Friday, July 31, 2015

Review your estate plan against this 14-point checklist


Many Americans have estate plans in place — but unfortunately, many are incomplete and the most important subjects aren’t even addressed.
I compiled a 14-point checklist to help create a sound estate plan, but first, if you don’t have an attorney who specializes in elder law, I strongly recommend that you get one. Start by visiting The National Academy of Elder Law Attorneys website and click on the red “Find an Attorney” button. To search for a local attorney, try theAmerican Bar Association Lawyer Referral Directory.
And if you need a financial adviser, here are a few tips for finding a competent, honest financial adviser willing to work for a reasonable fee. To find a certified financial planner, use the CFP Board’s search tool. To consider a fee-only adviser that charges by the hour, try The National Association of Personal Financial Advisors.
Now, your estate plan should include:
  • A will.
A will provides instructions for distributing assets to your family and other beneficiaries.. You will also appoint someone to be an executor to pay final expenses, taxes, etc. and then distribute the remaining assets. If you have minor children, a will is also a way to designate a guardian for them. A will doesn’t take effect until you die and it cannot provide for management of your assets if you become incapacitated. That’s why it is necessary to have other estate planning documents in place which become effective if you should be unable to act.
  • A durable power of attorney designating who will handle your business affairs and health-care decisions if you are disabled or unable to act.
A power of attorney is a legal document in which you name another person to act on your behalf. You can give this person/agent broad or limited powers. You should choose this person carefully because he or she will be able to sell, invest and spend or distribute your assets. A traditional power of attorney terminates upon your disability or death. A durable power of attorney continues during incapacity and terminates upon your death.
  • A power of attorney for health care (living will).
A health-care power of attorney authorizes the person you designate to make medical decisions for you in the event you are unable to do so yourself. This document, coupled with a living will are necessary to avoid family conflicts and even court intervention should you become unable to make your own health care decisions.
A living will provides your wishes regarding the use of life-sustaining measures in the event of a terminal illness. It says what you want done and what you don’t want done but doesn’t give any individual the legal authority to speak for you. That is why it is usually coupled with a health-care power of attorney.
  • A revocable living trust to transfer, manage and distribute assets while you are alive and that will avoid probate after your death.
There are many different kinds of trusts, which are usually put in place to minimize estate taxes. Each trust has benefits and should be discussed with your attorney. There are marital trusts, charitable trusts, generation-skipping trusts, bypass trusts, testamentary trusts, qualified terminable interest property trusts, and so on.
A revocable living trust is a trust often used in estate plans. By transferring assets into a revocable living trust, you can manage your financial affairs during your lifetime and provide management if you become incapacitated. A revocable living trust lets trust assets avoid probate, keeps personal information private, and can designate the disposition of trust assets to future generations.
  • A form where you can list all your assets and where they are located.
  • A do not resuscitate, or DNR, medical order written by a doctor. It instructs health-care providers not to do cardiopulmonary resuscitation (CPR) if a patient’s breathing stops or if the patient’s heart stops beating. Some feel this is an important document while others don't.
  • A legacy letter. This is a document designed to pass “ethical values” from one generation to the next. Traditional wills involve what you want your loved ones to have. Ethical wills involve what you want your loved ones to know.
  • A discussion with your attorney involving whom you want to inherit various assets.
  • A decision as to whom you want making medical decisions if you are unable to act yourself.
  • A list of how you want your assets distributed. Have this discussion with your attorney and/or spouse or appropriate family member, trustee, etc.
  • A decision as to whether you want to name a guardian for your minor children, if any.
  • A discussion with your accountant/CPA and attorney as to the tax consequences of your estate plan.
  • Check your digital footprints. Most people aren’t aware of the full extent of their digital presence and a review of the steps necessary to protect online information after your death or if you are no longer able to act is warranted.
  • Letters to your spouse/family. Consider writing a letter to your spouse or family regarding your wishes should you need to be removed from life support. This letter will make their doing so a great deal easier if you reiterate that this is your wish with a personal, not formal, request.

Thursday, July 30, 2015

Business Succession Planning in the Current Tax Environment

Business succession planning in the current tax environment may require an adjustment in thinking from traditional planning. Traditional planning usually attempts to transfer ownership of the business to the next owner (often children) as early as possible to avoid significant entity value being included in the owner's estate for federal estate tax purposes. This type of planning was driven by a low estate tax exemption, high estate and gift tax rates and a low federal capital gains tax rate. The current tax environment may reverse this in certain circumstances.
The current tax environment has a higher estate tax exemption, lower estate and gift tax rates, stepped-up basis for income tax purposes for inherited property (the same rules as previously existed) and a higher federal capital gains tax rate. A married couple is allowed an estate tax exemption equal to $10,860,000 in 2015. The exemption, indexed for inflation, is projected to grow to $13,160,000 by 2024 – in less than nine years! On the other hand, the highest marginal federal capital gains tax rate is now 23.8 percent. This means that business succession planning for businesses under these larger exemptions, may be turned on its head.
For example, imagine Dad and Mom own a business they grew over the years, which is now worth $10,000,000. If they retain ownership of the business for their joint lifetimes, the business will pass tax-free to their children. Even better, the children will take a basis, for income tax purposes, in the business equal to its fair market value at the time of each death, even if that value is much larger than the investments of capital made by Dad and Mom, without any capital gains tax. That means, in addition to no estate or gift tax on the inheritance of the business, there also is no capital gains tax on the first $10,000,000 of value received in the event the children sell the business. Even better, if the business is a limited liability company or a partnership (in both cases, taxed as a partnership for federal income tax purposes), when the children inherit the business, the business is permitted to "mark to market" all of the assets of the business (and if there are not enough identifiable assets to "mark to market", to record goodwill for tax purposes). If the children wish to retain and operate the business, this means additional depreciation and amortization deductions for the business which will reduce the business's taxable income and the income tax liabilities of the children.
Traditional planning for business succession – often, sales or gifts of ownership interests to children (or grandchildren) – may not be tax efficient given the tax environment we now find ourselves in. Planning now requires thoughtful preparation to achieve tax minimization.

Wednesday, July 29, 2015

IRS scam calls and threats heat up this summer


On average, some consumers have lost $5,000 or more to demands from people who pretended to be from the IRS. Many know to hang up but others run scared and pay up.

A guy with a digitized voice called my home the other day and said his name was Steve Martin. Or that’s what he seemed to say.

He claimed he was calling with an enforcement action executed by the U.S. Treasury.

“I advise you to cooperate,” Steve Martin said. “Help us to help you.”

He did not call me a “wild and crazy girl” so I am confident that this voice was not Steve Martin, the actor, comedian and author. No way.

Yes, the IRS-impersonation collection calls are filling up the landlines once again. I’ve heard from readers in Detroit, Florida, Texas and elsewhere who told me that they started getting these calls again in July.

And there’s a new twist: The con artists aren’t just dialing for dollars. The crooks now could be mailing or faxing falsified forms, too, according to the Internal Revenue Service.

Once again, IRS impostors are dialing for dollars

“Taxpayers need to know that scammers have started sending fake documents to trick people into sending money or ‘verifying’ their personal information,” said Luis D. Garcia, an IRS spokesman in Detroit.

If you verify information, that data can then be used to commit tax refund fraud and file a fake tax return using your name and ID.

The Federal Trade Commission put out a consumer notice in mid-July saying that scammers are out there impersonating the authorities — the IRS, the U.S. Treasury, local police, the Federal Trade Commission.

If they claim to be from the FTC, they might say they’re calling to help you recover money lost to a scammer. How nice, they want to help.

Tax scammers get bold with 'Get Transcript' accounts

In Oakland County, the local police in Beverly Hills said numerous residents had received phone calls this summer from a recording stating that they will be called before a magistrate for money owed for federal income taxes.

“The recorded voice has an ethnic accent. Do not reply or return any messages that have been left of this nature,” the police told residents in an alert.

For many of us, all those crazy calls are annoying but we’re not loading up cash on a prepaid money card or wiring money via Western Union. We get it. We’re working and hauling kids to swim meets. We’re not dealing with oddball callers or falling for this IRS scam.

The problem, though, is some people do get caught and that’s why the scammers keep calling.

“We have residents send money probably six to eight times a year,” said Public Safety Lt. Michael Vargas in Beverly Hills. “The last case was around $6,000.”

Eastpointe police said one elderly resident who was scammed out of more than $8,000 in July.

Deputy Chief Eric Keiser in the Eastpointe Police Department said the caller claimed that back taxes were owed to the U.S. Treasury and threatened that the person would be taken to jail if payment wasn’t immediately received. The resident was first to mail prepaid gift cards to a Treasury address in Washington, D.C., but then the callers had the resident send a MoneyGram to a Walmart in Florida.

“The Treasury will not send people out to arrest you for not paying your taxes,” Keiser said. “You don’t get calls out of nowhere from the Treasury.”

Keiser said people should call their local police if they believe they’re dealing with a suspicious call first before sending money. Again, the Treasury isn’t going to ask anyone to wire money to a Walmart or send prepaid cards to Washington, D.C.

Nationwide, about 3,052 individuals fell for this scam and ended up paying $15.5 million, according to the Treasury Inspector General for Tax Administration’s report to Congress. That data is from Oct. 1, 2013, through March 9, 2015. So scammers could have picked up more than $5,000 per victim on average. But the highest loss reported by one person was $500,000.

Reports of the phone impersonation scam began in August 2013 but the scam has grown into the “largest, most pervasive impersonation scam in the history” of the Treasury Inspector General’s office.

The agency noted that as of Feb. 28, the top five states by dollars lost by victims were California ($3.84 million), New York ($1.35 million), Texas ($795,884), Florida ($760,000) and Virginia ($648,363).

It’s not just the IRS scam, of course, where the phone or computer can lead to trouble.

I spoke with a reader last week who told me he’s spent up to $3,000 so far sending money, not to the IRS scammers, but to others pretending to be experts or officials from a computer company. He knows he’s being ripped off, he said, but he’s afraid of what could happen if he does not pay up.

The most recent caller demanded $199 to unlock his computer that appears to have been hit by ransomware. Experts advised him that he’s likely better off not paying it and getting a new computer with good security software and stick to safe Internet usage.

What many of these scammers do, of course, is try to speak with authority. They can even have some information on you that makes them sound more legitimate, maybe the last four digits of your Social Security number.

And they often have caller ID set up to make it appear that it’s a legitimate IRS phone number when it is not.

A sure sign of fraud, though, is if the caller starts making aggressive threats and demands that you pay up immediately. Another sign of a scam: Someone asks for credit card or debit card numbers over the phone or threatens to have the local police or other law enforcement groups have you arrested for not paying up.

Sometimes, people fear that if they don’t pay up they’ll owe even more money somehow. Or the elderly could fear losing their independence if they somehow end up in trouble with the IRS.

Nancy Willaford, who lives in San Antonio, told me that she received a scam call last spring in which the caller said she owed $3,598 in taxes for audited years from 2008 through 2013. If she didn’t pay, the caller threatened her with a lawsuit and a fine of $30,000 plus five years in jail.

Willaford didn’t pay because she knew it was a scam.

“My heart goes out to all the families who may fall for this scam,” Willaford said. “I can see where your mother or mine will fall into their hands out of fear of their well being.”

Willaford noted that the callers can be particularly abusive.

“These guys are brutal, ultimately threatening, rude and foul-mouthed,” she said.

Once again, it’s important to recognize that the IRS will not call you to demand immediate payment or tell you to put money on a prepaid debit card. The IRS will mail you a bill first if tax money is owed. But again, make sure to call the IRS before you pay anything. If you think you might owe taxes, call your tax preparer and the IRS at 800-829-1040. Or read more on the alerts at

If you do not believe you owe any taxes and think you’re being scammed, you can report the incident with the Treasury Inspector General for Tax Administration or TIGTA at 800-366-4484 at the integrity hotline. Consumers also can file a complaint at Add the words “IRS telephone scam” to the comments in your complaint.

Robocall technology is increasingly being used, like the call I received recently. And yes, some claim to have some regular sounding names, like Nicki Johnson, Steve Smith or even Steve Martin.

Best bet: Don’t bother to call them back if they leave a message. Simply hit delete

Tuesday, July 28, 2015

Your Home: 4 Tax-Smart Moves

For many people, a home is one of their most valuable assets. As such, it needs to be factored into your estate plan. Traditionally, homeowners have focused on limiting estate tax. Now, they need to shift their focus to saving on income tax. The reason: The estate tax exemption has climbed to $5.43 million per person (or $10.86 million for married couples), thereby making estate taxes less of an issue. Meanwhile, capital gains tax rates are at their highest in many years, and many people nearing or in retirement are living in homes that have increased enormously in value.
For example, assume Harry, 65, and Sally, 67, paid $300,000 many years ago for a house that's now worth $2 million. If they sell today, they would owe tax on a $1.7 million gain.

If Harry and Sally have lived in the house for at least two of the five years before the sale, they qualify for a special tax break that is available to homeowners who sell their principal residence (but not vacation homes): The first $250,000 (or $500,000 for married couples) of their gain on the sale is not subject to tax. That still leaves Harry and Sally with a taxable gain of $1.2 million. Including the 3.8% net investment income tax that took effect as a part of the Affordable Care Act, Harry and Sally would be taxed on that gain at a 23.8% rate, and owe Uncle Sam $285,600.
Various tax-saving maneuvers can help this couple--and others like them--reduce that bite.

If You Can Afford to Keep the HouseIf you leave the house to your heirs, they can avoid most, if not all, of the capital gains tax you would have to pay if you sell the house yourself. That's because with most assets, including real estate, inheritors can "step up" their tax basis to whatever an asset was worth at the original owner's death. This enables them to sell a highly appreciated home without being taxed on the gains that occurred before they inherited it.

If you need to move out of the house--say it has become unmanageable, or you want to relocate--consider renting your house. Renting would provide an income stream to help cover current living expenses--and avoid capital gains tax.

If One Spouse Is in Poor HealthBecause of health issues or a significant difference in age, sometimes you are fairly certain whether you or your spouse is more likely to die first. If your home has appreciated significantly in value, it might make sense to have it owned solely by the spouse whose death is more likely to occur first. This enables the spouse who inherits the home to take advantage of the step-up in basis.

Provided your spouse is a U.S. citizen, you can give an unlimited amount to him or her during your life or through your estate, with no tax applied--this is known as the unlimited marital deduction. If a couple owns the home jointly, the healthy (or younger) spouse ought to transfer his or her interest to the other.

One important condition applies: If your spouse transfers the assets, you die within a year, and your spouse inherits the same assets back, there is no step-up. This provision in the Internal Revenue Code prevents a healthy spouse from transferring everything to a dying spouse (with no gift tax) and getting it back with a basis step-up (and no estate tax).

In this respect, spouses have an advantage in community property states: When the first spouse dies, both halves of community property get a step-up in basis. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Two other states, Alaska and Tennessee, also have community property, but you have to "opt in" to it, and in Tennessee the property must be held in trust.

If You Want to Become a RenterBy converting your personal residence or vacation home into a rental property, you can position yourself to do what's called a Section 1031, or like-kind, exchange, and avoid paying capital gains tax.

This strategy, named for a section of the Internal Revenue Code, involves a swap of one investment asset for another--something that would ordinarily be taxable as a sale but isn't if you meet certain conditions, says Stephen J. Small, a Boston lawyer and the author of books on preserving family lands. First, you must move out of the house and rent it for a decent period of time (more about that below). After that, if you sell the rental property and buy another one of equal or greater value, you don't have to pay capital gains tax. (If the house you're selling has a mortgage, the mortgage on the new house must be for the same or a greater amount.) Any differential creates some gain--what's called "boot"--that's generally taxed as capital gain.
Not surprisingly, those who try to get cute with the rules tend to lose their battles with the IRS, so it's best to have a tax pro to guide you through the formalities. Nor is this a strategy for the sharing economy--for instance, when people rent their homes temporarily while they travel, says Stefan F. Tucker, a lawyer with Venable in Washington, D.C. Rather, "you must be able to show it's a bona fide investment property" and no longer your personal residence. He advises clients to rent the home for at least a full calendar year and part of another (for example, from September until the following December). Likewise, the new property that you buy must also be an investment, rather than a personal residence.

If You Anticipate a High-Income YearLet's say you expect your income will be higher than usual--perhaps because you plan to sell a business, exercise employee stock options, start drawing on retirement funds, convert a traditional IRA to a Roth, or take deferred compensation. Donating your home to charity in the same year as this income spike saves capital gains tax and entitles you to a tax deduction, which can reduce what you owe. For real estate, that deduction can equal up to 30% of your adjusted gross income, and any deduction that can't be taken in the year of the donation can be carried forward up to five years.

People who want to create an income stream for themselves or family while benefiting charity might consider a FLIP unitrust, says Lawrence P. Katzenstein, a lawyer with Thompson Coburn in St. Louis. Here's how it could work, again with Harry and Sally: They put their house into a charitable remainder trust. The trustees sell the house and invest the proceeds in a diversified portfolio. Starting in the year after the sale, the trust, as provided for in the original trust document, starts paying Harry and Sally, as trust beneficiaries, annual income expressed as a percentage of the fair market value of the trust assets revalued each year; in today's investment environment, 5% would be typical, Katzenstein says. This income stream continues until both Harry and Sally have died, at which point whatever assets remain in the trust go to charity.

Because the trust is a tax-exempt entity, it doesn't pay tax when it sells the house, so Harry and Sally save the capital gains tax they would otherwise have to pay. In addition, when they make the donation to the trust, they would get a current income tax deduction for the value of the charity's remainder interest, which in their case is $702,020, says Katzenstein. The deduction is based on their ages, the number of life beneficiaries (the older you are, the larger the deduction), the value of the property, and an assumed interest rate set by the IRS. If the house is sold for $2 million and the assets, as invested, hold steady at that amount, the 5% yearly payout to Harry and Sally would be $100,000. If the value of the trust assets fluctuates, so will the dollar amount paid to Harry and Sally each year.

A few caveats apply. To steer clear of various tax law restrictions, the property that is being donated should not be mortgaged, and you must move out before putting the house in the trust. In addition, beware of what's called the pre-arranged-sale rule. It prohibits you from making a commitment to sell a noncash asset, including real estate, before giving it to charity. If you violate the rule, you must pay tax on the gain.

Sunday, July 26, 2015

Divorce Has Tax Traps - Get Some Advice


When Christina Mehriary entered into a marital settlement agreement with Bradley Williams, the agreement included language that advised the parties to seek the opinion of a tax professional as to the tax ramifications of the agreement.  Talk about closing the barn door after the horse has left.  At any rate the $4,000 per month for 60 months that Ms. Mehriary was required to pay Mr. Williams as non-modifiable alimony, does appear to pass muster as deductible to the payor and taxable to the payee and lasts long enough to not trigger the alimony recapture rule.

In the marital settlement, Mr. Williams had received the marital residence and Ms. Mehiary had received another residence.  She transferred the second residence to Mr. Williams in lieu of $80,000 in alimony payments.

Unscrambling An Egg

I’m sure glad she wasn’t my client, because I still have a headache trying to figure out the right way to account for that transaction.  Ms. Mehriary took an $80,000 deduction on Schedule A, because the insurance company had indicated that the property was an investment property.  Not only is that clearly not the right answer, it is not even the most beneficial answer.  If you were going with that sort of theory, you would need to consider the basis in the property, but of course this is in conjunction with a marital dissolution, so no gain or loss is to be recognized.

Ms. Mehriary’s fallback position was to take an alimony deduction for the $80,000.  I’m still getting a headache trying to do the debits ad credits of that one, but Tax Court judges are not accountants and don’t have to trouble themselves about such thing.  The reason that it does not work is simple. Alimony to be deductible has to be paid in cash or its equivalent and a house is not a cash equivalent.

Petitioner’s argument that the transfer of $80,000 (the fair market value of the Sweet Briar property) was deductible as an alimony payment fails because it was not a payment in cash. Instead the transfer was a transfer of property and therefore does not constitute an alimony payment. Although petitioner and Mr. Williams agreed that petitioner’s transfer of the Sweet Briar property would replace $80,000 of petitioner’s alimony obligation, the intent of the parties does not determine the deductibility of a payment as alimony under section 71. See Okerson v. Commissioner, 123 T.C. 258, 264-265 (2004). Instead the test for [*7] whether a payment is deductible as alimony is a straightforward, objective test that rests entirely on the fulfillment of explicit requirements set forth in section 71, including that the payment be made in cash or a cash equivalent.

The bottom line ends up being a property transfer incident to the divorce.  No deduction for Ms. Mehriary and no income pickup for Mr. Williams.  Of course, we don’t know how Mr. Williams accounted for the transaction.  Hopefully the taxpayers did not get whipsawed.

Insult To Injury

The IRS asserted the accuracy penalty and the Tax Court backed them up.

Petitioner set forth no specific facts to show that she acted with reasonable cause and in good faith. Petitioner was advised to seek the opinion of a tax professional when she signed her marital settlement agreement, but she did not offer any testimony or other evidence to show that she relied on professional tax advice. See sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner merely testified that [*9] she relied on her insurance company’s characterization of the Sweet Briar property as investment property. The insurance company did not provide tax advice, and the record does not reflect that it ever represented itself as a competent professional.

 Thoughts On Return Presentation

The AICPA standards of tax practice prohibit me from giving audit lottery advice, but you are not my client, so I think I am safe in making this observation.  If Ms. Mehriary had taken an alimony deduction on her originally filed return, there is a very good chance she would have slid through even if Mr. Williams had not picked up income equal to her deduction.  The IRS computers match up the alimony deductions to the income pickups, but the Service cannot  just send out a bill for a mismatch, since it doesn’t know who is right.  According to a TIGTA report, in 2010 there were over a quarter million mismatches and the IRS opened examination in just over 10,000 cases.

On the other hand, a nice round $80,000 deduction on Schedule A sticks out like a sore thumb.  Ms. Merhriary represented herself in Tax Court, which makes me suspect that she prepared her own return.  I think that almost any preparer, even one who is technically weak, would not have gone with Schedule A.  I have to admit that I’m not sure where I would have ended up.  I do think the Tax Court has it right, but I am curious as to how another preparer might have handled this situation if Ms. Mehriary had plopped it on his or her desk.

You’ve Come A Long Way Baby

You youngsters will have to forgive me for this observation.  You have to remember that I am old enough to remember the “Want Ads” being divided into three section – “Help Wanted Male”, “Help Wanted Female” and a generally smaller gender neutral section.  At any rate for many years I have at least looked at every single Tax Court decision and those concerning divorce have been of particular interest to me.  This is the first time I have noted a decision about a woman paying alimony and being denied a deduction .  I’d have to do more research than I am inclined to do to determine whether this is an actual milestone, so I will leave it at that.

Saturday, July 25, 2015

4 keys to Roth conversions

In recent years, vast numbers of people have become eligible to 
consider Roth conversions. They include high-income people who were not eligible for Roth conversions prior to 2010 and millions of people who have become eligible to convert money to employer-sponsored Roth 401(k) accounts since they became available in 2006.
At least once every two years, financial advisors should have a “conversion conversation” with clients, to review and evaluate conversion options:
·       From Traditional IRAs and SEP-IRAs to Roth IRAs and From SIMPLEs to Roth IRAs, after two years of plan participation

The conversation need not be complex or lengthy, because there are just four key points that usually prevail in conversion decisions. Here’s the conversation, in a nutshell:
“Mr. and Mrs. Client, if you would like to consider converting part or all of your plan money to a Roth, there are four key issues you should evaluate.
Key #1 – Liquidity – To make the conversion work, you generally need enough liquidity to avoid tapping the Roth IRA for at least five years. To keep all your retirement plan assets working, you may want to pay the income taxes (on the conversion) with other money.
Key #2 – Income Tax Rates – If you think income tax rates will go higher in the future, a conversion can be attractive because it lets you lock in today’s tax rates. It’s important to plan conversions so that they don’t push your taxable income into a higher bracket, or subject your net investment income (excluding retirement plan income) to the 3.8% Medicare tax.
Key #3 – Retirement Freedom and Flexibility – How do you want to spend retirement? Choice A: You can estimate the required minimum distributions due each year (after age 70 ½). Choice B: You can write yourself a tax-free check from your Roth if and when you need it, and never face a required distribution as long as you live. How important is the quality and simplicity of retirement living for you?
Key #4 – Leaving Your Heirs “No Tax Strings” – With a Roth conversion and a little planning, you can make sure your beneficiary inherits an IRA with no income tax strings attached. This is opposed to leaving the beneficiary a Traditional IRA or 401(k) that could be fully taxable as ordinary income.
To brush up on the rules for Roth conversions, you may want to check the IRS FAQs on Roths.

Friday, July 24, 2015

8 Ways to Avoid a Nanny Tax Nightmare


Want to know how people who pay domestic helpers under the table get caught for dodging the IRS? They run for office. Or get put on a list of potential nominees for a high-profile cabinet position.
At least that's what brought into spotlight the tax laws related to employing domestic workers -- as in, there are actually laws about this stuff: In the early 1990s, we were reminded that if you hire a home helper that qualifies as your "employee" (according to IRS rules) but fail to pay employment taxes, your nomination for U.S. attorney general is pretty much toast.
So learned Zoe Baird, Bill Clinton's nominee for the position, when it was discovered that she and her husband had employed undocumented immigrants as domestic workers and -- on top of that hot-button issue -- failed to pay employment taxes.
Baird's name was subsequently crossed off the short list, as was Clinton's second choice for the job for similar reasons.
The term "nannygate" entered the popular lexicon and eventually Janet Reno (who had no children and, evidently, did her own dishes and yard work) was confirmed. 
"But everybody's doing it!" is not a good excuse in courtPerhaps you don't have political aspirations. Or you don't often apply for jobs where potential employers comb through your tax returns and probe into your household staffing business. Most people don't, and maybe that's why it's estimated that 75% to 95% of people who employ nannies, sitters, housekeepers, and home health aides don't bother paying employment taxes.
Still, it is the law. And even if the prospect of getting caught is slim, no one wants to intentionally run afoul of the IRS.
So, you need to figure out if the helpers you hire qualify as employees:
First, the good news: Your spouse, your parents, your child under the age of 21, and the neighbor's kid who is under the age of 18 generally aren't considered formal "employees" in the IRS's eyes, even if you pay them cash (on top of your deep gratitude and undying love) and they do the work of a small army.
Now, the other news: With respect to complete strangers, acquaintances, friends, and people who are old enough to vote: If in 2015 you pay someone $1,900 or more annually for household help, pay them directly (and not through an agency), dictate when and how they do the job and provide the tools they need for the work, and they are not operating as a small business, sole proprietorship, or contractor and don't offer the same services to the general public, then you, my friend, are an "employer." And like any employer, you're responsible for paying Social Security and Medicare taxes on the wages you pay your household help. (Here's more on what qualifies someone as a household worker and the rules straight from the source, IRS Publication 926.)
The price of breaking nanny tax lawsWhile many people inadvertently (or "unknowingly") ignore the rules and pay their home helpers under the table, you're doing yourself and your employee a disservice. And if weak moral fortitude and sleepless nights caused by living a life of lawlessness aren't reasons enough to follow the nanny tax rules, perhaps the following will change your mind.
According to, failure to pay employment taxes (e.g., the nanny tax) can cost on average $25,000 in penalties and interest. Not only that, but when you don't report the wages you pay, your employee has a harder time building their employment history, will have a less comfortable retirement because they won't get all the Social Security and Medicare benefits they've earned, and when you no longer need their services, they may not qualify for unemployment benefits.
 8 rules to prevent a personal nannygate scandalThe goal here is to avoid doing something stupid that will trigger an IRS audit, ignite tabloid headlines, or generate an exorbitant bill from the IRS for back taxes and penalties. Here are eight things to do to keep your hiring practices aboveboard:
Make your status as an "employer" official: Establish yourself as a law-abiding employer with the state and the IRS by applying for an Employer Identification Number via Form SS-4to use for all employee-related paperwork, reporting, and tax returns.
Decide how you will pay Social Security and Medicare taxes: Uncle Sam's cut of employment taxes is 15.3% of cash wages. You are required to pay at least half of that tab (7.65%) with your employee paying the other half (which is done by withholding it from their paycheck). However, many employers pay the worker's share. So determine how you want to handle that. Also, find out if you are on the hook for state income taxes.
Keep good records of when you paid and how much: Depending on when you pay your employee, you might owe more in taxes. IRS rules stipulate that if you pay $1,000 or more of their salary in any calendar quarter, you'll owe federal unemployment tax (and perhaps state unemployment tax) on top of the Social Security and Medicare taxes you're required to pay.
Fill out and file the right forms: Welcome to the world of being a boss! Part of the job is making sure Uncle Sam is kept in the loop. That means completing a bunch of forms for yourself and submitting some for your employee. All of these forms are available's employment tax form area:
  • Form I-9: When you hire someone, have them show you their Social Security card and fill out this form to establish their employment eligibility. If they don't have a Social Security number, they must file Form SS-5 to get one.
  • Form W-2: This is the wage and tax statement. Copy A (along with Form W-3) gets filed with the Social Security Administration. Copies, B, C and 2 go to your employee for their records and to file with their tax return.
  • Form W-3: This is essentially a summary of what you, as an employer, paid out in wages during the tax year and also amounts that were withheld for (for Social Security and Medicare). The numbers should match what is reported on the W-2 (if you had only one employee) or, if multiple people were on the payroll, the totals from all W-2 tax forms should equal the amounts reported on the W-3 statement.
  • Schedule H: This lets the IRS know which employment taxes were withheld from the employee's paychecks (if you did not cover the full amount) and which ones you paid. File it along with Form 1040 when you send in your federal tax return.
  • Form 1040: This is the basic form where you report your annual income taxes. When you file your federal tax return, attach Schedule H to this form 1040.
Pay your tax tab to the IRS throughout the year: Yes, in most cases you can pay all the taxes you owe at one time. But a better idea to avoid underpayment penalties or getting socked with a bigger-than-expected tax bill is to pay the IRS its due throughout the year. You can do this either by withholding more from your paycheck if you're earning income (via your W-4) or making estimated tax payments during the year using Form 1040-ES.
Mark your calendar for January: Just like your boss mails you a W-2 showing what you earned and what taxes were paid for the previous year, you must provide the same for your employee so they can do their taxes. You must deliver this in a timely fashion so that your employee can complete their tax return by the April deadline. As noted above, you'll also send a copy of the W-2 and W-3 to the Social Security Administration.
Don't try to dodge the issue with Form 1099: Form 1099 is how employers report what they paid to independent contractors. Trying to pass off your live-in nanny as an independent contractor isn't going to fly. IRS rules are pretty clear that nannies are almost always employees, not contractors.
Don't assume you won't get caught: Look into the future to a day when someone who worked for you files for unemployment, Social Security retirement, or disability benefits or Medicare. That's when your nonpayment into those programs may come back to haunt you. And if they do come to light, you'll be forced to pay back taxes, penalties, and interest. 

Thursday, July 23, 2015

The importance of tax planning for retirement

For most Americans, the two largest sources of income during retirement are Social Security benefits and retirement savings account, such as their 401(k) and Individual Retirement Account (IRA).
Most people are aware that withdrawals from a traditional IRA and 401(k) are fully taxable as normal income in the year these funds are distributed.
What may not be apparent is that there are special rules for determining if Social Security benefits are taxed, and by how much.
Under the tax rules, Social Security benefits will be subject to tax if the taxpayer’s provisional income exceeds certain income levels.
Provisional income, by definition, is the Adjusted Gross Income from the IRS Form 1040 plus nontaxable interest plus half of of Social Security Benefits. The end result determines whether there is no tax on the Social Security benefits, or if 50 percent or 85 percent of these benefits will be taxed. Under current tax law, 15 percent of Social Security benefits are tax free for everyone.
A taxpayer filing as single with a provisional income between $25,000 and $34,000, and married taxpayers filing jointly with a provisional income between $32,000 and $44,000 will pay taxes on 50 percent of their Social Security benefits.
A single taxpayer with provisional income over $34,000, and married taxpayers filing jointly with a provisional income over $44,000 will pay taxes on 85 percent of their Social Security benefits.
It should be noted that these income thresholds are not indexed for inflation and have been at these levels for many years.
So what is the problem?
If an individual is receiving both Social Security and income from a qualified retirement plan, he or she may be creating more tax liability than anticipated.
For example, if a single taxpayer withdraws just $2,000 monthly from his or her retirement plan in addition to Social Security, this taxpayer automatically causes 50 percent of their Social Security benefits to be taxed.
Married taxpayers filing taxes jointly have the same problem if they’re withdrawing about $2,500 monthly in addition to Social Security.
The more that’s withdrawn from a retirement plan, the higher likelihood of up to 85 percent of Social Security benefits being taxed.
For this reason, it is important for an individual or married couple to do some serious retirement and tax planning. With careful planning, it may be possible to significantly reduce or eliminate the taxation of Social Security, and perhaps even on retirement plan withdrawals.
Roth conversions
Re-characterizing IRA and other pre-tax retirement account funds to a Roth involves withdrawing these funds and re-depositing them into a Roth. The conversion requires paying taxes on the funds that are being re-characterized, so this wouldn’t necessarily be a step done in a single lump-sum, but rather gradually over time.
For this same reason, the taxpayer would not want to make this conversion the same tax year they were starting to receive Social Security benefits.
A second tax planning strategy involves postponing Social Security and subsequently “Spending Down” the IRA or other pre-tax retirement plan.
This strategy may be best suited for those individuals retiring early and who were considering drawing Social Security prior to their full retirement age (FRA), since any additional employment income prior to FRA could be penalized.
Spending down an IRA
Delaying Social Security can result in higher payments in the future, which could be advantageous to both the Social Security beneficiary and could have potentially higher benefits for his or her spouse.
The reduced retirement account balances could result in lower required minimum distributions after age 70 ½ as well, which could result in lower overall future income which would then include Social Security.
The drawbacks of this strategy include the fact that Social Security is only payable for the life of the beneficiary, whereas the retirement account values can be passed on to beneficiaries.
Should an individual not live long enough to realize the benefits of postponing Social Security, the overall result could be less overall income being passed to a surviving spouse or other beneficiary. Life insurance, however, could be built in as a replacement for these lost benefits in the event of a premature death.
Retirement planning has traditionally involved determining how much income would be needed at retirement, and creating a program of saving. The potential impact of taxes into this planning equation requires extra steps and consideration to be included in this process.
No taxpayer wants to pay more taxes than is necessary, and that is especially true in retirement when sources of income are limited.
We do not know what changes may take place with respect to the tax laws in the future. Every pre-retiree should build this tax planning into their retirement plans.
Speak with your tax professional and financial planning professional and create a plan for your retirement.

A little planning now may save you a lot of tax grief in the future.

Wednesday, July 22, 2015

Tax Secrets: Get a second opinion


Sometimes writing this column is a joy.  The joy expands into fun when the reader/caller wants a second opinion.
Well, following is the fun story or a reader (Joe), who called with a problem. Joe has been working on a combination lifetime/estate plan for years with his professional advisers. The plan just couldn’t seem to get done. Joe wanted to get a second opinion on what was in place and finally finish the plan.
Joe’s goals have two time frames — (1) during his life and (2) after his death. His lifetime goals are: keep working, but at a slower pace, until the day he dies; keep the business (Success Co., a C Corp.) growing; build his management team that handles day-to-day operations; minimize income taxes; and not sell the business. His afterlife goals are: keep the business in the family (his two business sons would own it 50/50 after Joe’s wife Mary died) and minimize estate taxes. One of Joe’s sons, a doctor, will never be active in the business.
Joe’s present tax plan would beat him up in two ways: (1) income tax wise and (2) at his death, Success Co. would probably have to be sold to pay taxes and to avoid putting the bulk of his wealth (Success Co. currently represents about 65 percent of his wealth and grows in value every year) at economic risk. Success Co. was professionally valued at $16 million.
Following is a list of some of the tax-saving techniques — with the help of my network of professionals — used to help Joe accomplish his goals. Most of the techniques are designed to keep Joe in control (including Success Co.) of his personal wealth, for as long as he lives, reduce the value of Success Co. for estate tax purposes, and slash overall taxes.
1. Success Co. elected S Corp. status. Joe will get S Corp. dividend via an IDT (see 4 below) each year without suffering a second income tax, supplemented by withdrawals from his profit-sharing plan, to assure maintaining his and Mary’s lifestyle.
2. All new equipment (to be purchased by a new LLC, owned by Joe) will be leased to Success Co.
3. All insurance policies (over $4 million) on Joe’s life owned by Success Co. were transferred to Joe and then to an irrevocable life insurance trust, (Both transfers are income tax-free and get the insurance out of his estate and Mary’s estate).
4. Success Co. was recapitalized: 100 shares of voting stock and 10,000 shares of nonvoting stock. After various discounts allowed by the tax law, Success Co.’s value was reduced by 40 percent, reducing the $16 million valuation to $9.6 million (really the value of the nonvoting stock) for tax purposes. Joe sold the nonvoting stock to the intentionally defective trust (IDT) for $9.6 million. He was paid with a note from the IDT for $9.6 million (to be paid from future earnings of Success Co.). Under crazy American tax law, all payments received by Joe to pay off the note (both principal and interest) will be tax-free.
5. Joe will control Success Co. for life via the voting stock.
Joe’s family will save about $160,000 a year in income taxes and payroll taxes. The potential estate tax liability will be reduced from over $4 million to under $500,000 (will be paid with the tax-free life insurance proceeds).