Start end-of-year tax planning now

It’s now only 52 days till Christmas and 60 days until 2016! Wait a minute! I know I was just celebrating Independence Day recently. How did we get here so fast?

If you owed taxes last year (for 2014 returns) and would like to avoid that nightmare again, I have some ideas for you.

First, look at 2015 so far compared to 2014. Are all your income and expenses about the same? Is your tax withheld higher this year? (Or have you been paying higher estimated tax payments this year)? If so, you may be OK, but if you haven’t increased your withholding and/or estimated tax payments, now is the time to fix that while you still have two months left. A simple formula is to divide the amount you owed last year by two months and have that much extra withheld for the rest of 2015. If that is a bit too much, then increase your withholding by as much as you can afford and keep putting aside an extra amount until April 2016. (If you pay estimated taxes, pay a larger amount for the fourth quarter payment).

Can you delay any income that would normally be received in 2015 to being received in early 2016? Talk to the paying party and see if they would be willing to put off the payment until early January 2016. You usually don’t get what you don’t ask for.

Do you plan on having enough to itemize in 2015? If so, you might increase your planned charity giving for 2016 into 2015. You might make your early 2016 property tax payment now in 2015. Get the idea? Accelerate some discretionary itemized deduction items into 2015. Now I have to warn you this only saves you some tax in 2015. It then opens you up to possibly owing more tax in 2016. All this really does is gives you more time to spread out having more tax withheld to cover that.

If you own a business, use the Cash Basis of accounting, and expect to have taxable income. You can do the same as above. Accelerate early 2016 expenses into 2015, delay income from late 2015 until 2016.

On top of that, currently the expense election on purchasing new equipment is $25,000, but Congress is expected to retroactively increase that to at least $250,000 before the end of 2015. So, if you planned on making any major purchases in the next 10 months or so, accelerating that into 2015 might be a good idea.

How are your business records looking? Have you been too busy to keep them up very well? Now is a good time to start working on catching up rather the night before your tax appointment. All too often, accounting records hastily put together miss potential tax saving deductions and have you paying more tax than you need to. One good idea? Reconcile all your bank accounts to make sure all transactions are accounted for. Another? If you use any personal bank accounts and/or credit cards for business occasionally, go through all those statements now and highlight any business related transactions.

You should call your tax preparer to go over everything now to make sure there isn’t anything else.

Estate Planning Moves you need to make before December 31

Many people are under the misconception that estate planning is only for the wealthy. On the contrary, preparing for life’s unknowns is one of the most loving things you can do for your family.

Here are a few ways to get started:

1. Update your estate plan

If you’ve had any major life changes in the past year — a new baby, a divorce, a marriage, or one of your future heirs passed way — you should update your estate plan with an attorney.

We recently met with clients who paid for trusts to be drafted years ago but had never funded the accounts, and the people they named in their trust to be successor trustees had both passed away.

2. Contribute to a 529 plan

The holidays are right around the corner, and if you have a grandchild, niece or child that seems to have everything, consider making a 529 plan contribution on their behalf.  This is a great way to use the power of compounding interest to help a loved one pay for college as the growth in the account is tax-free (assuming it’s used for qualified education expenses).

To find 529 college savings plans in your state and to compare plans visit Savingforcollege.com.

3. Use your 2015 annual gifting limit before Dec. 31

You can give any number of people up to $14,000 in 2015 without incurring any gift tax. If you are married, then you and your spouse can give up to a total of $28,000 to any number of people.  Turbo Tax has a very good explanation of The Gift Tax rules.

4. Have a plan (and share it with family) should you be unable to make medical or financial decisions

While you are gathered with family, it’s a good time to talk to them about your wishes, should something happen to you if you become unable to make financial or medical decisions for yourself. There are two very important documents that you and your spouse or partner should have in place:

• Financial Power of Attorney:  Creating a financial power of attorney lets you designate someone to make financial decisions on your behalf, should you become incapacitated or unable to make those decisions for yourself.  You can decide the scope of powers to grant your “agent” from access to your financial accounts to managing all your financial affairs.  Without a financial POA, the court will step in and appoint someone to take care of these, it they may not be the person you would choose.  This is especially imperative if you have a non-spouse partner.

• Medical Power of Attorney: Like the financial power of attorney, the medical POA lets you choose who will make medical decisions on your behalf if you are not able to make those for yourself. It allows your designee to have access to your medical records, consult with your doctors and admit you to a hospital or long-term care facility, among other things. He will also see that your advanced medical directive is carried out.  In this important document, you provide specific end-of-life instructions for what type of care you want or don’t want.

5. Update your beneficiary designations

If you have a life insurance policy, or any type of retirement account, you likely have signed a beneficiary designation. This is an extremely important piece of paper because who gets this money is not determined by your will, but who you named on this form.

If there were any changes in your life, like getting married or divorced, or having a child and then more children, it’s time to revisit who’s listed as your beneficiaries.  To find out who you currently have designated, contact your insurance company (for life insurance), employer (for 401ks) or brokerage firm (for IRAs).

Financial Moves you need to make before December 31

When December rolls around, do you ever wish you had more time to look over your finances and do something that would lower your taxes or put more money in your pocket before those opportunities go away at year-end?

If you answered yes, then this three-part, year-end planning series is designed to help you get started now. In this article, I focus on taxes (everyone’s favorite topic) and actions you should consider before Dec. 31.

There are some simple steps you can take right away. Others may require the expertise of a financial adviser or accountant, but their advice may be worthwhile if it lowers your tax bill.

Realize capital losses or capital gains:

If your investments have done poorly, talk to your accountant about realizing losses.  This can be a great tool to offset future capital gains as well reduce your ordinary income by $3,000 a year until the losses are used up. On the opposite side of the coin, consider realizing capital gains if you have less income than usual.  This lets you lock in gains while paying less in taxes.

Adjust your tax withholding:

Think back over the past year: If you got married, divorced or had another child, chances are you’ll need to adjust your withholding on your W-4.  Talk to your CPA so that you don’t end up giving the government an interest-free loan or worse, owing a penalty for not paying enough tax over the course of the year.

Max out your 401k:

In 2015, you can contribute $18,000 to a 401(k), TSP, 403(b), or 457 retirement plan.  Plus, if you’re over 50, you can contribute an extra $6,000.  You have until Dec. 31 to max out your plan and receive the benefit of deferring your income.  If you’re contributing to a Roth 401(k), you have the same contribution limits, but you’ll pay taxes on your contributions now so that all growth in the account grows tax-free forever.

If you are self-employed, consider opening up an Individual K, which is essentially a personal 401k and profit-sharing plan for those who are self-employed. For 2015, the maximum elective deferral is $53,000, or $59,000 if you are over 50. Bankrate.com has a great Self-Employed 401k Calculator to help you know how much you can contribute.

Make your state income tax quarterly payment:

If you’re writing checks for your estimated tax payments, be sure to get your fourth quarter state tax payment in before Dec. 31.  This allows you to take the deduction on your 2015 tax return as opposed to waiting until 2016 if you had paid it in January.

Talk to your CPA about a Roth conversion:

If you had a year with less income than usual, consider a Roth conversion.  We met with a client in the first part of the year who shared with us that he left his company.  As a former CEO, he knew it would probably take a full year to find his next position.  Without any income and living off an emergency fund, we recommended he convert part of his IRA to a Roth IRA.

In a year where they were going to be in one of the lowest tax brackets, we took advantage of this opportunity by adding income to his return.  When he returns to work, this opportunity will be gone, since his salary and bonuses will push him back into the highest bracket.

Donate to charity:

You have until Dec. 31 to make charitable contributions.  This year, instead of giving your favorite church or charity cash, gift appreciated stock.  You won’t have to pay tax on the capital gains and neither will the charity when they receive your gift.  Plus, you’ll receive a charitable deduction on your tax return.  It’s a win-win for everyone.  We have a client that gifts $600/month to his church.  We convinced him to use his highly appreciated McDonald’s stock so he wouldn’t have to pay unnecessary capital gains taxes.

How To Pay Zero Tax On Capital Gains And Other Tax Saving Moves For 2015

FROM FORBES.COM

There’s still ample time in 2015 to rearrange the timing of your investments, trading, retirement and business affairs to improve your overall taxes for 2015 and surrounding years.

Tax planning may be challenging, but it pays off
With plenty of moving parts, graduated tax rates and a long list of loopholes, tax breaks and penalties, you’ll need extra diligence for tax planning this year. Upper-income individuals must contend with AMT, Obamacare NIT and AGI-based phase-outs of tax breaks on itemized deductions, personal exemptions and credits.

We focus on traders, investors and investment managers and with volatile financial markets in 2015, many experienced wide swings in income and losses. Several face an unfamiliar tax landscape, such as much higher income and not realizing or setting aside higher taxes with surprises like Obamacare NIT; or huge losses, missing a timely Section 475 election for business ordinary loss treatment and getting stuck with significant capital loss carryovers.

Traders have special issues to contend with
Wash sales: Securities traders must comply with onerous wash sale loss rules (Section 1091) and brokers make it more difficult for them by applying different rules from taxpayers on tax reports and Form 1099-Bs. Taxpayers must report wash sales on substantially identical positions across all accounts, whereas brokers report only identical positions per account. Use TradeLog to identify potential wash-sale loss problems. Break the chain by selling the position before year-end and not buying a substantially identical position back 30 days before or after in any of your individual taxable or IRA accounts. (Starting a new entity effective Jan. 1, 2016 can break the chain on individual account wash sales at year-end 2015 providing you don’t purposely avoid wash sales with the related party entity.)

Section 475 elections: Business traders qualifying for trader tax status like Section 475 on securities for exemption from wash-sale rules and capital loss limitations. Section 475 ordinary losses contribute to NOL refunds. Individuals and existing partnerships can elect Section 475 by April 15, 2016 for 2016 (March 15 for S-Corps).

Trading entities: A “new taxpayer” entity can elect Section 475 within 75 days of inception. Consider that for 2015, especially later in the year. But it’s too late to form a new trading entity by late November and still qualify for trader tax status in that short period before year-end. Unlock employee benefit plan deductions for traders with an S-Corp trading company or C-Corp management company with a trading partnership. Sole proprietor traders can’t have employee-benefit plan deductions since trading income is not self-employment income (SEI). An entity formed late in the year can unlock employee-benefit plan deductions for an entire year by paying officer wages in December.

Trader tax status (TTS): If you qualify for TTS (business expense treatment — no election needed) in 2015, accelerate trading expenses into that qualification period as a sole proprietor or entity. If you won’t qualify until 2016, defer trading expenses until then. You may also capitalize and amortize Section 195 startup costs in the new business, going back six months before commencement. Business expense treatment is far better than investment expense treatment. Investment expenses are part of miscellaneous itemized deductions which are only deductible in excess 2% of adjusted gross income (AGI) and are non-deductible for AMT. If you are stuck with investment expense treatment, try to bunch expenses into one useful year rather than two. The bunching strategy may also be effective for medical expenses and other itemized deductions.

Fill the gaps in tax brackets
If you own an investment portfolio, you have the opportunity to do tax loss selling or the reverse by selling winning positions for capital gains.

Traders like to study investment charts, and they should also study the IRS charts for tax rates with graduated tax brackets, Social Security and retirement contribution limits, standard deductions, exemptions and more. See Tax Rates and other tax charts in ourTax Center. There are significant differences in the charts for filing status: single, married filing joint, married filing separate and head of household. Did you change your filing status in 2015?

Focus on the ordinary income and long-term capital gains brackets. Consider accelerating income and deferring expenses to fill a gap in a bracket before entering the next higher tax bracket. Or, defer income and accelerate expenses to drop down a marginal tax bracket. Just keep an eye out for triggering AMT, a minimum tax rate.

Miscellaneous considerations for individuals

1. Note inflation adjustment increases to rate brackets and more.
2. Consider your time-value of money when considering acceleration or deferral of tax payments.
3. Consider estimated tax payment rules including the safe-harbor exceptions. If you accelerate income, you may need to pay Q4 2015 estimated taxes by Jan. 15, 2015.
4. Alternatively, increase tax withholding on wages to avoid estimated tax underpayment penalties.
5. If you still need to avoid estimated tax underpayment penalties, arrange a rollover distribution from a qualified retirement plan with significant tax withholding before year-end. Next, rollover the gross amount into a Rollover IRA. The result is zero income and avoidance of an estimated tax penalty.
6. Consider year-end gifts of appreciated property to family members within the annual gift exclusions ($14,000 for 2015) to shift income. Consider the “kiddie tax” rules.
7. Sell off passive loss activities to unlock and utilize suspended passive-activity losses.
8. Maximize contributions to retirement plans.
9. The IRS has many obstacles to deferring income including passive-activity loss rules, a requirement that certain taxpayers use the accrual method of accounting, and limitations on certain itemized deductions like investment interest expense and charitable contributions.
10. Individuals on the cash method get credit for purchases charged to their credit card by Dec. 31.

Long-term capital gains rates are lower than most people think
If you are married filing joint and your taxable income is under the 2015 15% ordinary bracket $74,900 maximum, you have zero federal taxes on long-term capital gains income. For example, if your taxable income is $60,000, you can sell a security held over 12 months for a $14,900 long-term capital gain and not pay any additional federal tax on that capital gain. (For a single filer, the corresponding 2015 15% ordinary bracket maximum is $37,450 of taxable income.)

Long-term capital gain graduated rate brackets:
..Zero for the 10% and 15% ordinary rates,
..15% above the 15% ordinary rate, except,
..20% in the 39.6% top ordinary rate.

Match short-term vs. long-term capital gains and losses
It’s not tax efficient to do “tax-loss selling” on short-term positions while eating into lower long-term capital gain rate benefits — in other words, to offset short-term capital losses against long-term capital gains. The IRS rules for accounting for the two separate buckets can be confusing. Read last year’s tax planning blog 2014 year-end tax planning for traders point #10.

Qualified dividends are taxed at long-term capital gains rates
Another beauty left over from the Bush-era tax cuts is the rule for qualified dividends taxed at lower long-term capital gains rates: A fiscal incentive was given to long-term investors who hold dividend-paying stocks. As pointed out above, the long-term capital gains rate tax break transcends all tax brackets; it’s not just for the upper-income.

How to qualify: To be a qualified dividend, the dividend must be paid from a domestic corporation or certain (“qualified”) foreign corporation. The taxpayer must hold common stock for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. For preferred stock, the holding period is 90 days during the 180-day period beginning 90 days before the stock’s ex-dividend date.

The long-term capital gains rate affects futures trading, too
Section 1256 contracts (including futures, broad-based indexes and non-equity options) are subject to 60/40 capital gains tax rates and mark-to-market accounting: 60% is long-term even on day trades and 40% is short-term taxed at ordinary rates. The blended 60/40 rate in the top bracket is 28%. That’s 12% less than the top ordinary rate of 39.6%.

With zero long-term rates in the 10% and 15% ordinary brackets, there is meaningful tax rate reduction throughout the brackets. In the 15% ordinary tax bracket, the blended 60/40 rate is 6%. (Here’s the math: 60% LT x 0% LT rate = 0%. Plus, 40% ST x 15% ST rate = 6%.) In the 10% ordinary tax bracket, the blended 60/40 rate is 4%. States don’t apply a long-term rate, so regular state tax rates apply. Tax Foundation has a useful chart on top federal and state capital gains tax rates.

Instead of day or swing trading the Nasdaq 100 ETF (Nasdaq: QQQ) taxed as a security at ordinary rates, consider trading the Nasdaq 100 emini index (CME: NQ), a Section 1256 contract taxed at lower 60/40 tax rates. There’s also a Section 1256 loss carry back election allowed to apply the loss in the prior three tax years against Section 1256 gains only.

AGI-based phase-outs and tax rates
It’s not always evident whether it’s better to defer or accelerate income, loss and expenses. Consider AGI-based phaseouts of various tax breaks and effective use of marginal tax brackets in the current and surrounding years.

AGI-based phaseouts include the 2% AGI threshold for miscellaneous itemized deductions, which includes investment expenses, the Pease itemized deduction limitation on upper-income taxpayers, child and dependent care tax credits, higher education tax credits, deductions for student loan interest and allowed deductible IRA contribution limits.

Alternative tax regimes NIT and AMT
The Patient Protection and Affordable Care Act has many new and different types of taxes to finance the law, starting on different dates. One of these new tax regimes — the “Net Investment Income Tax” (NIT) originally referred to as “ObamaCare 3.8% Medicare surtax on unearned income” — affects upper-income taxpayers as of Jan. 1, 2013. It only applies to individuals with net investment income (NII) and modified AGI exceeding $200,000 (single), $250,000 (married filing jointly) or $125,000 (married filing separately). (Modified AGI means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.) The tax also applies to irrevocable trusts (and estates) on the undistributed NII in excess of the dollar amount at which the highest tax bracket for trusts begins (this amount is $12,300 in 2015).

Try to defer income and accelerate expenses to reduce MAGI under the NIT threshold above. In calculating NII, deduct properly allocated expenses including but not limited to trading and investment expenses. If you are stuck over the MAGI threshold, try to reduce NII to reduce NIT. There’s also a 0.9% Medicare tax that applies to individuals receiving wages in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).

If you are in a lower income situation and purchase health insurance on an Obamacare exchange, consider how deferral or acceleration of income might affect your current and subsequent year exchange subsidies on Form 8962 (Premium Tax Credit). You don’t want to owe expensive subsidies back to Treasury.

The Alternative Minimum Tax (AMT) was enacted in 1982. Originally intended as a second tax regime to prevent the rich from avoiding most income tax, with lack of indexing for inflation, AMT has exploded on the upper middle-class, too. The AMT rates are 26% and 28%, which are not bad compared to the top regular income tax rate of 39.6%. Many tax advisors suggest that upper income individuals enjoy the AMT rate and accelerate income to pay 28% rates when they can, rather than higher ordinary tax rates. Just don’t bother accelerating deductions that are non-deductible for AMT (as preferences). AMT preferences include real estate and property taxes, state income taxes, miscellaneous itemized deductions and personal exemption deductions. Medical expenses are calculated in a more restrictive way for AMT for taxpayers over age 65. Congress passed the AMT patch (inflation adjustment) for 2015 earlier in the year, rather than wait until year-end as is par for their course.

Will Congress renew lapsed tax extenders?
There’s a long list of temporary tax breaks that Congress can’t afford to write into permanent tax law, even with a sunset provision since it would bust the budget. Each year, Congress has dealt with this mini-fiscal cliff to renew these so-called “tax extenders.”

Per Thomson Reuters, “These tax breaks include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence. For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include: 50% bonus first year depreciation for most new machinery, equipment and software; the $500,000 annual expensing limitation; the research tax credit; and the 15-year write off for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.”

They lapsed at year-end 2014 and I suspect Congress will renew them again around year-end 2015. Perhaps a GOP-led Congress won’t want to affect the 2016 presidential and Congressional elections by upsetting so many taxpayers without a renewal. Neither will President Obama and Democrats. Tax reform is more important and a bigger issue which can include tax extenders but it’s doubtful Congress can address tax reform until 2017 when the next Congress and President take office

Consult your tax advisor
If your tax planning is complex, consider having your CPA prepare a draft tax return to weigh the different “what if” scenarios and options. Many CPAs like our firm use professional tax planning software making the process easier and more effective. If you are a securities trader, run TradeLog accounting software year to date and use its Potential Wash Sale Loss report to avoid wash-sale loss conditions at year-end. Give your CPA a chance to save you some big bucks!

4 Tax Mistakes Business Owners Make And How To Avoid Them

FROM FORBES.COM

“I’m proud to pay taxes in the United States,” ukulele-wielding entertainer Arthur Godfrey once said. “The only thing is, I could be just as proud for half the money.”

Some business owners take the sentiment too far. They fall for a misguided tax scheme, get in trouble with the IRS and pay twice the money rather than half. There aren’t enough ukulele gigs in the world to make up for that.

It’s not always easy to distinguish between smart tax planning, aggressive tax strategies and downright tax evasion. With the help of a trusted advisor a business owner can review a tax strategy and decide whether to proceed.

When tax strategy goes wrong, it can be entertaining as much as it is informative. Don’t do what these taxpayers did.

Lesson 1: Don’t try to deduct personal costs as business expenses

Indictment: Doctor falsely reported wedding expenses to IRS.

That was the Associated Press headline just a few weeks ago when a pain management physician was alleged to have falsely reported at least $56,000 of wedding-related expenses as business costs. Ouch.

She is accused of filing corporate income tax returns with many entries identified as business expenses that were actually personal expenses to pay for her wedding.

An advantage of having a business is that the Internal Revenue Code (IRC) allows a deduction for “ordinary and necessary expenses.” But these expenses must be related to the business. Over the years, the IRS has developed sophisticated tracking systems for assessing personal versus business expenses.

Ethics aside, it simply is not worth it to try to sneak personal expenses through a business account. It will likely be found, and the penalties are potentially huge. Who needs pain management now?

Lesson 2: Avoid too-good-to-be-true tax opportunities

Federal tax law is awash with tax breaks. Beware of promoters who try to take these tax breaks and make them do the impossible.

Life insurance is a good example. This product has long enjoyed favorable tax features, including the tax-deferred build-up of cash values, first-in-first-out taxation of surrenders and tax-free treatment of death benefits. Some promoters, however, feel the need to take a good thing and leverage it beyond its intended benefits.

For businesses, these promoters typically try to add the element of deductibility of life insurance premiums. The pattern has been to leverage other provisions in the Internal Revenue Code (specifically sections 79, 412 and 419) to create a business deduction for all or part of the premium without generating a matching tax inclusion to the recipient – usually a business owner or key employee.

In a case decided this summer, an attempt to justify a life insurance transaction under IRC 419(e) ended up with the employer losing the deduction and the employees being taxed. To make matters worse, the court imposed the 30 percent accuracy-related penalty applicable to tax shelters. The total bill? Approximately $2.5 million of taxes additional taxes were assessed, as well as over $500,000 in accuracy-related penalties

The old adage still applies. If it looks too good to be true, it probably is.

Lesson 3: Be prepared for the consequences of aggressive tax planning

This is a lesson from the late owner of the Detroit Pistons.

William Davidson, at his death in 2009, was listed by Forbes as the 68th wealthiest American. His estate plan included what planners typically would call a “SCIN in GRAT” transaction. That would be a self-cancelling installment note in a grantor retained annuity trust.

In past posts, I’ve discussed both SCINs and GRATs, and they can both be effective estate planning tools in their own right. In this case, the aggressive, combined use of the concepts did not work out as intended. The bill to Davidson’s estate was in excess of $500 million.

In a new twist, a complaint has now been filed in New York on behalf of the Davidson’s estate against Deloitte Tax, LLP, for over $500 million in damages. It’s alleged that Deloitte harmed the estate in devising the unsuccessful plan. A key contention is the alleged failure by Deloitte to warn of the arrangement’s risks.

Consider yourself warned.

Lesson 4: Bad tax strategies can lead to other bad decisions

Just over a decade ago, a popular but abusive tax shelter that came to be known as “Son of BOSS” was shut down by the IRS. Its predecessor was called the Bond Options Sales Strategy (BOSS) – hence the son of BOSS – had been busted earlier, but this was a slightly different take.

For Son of BOSS, the idea was to create an artificial tax loss to balance taxable gains. Bad idea. Eventually, the IRS collected $3.2 billion from the tax dodge. The promoter of the scheme, KPMG, paid $456 million to the IRS and admitted criminal wrongdoing.

Scott and Robin Baker are just one family shattered by the greedy use of this tax shelter. Hardly victims, the unsuccessful use of Son of BOSS in 2001 initiated a decade-long series of bogus business transactions that only made the family’s financial mess worse.

Eventually, the couple, in deep financial distress, divorced. Even with the split, their troubles continued. This year, Scott was found liable for fraudulent transfers made as part of the divorce.

While the court did not declare the divorce itself invalid, it held that the property transferred from Scott to Robin in the separation was a fraudulent transfer. Dishonest tax planning led to even worse legal problems. For this family, bad has gone to horrible.

Tax Benefits to Health Insurance Premium Reimbursement

Tax strategy is an essential component of any small business plan. Many of the most successful small business owners carefully study tax code, consult qualified tax professionals, and make decisions based on their tax consequences. In recent years, many of those decisions have pertained to healthcare in general and the Affordable Care Act specifically. One strategy in particular has garnered attention from savvy small business owners looking for tax-friendly ways to offer health benefits to their employees. That strategy, commonly called health insurance premium reimbursement, helps companies to offer their employees monthly real dollar contributions as reimbursement for qualified medical expenses. These reimbursement contributions offer several specific tax advantages.

Income Tax Benefits

Under Section 105 of the tax code, employers are allowed to reimburse employees for qualified health expenses, including individual health insurance premiums. These arrangements, known as medical reimbursement plans, allow for premium reimbursements to be passed from employer to employee entirely tax free. In other words, an employee of a small business can purchase an individual health insurance policy on the healthcare exchange and receive a tax-free reimbursement for that purchase.

Payroll Tax Benefits

For many small businesses, payroll is one of the largest expenses to hit the books each month. Most of that expense, of course, can be attributed to the salaries and wages of employees. Some of it, however, comes from payroll taxes, or the percentage of salaries paid to the federal and/or state government. Because these real dollar contributions are reimbursements for qualified expenses and not a form of salary, they are not subject to payroll tax. Decreasing payroll taxes, of course, can have major benefits for small businesses, which sometimes operate on tight monthly budgets.

Tax Credits

While there are several direct tax benefits associated with health insurance premium reimbursement, other advantages are less obvious. For example, many Americans that don’t get health insurance through their work are eligible for tax credits, or discounts on individual health policies. Of course, eligibility is dependent upon several factors, including income level. In order to qualify for these subsidies, buyers must purchase a policy through their state’s healthcare exchange.

Conclusion

Savvy business owners and smart employees make financial decisions with their tax consequences in mind. These tax-minded small business owners have increasingly been drawn to medical reimbursement plans as a means of offering tax-free health benefits to their employees. Considering the savings they offer on income tax and payroll tax, it’s no surprise that these plans are being adopted by more and more small businesses in the United States.

Deferring taxes not always best plan

In preparing for retirement, one accumulates as much money as possible. Most strategies focus on qualified accumulation, which defers income tax until the distribution phase when a person presumably has fewer exemptions and deductions. For high-income earners paying taxes at the highest levels during the accumulation phase, this is an advantage. For those at lower levels, income tax during the distribution phase can be challenging.

With a market more volatile than ever, investors need to create balance within a retirement portfolio.

Vincent Serratore, senior managing director of Heritage Wealth Management, explains: “Many retirees are exposed to more risk than usual because they are not taking into consideration their current age, time horizon and future distributions. We do believe that a portion of a client's investments should be in the stock market to keep up with inflation, but limited to quality, dividend-growing companies and not the hot-flying stocks of the year.” 

Mr. Serratore supports this with his “reality check” of 30+43=0, where a loss of 30% the previous year needs a 43% growth in the next to recuperate.

High-income earners can use Roth conversions and the Roth loophole, but the conversion requires paying taxes and the inability to use the funds for five years.

TAX-FREE DISTRIBUTION

One option both levels of income earners rarely use can be done in the early stage of retirement planning: Creating nonqualified, tax-deferred growth during the accumulation phase and tax-free distribution during retirement or sooner.

Recently, I met a 35-year-old high-income earner who was looking for ideas for retirement planning. He was interested in learning more about how a permanent life insurance plan would help him offset his qualified contributions when he retires. We presented him with the opportunity to save for retirement while providing for his family if he dies prematurely.

In summary, a $16,000 annual premium, structured properly, will provide him with $157,000 a year, tax-free, from age 65 for the rest of his life. It will also provide his family with several million dollars depending on when he dies. Although the annual premium is taxed, the growth is deferred and will never be taxed.

This and his Roth accumulation will counteract the need to pull from his taxable qualified funds beyond his required minimum distributions and will help minimize his income tax during the distribution phase. Furthermore, the fixed life insurance program helps balance an investment portfolio against a negative market. Since this type of program grows at a steady rate, generally 6% to 8%, it creates stability and provides an opportunity to cushion your investment portfolio distributions during retirement.

Most moderate- to high-income earners will use trusts in coordination with these strategies to minimize estate tax.

“Estate tax is payable within nine months of your death or delayed until the surviving spouse's death,” said Lawrence S. Zaharoff of Zaharoff & Zaharoff Attorneys at Law. Creating separate entities to house assets reduces the size of the estate, minimizes estate tax and opens the door for government-funded programs while increasing inheritable wealth.

LONG-TERM CARE

The biggest threat to moderate-income earners' retirement portfolios is the need for long-term care, which must be funded with qualified assets before making use of government-funded programs. An irrevocable IRS retirement trust can't protect qualified funds while the income earner is alive.

“The goal is to protect your assets that you spend a lifetime accumulating,” Mr. Zaharoff said. “The IRS has given people ways (LTCI and trusts) to protect their assets, but many people are unaware that the means exist.”