Tuesday, May 31, 2016

Gift or loan? Parents give kids money to buy a home

A husband and wife may give a child and son/daughter-in-law a total of $56,000 per year without triggering tax issues ($14,000 per donor to each one).

The IRS will presume an interest rate on a loan between parent/child even if there is no stated rate. Thus, the parent may unwittingly receive interest income that is not wanted/needed unless a gift of the interest is made to the child.

Rather than go to a tax preparer, complicated matters such as this should be planned with an accountant or estate planning attorney.

You can't count on a storefront tax preparations service company to consider all the nuances.
We think you are referring to a column where a parent was asking about gifts or loans to children when they are buying a home. You are correct that a father and mother can gift $56,000 in one year to a child and his or her spouse or partner without triggering any tax consequences with the IRS.
However, the issue in the question was whether they could give their kids a loan. Presumably, the parents wanted their kids to pay back the money that they were given toward the purchase of their new home.

Again, there are competing interests when it comes to buying a home and receiving gifts and/or loans from parents. The lender wants to see gifts to the kids with no obligation to repay. The parents may want to see it as a loan. The parents want to get repaid, but the lender doesn't want to see that as an obligation.

The underlying issue is the debt-to-income ratios the children have when they purchase a home. If the children receive the money as a loan, they may not be able to borrow as much from the bank to purchase their new home. From the kids' perspective, if they can't borrow the amount they need from the bank to buy the home, the loan from the parents doesn't help them much.
Lenders want to see parents give their kids the money but also want parents to sign something saying that the parents have given the kids a gift and don't expect repayment. If the kids need money in excess of the $56,000, or the child is buying a home alone, the kid may only be able to get $28,000 from the parents as a gift. If these amounts are not enough to cover what the kid needs to purchase the home and the parents give more than the allotted amount of $14,000 per person per year, the parent may need to file a gift tax form with the IRS.

Having said that, parents can plan ahead and gift money over several years into an account that is in the name of their kids. That amount can transfer to their children and the parent won't have to pay taxes on the gift or file gift tax forms. In addition, the money will be seasoned in the account, and the lender down the line will see that money as the kid's money without any strings attached. So with some planning, the parents' idea to give money to their kids can work to transfer wealth from one generation to the next, and neither the kids nor the lender should have any issues with it.
However, once the money has been given to the child, it's their money to do with as he or she pleases. And, much to the displeasure of the parent, the kid might not make use of that money as intended.
If the parents have their own money but need it for retirement, they will need that money repaid. Once that money is gifted to the kid, the kid won't have a legal obligation to repay the money and will only have a moral obligation to repay the money.

As the situation gets more complicated, and more kids (and spouses and partners) are involved, parents should seek professional help.

The best help comes from estate planners and accountants. We don't usually recommend that people seek help from tax preparation companies that help people fill out forms and file income tax returns, as they may not have sufficient knowledge or experience to advise families on issues that go beyond tax preparation issues.

Friday, May 27, 2016

Every business owner needs an estate plan

Planning is an important element of any successful venture. Whether you are just starting your first business or you have been operating successful companies for years, you need to take the same care in planning your personal affairs as you take with your business. Regardless of your family status or your station in life, taking stock of both the life planning and the death planning aspects of estate planning will ensure that you are taken care of while you are living and your family and possessions are secure when you die.
Life planning
Life planning starts with your power of attorney and advance health care directive. Injury or illness can strike anyone, so these planning documents are essential for everyone. A power of attorney allows you to name another individual who can act on your behalf for financial purposes. There are several different types of powers of attorney. The most common type is a general, durable power of attorney, which allows the person you choose, your “agent,” to deal with any of your property in the same way that you could deal with it yourself. You can tailor your power of attorney to be limited in scope to a particular task or asset. Your power of attorney can also be “springing,” so that your agent can only act for you when you are unable.
An advance healthcare directive is similar to a financial power of attorney except that it allows you to appoint an agent to make healthcare decisions for you if you are unable. You can also choose how you would like to be treated under a number of scenarios, such as if you are in a coma or you have sustained a serious, life-threatening injury. That portion of the advance healthcare directive is often known as your “living will.” Although there is no way of knowing exactly what could happen to you, your agent and healthcare provider will use your living will to make the best possible decisions for you. You should always communicate openly with your loved ones and medical providers about your wishes so that they can provide for you in the best way possible.
Death planning
The most essential element of death planning is your will. Without a will, your property will be distributed according to the laws of “intestate succession.” To make sure that your possessions are given to the right people, you can list specific items that you want to go to particular individuals, such as giving grandma’s wedding ring to your oldest daughter. After making specific gifts, you can decide who will receive the rest of your property and in what percentages. In addition to the ability to name takers of your property, you can name a personal representative who will distribute your property when you die, and a guardian who will take care of your minor children. Nominating your children’s guardian in your will can help to avoid lengthy court proceedings at an already difficult and scary time for your children.
“Will substitutes” are invaluable in estate planning. Will substitutes create certainty in your planning and speed up the process of administering your estate at death. If you own certain property in your own name at death, including a house or land, your estate must go through the probate court to transfer that property to the person who you have named in your will. Creating a trust during your life can avoid the need for probate. While you are living, you can continue to deal with trust property in the same way as if you owned it directly. By naming a “successor trustee,” the trust property can pass to your chosen beneficiaries at your death outside of the court system.
Naming beneficiaries on insurance policies or “payable on death” accounts are also will substitutes because they operate to transfer your property to the named beneficiaries by contract rather than according to your will. Many LLC operating agreements allow the members to designate beneficiaries of their membership interests at death. You should review your beneficiary designations regularly, especially when you undergo a major life event like a marriage, divorce or when you have children.
Life planning and death planning are both fundamental to an effective estate plan. Ensuring that your power of attorney, advance health care directive, will, trust and other will substitutes are established and regularly maintained makes it possible for you to focus on your business knowing that your personal affairs are in order.

Thursday, May 26, 2016

The many missed opportunities of Prince’s estate

FROM http://www.financial-planning.com/

For those who made much of musician Prince’s lack of a will after his unexpected death in April, estate planning attorney Ilene McCauley sounds a harsh wake-up call.
There’s no such thing as a person without an estate plan, says McCauley, principal at Goldinov & McCauley in Scottsdale, Ariz., and a speaker at the 2016 NAPFA conference in Phoenix. “If you don’t have an estate plan, the state you live in will give you one,” she says.
That’s exactly what happened to Prince Rogers Nelson, who died on April 21. “He died with hundreds of millions of dollars in assets,” McCauley says. “He was a brilliant singer, a brilliant man, a brilliant businessman, but for whatever reason he did no estate planning.
The Prince estate has been estimated at $250 million. The performer had one full sister, five half siblings and may have an adult child, pending a DNA test. “The estate will pay $100 million to the federal government, due nine months from the day he died,” McCauley says. “The planning he could have done would have eliminated estate tax at his death.”
Prince’s estate will also be distributed to siblings he cared for as well as to those he may have disliked (Minnesota law treats full and half siblings identically), and possibly to a son he never knew. Estate planning, McCauley says, allows people to control their property while they are alive, take care of themselves and their loved ones if and when they are disabled, and give what they want, to whom they want, how they want, with the least possible cost and hassle.
“Estate planning is about control, full stop,” McCauley says. “If you don’t plan, you have no control. Property passes to unintended heirs in unintended ways. You lose planning opportunities, create excellent opportunities for creditors and predators, and spend way too much in tax dollars.”
McCauley says that a variety of trusts could have provided Prince the control he otherwise demanded in his creative endeavors. “Prince could have had his money go wherever he wanted after his death, tax-free,” she says.
A foundation trust would have combined well with a charitable remainder and/or a charitable lead trust, she says. A charitable remainder trust is designed primarily to save on income taxes. The person creating the trust funds it with appreciated assets, can take an income tax deduction over five years, receives an income stream for life and can assign the stream to a second person as well. At the founder’s death, the trust’s assets go to a selected charity.
Alongside a charitable remainder trust, Prince could have used an irrevocable life insurance trust, or ILIT, which puts money into a trust and uses the principle and increase to buy life insurance on the founder. The death benefit is a tax-free way to replace the money going to charity. “I’ve rarely done a charitable remainder trust without a life insurance trust,” McCauley says.
A charitable lead trust, on the other hand, pays income first to a designated charity organization. The remainder passes to heirs, free of estate and income tax. There is no income tax deduction for the founder, who also pays tax on the trust’s investment income during his or her lifetime. This trust is a good tool for passing assets tax-free to the next generation.
“Usually there is great growth within the trust, so families end up with a lot more,” McCauley says. Charitable trusts are irrevocable, though the founder can change the trustee and/or the charitable beneficiary.
An intentionally defective grantor trust, or IDGT, is another vehicle for moving assets on to the next generation. In an IDGT, the founder loans the trust assets, receiving an interest rate below the rate at which the assets are expected to appreciate. The grantor pays income taxes on trust income, allowing the assets to appreciate unencumbered by that expense, and beneficiaries receive the assets tax-free.
“You can also design an IDGT that invests in annuities that don’t pay out immediately, so you pay no income tax,” McCauley says.
IDGTs are irrevocable and not changeable, McCauley says. Grantors and beneficiaries pay neither gift tax nor estate tax. “These are for people who have tons of money and really want to reduce their assets and pass everything to the next generation,” she says. “You can do your charitable giving through an IDGT, and you can also move equally valued assets into and out of the IDGT. Cash goes out, real estate goes in, as long as the values are the same.”
With any trust, it’s important to ensure that the client’s cash flow will be adequate to meet future needs. “Clients will be really ticked at you when they go to the lawyer to unravel this when it’s 10 years later and they can’t pay their bills,” McCauley says.
The hardest part of creating trusts, McCauley says, is persuading clients to take action and regularly review their plans, making whatever changes are necessary. “I have clients come in for yearly updates at discounted rates,” she says. “I have yet to have a client who hasn’t made a material change.”
It’s too late for a planner to persuade Prince to work on his estate — but it’s not too late for your living clients

Wednesday, May 25, 2016

Will the IRS Audit Me?


Tax audits are a common fear in the United States. A survey this year by the folks at NerdWallet found that 11% of respondents fear an audit, while 69% are worried about tax preparation in general and 17% have concerns about making a mistake. If you find yourself lying awake at night wondering, "Will I get audited?" then take a deep breath.
The truth is that you probably won't be audited, and there are ways to reduce your chances further.

The odds favor you

Just how unlikely is it that you'll be audited? Well, according to the IRS' 2014 Data Book, the odds of being audited were lower than 1% for those with incomes between $1 and $199,999. (That probably includes you, right?) For those earning between $200,000 and $499,999, it was still under 2%, and for those with incomes between $25,000 and $99,999, it was close to 0.5%.
On top of that, IRS Commissioner John Koskinen recently said that relentless budget cuts in Congress have left the IRS less effective:
The portion of our full-time workforce that has been lost since 2010 includes over 5,000 key enforcement personnel. These are the people who audit returns and perform collection activities, as well as the special agents in our criminal investigation division who investigate stolen identity, refund fraud, and other tax-related crimes. ...
As you might imagine, these staffing losses have translated into a steady decline in the number of individual audits over the past six years. Last year, in fact, we completed the fewest audits in a decade. ... That trend line of fewer audits will continue this year.
Clearly, there's no reason to lose sleep over fears of an IRS audit.
Don't celebrate that news too much, though, as it's not all good. Fewer audits mean the government loses out on more money that it's owed. Koskinen added that "historical collection results suggest that the government is forgoing more than $5 billion a year in enforcement revenue, just to achieve budget savings of a few hundred million dollars."

Even though your chances of getting audited are low, you can take steps to make them more so. Here are some tips:
Reduce your odds of getting audited even more

  • Don't be messy. If your handwriting is hard to read or you're not careful when filling out forms, that can increase your odds of being audited. The IRS needs to be able to make sense of your tax return, and if it can't tell whether that's a 0 or a 6, or your return is just too hard to read, it will draw attention. You don't want any attention drawn to your return. You want it to be one of many millions that smoothly get processed without question.
  • Don't make math mistakes or other ones. Be sure that any numbers you're entering in your return are correct. Double-check your calculations and be sure you're entering data in the right boxes. It can make a big difference to use tax-preparation software and to electronically file your return, as such filers can have greater accuracy in their returns than hand-prepared ones. Remember to sign your return, too -- as unsigned returns can also draw the attention of the IRS.
  • Don't leave out information. If you fail to report any income or omit any other information, that can raise flags at the IRS and get you audited. Even if it's just a seemingly inconsequential dividend payment you don't want to bother mentioning, it needs to be included. It's the right thing to do, of course, but note that the IRS probably already knows about that payment to you and will be wondering why you haven't mentioned it. Entities that pay you generally report having done so to the IRS -- whether they're reporting salary payments, dividend income, interest paid, or something else. The IRS then expects your return to include all of these payments.
  • Don't neglect to file a return -- or have no income. If you don't file a tax return for any reason, then the IRS may contact and question you. Even those with no income or no taxes due need to file a return, explaining that they have no income and/or demonstrating that they have no taxes due. Your odds of being audited are higher if you report no income -- even if you've filed a return. For example, if you have your own business and you posted a net loss for the year, then the IRS might want to double-check to make sure you're not pulling a fast one. In 2014, about 5.3%of returns with no income were audited.
  • Don't be dishonest. If you're stretching the truth on your tax return -- especially if you're self-employed -- you may catch the attention of auditors. Be ready to substantiate any claims (business meals, business-related miles driven, business entertainment costs, etc.) with receipts or other documentation. If you're claiming a home-office deduction, you'd better have a home office, and one that conforms to the rules, such as being used solely for the business.
  • Don't use a problematic tax preparer. If your tax return is prepared by your well-meaning uncle, that could land you in an audit, if he makes mistakes. Using a professional won't protect you from an audit, either, because the pros can make mistakes, too. Unscrupulous ones can be committing fraud with your return to lower your taxes, or they can even be stealing from you. Ultimately, you're the one responsible for your tax return. Don't give up on using a qualified preparer, though, as preparers should be much more informed about deductions you might take and strategies you might employ. Good ones can serve you well and reduce your tax bill.

You may still end up getting audited, of course, possibly because of factors outside your control. For example, self-employed folks and those with very high incomes are audited more often than more typical taxpayers. Those with deductions of unusual size can also trigger audits. That's because the IRS will generally compare the numbers in your return with averages. If you're claiming a much bigger deduction for charitable donations than the average taxpayer with your income profile, that will draw attention. Similarly, if you claim deductions for business travel or meals that are above average for a business like yours, the IRS might want to look a little closer.Bad news and good news

Even if an audit happens, though, don't freak out. It's often a relatively minor event. About 70% or more of audits are conducted through the mail, so you probably won't have to sit across a desk from an IRS agent. And sometimes an audit even reveals that thetaxpayer is owed money. Audits can seem scary, but they're rarely a problem if you've been honest.

Tuesday, May 24, 2016

13 Ways to Pay Lower Taxes Next Year

Taxes are kind of necessary to keep our civilization humming, with schools, police, courts, roads, and so on. Still, most of us would like to pay as little in taxes as we have to. Fortunately, there are lots of ways to pay lower taxes next year -- and in years beyond. Following are 13 of them. Some may not be of interest to you or even possible, but some could save you a lot of money.
  1. Earn less. One way to pay lower taxes next year is to earn less. That's not going to be a popular strategy for most of us, but if you do find yourself earning less, enjoy the silver lining of lower taxes.
  2. Take the Earned Income Tax Credit (EITC). If you do earn relatively little, you will not only pay lower taxes based on your income, but you may also be able to take advantage of the EITC, a very powerful but underused tax credit potentially worth thousands of dollars to those who qualify.
  3. Have kids. Don't base your family planning on taxes, but if you're planning to have children, or more children, you'll enjoy some tax breaks. For example, the Child Tax Credit offers $1,000 for every eligible child you have under the age of 17 (as of the end of the tax year), while the Child and Dependent Care Credit is worth up to $3,000 for a single child or $6,000 for two or more children, and is tied to expenses you incur for the care of children or dependents that lets you work or seek work.
  4. Buy a house. If you're deliberating between renting or buying a home, remember that mortgage interest is deductible -- as are property taxes. And in the early years of a mortgage, much of your monthly payments is made up of interest.
  5. Contribute to an IRA and/or 401(k). Traditional (not Roth) IRAs and 401(k)s receive pre-tax contributions, meaning that if you contribute $5,000, you get to subtract that from your taxable income and thereby pay lower taxes. (You'll ultimately be taxed on that money when you make withdrawals in retirement.) If you're in the 25% tax bracket and contribute $10,000 to these accounts, you'll cut your tax bill by $2,500!
    HSAs and FSAs can save you money on healthcare and taxes. Image: Pixabay

  6. Contribute to an HSA or FSA. Contributions to Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are made with pre-tax money, too, so that's another way to pay lower taxes next year. Note that you need to have a qualifying high-deductible health insurance plan to be able to take advantage of HSAs. They can be well worth it, though, as they let savings accumulate and grow over time, with withdrawals for qualifying medical expenses tax-free. After age 65, you can withdraw money from an HSA for any purpose, paying ordinary income tax rates on withdrawals. FSA money, on the other hand, is mainly use-it-or-lose-it from year to year.
  7. Donate to charity. If it's worth it for you to itemize deductions, then being extra generous with charitable contributions can get you bigger deductions. Just follow the rules and have documentation of donations.
  8. Make most of hefty medical expenses. Just as with charitable contributions, medical expenses can often be deducted, so if you have the bad luck to have spent a lot on healthcare, you may be able to enjoy a little benefit by deducting many of those expenses.
  9. Bundle deductions. If you have trouble accumulating sufficient deductions to make itemizing worthwhile, consider bundling. That's when you try to concentrate deductions in every other year, so that you're able to itemize in one year and take the standard deduction in the next. For example, you might make annual charitable contributions in January and December of one year, and might pay deductible taxes that are due in January in December instead.
  10. Harvest capital losses. Many people forget that their sunken stocks have a little upside: Losses can be used to offset gains. If you're sitting on $10,000 of long-term capital gains, facing a 15% tax hit on them that will cost you $1,500, you could wipe out half of that if you have $5,000 in losses.
  11. Keep stocks for long term. Remember, too, that while most people face a 15% long-term capital gains tax rate, short-term gains are taxed at ordinary income tax rates, which are often 25% or 28% and can approach 40% for very high earners. Don't base stock-selling decisions solely on tax concerns, but if you're thinking of selling a winning stock, see if you might hold it for at least a year and a day, to qualify for the lower tax rate.
  12. Grab tax credits for energy-efficient improvements to your home. There are some tax credits available for qualifying improvements to your home that you paid for in 2016. These include insulation, energy-efficient central air conditioning, geothermal heat pumps, small residential wind turbines, and solar energy systems.
  13. Hire a tax pro. Finally, one of the best ways to pay lower taxes next year is to hire a good tax professional. Don't just hire anyone or go to a random tax-preparer, though. Ask around for recommendations. Consider hiring an "Enrolled Agent," a tax pro licensed by the IRS who is authorized to represent you before the IRS if need be. You might find onethrough the National Association of Enrolled Agents website. Or find a certified public accountant through your state's CPA society or state board of accountancy.
When it comes to paying taxes, you have more power than you think you do to lower your tax bill. See how many of these ways to pay lower taxes next year and beyond will work for you. You may be able to shave thousands off your next tax bill.

Monday, May 23, 2016

Navigating the Alternative Minimum Tax

FROM http://www.csmonitor.com/

Tax season is over, but if you had to pay the federal Alternative Minimum Tax, the pain may linger long after you’ve filed.

The AMT is an alternative method of calculating federal income tax that runs parallel to the ordinary method. To determine whether you are subject to the AMT, you have to map both routes simultaneously. Whichever route results in the greater tax amount, that’s the one you follow — and that’s the amount you pay.

Of course, the AMT is the road no one likes to travel — it’s the higher tax route. To develop appropriate planning strategies, it is important to first understand how AMT works.

Where the road began
In 1969, Congress created the AMT as a tax on the wealthy, with the aim of making sure the highest earners paid their fair share. At the time, the AMT affected just a handful of high earners with annual incomes of more than $200,000. Today, despite tax law changes over the years, the AMT affects more and more people earning upper-middle-class incomes.

The AMT has its own tax rates and set of rules regarding income and expenses. Under the regular tax system, depending on your filing status and how much net income you earn in a year, you fall into one or more of seven tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. AMT rates are more complicated, though there are fewer official marginal tax rates: 0%, 26% and 28%. Due to the AMT exemption, which phases out as income increases, the highest “unofficial” rate is 35%. (More on this below.)

How it works
Under the AMT calculation, you can’t claim many of the regular deductions or the personal exemption you would normally claim. Only the applicable AMT exemption and a few specific deductions are allowed.

Your alternative minimum taxable income, or AMTI, will generally be your adjusted gross income less itemized deductions (your income as seen on line 41 of Form 1040), plus those other deductions added back in. This includes state income taxes, personal property taxes and real estate taxes, home mortgage interest, miscellaneous deductions and other items (see Form 6251 for a complete list). You’ll also need to add in any preferential income, like the bargain element (the difference between the price you pay as an employee and the market price) on the exercise of any incentive stock options. These additions can cause your AMTI to exceed your AGI.

Your AMTI may then be reduced by the applicable AMT exemption. This exemption starts at $83,800 for a married couple filing jointly in 2016, but it is reduced by 25 cents for every $1 of AMTI above $159,700. The exemption is fully phased out when AMTI exceeds $494,500.

Assuming there are no qualified dividends or capital gains, you then calculate the AMT on the result: That’s 26% of the first $186,300, and 28% on amounts above that. These are the official AMT tax brackets. The presence of the phase-out of the AMT exemption creates a window between $186,300 and $494,500 where AMTI is effectively being taxed at a 35% marginal rate. It is critical to know whether you are in this window or above this window to plan effective tax strategies.

Other income
An additional wrinkle is created when investors realize long-term capital gains or receive qualified dividends. While the lower maximum tax rates that apply to long-term capital gains are also in effect under the AMT, long-term capital gains and dividends still count as income under the AMT. Significant earnings from those sources could actually push your overall income to the levels where the AMT exemption begins to phase out, causing your non-dividend and non-capital-gain income to be taxed at higher rates under the AMT. So, even though capital gains and qualified dividends are technically taxed at their usual preferential rates, their presence can cause other income to be taxed at higher marginal rates.

Also note that passive activity gains and losses, depreciation and a number of other items are treated differently under AMT than under the ordinary system. Be sure to discuss these issues with a qualified tax professional.

Knowing whether you have to get on that road
Certain circumstances trigger the AMT, and knowing what to watch for can help you plan how to manage your tax burden. You may be subject to the AMT if you claim a large number of itemized deductions and personal exemptions, if you claim state and local deductions, or if you exercised incentive stock options. The more deductions there are, the more likely you will be subject to the AMT, because these types of deductions have to be added back to income when calculating AMTI.

To find out whether you are subject to the AMT, you must essentially calculate your federal income taxes twice: once under the standard tax system and once under the AMT system. And you don’t really have a choice about which route you take; it’s whichever one yields a higher tax liability.

Fortunately, once you understand the AMT, you can start thinking about steps you may be able to take to avoid it. If you’re a high earner, it’s a topic you should address before the next tax season rolls around.

Sunday, May 22, 2016

Should you pay off your mortgage before retiring?

FROM http://www.dailyherald.com/

Survey after survey indicates that one of our biggest worries in retirement is running out of money.

More than a third of retired investors and half who aren't retired said they worry they will run out of money and be forced to depend on Social Security as their main income source, according to a Wells Fargo-Gallup survey.

You might think that it would make people save more. But few of us even know how much we need to save for a comfortable retirement.

However, one way people can feel better about retirement is to start out with as little debt as possible. And that leads us to a question many financial planners are asked by pre-retirees: Should you pay off that mortgage before you retire?

The percentage of homeowners 65 and older with mortgage debt jumped from 22 percent in 2001 to 30 percent in 2011, according to the Consumer Financial Protection Bureau. Among those 75 and older, the rate nearly tripled, from 8.4 percent to 21.2 percent. The median mortgage debt for seniors, meanwhile, increased 82 percent (from $43,400 to $79,000).

Unlike many areas of retirement planning, there is no easy answer to this question. What is clear is that there are a lot of variables, and there's no one correct answer. So the simplest answer is: It depends.

"It's very dependent on the actual individual," says Jimmy Lee, chief executive of the Wealth Consulting Group in Las Vegas. "So much of it has to do with risk tolerance and their sources of income.

"The people who have more reliable sources of income may be more suited to carrying a mortgage," he says. "They are less dependent on withdrawals from investment accounts. Interest rates are a big factor. In today's low-interest environment, it would make sense to carry a mortgage if your mortgage rate is under 4 percent and you can get an investment rate of 6 percent."

Lee says that, generally speaking, "Debt-free is preferable and wise."
Mitch Katz, financial adviser and partner at Capital Associates in Bethesda, says having that mortgage paid off helps some people sleep at night.

"It's kind of an emotional thing more than a fiscal thing," Katz says. "At the end of the day, financially it makes more sense to not pay off the mortgage. But that's easy to say in theory and harder in practice.

"We can control only what we can control," he says. "You can go to the gym and eat healthy, and walk outside and get hit by a bus. We can't control that. But, paying off a mortgage, you can control. By paying off the mortgage, it gives you the ability to pay off other things. Emotionally, it's very powerful."
Nick Abrams, financial planner at AJW Financial Partners in Columbia, says it depends on how much money the client has in cash. He says some clients are eager to pay off the mortgage, but he tries to take the emotion out and look at the numbers. When they "run the numbers," sometimes it is clear that it would make no sense to pay off the mortgage because most of their savings are in their retirement plan.
"If a client has enough liquid cash, money outside of the retirement plan, that they can pay off the mortgage and still maintain a healthy cash reserve, we do make that recommendation," he says. "But, if a client is looking at paying off the mortgage, but the majority of the money is in a qualified plan, and they would incur a huge tax bill as a result, we do not recommend paying off the mortgage."
Katz says paying off the mortgage out of your retirement account "sounds good in your head" but is not a good thing.
"When you take money out of retirement accounts, first you have to pay taxes," he says. "In the retirement account, money gets to grow without taxes. The power is in longevity. You are essentially taking something that will produce income later and at an exponential level, and paying into something that will not produce income."
Abrams says he looks at how much guaranteed income a client will have in retirement: "We look at how much will the get out of Social Security, if they have a defined benefit plan, how much they will get, and if they have an annuity. If those numbers are large enough to cover a mortgage and all other expenses going into retirement, we will say don't pay off the mortgage."
But, he says, he takes everything on a case-by-case basis.
"In a perfect world, if a client comes in and has the mortgage paid off before they retire, that would be perfect," he says. "But most people have refinanced or moved up. And we have a considerable number of clients who have mortgages in retirement. But they are still doing well because they have enough income."
Debt is a litmus test, says Charles Winfrey, president of the Rollover Company in Nashville. "Many people have low-interest mortgages and high-interest credit cards," he says. "Get the high-interest credit cards out of the way."

Saturday, May 21, 2016

10 easy HSA FAQs


Health savings accounts emerged from two potentially conflicting goals--to keep health care costs down and to give consumers control over their health care choices.

HSAs continue to be popular ten years later.

EBRI estimates over 13 million HSAs existed as of the end of 2014, with over $24 billion in assets. And those numbers are growing.

This BenefitsPro story is excerpted from:

What are some advantages of an HSA?

With HSAs, employees own their account—even if they leave their job—and earnings in the account grow tax free. With flexible spending accounts, the other popular health care account, the employer owns the account and no earnings are paid.

Read: HSA holders don’t understand accounts

With HSAs, funds roll over at year’s end. With FSAs, funds don’t roll over or, as we’ve seen recently, there’s a limit to how much is allowed to roll over. And with HSAs, no employer involvement is necessary, unlike FSAs, where employers must review claims.

To be eligible for an HSA, an employee must be covered under a high-deductible health plan. However, just because someone is covered under an HDHP doesn’t mean they have to open an HSA.

It’s been estimated that nearly half of Americans who are eligible to open an HSA, haven’t—usually because they can’t afford to. Unfortunately, they are missing out on potential tax benefits.

What’s the down side to HSAs?

Well, besides having to come up with money to fund it if your employer doesn’t put some in, the rules around them can get complex. The employee who owns an HSA will need to take more responsibility for learning about these rules.

Some are also concerned about the so-called Cadillac tax kicking in in the future. This is the Patient Protection and Affordable Care Act law that places a tax on high-priced health plans starting in 2018. The IRS said that both employer and employee payroll deferral HSA contributions count toward the tax cap. This is something employers and the insurance industry are watching closely.

Now that that's covered, let's look at these 10 FAQs about HSAs.

#1: Why is having an HDHP a requirement for having an HSA?

Opponents of the HSA legislation were concerned that HSAs would become just another tax break for the wealthy.

To partially counter that concern, the HSA laws require that in order to be eligible for an HSA you must be covered by an HDHP and no other health plan.

This is to avoid the situation where a taxpayer could get a large deduction for an HSA contribution and then not really need the HSA to pay for day-to-day medical expenses because the person either had traditional, low-deductible insurance, or was double covered and had both traditional and HDHP coverage.

People with HDHP coverage and no other health plan coverage (other than permitted coverage or coverage by another HDHP) need the benefits of an HSA because they face a high deductible.

The idea behind HSAs is that HSA owners would pay day-to-day medical expenses with the HSA. Their HDHP insurance is only accessed for catastrophic events or very large medical expenses.

#2: Are HDHP-covered individuals that are also covered by their spouse’s traditional insurance eligible for an HSA?

No. The individual would have “other health coverage” that disqualifies the individual for an HSA.

This type of double coverage represents the typical example of someone that is not eligible for an HSA due to the “other health coverage” rule.

#3: Are counseling, disease management, and wellness EAP programs considered to “provide significant benefits in the nature of medical care and treatment” and be a health plan and disqualify one from an HSA?

No. The three types of EAP programs below are generally not considered to be a health plan and would not disqualify you for an HSA.

Counseling EAP Program. EAPs designed to provide short-term counseling to identify problems that may impact work performance are generally allowed with an HSA. Issues addressed in this type of EAP program often include substance abuse, mental health or emotional disorders, financial or legal difficulties, and dependent care needs.

Disease Management EAP Program. EAPs designed for disease management are generally allowed with an HSA. This type of EAP identifies employees and their family members who have, or are at risk for, certain chronic conditions.  The program provides evidence-based information, disease specific support, case monitoring, and coordination of care (not the actual care).

Wellness EAP Program. EAPs designed for employee wellness are generally allowed with an HSA. A wellness program provides a wide range of education and fitness services designed to improve the overall health of the employees and prevent illness. (IRS Notice 2004-50)

#4: When can an HSA be opened?

An HSA can be opened at any time of year, as long as the individual is already enrolled in a qualified HDHP and is otherwise HSA-eligible. If enrolling through an employer, generally people enroll during the employer’s open enrollment period.

#5: Can an HSA owner “establish” an HSA with a zero balance?

Pursuant to many state laws, the HSA must be funded to be considered “established.”

Without researching state laws, a conservative approach is for HSA owners to fund the HSA with a small amount to get it “established.”

#6: What are the ramifications when someone loses eligibility for an HSA?

Common reasons that people lose HSA eligibility include changing jobs, becoming eligible for Medicare, or just switching insurance plans. Some items for HSA owners to consider are listed below:

The money belongs to the HSA owner. The HSA belongs to the HSA owner regardless of whether the HSA owner or the employer made the contribution to the HSA.

Use HSA for qualified medical expenses. The HSA owner can continue to use the HSA for qualified medical expenses even if no longer eligible for an HSA. The HSA owner just cannot add more money. The HSA works to pay co-pays, deductibles, dental, and other general medical expenses not covered by insurance, at least until the HSA is exhausted.

Use as retirement fund. HSA owners can simply let the account grow until they do need it. At age 65, an HSA owner can use the balance for any reason without penalty, but the HSA owner will have to pay income taxes on amounts withdrawn for nonmedical expenses.

Maximize contribution or remove an excess. In an HSA owner’s final year of HSA eligibility, the HSA owner may want to maximize the HSA contribution. HSA owners can make an HSA contribution even if no longer eligible so long as the HSA owner is making the contribution for when the HSA owner was eligible (assuming the HSA owner makes the HSA contribution prior to the tax due date).

Protect the establishment date. HSA owners should consider keeping the HSA open to protect the “establishment date.”

#7: Are there limitations on HSA investment options?

Yes. There are actually few limitations on investment choices, but HSAs may not be invested in collectibles. This includes works of art, antiques, metal (some exceptions involving platinum, gold and silver coins and bullion), gems, stamps, coins, alcoholic beverages, or other tangible personal property (specified by the IRS in guidance on IRC Sec. 408(m).)

HSAs may not be invested in life insurance contracts, and HSAs cannot be commingled with other property except in a common investment fund. You have to open your HSA with an approved HSA custodian, so finding one that allows for your investment choice is vital. (IRC Sec. 223 (d)(l)(C), IRC Sec. 408(m), IRS Notice 2004-50)

#8: Are there tax benefits to making an HSA contribution?

Yes. HSA owners making an HSA contribution enjoy a number of tax benefits.

Federal income tax deduction. HSA contributions reduce an HSA owner’s income for federal income tax purposes.

State income tax deduction. Most states with income taxes allow HSA owners to reduce the state taxable income by the amount of the HSA contribution.

Payroll tax avoidance. HSA owners receiving HSA contributions pretax through an employer, either employer contributions or employee payroll deferral through a Section 125 plan also avoid Social Security taxes, Medicare taxes (together with Social Security referred to as FICA), federal unemployment taxes, Railroad Retirement Act taxes, and in most cases state unemployment taxes.

Tax deferred earnings growth. Any interest, dividends, or other appreciation of the assets in an HSA grow tax-deferred while in the HSA.

Tax-free distributions. HSA owners that use the HSA for qualified medical expenses enjoy tax-free distributions. This is a better deal than Traditional IRA or 401(k)s because those plans are only tax-deferred, not tax-free (although Roth IRAS/401(k)s are tax-free, contributions made to Roth accounts are not tax deductible).

#9: What types of records do HSA owners have to save?

The receipts show the amount paid, a description of the service/item purchases, the date, and the name of the service/item provider.

HSA owners must keep records sufficient to show that:

The distributions were exclusively to pay or reimburse qualified medical expenses

The qualified medical expenses had not been previously paid or reimbursed from another source, and

The medical expenses had not been taken as an itemized deduction in any year.

#10: How much can an HSA owner contribute to an HSA?

The simple answer is $3,350 for 2016 ($3,350 for 2015) for HSA-eligible individuals covered by self-only HDHPs, and $6,750 for 2016 ($6,650 for 2015) for individuals with family HDHP coverage.

Additionally, there is a $1,000 catch-up contribution amount allowed for those over age 55.

The simple answer is inadequate because it ignores the issue of eligibility through the year. The amount an individual can contribute depends on the following factors:

HSA maximums for the year. The HSA maximum limits are adjusted each year for inflation.

Self-only or family HDHP coverage. The HSA maximum depends on whether the individual had self-only HDHP coverage or family HDHP coverage.

Age. Individuals over age 55 are entitled to take advantage of a catch-up contribution.

First day of eligibility – Eligibility on December 1. Individuals that become eligible before December 1 of the year and who remain eligible on December 1 can take advantage of the “full contribution rule.” December 1 is the key date for most taxpayers; if a taxpayer’s tax year does not end in December, then the first day of the last month of the tax year is the key date.

Last day of eligibility – Not eligible on December 1. If an individual’s last day of eligibility falls in the calendar year and the individual is not eligible on December 1 (calendar year taxpayer), the individual will need to reduce the HSA contribution amount using the “sum-of-the months” rule.

First day of the month. Eligibility is tied to whether the person was eligible as of the first day of a month.

Friday, May 20, 2016

Understanding How Financial Advisors Are Compensated


With the value provided by good financial decision making and the impediments people face to achieve good financial outcomes for themselves, it is worthwhile discussing more about the advisory profession and understanding how advisors are paid, if for no other reason than in the interest of increased transparency.

Though the financial services profession is highly regulated at both the state and national levels, use of the terms “financial advisor” or “financial planner” as job titles is hardly regulated. Regulation generally focuses on the nature of business activities rather than job titles. Pretty much anyone can use these terms without any further oversight about training, competency, education, or qualifications.

Generally, those calling themselves financial planners or advisors represent one of three types: registered investment advisors, stock brokers, or insurance agents.
Of the three types, investment advisors are the only ones required to serve as fiduciaries for their clients, at least when they are wearing their “investment advisor” hat. The fiduciary standard of care requires investment advisors to act in the best interests of clients and disclose any material conflicts of interest to clients for the advice they provide.
Fiduciary advisors who serve only as fiduciary advisors are generally part of Registered Investment Advisor (RIA) firms, and they often use the term “fee only” to differentiate themselves from competitors. The National Association for Personal Financial Advisors (NAPFA) is the membership organization for fee-only advisors.

A fee-only advisor is paid directly and only by their clients, generally as a percentage of assets the advisor manages. That percentage generally decreases as the account size increases. Fees usually cover financial planning advice and investment management.
Some fee-only advisors may have different fee structures. Other possibilities include an hourly charge or fixed retainer fees for services. With other fee arrangements, the advisor is less likely to make trades on their client’s behalf. With such fee arrangements, the advisor makes investment recommendations but the client implements them.
The important point of this fee structure, and the meaning of “only” within the term “fee only,” is that these advisors are paid only by their clients. They do not receive any commissions or other financial incentives for getting their clients into any particular investments or financial products, which eliminates an obvious source of potential conflicts. A comprehensive financial planner should assist their clients with eight core planning areas: investments, taxes, debt management, education planning, retirement planning, estate planning, insurance, and household budgeting.

As you can see, there is much to do beyond just investment management.
Presently, the fiduciary standard of care is not applied to brokers or insurance agents, though proposals on Capitol Hill could change this policy. For instance, in April 2016 the Department of Labor enacted rules to strengthen requirements for those advising on retirement plans to serve as fiduciaries. These landmark rule changes could have big impacts over the coming years, since retirement plan assets represent a significant portion of the investment assets help by American households.
Brokers and insurance agents are currently treated generally as salespeople, and they are required to use a suitability standard of care with their customers. Any recommended financial products must be “suitable” for the purchaser’s situation, though the recommendations do not necessarily need to serve the best interests of the purchaser.
For those acting as brokers and insurance agents, their primary professional obligation is to their employer rather than their client. For instance, a suitable investment or insurance product that pays a higher commission to the broker or agent—presumably because it is a more profitable product for the employer—could be recommended under the suitability standard, even if another approach would better serve the customer’s interests.
Surveys of the public generally reveal that most people do not understand the distinctions between the fiduciary and suitability standards, nor do they understand the differences between investment advisors and brokers. Perhaps a simple example is the analogy of selling cars. When you go to a Honda dealership, you reasonably expect the salesperson to sell you a Honda. The salesperson will probably not suggest that you would be better served by heading over to an unaffiliated Ford dealership.
Consumers understand this about people who sell cars, but they often do not recognize that this same issue exists for brokers and agents. People naturally tend to believe financial advisors are independent and seek to work in their clients’ best interests, as they should.

A fiduciary investment advisor faces little to no conflict in directing client investments because his or her compensation is not tied to a specific product. They can essentially recommend you buy the most fitting car from any available car dealership, which is the treatment consumers generally expect from all advisors.
But brokers do not have this freedom; they are obligated to sell their sponsoring company’s financial products. If another dealership would fit your needs better, they would still encourage you to buy from them instead.

To make matters worse, low-cost products that can better serve consumers carry a lower commission, making them less desirable for brokers to sell. Products that are harder to sell because of their complexity may have reduced effectiveness for clients, but they tend to carry higher commissions in order to incentivize their sale. It’s like doctors providing prescriptions based on pharmaceutical company kickbacks rather than the patient’s health.
Many advisor websites make it difficult to understand how they are registered and what sort of standard of care they provide. It would be simple if we could just separate the advisors from the brokers, but a number of advisors are registered as investment advisors and brokers or agents.
Dual registration muddles the situation for clients further, as it may not always be clear when the advisor is wearing the hat of a fiduciary, and when they are making recommendations under suitability requirements. Because they can also receive commissions, such dually registered advisors should use the term “fee-based” to describe their firms, rather than “fee-only.” Clients could then have a clear understanding of when they are being served under the fiduciary or suitability standard.

Thursday, May 19, 2016

Feel Free To Get A Law Degree, But Don't Plan On Deducting The Tuition


When you make your hay in a career as mundane as tax preparation, it’s common to spend your darker days hanging on to the hope that with one small change, you’ll be able to move on to something more exhilarating. Lose ten pounds and you’ll be an underwear model. Get that scuba certification and you’ll unearth sunken treasure on your next vacation  Go back to law school and you’ll soon deliver impassioned closing arguments that will leave witnesses confessing their guilt to an astonished jury. It all beats cranking out another Form 1065.
But losing weight is hard. Scuba certification is expensive. Any getting a law degree, well…that’s both hard and expensive, and truth be told, a tax pro getting a law degree is far less likely to lead to a career as defense attorney to the stars as it is to leading right back to a career as a tax professional. Only one with a lot more debt. And that stings.
So if you’re a tax pro who shells out $100K only to become a deeper-in-debt tax pro, you should at least get a tax deduction for your tuition, no? After all, the degree has undoubtedly strengthened your knowledge of the tax law and thus enhanced your ability as a professional. But is that enough?
To understand the answer, consider the case of Emmanuel Santos. Santos owned an undergraduate degree in accounting and a career as an enrolled agent preparing tax returns, but he wanted more. He went back to school and earned a masters degree in taxation – which allowed him to expand his practice to accounting work and financial planning – but still, he wanted more. So he went to law school, passed the bar, and started a law firm focusing on tax planning. Santos was also admitted to practice before the Tax Court. which would soon come in handy on a very personal level.

On his tax return for 2010, a year in which Santos was in law school, he reported the income from his tax preparation business on Schedule C. He also reported $22,000 of law school tuition as a deductible expense. The IRS denied the tuition deduction, Santos sued, and the issue landed both parties in the Tax Court, where Santos represented himself.
Deductible Tuition Expenses
Section 162 permits a deduction “for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Section 262, however, adds that no deduction is allowed for personal, living, or family expenses. So which category do tuition expenses find themselves in? Are they deductible business expenses? Or nondeductible personal expenses?

The answer, as is often the case in the tax law, is it depends. The general rule is that tuition expenses are considered nondeductible personal expenses unless they meet an exception provided for in the Section 162 regulations. Those regulations permit a deduction for education expenses in two scenarios; when the education:
(1) maintains or improve skills required by the taxpayer in his or her employment or
(2) meets the express requirements of the taxpayer’s employer, or of applicable law or regulations, imposed as a condition to the retention by the taxpayer of an established employment relationship, status, or rate of compensation.
While that sounds promising, particularly  in the case of Santos, who could justifiably claim that his law degree “maintained or improved skills required in his employment,” there is an additional hurdle. The regulations go on to provide that there are specific types of tuition expenses that are NOT deductible, including:
Education that is part of a program of study which will lead to qualifying the taxpayer for a new trade or business. 
That’s where thing get interesting. Santos was a tax guy before his law degree, and a tax guy afterhis law degree. He didn’t suddenly transition from Louis Tully to Matlock. So couldn’t the argument be made that the law degree, in this case, did not ready him for a new trade or business?
It probably could, but it would, and did, fail. And it failed because the regulations use the word “qualify,” as in, did the law degree free you to do things you couldn’t do before, even  if  you didn’t take advantage of those new options? An example in the regulations makes clear that a law degree will always qualify you for a new trade or business, by stating,
 “A, a self-employed individual practicing a profession other than law, for example, engineering, accounting, etc., attends law school at night and after completing his law school studies receives a bachelor of laws degree. The expenditures made by A in attending law school are nondeductible because this course of study qualifies him for a new trade or business.”
The courts have sided with this interpretation, holding that the critical factor is that a law degree qualifies you for a new business, even if you aren’t aiming to make a change. In O’Donnell v. Commissioner, 62 T.C. 781 (1974), the Tax Court concluded that a CPA could not deduct his law school tuition, even though he undertook the education to improve his accounting and tax skills, and had no intention of ever practicing law, because he could have had  he wanted to.
Santos attempted to argue that the regulations were invalid, but the court quickly dismissed this notion.
So miserable tax preparers of America, feel free to flee the industry and pursue your dreams. But understand that any tuition you pay to prepare you for that new life is not deductible. Of course, given  your history as a tax preparer, you probably  should have already known that.