3% self employment insurance, some people will be owing upwards of 40% of what they earned in Federal taxes. Which, yikes.

And if your freelance employer hasn't told you how your 1099 taxes work, that's not a bug—it's a feature.

These companies lean on independent contractors for all sorts of reasons that, depending on your vantage point, can range from nefarious to, well, a smart way to run a business. One of the reasons startups are hesitant to walk its contractors gently through the tax process is to distinguish themselves from a full-time employer. Huge penalties can be incurred if the distinction between a W2 employee and a 1099 worker isn’t clear. (It’s a lesson that on-demand house-cleaning service Handy is learning the hard way, when two contractors filed a lawsuit in California last November for allegedly misclassifying employees as independent contractors.)

"To maintain their workforce classification as independent contractors, [companies] need to be cautious about the training they provide to stay in compliance with the 20 point checklist the IRS guidelines provide," Schultz explains. "Not to mention, their lawyers and CPA’s probably advise against it."

Adding to the confusion is the fact that different companies dipping into the sharing-economy cookie jar can take radically different approaches. Lyft, for example, goes out of its way to make it abundantly clear from the outset that taxes are not withheld when drivers are paid. "Lyft provides a lot of basic guidance on their driver portal," says Ayanna Mack, a Lyft driver who recently started in Washington, D.C., "but they encourage drivers to be aware of their local tax requirements and unique factors that impact their individual reporting situations."

"As a driver I feel like they were very clear [about how you are taxed]," she adds.

While several of the Airbnb renters I talked to understood that their income was not being taxed at the outset, and were thus prepared for tax season, they felt they were in the minority. "I think I'm one of the only people I knew who expected that," says Zachary Mack, a New York-based writer and bar owner. "I had friends email me in a panic asking if the same thing had happened to me because they owed a lot of money in some cases." Mack says that Airbnb did not try to bury the fact that you are being taxed when you list your space for rental, while others said the company could be more thorough: Airbnb’s walkthrough on what’s income deductible (and what isn’t) is, shall we say, not very thorough at about a paragraph long. Here's what Airbnb recommends:

"We encourage you to consult a tax advisor for more details as there are many special rules in this area and we aren’t able to provide tax advice."
Why Airbnb Is So Confusing

Slapping a pink mustache on your Prius grill and chaperoning strangers to where they need to be is easy enough. It’s a relatively simple transaction, from Point A to Point B, financially speaking. Part of what makes Airbnb so confusing for some people, though, is that the rulebook for rentals is this big, opaque, multi-pronged mess that can change on a whim based on a number of factors: Whether you’re renting the whole apartment or just your room, how many times you do it in a year, what you can and can’t write-off. It’s sort of like a Choose Your Own Adventure, only the wrong decision might mean deducting a couple hundred extra dollars from your saving account.

"When it comes to your own house, the rules are just different," says Dan Hobbs, a former Goldman Sachs analyst who currently specializes as a tax advisor for the sharing economy, having authored a mouthful of an e-book called 2014 Income Tax Guide for Airbnb Hosts: Hosting Less than 15 Days a Year. (Phew!) "The real consequence is knowing what you can and can’t deduct."

Nicer furniture, for example, isn’t deductible, which is something to think about before your splurge for a Tumblr-ready Eames chair in the lounge. But say you sign up for a concierge service like You can leave a copy of your keys with, go on vacation, let them know when an Airbnb renter is going to swing by, gives them the key, and voila!—you incur a $50 fee. That’s tax deductible.

Confusing? You bet. So I asked Hobbs: What are some things an Airbnb renters should know?

"I’d say two things," he says. "One in general, if you rent your apartment for less than 15 days a year, it’s not taxable income. You don’t pay any taxes on a federal level. And if you do over that, it gets really complicated, because it’s treated as income."

And two? "If you live in a studio apartment or an entire apartment, that whole day’s apartment is tax deductible. If you only rent out the bedroom, only the size of the bedroom is going to be tax deductible. It doesn’t matter if you share a common area or anything else. That percentage of that days rent is going to be taxed."

Perhaps the wisest (and dare we say, most obvious?) thing anyone partaking in the pocket-padding graces of the sharing economy can do is familiarize themselves with how and when their services are being taxed from the outset. It's not free money. That way, when a 1099-K magically floats its way into your mailbox, you'll be prepared instead of surprised. And broke, probably.

Tuesday, January 27, 2015


If you make more than $125,000 a year, you will want to read on. A new tax as a part of the Affordable Care Act may mean you will owe more in taxes. The Health Care and Education Reconciliation Act has presented us the Net Investment Income Tax, referred to by many as NIIT or the super Medicare tax. This tax exposes the net investment income of individuals, estates and trusts to a 3.8% tax when their modified adjusted gross income exceeds certain threshold levels.

These levels are: $250,000 for married individuals filing a joint return, $125,000/each for married individuals filing separate returns and $200,000 for unmarried individuals and other cases. Trusts and estates have a much lower threshold for when this tax applies. This new tax is creeping up on many and there could be unpleasant consequences for those that don't comply.

This new tax calls for taxpayers to truly understand what constitutes net investment income. The obvious components are involved- interest, dividends, annuities, royalties and rents. These are just the tip of the iceberg and those that feel they could be affected by the tax should consult a CPA immediately to understand its complexity.

Interest, dividends, trusts and estates can all make their way to a taxpayer through a pass through entity and then maintain their net investment character.  The concept of “passive activity” also comes into play here. As income from passive business activities, this includes any capital gain from the sale of those activities, is generally subject to the NIIT, whereas income from nonpassive business activities generally is not. Bloomberg BNA summarizes this concept best, explaining that it stems from the IRS's passive activity loss rules, which prohibit taxpayers from deducting losses from so-called passive activities, or activities in which the taxpayer does not materially participate. These guidelines usually apply to the actions of the owner of the business interest, not the business itself, although special rules apply to real estate activities. When is your interest in a business not to be a passive activity? Again, according to IRS rules and regulations, you must materially participate in the operations of the business. Meaning, your involvement in the business operations is regular, continuous and substantial. The IRS regulations provide both quantitative as well as qualitative tests for meeting this requirement. For example, you will be materially participating if you work more than 500 hours during the year in the business.

Because the IRS passive activity rules apply to restrictions on deducting losses, taxpayers with positive income from passive activities may have had little reason to differentiate those activities from nonpassive activities. However, the distinction might become significant. For example, the IRS has rules that have allowed taxpayers to “group” related activities in order to determine whether the overall group represents a passive or nonpassive activity. Taxpayers with multiple business or real estate investments might be able to eliminate or reduce their exposure to the NIIT with appropriate decisions in this area.

The super Medicare tax will affect the tax returns of many people. Knowing the ins and outs of this new tax could save them thousands of dollars. Don't wait until your return is prepared to learn how this will affect you. Contact a tax professional today that is already well versed on 1411.

Monday, January 26, 2015

Getting Organized for Tax Preparation

The holiday season is behind us; our New Year’s resolutions are in place and now we must get ready to meet with our tax pro to file 2014 income tax returns. If you started a 2014 income tax file at the beginning of last year and have been filing away important tax documents throughout the year, you may find the task will not be too daunting. The backup data you require will be at your fingertips. If you kept your personal finances on an accounting program such as QuickBooks or Quicken, you will be able to generate reports that provide the data your tax professional requires to prepare your income tax return.

But if you must sit down instead and review your check registers and other receipts, the following tips should help you get organized quickly.

Start by labeling a file folder “2014 Income Taxes” to hold copies of cancelled checks, credit card statements and other back up data for the numbers you will be using on your tax return.

If your tax pro sent you an organizer, it is best to complete the appropriate fields within the organizer and return that along with your back-up documentation. But if you, like so many others, have your own system and do not use the organizer, then plow ahead compiling your data as you did in years past. Remember however, that your tax preparation fee is based on how organized you present your data as well as on the number of forms involved and the complexity of your tax situation. If you provide your tax pro with well-organized, complete, and totaled data, your fee may be lower. Discuss your presentation with your tax pro for organizational tips.

Most organizers have boxes to fill in with the information from your W2. Do not bother to fill in that data. Instead, simply staple your W2(s) to that page in the organizer. If a client presents me with a W2, I input the data directly from the W2. I never bother with what is listed on the organizer; there may have been transpositions or incomplete fields. The same principle applies to all other data requests that are backed up with 1099s or K-1s. Simply provide the document.

This will save a lot of time doing copy work.

In lieu of using the organizer you might prefer a spreadsheet program that can list all data and provide accurate totals. Refer to the organizer to make sure that you have not missed an important reportable item. The organizer normally contains columns with prior year data. This will jog your memory as to what deductions to look for as you review your financial data.

This year, because of Obamacare, there are two additional tax forms that may be required to file with your tax return. Your tax pro will likely provide an ACA questionnaire or worksheet for you to complete along with the organizer. If you did not have health insurance coverage for the entire year, you may be required to pay a penalty. Your tax professional will need dates of coverage and amounts paid listed by month in order to make the calculation or to determine if you are exempt from the penalty. Because tax pros have been put in a position to police the Affordable Care Act, your tax preparation fees will likely be slightly higher than last year. If you or your employer provided health care coverage for the entire year, you will not be required to break down the monthly costs.

As you organize your data think in terms of audit proofing your tax return. Make sure that you put receipts and cancelled checks in your tax file in the event of audit. Also be sure that all charitable contributions are backed up with an acknowledgement letter from the nonprofit. This is required and must be in place before filing the tax return. You cannot obtain the letter years later when you are audited. The IRS will disallow the deduction. If you have deductible automobile, travel and entertainment expenses – all red flags in the eyes of the IRS – be sure to have other documentation in your tax file to provide a bona fide tax deductible purpose for the expense. To substantiate automobile mileage you should have a mileage log, but absent that, you should have at least an appointment book or some other documentation showing dates, destinations, and number of miles traveled.

In this day and age, it’s rare to see an actual paper appointment book. Review your electronic calendar and on paper make a list of dates, destinations and miles driven to substantiate the expense. Keep this information in your tax file.

If you purchased or refinanced your home, second home, or a rental property during 2014, provide your tax pro with the settlement papers from escrow. There may be deductible items such as points or property taxes paid that provide a tax benefit.

Once you have compiled your data, review the organizer to ensure that you have completed all requirements for filing your return.

And start a tax file for 2015. If you take auto expense deduction, log in the beginning odometer reading from your vehicle. Then make a note in your calendar to log in the ending odometer reading on December 31. As the year progresses, file all documents, cancelled checks, and receipts in the tax file that are related to your 2015 income tax return. You’ll be pleased at how easy this will make tax preparation next year at this time!

Saturday, January 24, 2015

Seriously, start planning for 2015 tax returns now

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, January 23, 2015

Private College 529 Plan May Be a Smart Choice

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

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

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

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

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

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

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

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

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

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

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

Thursday, January 22, 2015

Dependency Exemption for Children of Divorced Parents

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

Wednesday, January 21, 2015

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

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

Tuesday, January 20, 2015

Due-diligence considerations for 2014 individual income tax returns


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

1. Do you own or use any virtual currency?

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

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

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

3. Did you receive a Form 1095-A?

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

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

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

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

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

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

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

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

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

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

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

5. Do you have foreign assets?

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

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

Standard questions

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

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

Monday, January 19, 2015

Retirement Plans for Young People: Know Your Choices

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

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

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

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

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

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

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

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

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

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

Sunday, January 18, 2015

Tax season is here again

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

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

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

Health care compliance

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

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

There are three possible scenarios:

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

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

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

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

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

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

Surf, don’t call

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

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

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

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

Avoid the audit

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

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

Faster refunds?

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

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

Friday, January 16, 2015

5 Great Tax Breaks for Investors

With tax season right around the corner, now is a great time to think about the deductions you'll take advantage of on your upcoming tax return and to start planning for the 2015 tax year. With that in mind, here are five great tax benefits for investors that can lower your taxes and boost your investment returns.
Losses are tax-deductibleOne of the best tax breaks available to investors is the ability to use investment losses to offset capital gains. For example, if you sell one of your stocks for a gain of $2,000 and sell another at a loss of $500, you can reduce the amount of capital gains subject to tax to $1,500.
You can deduct your losses from your taxable income even if you don't have any capital gains for the year. You can deduct up to $3,000 per year in investment losses, and any excess can be carried over to the next tax year. You can find the complete rules and guidelines regarding investment losses on the IRS website.
Long-term capital gains tax ratesIf you hold your investments for at least a year and a day, any profit you make on their sale will be considered long-term capital gains, and you'll pay a favorable tax rate on those gains. Meanwhile, if you sell investments in a year or less after buying them, any profits will be considered short-term capital gains, which are taxed at your ordinary income tax rate.
Here are the current rates, valid for both your 2014 and 2015 taxes.
Ordinary Income Tax Rate (Short-Term)Long-Term Capital Gains Rate
Roth IRAs and 401(k)sThere are two main types of tax-advantaged retirement accounts, and I believe Roth IRAs and Roth 401(k)s offer the best tax advantage, as they take the tax uncertainty out of investing.
When you contribute to a Roth account, your money is deposited on a post-tax basis, meaning you can't deduct contributions on your current taxes. However, all qualified withdrawals are tax-free. The big benefit here is that Roth IRA investors don't have to worry about what happens to tax rates in the future. By contributing today, you "lock in" the tax you pay on your retirement savings, which is your current income tax rate. Even if the income tax rate rises to 50% or more by the time you retire, it won't affect your savings at all.
Traditional IRAs and 401(k)sThese accounts allow you to contribute on a pre-tax basis, meaning that your contributions can potentially be deducted from the current year's taxable income.
If you have a 401(k) or similar plan at work, you can contribute up to $18,000 in 2015 on a tax-deferred basis ($24,000 if you're over 50). And with a traditional IRA, as with a Roth IRA, you can generally contribute up to $5,500 ($6,500 if you're over 50) on a tax-deferred basis, depending on your income and whether or not your employer offers a retirement plan.
The downside to traditional retirement accounts is that you'll have to pay taxes on your withdrawals in retirement at whatever your tax rate is at that point in time. However, if you would rather take the deduction on your current taxes -- particularly if you expect to be in a lower tax bracket in retirement -- they can be a great option.
Retirement savings contribution creditIf your income is below a certain level, the government will actually pay you to save for your retirement. For married couples whose adjusted gross income is less than $61,000, a credit is available ranging from 10%-50% of up to $4,000 in contributions (or $2,000 for single filers) to an IRA or employer-sponsored retirement plan. So a married can actually receive $2,000 just for saving for their future.