April 15 is still a ways off and taxes are probably pretty far from your mind. Now, however, is a great time to take advantage of tax-saving opportunities that will be lost once the year is over.
The following are some often overlooked tax-planning areas to consider while there is still time to act and pay less in taxes in this tax year and beyond.
1. Contribute to a Roth
Most folks know that saving in a workplace retirement plan such as a 401k is a great way to shield income from taxes while building up a nest egg for retirement.
Many of us forget, however, that these pre-tax savings will someday be taxed as income when we begin making withdrawals in retirement. Ideally, the rates at which these withdrawals are taxed will be lower than the tax bracket we were in when making contributions. This is the ideal arbitrage scenario and is often true for mid-career and senior employees.
Younger workers just starting the climb up the career ladder, however, are typically in a lower tax bracket than they will be later in their careers and in retirement. For these folks, another retirement savings vehicle, the Roth IRA, may be a better option.
While contributions to a Roth are made with after-tax dollars, both these contributions and their earnings can be withdrawn free of income tax in the future. Younger workers can come out ahead by investing in a Roth with after-tax money when in a lower tax bracket in exchange for not paying income taxes in the future on withdrawals when they have entered a higher tax bracket.
One caveat is that if an employer matches 401k contributions, it is a good idea to save enough to qualify for the match before directing after-tax savings to a Roth. The match is, in effect, a guaranteed return and should not be passed up. Note that while contributions to an employer Roth 401K must be made by 12/31, you actually have until April 15 of the following year to make an individual Roth IRA contribution for the current tax year.
2. Spend Your Flexible Spending Account (FSA) Money
Many employers offer their employees a way to set aside a portion of their salary on a pre-tax basis to pay for out-of-pocket medical expenses and for child and dependent care. Given that the IRS does not allow a deduction for medical expenses that do not exceed 10 percent of adjusted gross income, an FSA is usually the only way to save taxes on these expenses.
FSAs are particularly valuable for taxpayers who are impacted by the AMT tax as a way to lower their taxes via pre-tax savings, thereby offsetting some of the deductions lost due to the AMT.
You need to spend unused savings before year end or risk losing them if your company’s plan is the “use it or lose it” kind. IRS rules allow employers to offer the option of rolling over as much as $500 of unused savings to the following year, but this is not mandatory.
3. Check Your Income and Withholdings to Date
We need to pay taxes throughout the year on our income to avoid a large tax bill and penalties for under withholding. We do this via payroll withholdings and estimated tax payments. The rule for avoiding an underpayment penalty, known as the “safe harbor,” is to withhold 100 percent (110 percent for higher earners) of the tax due in the previous year or 90 percent of the tax due in the current year.
An additional complication is the 0.9 percent Medicare surtax for higher earners. This is due on earned income over $250,000 for married couples ($200,000 for singles). Couples earning more than $250,000 may be at risk of under withholding because employers only begin withholding for this surtax once individual wages reach $200,000. If each spouse earns $200,000, as a couple they will earn $400,000 and will owe additional tax on $150,000, the excess over $250,000.
Since none of the Medicare surtax would have been withheld from their salary, additional estimated taxes are needed to avoid a possible underpayment penalty.
4. Perform a Roth Conversion in a Low Income Year
Despite improvements, our economy is still recovering. While unemployment has fallen, many of us remain out of work and it is taking longer for the unemployed to find a new job. Unemployed workers can experience a significant income decline and drop down one or more tax brackets as a result.
While upsetting and stressful, a significant temporary drop in income opens up the opportunity to convert an IRA to a Roth at a low tax rate and convert taxable income to tax-free income for a relatively low cost. Folks whose income has fallen low enough that their deductions exceed their tax can even perform a partial Roth conversion for no tax at all.
The above are just some of the tax-planning issues often overlooked by taxpayers. A little time spent planning for these before Dec. 31 can help you reap large rewards in the form of tax savings and future growth of wealth.
Speak to a tax professional to review your situation and put the tax code to work for you to help you save money and avoid surprises next April.
Showing posts with label Third Ward CPA Milwaukee. Show all posts
Showing posts with label Third Ward CPA Milwaukee. Show all posts
Thursday, October 9, 2014
Saturday, August 2, 2014
5 Questions to Ask Before Making Gifts for Medicaid or Tax Planning
Many seniors consider transferring assets for estate and long-term care planning purposes, or just to help out children and grandchildren. Gifts and transfers to a trust often make a lot of sense. They can save money in taxes and long-term care expenditures, and they can help out family members in need and serve as expressions of love and caring.
But some gifts can cause problems, for both the generous donor and the recipient. Following are a few questions to ask yourself before writing the check:
- Why are you making the gift? Is it simply an expression of love on a birthday or big event, such as a graduation or wedding? Or is it for tax planning or long-term care planning purposes? If the latter, make sure that there's really a benefit to the transfer. If the value of your assets totals less than the estate tax threshold in your state, your estate will pay no tax in any case. For federal purposes the threshold is $5.34 million (in 2014). Gifts can also cause up to five years of ineligibility for Medicaid, which you may need to help pay long-term care costs.
- Are you keeping enough money? If you're making small gifts, you might not need to worry about this question. But before making any large gifts, it makes sense to do some budgeting to make sure that you will not run short of funds for your basic needs, activities you enjoy -- whether that's traveling, taking courses or going out to eat -- and emergencies such as the need for care for yourself or to assist someone in financial trouble.
- Is it really a gift (part one)? Are you expecting the money to be paid back or for the recipient to perform some task for you? In either case, make sure that the beneficiary of your generosity is on the same page as you. The best way to do this is in writing, with a promissory note in the case of a loan or an agreement if you have an expectation that certain tasks will be performed.
- Is it really a gift (part two)? Another way a gift may not really be a gift is if you expect the recipient to hold the funds for you (or for someone else, such as a disabled child) or to let you live in or use a house that you have transferred. These are gifts with strings attached, at least in theory. But if you don't use a trust or, in the case of real estate, a life estate, legally there are no strings attached. Your expectations may not pan out if the recipient doesn't do what you want or runs into circumstances -- bankruptcy, a lawsuit, divorce, illness -- that no one anticipated. If the idea is to make the gifts with strings attached, it's best to attach those strings legally through a trust or life estate.
- Is the gift good for the recipient? If the recipient has special needs, the funds could make her ineligible for various public benefits, such as Medicaid, Supplemental Security Income or subsidized housing. If you make many gifts to the same person, you may help create a dependency that interferes with the recipient learning to stand on his own two feet. If the recipient has issues with drugs or alcohol, he may use the gifted funds to further the habit. You may need to permit the individual to hit bottom in order to learn to live on his own (i.e., don't be an "enabler").
If after you've answered all of these questions, you still want to make a gift, please go ahead. But unless the gift is for a nominal amount, it is advisable to check with your attorney to make sure you are aware of the Medicaid, tax and other possible implications of your generosity.
Monday, July 28, 2014
5 Smart Mid-Year Tax Moves for Right Now
During the summer months, your personal income taxes may be far from your mind as you contemplate possible travel, vacation time, and lots of outdoor fun. But right now is actually an excellent opportunity to spend time planning ahead for tax season in 2015.
Some people meet with their accountants each January to go over their annual taxes. Before 2014 ends, however, there are several key financial strategies you can use to save money on taxes.
Use the following tax wisdom, and implement these five smart mid-year tax moves to reduce the amount of money you’ll pay Uncle Sam come next April. In fact, by checking these tax moves off your “to do” list, you may even wind up getting a bigger tax refund.
1. Plan your annual donations
During the upcoming back-to-school season—and later, during the holidays—you’ll likely be solicited by co-workers for all kinds of donations, including gifts to their charities, cookies for their kids’ school drives, and money for various fundraisers.
After a while, all these solicitations can really add up. Sometimes, if you don’t have the extra money to donate, it’s best to politely decline. But other times, when you can afford to make a donation, you should make sure you get receipts for your generosity—to help document the tax deduction your contribution will bring.
According to the Association of Fund-Raising Distributors and Suppliers, schools, church groups and sports leagues raise about $1.4 billion annually in merchandise sales. So if someone hits you up for a donation, use the IRS online search tool to double-check that it’s a bona fide 501c3 charity. It’s fine to give to a worthy cause, but you should also be financially savvy about your giving. Only IRS-approved charities are eligible for a tax deduction.
2. Accelerate your expenses
Entrepreneurs should make business purchases, for things like copy machines, printers, faxes or office equipment before December 31 to get a tax deduction for business expenses.
But even if you’re not a business owner, you can accelerate other deductions, like donations you might make to charity or any property taxes you might plan to pay in January. The same is true for things like mortgage interest on your home; by making extra payments now, or anytime before year-end, you can write off the mortgage interest paid and increase your itemized deductions.
3. Delay your income
If your boss or a client is planning to make a fat year-end payment or bonus to you, when possible, try to get that payment on or after January 1, 2015. Delaying payment in this way will reduce your 2014 tax liability.
And does it really matter to your monthly budget if you get a sales bonus or a commission check on December 30 instead of January 1? Probably not. So do yourself a tax favor and get that check next year. By taking the payment in early 2015, the taxes won’t be due until tax season 2016.
4. Dump your losers
Have you been a victim of the lousy stock market? Now’s the time to take your losses. Write off investment losses on your 2014 taxes by selling depreciated shares of individual stocks or mutual funds before January 1, 2015.
5. Contribute to your retirement plan
Socking away more money into your retirement plan, such as a 401k or a 403b plan, can also net you significant savings come tax time.
When you contribute to a qualified retirement plan, you’re putting that money away on a pre-tax basis, thereby lowering your taxable income. So if you haven’t started making those contributions, stop procrastinating and head to your human resources department to get signed up immediately.
If you’re already contributing to your employer-sponsored retirement savings plan, consider boosting your annual contribution levels. Not only will you be doing a smart thing by saving more for your “golden years,” you may also net an additional financial benefit if your employer offers a matching contribution.
By putting these five smart mid-year tax moves into effect now, you’ll help make tax season a lot less taxing next year.
Sunday, July 27, 2014
Tax Planning Tips
Online publications typically circulate their tax planning tips at the end of the year. But tax planning can take place all year long; it doesn't matter whether the April filing deadline is 12 months away or just around the corner.
Tax Planning Strategies
Planning strategies really come down to one simplified income tax formula:
Gross Income - Deductible Expenses = Net Taxable Income
Tax Deductions
The overall tax-planning objective is to minimize net taxable income. The tactics involved with meeting that objective are twofold: minimizing gross income, while maximizing deductible expenses. The following paragraphs are going to look at each of these tactics separately.
Minimizing Gross Income
No doubt it's possible to minimize taxable income by taking some time off from work, but that's not going to help anyone's lifestyle in the long run. The tax tips discussed in this section include tactics that allow a filer to exclude income from federal income taxes. Therefore, the first tip has to do with retirement planning.
Tax Tip 1: Lowering Gross Income using Retirement Plans
It's no accident this is the first item listed. One of the most effective ways to lower gross income is to have it directed into a 401(k) or 403(b) plan.
The 401(k) rules are quite generous when it comes to lowering income, and they are mirrored by the 403(b) contribution rules. On a pre-tax basis, it's possible to invest up to $17,500 in 2013 and 2014, and employee contributions are often matched by an employer. In 2015 and beyond, these contribution amounts will rise with an index of inflation. That means it's possible to lower taxable income by $17,500, get an instant return on investment, and save for retirement at the same time. It's really a win-win.
Tax Tip 2: Deferring Income
A second way to lower gross taxable income is by deferring it. The objective here is to defer money, or income, to another tax year. Perhaps the best example uses the tax laws to defer stock market gains.
Individuals that have shares of stock that have gone up since they were purchased can defer taking a capital gain and raising their gross income. This is especially desirable if it's possible to offset that capital gain with a capital loss in later years.
Keep in mind the IRS disallows the loss on sales of securities if substantially identical securities are purchased within 30 days, which is called a wash sale.
Maximizing Deductible Expenses
Even though this section has been labeled as deductible expenses, it really includes two items: tax deductions and tax credits. A tax deduction lowers taxable income, while a tax credit is just as the name implies; a credit that's applied to the total tax bill. Tax credits are far more valuable on a dollar-for-dollar basis.
Tax Tip 3: Tax Credits
Admittedly, the qualifying rules for tax credits are typically complex and very specific to each program.
Child Tax Credit: provides a credit of $1,000 per qualifying child under the age of seventeen. In 2013, this credit is phased-out for taxpayers with modified adjusted gross incomes (AGI) in excess of $110,000 for married-joint filers, $55,000 for married filing separately, and $75,000 for all other taxpayers.
Hope and Lifetime Learning Credit: up to $2,500 in credits for each qualifying student enrolled in a qualifying institution of higher education are available through the Hope Credit and Lifetime Learning Credit programs.
Child and Dependent Care Credit: individuals paying a childcare provider for a child under age 13 so they can work, may be able to claim the child and dependent care credit. The credit may be lowered or eliminated for individuals with higher adjusted gross incomes.
Energy Saving Devices: homeowners that install some of the newer energy saving devices such as air conditioners, water heaters, furnaces, boilers or solar panels may be eligible for a tax credit of up to $2,000. Check with local electric or gas utilities to find out which energy saving devices provide tax credits or rebates.
Tax Tip 4: Tax Deductions
This final set of planning tips has to do with tax deductions. While it's certainly possible to buy a new home and deduct mortgage interest and property taxes; that's not the intention of this section. These are actions a taxpayer can take to squeeze out more deductions.
IRA Accounts: Roth IRAs do not provide immediate tax help, although the money removed from these accounts is not considered taxable income. Individuals looking for immediate relief might want to consider funding a Traditional IRA, which can be tax deductible. It's just another way the government provides incentives to save for retirement.
Medical Expenses: no one plans to get sick, but there is one way to use those medical expenses to a taxpayer's advantage. Only medical expenses in excess of 7.5% are allowed as tax deductions. That's where the strategy of grouping medical expenses comes into play. If a family has been hit hard with a lot of medical expenses in a given year, then it may be worthwhile to accelerate additional elective medical payments into the same tax year. This way it's possible to get a tax break on medical expenses, even with the 7.5% threshold.
Homeowner Deductions: it's also possible to accelerate mortgage and property tax deductions merely by changing the timing of certain payments. By writing checks before December 31st, it's possible to claim the interest expense or property taxes in that same tax year.
Business and Personal Expenses: this final tax planning tip has to do with accelerating personal or business-related expenses. By charging some of these costs on a credit card, it's possible to claim the expense in one tax year, and pay for them in the following year.
Prepaying Taxes and Adjusting Withholding
One last suggestion doesn't involve a tax-lowering strategy, but rather the payment of income taxes themselves. For some taxpayers, the April deadline can be financially difficult in terms of paying what is owed on a federal tax return.
There are two actions that can help take the pain out of tax time. The first has to do with prepaying taxes. This is as simple as filling out a tax form, and sending the IRS a check each quarter.
Correct Withholding
The second has to do with adjusting withholding. Neither getting a large tax refund nor sending a large check to the IRS makes a lot of sense. Anyone getting a large refund is lending the federal government money, interest free.
On the other hand, owing a lot of money to the IRS each year is not a good place to be either. In fact, withholding too little in taxes could result in unnecessary penalties.
Anyone in either of these situations should adjust their withholding. This process involves filling out a fairly simple tax form that can be downloaded from the IRS website or obtained from an employer. The W-4 takes about ten minutes to complete and filling out the form now will avoid a big tax bill later on
Friday, July 25, 2014
Monday, July 21, 2014
Tax planning moves to consider for your new child
Now obviously, everybody’s situation is different, but below are 3 tax-planning moves you should plan to make as soon as possible once you become a father. Perhaps one or more of them is relevant for you and your planning.
- Fund a 529 Plan – 529 plans are great way to save money for a child’s education. These accounts, like IRAs, allow you to accumulate funds on a tax-favored basis. Although there is no federal income tax deduction for contributions to a 529 plan, funds grow tax-deferred while in a 529 account and, if distributions are used to pay qualified higher education costs, those distributions are tax-free. Plus, although there is no federal income tax deduction available, many states offer a state income tax break for contributions made by its residents to its own plan. Just like IRAs, the earlier one starts saving in a 529 plan, the better off they will be. With higher education costs continuing to sky rocket, I’m going to start as early as I can!
- Attempt to Establish a Roth IRA as Soon as Possible – There are no minimum age requirements to open a Roth IRA. In theory, even a newborn can have one. The key, however, is that a person, regardless of age, needs some sort of “compensation” to make a Roth IRA contribution. Usually, that compensation is some sort of earned income. Now you might ask, “How can a newborn have earned income?” Well, there are a number of ways. Perhaps you own a business and you use your child’s likeness on marketing material. You could pay them for that, legitimately of course. Then, an amount equal to that earned income could be contributed to their Roth IRA (provided they meet the other requirements). I personally have no idea when my child will generate earned income. Maybe it will be soon. Maybe not for 20 or more years. That said, whenever the time comes, I am going to do everything in my power to start his tax-free retirement savings off as early as possible, even if it means I have to make a contribution to his Roth IRA with my own money.
- Update my Beneficiary Forms – Updating one’s beneficiary forms doesn’t sound like a tax-planning move, but instead, simply an estate planning move. In reality, it is both. Designated beneficiaries – generally living, breathing people named on the beneficiary form – are able to stretch distributions over their life expectancy. This helps an account grow tax-deferred as long as possible and minimize the tax impact on any distributions.
Sunday, July 20, 2014
Tapping a 529 Plan: 5 Tips to Get the Most Out of College Savings
Apart from retirement, saving for college expenses is one of the longest-term goals that families set for their finances. After scrimping for years to build up your college savings, the last thing you want to do is make mistakes that will cost you when it comes time to make withdrawals.
If you've used 529 plans to save for college, making the most of the available tax advantages is just part of the picture. Here are five tips for making the most of your 529 plan cash.
1. Spend Your 529 Plan Money on the Right Expenses
You're allowed to get tax-free treatment on withdrawals for qualified higher education expenses. Those expenses include tuition, fees, books, supplies and equipment.
If the student attends college at least half-time or more, room and board also qualifies -- but the amount is limited to a figure set by the school. So if the student lives off-campus, ask the school for its maximum.
2. Don't Waste Your Opportunities for Other Tax Credits
Even if you have enough 529 plan money to cover every penny of your college expenses, you still might not want to withdraw the full amount you owe. That's because multiple tax breaks are available for college expenses, but you can only use each dollar of expenses for one benefit.
Specifically, many students and parents are eligible for the American Opportunity credit, which gives a tax credit of 100 percent of the first $2,000 and 25 percent of the next $2,000 of educational expenses. You can use 529 plan money to claim that credit, but if you do, then it won't be eligible for the usual tax-free treatment on 529 plan distributions. Yet you definitely don't want to miss out on what could be as much as $2,500 in free tax credits, so being smart with your planning involves using expenses where they'll help you and your kids the most.
3. Know the Implications of Who Gets the Check
Most 529 plans give you a choice to have withdrawals paid to you, your student or the college. Having money go directly to the school might seem to make the most sense, but some experts worry that can affect a student's financial aid from the school.
Having money paid to a parent or the student can raise tax-audit flags. Parents and students should keep meticulous records matching up money withdrawn from 529 plans to the qualifying expenses to convince the Internal Revenue Service that they in fact used withdrawals for eligible expenses.
4. Get the Timing Right
Schools don't typically use the calendar-year system that the IRS uses. So while withdrawing a full school year's worth of expenses might seem like the simplest, it won't pass muster with the IRS.
Rather, the IRS wants to see you take money out in the same calendar year in which it's due. So if your spring-semester bill isn't due until January, wait until January to take that money out of your 529 plan account.
5. Be Smart About Scholarships
One frequent concern among 529 plan savers is that their child will get a scholarship and not need the 529 plan money. If that happens, you can withdraw the scholarship amount from the 529 plan account. It won't be treated as a tax-free distribution, but you won't owe a 10 percent penalty on that amount.
Whether you want to take a scholarship-exception withdrawal depends on how much money you have in the 529 plan, what future expenses might be, and whether you have other children who need college money. But if this is the last chance to get money out of a 529 plan without paying a penalty, it's usually worth it to avoid paying more later on.
If you've used 529 plans to save for college, making the most of the available tax advantages is just part of the picture. Here are five tips for making the most of your 529 plan cash.
1. Spend Your 529 Plan Money on the Right Expenses
You're allowed to get tax-free treatment on withdrawals for qualified higher education expenses. Those expenses include tuition, fees, books, supplies and equipment.
If the student attends college at least half-time or more, room and board also qualifies -- but the amount is limited to a figure set by the school. So if the student lives off-campus, ask the school for its maximum.
2. Don't Waste Your Opportunities for Other Tax Credits
Even if you have enough 529 plan money to cover every penny of your college expenses, you still might not want to withdraw the full amount you owe. That's because multiple tax breaks are available for college expenses, but you can only use each dollar of expenses for one benefit.
Specifically, many students and parents are eligible for the American Opportunity credit, which gives a tax credit of 100 percent of the first $2,000 and 25 percent of the next $2,000 of educational expenses. You can use 529 plan money to claim that credit, but if you do, then it won't be eligible for the usual tax-free treatment on 529 plan distributions. Yet you definitely don't want to miss out on what could be as much as $2,500 in free tax credits, so being smart with your planning involves using expenses where they'll help you and your kids the most.
3. Know the Implications of Who Gets the Check
Most 529 plans give you a choice to have withdrawals paid to you, your student or the college. Having money go directly to the school might seem to make the most sense, but some experts worry that can affect a student's financial aid from the school.
Having money paid to a parent or the student can raise tax-audit flags. Parents and students should keep meticulous records matching up money withdrawn from 529 plans to the qualifying expenses to convince the Internal Revenue Service that they in fact used withdrawals for eligible expenses.
4. Get the Timing Right
Schools don't typically use the calendar-year system that the IRS uses. So while withdrawing a full school year's worth of expenses might seem like the simplest, it won't pass muster with the IRS.
Rather, the IRS wants to see you take money out in the same calendar year in which it's due. So if your spring-semester bill isn't due until January, wait until January to take that money out of your 529 plan account.
5. Be Smart About Scholarships
One frequent concern among 529 plan savers is that their child will get a scholarship and not need the 529 plan money. If that happens, you can withdraw the scholarship amount from the 529 plan account. It won't be treated as a tax-free distribution, but you won't owe a 10 percent penalty on that amount.
Whether you want to take a scholarship-exception withdrawal depends on how much money you have in the 529 plan, what future expenses might be, and whether you have other children who need college money. But if this is the last chance to get money out of a 529 plan without paying a penalty, it's usually worth it to avoid paying more later on.
Friday, July 18, 2014
5 Questions to Ask Before Making Gifts for Medicaid or Tax Planning
Many seniors consider transferring assets for estate and long-term care planning purposes, or just to help out children and grandchildren. Gifts and transfers to a trust often make a lot of sense. They can save money in taxes and long-term care expenditures, and they can help out family members in need and serve as expressions of love and caring.
But some gifts can cause problems, for both the generous donor and the recipient. Following are a few questions to ask yourself before writing the check:
- Why are you making the gift? Is it simply an expression of love on a birthday or big event, such as a graduation or wedding? Or is it for tax planning or long-term care planning purposes? If the latter, make sure that there's really a benefit to the transfer. If the value of your assets totals less than the estate tax threshold in your state, your estate will pay no tax in any case. For federal purposes the threshold is $5.34 million (in 2014). Gifts can also cause up to five years of ineligibility for Medicaid, which you may need to help pay long-term care costs.
- Are you keeping enough money? If you're making small gifts, you might not need to worry about this question. But before making any large gifts, it makes sense to do some budgeting to make sure that you will not run short of funds for your basic needs, activities you enjoy -- whether that's traveling, taking courses or going out to eat -- and emergencies such as the need for care for yourself or to assist someone in financial trouble.
- Is it really a gift (part one)? Are you expecting the money to be paid back or for the recipient to perform some task for you? In either case, make sure that the beneficiary of your generosity is on the same page as you. The best way to do this is in writing, with a promissory note in the case of a loan or an agreement if you have an expectation that certain tasks will be performed.
- Is it really a gift (part two)? Another way a gift may not really be a gift is if you expect the recipient to hold the funds for you (or for someone else, such as a disabled child) or to let you live in or use a house that you have transferred. These are gifts with strings attached, at least in theory. But if you don't use a trust or, in the case of real estate, a life estate, legally there are no strings attached. Your expectations may not pan out if the recipient doesn't do what you want or runs into circumstances -- bankruptcy, a lawsuit, divorce, illness -- that no one anticipated. If the idea is to make the gifts with strings attached, it's best to attach those strings legally through a trust or life estate.
- Is the gift good for the recipient? If the recipient has special needs, the funds could make her ineligible for various public benefits, such as Medicaid, Supplemental Security Income or subsidized housing. If you make many gifts to the same person, you may help create a dependency that interferes with the recipient learning to stand on his own two feet. If the recipient has issues with drugs or alcohol, he may use the gifted funds to further the habit. You may need to permit the individual to hit bottom in order to learn to live on his own (i.e., don't be an "enabler").
If after you've answered all of these questions, you still want to make a gift, please go ahead. But unless the gift is for a nominal amount, it is advisable to check with your attorney to make sure you are aware of the Medicaid, tax and other possible implications of your generosity.
Thursday, July 17, 2014
WHAT SHOULD TAXPAYERS TRACK FOR MID-YEAR TAX PLANNING?
Many consumers may not like to think about it, but tax time is probably closer than they might realize, at least in terms of when the filing period opens. While the deadline is months away, experts generally agree that those who stay on top of planning all year long are going to be in the best position to keep their liabilities as low as possible.
There are many things to consider when doing tax planning far out from the filing deadline, and a lot of them are typically going to be based on educated guesses, according to a report from Bluffton Today. For instance, those who are slated to have a child in the second half of the year should keep in mind that this kind of life event can have major tax implications in a number of ways, and therefore looking into what those are so that they can be properly factored in before the baby arrives and things get a little more hectic.
The same is true for those who are expecting raises or promotions from their jobs, because this too will drastically alter their liabilities, the report said. Spending half the year at one salary and then jumping to another will result in a larger taxable income than the worker likely faced the year prior, and as such they might need to prepare to write a larger check once filing season arrives.
What else could be done?
Consumers should keep in mind that some changes, such as having a baby or getting married or divorced, can alter their filing statuses as well, sometimes for the better, the report said. Of course, when that changes, it should bring with it additional advance work to make sure that the taxpayer knows exactly what will be different about their filings in a few months' time.
Of course, those hoping to make sure their necessary documents are completely ready to go once filing season rolls around should also try to work with a tax professional throughout the year as well. Doing so will help them prepare in this way, and also to identify any potential hiccups they might face which could make their ability to submit a little trickier.
There are many things to consider when doing tax planning far out from the filing deadline, and a lot of them are typically going to be based on educated guesses, according to a report from Bluffton Today. For instance, those who are slated to have a child in the second half of the year should keep in mind that this kind of life event can have major tax implications in a number of ways, and therefore looking into what those are so that they can be properly factored in before the baby arrives and things get a little more hectic.
The same is true for those who are expecting raises or promotions from their jobs, because this too will drastically alter their liabilities, the report said. Spending half the year at one salary and then jumping to another will result in a larger taxable income than the worker likely faced the year prior, and as such they might need to prepare to write a larger check once filing season arrives.
What else could be done?
Consumers should keep in mind that some changes, such as having a baby or getting married or divorced, can alter their filing statuses as well, sometimes for the better, the report said. Of course, when that changes, it should bring with it additional advance work to make sure that the taxpayer knows exactly what will be different about their filings in a few months' time.
Of course, those hoping to make sure their necessary documents are completely ready to go once filing season rolls around should also try to work with a tax professional throughout the year as well. Doing so will help them prepare in this way, and also to identify any potential hiccups they might face which could make their ability to submit a little trickier.
Sunday, July 13, 2014
Retirees, Get a Jump-Start on Your 2014 Tax Bill
The beach chair is beckoning, but isn’t it also tempting to save a wad of cash? Hold off on the sand and surf for just a bit, and take some time for your midyear tax review. By getting a head start on your 2014 planning, you’re likely to find many strategies to shave your payments to Uncle Sam.
To get started, take out your 2013 return. “Note what is changing for 2014 regarding your income and deductions,” says Martin James, a certified public accountant in Mooresville, Ind. “You need to look at every line item.”
It’s also crucial, according to James and other tax experts, for taxpayers to take a multi-year approach to their annual tax review. James says a move that could trim taxes one year could “create a tax nightmare in the future.” For instance, he says, a taxpayer who reduces her tax tab each year by pulling money from a taxable account—rather than withdrawing from an IRA and paying taxes—could find herself in a higher tax bracket later when it’s time to take required minimum distributions from a large IRA.
The bottom line of your 1040 from 2013 could be sending a loud message if it shows you got a big refund this year or sent Uncle Sam a big check. In either case, you should change the amount of tax withheld from your paycheck or paid quarterly. You also should re-evaluate your withholding if you believe your income will change much from last year, says Rebecca Pavese, a certified public accountant with Palisades Hudson Financial Group, in Atlanta. By making the move now, “you won’t have a large bill due or give the government your money all year long,” she says.
While taxpayers like tax refunds, you’re better off getting bigger paychecks for the rest of this year. “Let that money work for you,” Pavese says, perhaps by investing it or paying off credit-card debt. Withhold too little, though, and you could end up owing a penalty.
If you’re employed, file a revised W-4 with your employer. The more allowances you claim, the less tax will be withheld. If your income will be similar to last year’s, you can figure the appropriate number of allowances to claim with Kiplinger’s Easy to Use Tax Withholding Calculator.
Top off your retirement accounts. You can reduce your adjusted gross income and taxable income by maximizing pretax contributions to tax-deferred retirement accounts. Taxpayers who will be 50 or older by year-end can contribute up to $6,500 to a traditional IRA. If your spouse isn’t working, you can contribute up to the same amount to a spousal IRA as long as you have enough earned income to cover the contribution. If you are covered by a 401(k) at work, you can contribute to a traditional IRA but, depending on your income, you may not be able to deduct the IRA contributions.
Pavese suggests that taxpayers not wait until the last days of the year to make contributions. “The longer your money grows tax deferred, the better,” she says.
If you’re newly retired yet still bringing in income as a consultant or from a small business, be sure to set up one of several types of retirement accounts designed for the self-employed. Jeffrey Cutter, a certified public accountant in East Falmouth, Mass., says one of his clients who retired with a federal pension did not need the income from a new consulting job that paid $85,000 a year. He opened an individual 401(k), which allows him to sock away and deduct up to $52,000 of that income in 2014.
Reduce taxes on investments. Your investments can open a treasure trove of tax-trimming opportunities. Finding tax-trimming gems in your portfolio became especially important when higher tax rates—as well as a new 3.8% surtax on “net investment income”—took effect in the 2013 tax year. As you probably realized during the last tax year, each rate kicks in at a different income threshold.
If you can, try to keep your income below certain tax triggers or from crossing into higher brackets. If you’re planning a Roth conversion, for example, be sure to consider the 3.8% surtax, which kicks in for singles with modified adjusted gross income above $200,000 and for joint filers with AGI above $250,000.
Also keep in mind, James says, that you will pay higher Medicare Part B and Part D premiums if your modified AGI exceeds $85,000 for singles and $170,000 for married couples. And you could be eligible for a tax credit to help pay for health insurance purchased on the new health exchanges if your modified AGI is less than $46,680 for a single and $62,690 for a couple. Those on the cusp of those thresholds should stagger Roth conversions over several years—rather than taking all of the income in a single year. You need to “look at the stealth taxes that happen when AGI goes up,” James says.
Taxpayers who are selling a business, real estate or rental property might consider an installment sale, James says. By deferring the sales proceeds over more than a year, you can defer annual gains subject to the surtax and reduce your AGI, he says. (Net investment income includes interest, dividends, capital gains, annuity payments, rents and royalties.)
Also start your tax loss “harvesting” now, looking “for the dogs in your portfolio” to sell, Cutter says. Once you bank your losses, “see if it makes sense to sell any of your appreciated stock,” he says. You can take the profits for living expenses and use the capital losses to offset the gains dollar-for-dollar.
Taxpayers in the 10% and 15% tax brackets—up to $36,900 for singles and $73,800 for joint filers—are once again eligible for the 0% tax rate on long-term capital gains. Consider this maneuver: If you have appreciated stock you like, you can sell it and pay no capital-gains tax if you stay within the 15% bracket. Then buy back the shares. In the future, when you sell, you’ll only pay tax on the appreciation on the current higher value.
Whether you’re in the crosshairs of the surtax or not, you can trim your tax tab, in both the long and short terms, by keeping an eye on the location of your assets (read Boost Your After-Tax Investment Returns). As a rule of thumb, assets that generate a lot of ordinary income, such as real estate investment trusts and high-yield bond funds, should be placed in tax-deferred accounts where earnings can compound without annual interruptions by the IRS. Taxable brokerage accounts should hold tax-exempt municipal bonds and stock index funds, which generate tax-favored long-term capital gains and then primarily only when you sell. Actively managed funds, which tend to generate ordinary income and short- and long-term gains even if you don’t sell shares, should be in your tax-deferred account.
Save cash on your charitable intent. Congress has yet to extend the popular tax break that allows individuals 70½ and older to transfer up to $100,000 tax-free from an IRA directly to charity. The donation can count toward a required minimum distribution. You can’t deduct the contribution, but this maneuver lowers your AGI compared with taking a taxable distribution and donating it to the charity.
It’s likely that lawmakers will revive this provision but not until after the November elections. For seniors who want to make an IRA charitable transfer, it makes sense to wait on your RMDs and charitable gifts until later in the year. You cannot use this strategy to contribute to a donor-advised fund.
A midyear tax review is a good time to scour your taxable portfolio for appreciated stock that could be used for a charitable donation. “An appreciated security is a very tax-efficient gift,” Pavese says. “If you sell the stock and give the cash to the charity, you’ll have to pay tax on the gain. And you’ll have less money to give to the charity.” If you donate the stock itself, though, you’ll get an income-tax deduction for the market value of the securities, assuming you’ve owned them for more than one year. You can place the shares in a donor-advised fund if you want. That way, you get the deduction this year, but you can decide at a later date which charities will get your money.
Ask your favorite charities if they will take artwork, antiques or real estate. Gifts of tangible personal property worth more than $5,000 must be independently appraised, so line up an appraiser before the year-end dash.
Keep track of what you spend on charitable work. For example, you can deduct the costs of fund-raising activities. If you drive your car for charitable work, you can deduct 14 cents per mile
To get started, take out your 2013 return. “Note what is changing for 2014 regarding your income and deductions,” says Martin James, a certified public accountant in Mooresville, Ind. “You need to look at every line item.”
It’s also crucial, according to James and other tax experts, for taxpayers to take a multi-year approach to their annual tax review. James says a move that could trim taxes one year could “create a tax nightmare in the future.” For instance, he says, a taxpayer who reduces her tax tab each year by pulling money from a taxable account—rather than withdrawing from an IRA and paying taxes—could find herself in a higher tax bracket later when it’s time to take required minimum distributions from a large IRA.
The bottom line of your 1040 from 2013 could be sending a loud message if it shows you got a big refund this year or sent Uncle Sam a big check. In either case, you should change the amount of tax withheld from your paycheck or paid quarterly. You also should re-evaluate your withholding if you believe your income will change much from last year, says Rebecca Pavese, a certified public accountant with Palisades Hudson Financial Group, in Atlanta. By making the move now, “you won’t have a large bill due or give the government your money all year long,” she says.
While taxpayers like tax refunds, you’re better off getting bigger paychecks for the rest of this year. “Let that money work for you,” Pavese says, perhaps by investing it or paying off credit-card debt. Withhold too little, though, and you could end up owing a penalty.
If you’re employed, file a revised W-4 with your employer. The more allowances you claim, the less tax will be withheld. If your income will be similar to last year’s, you can figure the appropriate number of allowances to claim with Kiplinger’s Easy to Use Tax Withholding Calculator.
Top off your retirement accounts. You can reduce your adjusted gross income and taxable income by maximizing pretax contributions to tax-deferred retirement accounts. Taxpayers who will be 50 or older by year-end can contribute up to $6,500 to a traditional IRA. If your spouse isn’t working, you can contribute up to the same amount to a spousal IRA as long as you have enough earned income to cover the contribution. If you are covered by a 401(k) at work, you can contribute to a traditional IRA but, depending on your income, you may not be able to deduct the IRA contributions.
Pavese suggests that taxpayers not wait until the last days of the year to make contributions. “The longer your money grows tax deferred, the better,” she says.
If you’re newly retired yet still bringing in income as a consultant or from a small business, be sure to set up one of several types of retirement accounts designed for the self-employed. Jeffrey Cutter, a certified public accountant in East Falmouth, Mass., says one of his clients who retired with a federal pension did not need the income from a new consulting job that paid $85,000 a year. He opened an individual 401(k), which allows him to sock away and deduct up to $52,000 of that income in 2014.
Reduce taxes on investments. Your investments can open a treasure trove of tax-trimming opportunities. Finding tax-trimming gems in your portfolio became especially important when higher tax rates—as well as a new 3.8% surtax on “net investment income”—took effect in the 2013 tax year. As you probably realized during the last tax year, each rate kicks in at a different income threshold.
If you can, try to keep your income below certain tax triggers or from crossing into higher brackets. If you’re planning a Roth conversion, for example, be sure to consider the 3.8% surtax, which kicks in for singles with modified adjusted gross income above $200,000 and for joint filers with AGI above $250,000.
Also keep in mind, James says, that you will pay higher Medicare Part B and Part D premiums if your modified AGI exceeds $85,000 for singles and $170,000 for married couples. And you could be eligible for a tax credit to help pay for health insurance purchased on the new health exchanges if your modified AGI is less than $46,680 for a single and $62,690 for a couple. Those on the cusp of those thresholds should stagger Roth conversions over several years—rather than taking all of the income in a single year. You need to “look at the stealth taxes that happen when AGI goes up,” James says.
Taxpayers who are selling a business, real estate or rental property might consider an installment sale, James says. By deferring the sales proceeds over more than a year, you can defer annual gains subject to the surtax and reduce your AGI, he says. (Net investment income includes interest, dividends, capital gains, annuity payments, rents and royalties.)
Also start your tax loss “harvesting” now, looking “for the dogs in your portfolio” to sell, Cutter says. Once you bank your losses, “see if it makes sense to sell any of your appreciated stock,” he says. You can take the profits for living expenses and use the capital losses to offset the gains dollar-for-dollar.
Taxpayers in the 10% and 15% tax brackets—up to $36,900 for singles and $73,800 for joint filers—are once again eligible for the 0% tax rate on long-term capital gains. Consider this maneuver: If you have appreciated stock you like, you can sell it and pay no capital-gains tax if you stay within the 15% bracket. Then buy back the shares. In the future, when you sell, you’ll only pay tax on the appreciation on the current higher value.
Whether you’re in the crosshairs of the surtax or not, you can trim your tax tab, in both the long and short terms, by keeping an eye on the location of your assets (read Boost Your After-Tax Investment Returns). As a rule of thumb, assets that generate a lot of ordinary income, such as real estate investment trusts and high-yield bond funds, should be placed in tax-deferred accounts where earnings can compound without annual interruptions by the IRS. Taxable brokerage accounts should hold tax-exempt municipal bonds and stock index funds, which generate tax-favored long-term capital gains and then primarily only when you sell. Actively managed funds, which tend to generate ordinary income and short- and long-term gains even if you don’t sell shares, should be in your tax-deferred account.
Save cash on your charitable intent. Congress has yet to extend the popular tax break that allows individuals 70½ and older to transfer up to $100,000 tax-free from an IRA directly to charity. The donation can count toward a required minimum distribution. You can’t deduct the contribution, but this maneuver lowers your AGI compared with taking a taxable distribution and donating it to the charity.
It’s likely that lawmakers will revive this provision but not until after the November elections. For seniors who want to make an IRA charitable transfer, it makes sense to wait on your RMDs and charitable gifts until later in the year. You cannot use this strategy to contribute to a donor-advised fund.
A midyear tax review is a good time to scour your taxable portfolio for appreciated stock that could be used for a charitable donation. “An appreciated security is a very tax-efficient gift,” Pavese says. “If you sell the stock and give the cash to the charity, you’ll have to pay tax on the gain. And you’ll have less money to give to the charity.” If you donate the stock itself, though, you’ll get an income-tax deduction for the market value of the securities, assuming you’ve owned them for more than one year. You can place the shares in a donor-advised fund if you want. That way, you get the deduction this year, but you can decide at a later date which charities will get your money.
Ask your favorite charities if they will take artwork, antiques or real estate. Gifts of tangible personal property worth more than $5,000 must be independently appraised, so line up an appraiser before the year-end dash.
Keep track of what you spend on charitable work. For example, you can deduct the costs of fund-raising activities. If you drive your car for charitable work, you can deduct 14 cents per mile
Saturday, July 12, 2014
Retirement Plans for Small Businesses: The Keogh Plan Is Not Extinct
In the not-so-distant past, the Keogh plan was the hottest retirement planning commodity around. But like fax machines and VHS recorders, Keoghs are now regarded by many as relics. Nevertheless, this type of plan still might fit the bill for certain sole practitioners.
Here’s a quick recap. The Keogh plan, named for the Brooklyn, NY Congressman who sponsored the legislation, was intended to provide a viable option for unincorporated small business owners who were otherwise restricted or closed out of qualified retirement plans. (The plan was also called an HR-10 plan after the number assigned to an early version of the bill.) After Congress adopted the Keogh, it quickly became popular among professionals, like physicians and dentists, who were self-employed and employed a small staff.
There are two main types of Keogh plans: the defined contribution Keogh and the defined benefit Keogh. As you might imagine, these mirror the basic rules for defined contribution and defined benefit plans, including annual limits on contributions, with a few tweaks here and there.
Defined contribution Keogh: The maximum deductible contribution for 2014 is equal to the lesser of $52,000 or 15% of earned income. One variation is a money purchase plan where contributions are based on a percentage of annual income. With this type of plan, you can contribute and deduct the lesser of $52,000 or 25% of earned income.
Defined benefit Keogh: Like other defined benefit plans, the limit for this type of Keogh is based on actuarial computations. The plan may provide an annual retirement benefit equal to the lesser of 100% of earned income for the three highest-paid years or a specific dollar amount adjusted for inflation. The dollar limit for 2014 is $210,000.
But be aware of this tax twist. To compute “earned income” for a plan, your earnings from self-employment are reduced by your contributions and one-half of the self- employment tax you pay. Furthermore, note that the maximum amount of compensation allowed for this calculation is limited in 2014 to $260,000.
Most other rules for qualified retirement plans also apply to Keogh plans. For instance, pre-age 59 ½ withdrawals are subject to regular income tax, plus a 10% tax penalty, unless you qualify under a special tax law exception. Required minimum distributions (RMDs) must begin in the year after the year in which you attain age 70 ½.
If you have other employees, you’re required to cover them under the Keogh plan in the same proportion as you do for yourself. Because contributions are based on a percentage, the actual dollars allocated to yourself can far exceed the amounts contributed for other staff members. For some small business owners, this may give the Keogh an edge over certain other plans like a SIMPLE or a SEP.
Caution: When a plan is “top-heavy,” certain minimum contributions must be made for employees. A plan is top-heavy if more than 60% of contributions or benefits go to key employees of the firm.
Finally, the deadline for contributions to a Keogh plan for the 2014 tax year is your tax return due date, plus extensions, as long as the plan is set up before January 1, 2015. This provides a late-year planning opportunity for procrastinators.
The Keogh plan certainly isn’t as prevalent as it once was due to subsequent tax law modifications and the emergence of solo 401(k) plans. But it’s hardly a dinosaur either. Keogh plans still abound and can provide a fast way for unincorporated business owners to build up a nest egg.
Here’s a quick recap. The Keogh plan, named for the Brooklyn, NY Congressman who sponsored the legislation, was intended to provide a viable option for unincorporated small business owners who were otherwise restricted or closed out of qualified retirement plans. (The plan was also called an HR-10 plan after the number assigned to an early version of the bill.) After Congress adopted the Keogh, it quickly became popular among professionals, like physicians and dentists, who were self-employed and employed a small staff.
There are two main types of Keogh plans: the defined contribution Keogh and the defined benefit Keogh. As you might imagine, these mirror the basic rules for defined contribution and defined benefit plans, including annual limits on contributions, with a few tweaks here and there.
Defined contribution Keogh: The maximum deductible contribution for 2014 is equal to the lesser of $52,000 or 15% of earned income. One variation is a money purchase plan where contributions are based on a percentage of annual income. With this type of plan, you can contribute and deduct the lesser of $52,000 or 25% of earned income.
Defined benefit Keogh: Like other defined benefit plans, the limit for this type of Keogh is based on actuarial computations. The plan may provide an annual retirement benefit equal to the lesser of 100% of earned income for the three highest-paid years or a specific dollar amount adjusted for inflation. The dollar limit for 2014 is $210,000.
But be aware of this tax twist. To compute “earned income” for a plan, your earnings from self-employment are reduced by your contributions and one-half of the self- employment tax you pay. Furthermore, note that the maximum amount of compensation allowed for this calculation is limited in 2014 to $260,000.
Most other rules for qualified retirement plans also apply to Keogh plans. For instance, pre-age 59 ½ withdrawals are subject to regular income tax, plus a 10% tax penalty, unless you qualify under a special tax law exception. Required minimum distributions (RMDs) must begin in the year after the year in which you attain age 70 ½.
If you have other employees, you’re required to cover them under the Keogh plan in the same proportion as you do for yourself. Because contributions are based on a percentage, the actual dollars allocated to yourself can far exceed the amounts contributed for other staff members. For some small business owners, this may give the Keogh an edge over certain other plans like a SIMPLE or a SEP.
Caution: When a plan is “top-heavy,” certain minimum contributions must be made for employees. A plan is top-heavy if more than 60% of contributions or benefits go to key employees of the firm.
Finally, the deadline for contributions to a Keogh plan for the 2014 tax year is your tax return due date, plus extensions, as long as the plan is set up before January 1, 2015. This provides a late-year planning opportunity for procrastinators.
The Keogh plan certainly isn’t as prevalent as it once was due to subsequent tax law modifications and the emergence of solo 401(k) plans. But it’s hardly a dinosaur either. Keogh plans still abound and can provide a fast way for unincorporated business owners to build up a nest egg.
Thursday, July 10, 2014
Your Retirement: Navigating the Social Security ‘Tax Trap’
If you haven’t discovered it already, up to 85 percent of your Social Security benefits could be taxed.
As financial advisors, we are often surprised by the number of prospective retirees who come to us for planning and are shocked that they have to pay taxes on their Social Security when they retire.
In fact, in 2012, Social Security beneficiaries paid a total of $45.9 billion in income taxes on their benefits. That’s right!
Sadly, for many people this taxation could be avoided or at the very least, significantly reduced. You have to plan ahead for it – and that means understanding how taxes work in retirement.
So here’s how it works: First, to determine the taxability of your Social Security, you must take into consideration your combined income, also known as provisional income, which is arrived at by taking 50 percent of your Social Security benefits and adding that figure to all the other taxable and tax-free interest income you receive in retirement. Yes, even municipal bonds are considered in this equation.
If you file as an individual and your combined income is below $25,000, your benefits won’t be taxed at all. If your income is between $25,000 and $34,000, up to 50 percent of your benefits may be subject to tax. For income of more than $34,000, up to 85 percent of your benefits may be considered taxable income.
If you and your spouse file a joint return with combined income below $32,000, your benefits are safe. For income between $32,000 and $44,000, up to 50 percent of benefits may be subject to taxation, and up to 85 percent if combined income exceeds $44,000.
It is possible to have income in excess of these thresholds while keeping your benefits out of the hands of Uncle Sam. Let’s look at a case to see how this plays out.
Case Study:
A married couple, Jerry and Linda, are both 62 and have recently decided to retire. They’re income need is $62,000 per year. As it stands currently, they have $38,000 of income. So they will have to make up the shortfall of $24,000 ($62,000 - $38,000 = $24,000) from their investment assets.
Jerry and Linda have done a good job accumulating assets to make up for the shortfall between their fixed income resources and their desired income need. However, we want to distribute the assets in the most tax-efficient manner. After all, a dollar paid out in taxes is a dollar that never returns!
Current Income:
Interest and Dividends Income..$2,000
Social Security Income.........$18,000
Pension Income.................$18,000
Total Income...................$38,000
Current Assets:
Bank Accounts....$150,000
Mutual Funds.....$300,000
IRA..............$250,000
401K.............$300,000
Total Assets.....$1,000,000
Jerry and Linda obviously could draw $24,000 from any one of the accounts listed above. However, what option would allow them to access it without causing their Social Security benefits to become taxable? Through our analysis, we found that they could distribute $15,000 from the mutual funds of which only $2,942 is taxable as a gain. The remaining $12,058 would be consider principal and is not taxable.
They could also distribute $9,000 from their bank accounts, which again would be non-taxable. Any interest accrued on the bank accounts is taxed as interest and dividends and is already accounted for in the combined income above.
So as you can see, we devised an income plan that allows them to attain their $62,000 income goal. But does it muster up to our “tax free” goal? Let’s work through the calculation:
Interest and Dividends Income..........$2,000
50 percent of Social Security Income...$9,000
Pension Income.........................$18,000
Mutual Funds capital gain..............$2,942
Bank Accounts..........................$0
Combined Income Total..................$31,942
It sure does with $58 to spare! You see, with proper planning Jerry and Linda were able to produce an income of $62,000 without causing one cent of their Social Security to become taxable. Had they made a different choice they could have had a combined income of $53,000 rather than $31,942, causing 85 percent of their Social Security to become taxable.
A fundamental part of any financial plan is the need for a strategy to help prevent or minimize the effect of income taxes on your wealth. If you do not have such a plan, you can lose significant amounts of money that you may never be able to recapture. There are numerous income-tax savings concepts at your disposal. Unfortunately, most people don’t use any, and many use the wrong ones.
To learn more about this and other critical strategies to help make the most out of your Social Security benefits, consider reserving your seat at Shope & Associates’ upcoming Social Security Seminar. For more information, call Shope & Associates at 734-479-1400.
This is for illustrative purposes only and may not be indicative of your situation. This is also for informational purposes only and should not be construed as tax advice. Consult your tax advisor regarding your specific situation.
As financial advisors, we are often surprised by the number of prospective retirees who come to us for planning and are shocked that they have to pay taxes on their Social Security when they retire.
In fact, in 2012, Social Security beneficiaries paid a total of $45.9 billion in income taxes on their benefits. That’s right!
Sadly, for many people this taxation could be avoided or at the very least, significantly reduced. You have to plan ahead for it – and that means understanding how taxes work in retirement.
So here’s how it works: First, to determine the taxability of your Social Security, you must take into consideration your combined income, also known as provisional income, which is arrived at by taking 50 percent of your Social Security benefits and adding that figure to all the other taxable and tax-free interest income you receive in retirement. Yes, even municipal bonds are considered in this equation.
If you file as an individual and your combined income is below $25,000, your benefits won’t be taxed at all. If your income is between $25,000 and $34,000, up to 50 percent of your benefits may be subject to tax. For income of more than $34,000, up to 85 percent of your benefits may be considered taxable income.
If you and your spouse file a joint return with combined income below $32,000, your benefits are safe. For income between $32,000 and $44,000, up to 50 percent of benefits may be subject to taxation, and up to 85 percent if combined income exceeds $44,000.
It is possible to have income in excess of these thresholds while keeping your benefits out of the hands of Uncle Sam. Let’s look at a case to see how this plays out.
Case Study:
A married couple, Jerry and Linda, are both 62 and have recently decided to retire. They’re income need is $62,000 per year. As it stands currently, they have $38,000 of income. So they will have to make up the shortfall of $24,000 ($62,000 - $38,000 = $24,000) from their investment assets.
Jerry and Linda have done a good job accumulating assets to make up for the shortfall between their fixed income resources and their desired income need. However, we want to distribute the assets in the most tax-efficient manner. After all, a dollar paid out in taxes is a dollar that never returns!
Current Income:
Interest and Dividends Income..$2,000
Social Security Income.........$18,000
Pension Income.................$18,000
Total Income...................$38,000
Current Assets:
Bank Accounts....$150,000
Mutual Funds.....$300,000
IRA..............$250,000
401K.............$300,000
Total Assets.....$1,000,000
Jerry and Linda obviously could draw $24,000 from any one of the accounts listed above. However, what option would allow them to access it without causing their Social Security benefits to become taxable? Through our analysis, we found that they could distribute $15,000 from the mutual funds of which only $2,942 is taxable as a gain. The remaining $12,058 would be consider principal and is not taxable.
They could also distribute $9,000 from their bank accounts, which again would be non-taxable. Any interest accrued on the bank accounts is taxed as interest and dividends and is already accounted for in the combined income above.
So as you can see, we devised an income plan that allows them to attain their $62,000 income goal. But does it muster up to our “tax free” goal? Let’s work through the calculation:
Interest and Dividends Income..........$2,000
50 percent of Social Security Income...$9,000
Pension Income.........................$18,000
Mutual Funds capital gain..............$2,942
Bank Accounts..........................$0
Combined Income Total..................$31,942
It sure does with $58 to spare! You see, with proper planning Jerry and Linda were able to produce an income of $62,000 without causing one cent of their Social Security to become taxable. Had they made a different choice they could have had a combined income of $53,000 rather than $31,942, causing 85 percent of their Social Security to become taxable.
A fundamental part of any financial plan is the need for a strategy to help prevent or minimize the effect of income taxes on your wealth. If you do not have such a plan, you can lose significant amounts of money that you may never be able to recapture. There are numerous income-tax savings concepts at your disposal. Unfortunately, most people don’t use any, and many use the wrong ones.
To learn more about this and other critical strategies to help make the most out of your Social Security benefits, consider reserving your seat at Shope & Associates’ upcoming Social Security Seminar. For more information, call Shope & Associates at 734-479-1400.
This is for illustrative purposes only and may not be indicative of your situation. This is also for informational purposes only and should not be construed as tax advice. Consult your tax advisor regarding your specific situation.
Friday, May 16, 2014
A Guide to the Tax Rules of Mortgage Refinancing
Recent drops in interest rates have prompted millions of households to refinance their mortgages. Borrowers who refinance need to familiarize themselves with tricky tax rules on what is or isn't deductible for interest payments. Here are some reminders on how the rules work.
Consider a client who owns a personal residence. It's worth more than the remaining principal balance on the mortgage. The lender is willing to allow a refinance for more than the balance of the existing mortgage. Tax rules allow the client to deduct interest payments on a refinancing loan as long as it's for the same amount as the existing balance. But is the client also entitled to deduct interest payments for the part of the refinancing that exceeds the existing balance? And does it matter that the client plans to use most of the excess refinancing proceeds to pay off credit card debts?
Whether borrowers are entitled to deduct interest on the excess amount depends upon how they use the proceeds from the refinancing and the amount of the proceeds. When borrowers use the amount in excess of the existing mortgage to buy, build or substantially improve principal residences, meaning year-round dwellings, or second homes such as vacation retreats, their interest payments come under the rules for home acquisition loans. Those rules allow them to deduct the entire interest as long as the excess plus all other home acquisition loans don't exceed $1 million ($500,000 for married couples filing separate returns).
However, when borrowers use the excess for any other purposes, another set of rules prohibits deductions for payments of interest on "consumer loans." This wide-ranging category includes credit card bills, auto loans, medical expenses and other personal debts such as overdue federal and state income taxes. There is, though, a limited exception for interest on student loans, one of those "above-the-line" subtractions to arrive at adjusted gross income.
But most borrowers are able to sidestep these restrictions on deductions for consumer interest, thanks to the rules for home equity loans. Those rules allow them to deduct the entire interest as long as the amount in excess of the existing mortgage plus all other home equity loans don't exceed $100,000, dropping to $50,000 for married couples filing separate returns. It makes no difference how borrowers use the proceeds.
When their refinanced loans are partly home acquisition loans and partly home equity loans, there's an overall limit of $1.1 million, which is a combination of $1 million from the home acquisition debt and $100,000 home equity debt. (That number drops to $550,000 for married couples filing separately.) When the loans exceed the ceiling of $1 million for home acquisition loans and $100,000 for home equity loans, the excess generally is categorized as nondeductible personal interest. The general disallowance is subject to exceptions for loan proceeds used for business or investment purposes.
Yet another restriction applies to the steadily growing number of borrowers burdened by the alternative minimum tax. The AMT allows deductions for interest payments on home acquisition loans of up to $1 million ($500,000 for married couples filing separately). But AMT rules deny any deductions for interest on home equity loans for first or second homes, unless the loan proceeds are used to buy, build, or substantially improve the dwellings.
Consider a client who owns a personal residence. It's worth more than the remaining principal balance on the mortgage. The lender is willing to allow a refinance for more than the balance of the existing mortgage. Tax rules allow the client to deduct interest payments on a refinancing loan as long as it's for the same amount as the existing balance. But is the client also entitled to deduct interest payments for the part of the refinancing that exceeds the existing balance? And does it matter that the client plans to use most of the excess refinancing proceeds to pay off credit card debts?
Whether borrowers are entitled to deduct interest on the excess amount depends upon how they use the proceeds from the refinancing and the amount of the proceeds. When borrowers use the amount in excess of the existing mortgage to buy, build or substantially improve principal residences, meaning year-round dwellings, or second homes such as vacation retreats, their interest payments come under the rules for home acquisition loans. Those rules allow them to deduct the entire interest as long as the excess plus all other home acquisition loans don't exceed $1 million ($500,000 for married couples filing separate returns).
However, when borrowers use the excess for any other purposes, another set of rules prohibits deductions for payments of interest on "consumer loans." This wide-ranging category includes credit card bills, auto loans, medical expenses and other personal debts such as overdue federal and state income taxes. There is, though, a limited exception for interest on student loans, one of those "above-the-line" subtractions to arrive at adjusted gross income.
But most borrowers are able to sidestep these restrictions on deductions for consumer interest, thanks to the rules for home equity loans. Those rules allow them to deduct the entire interest as long as the amount in excess of the existing mortgage plus all other home equity loans don't exceed $100,000, dropping to $50,000 for married couples filing separate returns. It makes no difference how borrowers use the proceeds.
When their refinanced loans are partly home acquisition loans and partly home equity loans, there's an overall limit of $1.1 million, which is a combination of $1 million from the home acquisition debt and $100,000 home equity debt. (That number drops to $550,000 for married couples filing separately.) When the loans exceed the ceiling of $1 million for home acquisition loans and $100,000 for home equity loans, the excess generally is categorized as nondeductible personal interest. The general disallowance is subject to exceptions for loan proceeds used for business or investment purposes.
Yet another restriction applies to the steadily growing number of borrowers burdened by the alternative minimum tax. The AMT allows deductions for interest payments on home acquisition loans of up to $1 million ($500,000 for married couples filing separately). But AMT rules deny any deductions for interest on home equity loans for first or second homes, unless the loan proceeds are used to buy, build, or substantially improve the dwellings.
Thursday, May 8, 2014
Clients' higher tax bills prompt Investment advisers to brush up on taxes
After a particularly brutal 2013 filing season, look for income tax planning to emerge as a specialty among financial advisers.
A combination of factors is elevating the importance of income tax planning with respect to high-net-worth clients. First, there's the fallout from the American Taxpayer Relief Act of 2012, which took effect on Jan. 1, 2013.
Essentially, ATRA hit the top earners the hardest. Single filers with taxable income exceeding $400,000, as well as those who are married and filing jointly with taxable income over $450,000, now face a top marginal income tax rate of 39.6%. They also are subject to a top marginal tax rate of 20% on long-term capital gains.
Beginning at the $250,000 income level for singles and $300,000 level for married-filing-jointly taxpayers, there's a tax bite in the form of the phaseout of personal exemptions and itemized deductions.
Meanwhile, those with $200,000 in income (single) and $250,000 (married, filing jointly) are subject to the 3.8% surtax on the lesser of income over those thresholds or net investment income, and the 0.9% Medicare tax on wages over those thresholds.
Though ATRA was particularly harsh on the income and capital gains side, it was a little more forgiving on the estate tax side. There, the individual exclusion for estate and gift taxes is now at $5.34 million and the tax rate at 40%.
Clients' post-ATRA income tax chickens have come home to roost in the form of higher tax bills. That, combined with the relatively high exemption for estate and gift taxes, means income tax planning is now on the front burner.
“There's a big paradigm shift,” said Charles Douglas, editor of the National Association of Estate Planners and Council's Journal of Estate and Tax Planning. “When you look at the federal, state and the 3.8% surtax on the income tax side, those can outweigh the gift transfer tax.”
That means analyzing and minimizing income taxes becomes the focal point in a number of planning scenarios. “This is about advising people on where to live for income tax purposes, where to die for estate tax purposes, as well as having trusts in other estates,” Mr. Douglas said.
It's important to remember that trusts' income in excess of $11,950 is taxed at the 39.6% rate — the highest income tax bracket. Advisers ought to guide clients to think about tax-efficient assets to hold, such as municipal bonds and life insurance, Mr. Douglas said.
With trusts, clients can also add a “sprinkle provision” to make distributions out of the trust to children and grandchildren who are in lower income tax brackets, as opposed to having the trust face the highest income tax rates, he added.
Outside of trusts, advisers can point clients to other tax-exempt investments. “There's a big opportunity in deferring the income taxes by using non-qualified annuities or cash value life insurance,” said J. Christopher Raulston, a wealth strategist at Raymond James Financial Inc. He expected he would see more individuals use annuities and save in them, with the expectation that by the time they tap them for income, they'll be retired and in a lower bracket. “You're in your earning years and making a good living — that's when you want to defer income,” Mr. Raulston said. “You're using that annuity to leapfrog the higher tax years and push income toward later years in retirement.”
There are also other vehicles to consider, such as a life insurance retirement plan, which is essentially a formalized strategy of socking money away into a life insurance policy with the intention of building cash value, according to Mr. Raulston. The cash value becomes an asset the client can tap free of taxes. But be sure to monitor the policy throughout its life: Universal life written 20 to 30 years ago has been experiencing pressure due to low interest rates.
Finally, have your clients get their charitable giving in order for the 2014 tax year. Charitable giving not only allows clients to offload highly appreciated assets, it also nets them a deduction that they can use to reduce their income taxes. Gavin Morrissey, senior vice president of wealth management at Commonwealth, notes that clients are getting a twofer deal by combining a gift of highly appreciated low basis stock to a donor-advised fund or to a charity and then using the income tax deduction to offset the taxes they'd pay on a Roth conversion.
In the long run, this also helps clients diversify the tax treatment of their pool of assets when they prepare to retire. They now have an array of accounts with different tax treatments, and they can plan their income withdrawal strategy with taxes in mind.
“One of the biggest puzzles is where do you get the income from,” Mr. Morrissey said. “If you have a Roth IRA, a non-qualified account and a traditional IRA, you'll want to control taxes. Where are you getting your withdrawals from so that you don't unintentionally run into a higher tax bracket?”
A combination of factors is elevating the importance of income tax planning with respect to high-net-worth clients. First, there's the fallout from the American Taxpayer Relief Act of 2012, which took effect on Jan. 1, 2013.
Essentially, ATRA hit the top earners the hardest. Single filers with taxable income exceeding $400,000, as well as those who are married and filing jointly with taxable income over $450,000, now face a top marginal income tax rate of 39.6%. They also are subject to a top marginal tax rate of 20% on long-term capital gains.
Beginning at the $250,000 income level for singles and $300,000 level for married-filing-jointly taxpayers, there's a tax bite in the form of the phaseout of personal exemptions and itemized deductions.
Meanwhile, those with $200,000 in income (single) and $250,000 (married, filing jointly) are subject to the 3.8% surtax on the lesser of income over those thresholds or net investment income, and the 0.9% Medicare tax on wages over those thresholds.
Though ATRA was particularly harsh on the income and capital gains side, it was a little more forgiving on the estate tax side. There, the individual exclusion for estate and gift taxes is now at $5.34 million and the tax rate at 40%.
Clients' post-ATRA income tax chickens have come home to roost in the form of higher tax bills. That, combined with the relatively high exemption for estate and gift taxes, means income tax planning is now on the front burner.
“There's a big paradigm shift,” said Charles Douglas, editor of the National Association of Estate Planners and Council's Journal of Estate and Tax Planning. “When you look at the federal, state and the 3.8% surtax on the income tax side, those can outweigh the gift transfer tax.”
That means analyzing and minimizing income taxes becomes the focal point in a number of planning scenarios. “This is about advising people on where to live for income tax purposes, where to die for estate tax purposes, as well as having trusts in other estates,” Mr. Douglas said.
It's important to remember that trusts' income in excess of $11,950 is taxed at the 39.6% rate — the highest income tax bracket. Advisers ought to guide clients to think about tax-efficient assets to hold, such as municipal bonds and life insurance, Mr. Douglas said.
With trusts, clients can also add a “sprinkle provision” to make distributions out of the trust to children and grandchildren who are in lower income tax brackets, as opposed to having the trust face the highest income tax rates, he added.
Outside of trusts, advisers can point clients to other tax-exempt investments. “There's a big opportunity in deferring the income taxes by using non-qualified annuities or cash value life insurance,” said J. Christopher Raulston, a wealth strategist at Raymond James Financial Inc. He expected he would see more individuals use annuities and save in them, with the expectation that by the time they tap them for income, they'll be retired and in a lower bracket. “You're in your earning years and making a good living — that's when you want to defer income,” Mr. Raulston said. “You're using that annuity to leapfrog the higher tax years and push income toward later years in retirement.”
There are also other vehicles to consider, such as a life insurance retirement plan, which is essentially a formalized strategy of socking money away into a life insurance policy with the intention of building cash value, according to Mr. Raulston. The cash value becomes an asset the client can tap free of taxes. But be sure to monitor the policy throughout its life: Universal life written 20 to 30 years ago has been experiencing pressure due to low interest rates.
Finally, have your clients get their charitable giving in order for the 2014 tax year. Charitable giving not only allows clients to offload highly appreciated assets, it also nets them a deduction that they can use to reduce their income taxes. Gavin Morrissey, senior vice president of wealth management at Commonwealth, notes that clients are getting a twofer deal by combining a gift of highly appreciated low basis stock to a donor-advised fund or to a charity and then using the income tax deduction to offset the taxes they'd pay on a Roth conversion.
In the long run, this also helps clients diversify the tax treatment of their pool of assets when they prepare to retire. They now have an array of accounts with different tax treatments, and they can plan their income withdrawal strategy with taxes in mind.
“One of the biggest puzzles is where do you get the income from,” Mr. Morrissey said. “If you have a Roth IRA, a non-qualified account and a traditional IRA, you'll want to control taxes. Where are you getting your withdrawals from so that you don't unintentionally run into a higher tax bracket?”
Monday, April 28, 2014
10 Mid-Year Tax Tips for Individual Taxpayers
Now that this year’s tax filing season for individuals is over, it’s time to concentrate on saving taxes in 2014. All too often, professional tax advisors don’t reach out to their clients until the very end of the year when it might be too late for them to implement meaningful tax planning strategies. Break up the spring and summer doldrums by presenting these ten ideas for their consideration.
- Harvest losses from securities sales. Capital losses can offset capital gains for the year plus up to $3,000 of ordinary income. Any excess loss is carried over. Thus, this could be an opportune time to realize losses that can offset earlier or anticipated gains. Note that this strategy also reduces exposure to the 3.8% Medicare surtax on net investment income.
- Cash in on 0% capital gains rate. Remarkably, taxpayers in the two lowest income tax brackets can benefit from an unprecedented 0% rate on long-term capital gains. Advise clients who are expecting to have a low-income year, or have a child in a low tax bracket who is holding appreciated securities, to maximize the tax-saving opportunities.
- Arrange an installment sale deal. Normally, you must recognize the entire gain from the sale of property, such as real estate, in the year of the sale. But tax on a portion of the gain is spread out over two or more years through an installment sale. Not only does this defer tax payment, it may reduce the overall tax liability for the seller.
- Sidestep the wash sale rule. The “wash sale rule” prevents someone from realizing a capital loss if substantially identical securities are acquired within 30 days of the sale. Don’t wait until year-end when the wash sale rule could hamper transactions. In lieu of waiting 30 days to buy the same securities, “double up” by acquiring the securities now and hold off selling the original shares for more than 30 days before selling.
- Adjust your portfolio. After a midyear review, you can fine-tune your investments for greater tax efficiency. For instance, you might buy dividend-paying stocks that qualify for the maximum capital gains tax rate of 15% (20% for taxpayers in the top ordinary income tax bracket). Another suggestion for upper-income taxpayers is to increase the allocation of tax-free municipal bonds and bond funds.
- Check out AMT status. It’s not too early to start thinking about the alternative minimum tax (AMT) for 2014. Figure out if it will make sense to postpone recognition of tax preference items, like tax-exempt interest on private activity bonds, to 2015. Alternatively, you might count on pulling more income into this year if the AMT rate, topping out at 28%, will be lower than your regular income tax rate.
- Give away property to charity. Generally, a donor can deduct the fair market value (FMV) of property that’s been owned longer than one year, within certain limits. Do a thorough “spring cleaning” to find households items in good condition that can be donated to charity. Use online resources to establish the FMV of donations.
- Add support for relatives. If you provide more than 50% of the support for a child under 19, or full-time student under 24, you can generally claim a dependency exemption for the child. For other relatives, the recipient also can’t have more than $3,950 in gross income in 2014. Consider that gifts of support to college grads or to a parent on Mother’s or Father’s Day can push you over the 50% threshold.
- Limit vacation home use. A taxpayer who rents out a vacation home may benefit from valuable deductions, including depreciation, that offset rental income. But you can’t claim a tax loss if your “personal use” exceeds the greater of 14 days or 10% of the days the home is rented out. Monitor your personal use in the summer to ensure you don’t cross over the line.
- Latch onto dependent care credit. If you pay a sitter or day care center to watch your young children this summer while you and your spouse work, you may be eligible for a dependent care credit. The maximum credit is generally $600 for one child; $1.200 for two or more children. Note that the cost of sending a child to day camp qualifies for the credit, but not overnight camp.
Thursday, April 10, 2014
Two Ways to Cut Investment-Related Taxes
We are in the thick of tax season and some of you who have completed your returns may have realized that your investment-related taxes went up last year. Most Americans are much more reactive than proactive when it comes to effective tax planning. There are various strategies you can deploy to minimize your investment-related taxes and here are two of my ideas to consider.
The $250,000 adjusted gross income (AGI) for married couples ($200,000 single) is an extremely important threshold to watch because it triggers the 3.8% Medicare surtax on ‘net investment income’. This applies to taxable interest, taxable dividends, net taxable capital gains on investments, and net income from a rental property. Since it is early in the year, you will want to consider strategies that may keep your income below these levels if you are floating around the threshold. Considerations include maxing out 401(k), using a deferred compensation plan if your company offers one, waiting on exercising stock options, health savings accounts and flexible spending accounts. This is not an end-all-be-all list, but a good place to start. Remember, the difference between a 15% capital gain tax and capital gain 18.8% tax isn’t 3.8%. It’s over 25%!
Another option that many investors miss out on is matching up their capital gains and losses within their brokerage accounts toward the end of the year. Remember, if you have carried forward capital-gain losses from a prior tax year then you can sell positions that have gains essentially at a zero tax rate. At a minimum, if you have a fair amount of positive capital gains in 2014, just look for loss positions to at least wipe out some of the liability.
The $250,000 adjusted gross income (AGI) for married couples ($200,000 single) is an extremely important threshold to watch because it triggers the 3.8% Medicare surtax on ‘net investment income’. This applies to taxable interest, taxable dividends, net taxable capital gains on investments, and net income from a rental property. Since it is early in the year, you will want to consider strategies that may keep your income below these levels if you are floating around the threshold. Considerations include maxing out 401(k), using a deferred compensation plan if your company offers one, waiting on exercising stock options, health savings accounts and flexible spending accounts. This is not an end-all-be-all list, but a good place to start. Remember, the difference between a 15% capital gain tax and capital gain 18.8% tax isn’t 3.8%. It’s over 25%!
Another option that many investors miss out on is matching up their capital gains and losses within their brokerage accounts toward the end of the year. Remember, if you have carried forward capital-gain losses from a prior tax year then you can sell positions that have gains essentially at a zero tax rate. At a minimum, if you have a fair amount of positive capital gains in 2014, just look for loss positions to at least wipe out some of the liability.
Tuesday, April 8, 2014
Some ways to save at tax time
It’s that time of year. If you’ve filed your taxes, congratulations! Year-round tax planning is the best way to avoid last-minute surprises.
The IRS website publishes very helpful information, particularly in the Tax Tips series at www.irs.gov/uac/IRS-Tax-Tips. I can’t give you tax advice, of course, but if you are selling a home, here are a few items you may want to discuss with your tax advisor:
• Capital Gain Exclusion. You may be able to exclude up to $250,000 ($500,000 for joint filers) of the gain from the sale of your main home;
• Ownership/Use Tests. In general, you need to have owned and lived in your main home for at least two out of the five years before the date of sale;
• Main Home. If you own more than one home, only your main home (the one you live in most of the time) is eligible for the exclusion;
• Reduced Exclusion. If you don’t qualify for the full exclusion, there are specific circumstances in which you may qualify for a reduced exclusion.
This reminded me of the 1031 Exchange provision in the tax code. I have clients who are using it right now to postpone paying tax on the gain from the sale of an investment property by reinvesting the proceeds in similar property as part of a qualifying like-kind exchange. It’s important to note that the tax is deferred, not excluded. Always consult a qualified tax professional if you are contemplating this kind of transaction. There are specific rules and requirements to follow or you won’t get the advantage of the deferment.
Finally, I have a favorite way to save money over the long term: refinance your 30-year mortgage to a 15-year mortgage and build your net worth by tens of thousands of dollars. You will own your home free and clear, pay less interest over time, and be able to use the money you aren’t spending on your home loan for other purposes.
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