FROM USATODAY.COM -
There are plenty of things we think about when preparing for retirement. Unfortunately, taxes is not usually one of them.
With a little over a month to go before Tax Day, that could be a problem, according to tax experts and financial planners. Tax planning is an integral part of retirement planning. Not planning for taxes in retirement could be a critical and costly mistake.
So, here are five tax tips for those thinking about or getting ready for retirement.
1. Don't forget about taxes when you look at the size of that retirement nest egg.
"We look at our assets on a gross basis, which creates a wealth illusion," says Robert Fishbein, vice president and corporate counsel at Prudential Financial. "Wealth illusion is simply a term used to describe thinking an asset provides more value for retirement than it does."
In other words, look at our 401(k), pension or IRA balance with the view that we still have to pay taxes when we start withdrawing.
Fishbein's example: Your retirement nest egg is $100,000. You plan to withdraw 3% a year for living expenses, or $3,000. "But if the individual is subject to combined federal and state tax rate of 30%, that $3,000 of income provides $2,100 of after-tax income."
"The after-tax amount is what is there for paying for your housing costs, your food, your utilities," he says. "We live on after-tax dollars so we need to see though our retirement assets so that we see their true value."
2. Diversify your retirement assets by adding a Roth IRA, even if you are close to retirement.
Diversity does three things, says Fishbein. It creates tax-planning options, gives you the ability to manage your tax liability, and sets up a hedge against future tax increases. With a Roth, contributions are not tax-deductible, but withdrawals are tax-free. Thus, in retirement, the Roth will let you withdraw tax-free money along with your taxable income.
"It is hard for people to take the action to convert (a traditional IRA) to a Roth and pay a tax to the government before they have to," he says. "But for some of one's retirement nest egg, it makes sense to convert some of the funds."
3. Remember, you must pay estimated taxes in retirement. If you've been working all your life, you've probably had taxes taken out of your paycheck automatically. But when you retire, that's not necessarily the case. If you're getting pension payments and taking IRA withdrawals, you're going to have to get used to writing a check to the government every quarter.
"They [new retirees] are used to getting withholding," says Paul Gevertzman, tax partner at Anchin, Block & Anchin in New York. "Now they have to make estimated tax payments. They can end up with a big tax bill in April that they never thought about." There may also be a penalty for underpayment of tax.
Some financial institutions will let you withhold taxes from retirement plan withdrawals, but you have to set those up. You can also set up withholding from Social Security checks.
4. Even if you wait until 66, it may not pay to take Social Security the first year of eligibility. If you worked for part of the year, those earnings may push you over the limits and result in taxes on your Social Security, says Ted Sarenski, CEO of Blue Ocean Strategic Capital in Syracuse, N.Y.
"My birthday is Sept. 5," he says. "In the year I turn 66, I already have nine months of income. If I have earned $50,000, I am $10,000 over $40,000 limit. I have to give back $1 for every $3 over that. It may not pay for me to take Social Security (in the first year)."
5. Don't put retirement planning on autopilot. Be aware of changes to the tax laws and how they may affect you. It would be a mistake to not revisit your tax and financial-planning assumptions to make sure they are still accurate, planners say.
For example, the old rules of thumb on how much you should withdraw from your retirement savings each year may no longer apply, says Thomas Langdon, professor at Roger Williams University in Bristol, R.I. The old thinking was 4% a year, but after the financial crisis, he says, new research predicts that is too much and you may run out of money. Three percent may be a better goal.
Wednesday, March 13, 2013
Wednesday, March 6, 2013
Most Commonly Asked Tax Questions.
Tax season is now fully underway, and with it comes a wide range of tax questions from filers. These questions range from those asked perennially (“can I claim my boyfriend as a dependent?”) to those specific to the events of 2012 (Hurricane Sandy, healthcare reform and the fiscal cliff). To help make the tax filing process as easy as possible, I have answered the most commonly asked tax questions for this tax season.
Who can I claim as a dependent?
Your significant other is probably many things to you—but is he or she also a tax deduction? The question of who you can claim as a dependent has confused taxpayers for years.
The short answer: You can claim a “qualifying child” or “qualifying relative” if they meet specific requirements related to residence, relationship to you, age, financial support provided and income. And yes, you may be able to claim a girlfriend, boyfriend, domestic partner or friend as a qualifying relative in some cases. Claiming dependents can give you a tax deduction worth up to $3,800 per dependent and also make you eligible for many other tax deductions like the Earned Income Tax Credit.
What is the Earned Income Tax Credit and How Do I Claim it?
The Earned Income Tax Credit is a tax credit for low to middle income wage earners that has lifted nearly 7 million people out of poverty, however many people still miss it. Why do so many people miss it? Many think they don’t make enough to file their taxes so they don’t claim it. You have to file your taxes to get this valuable tax credit, which may help a family with three dependents receive a credit worth up to $5,891.
Does healthcare reform impact my 2012 taxes?
There’s been a lot of confusion about healthcare reform and taxes. Rest assured, the requirement to purchase healthcare does not impact your 2012 or 2013 taxes. You do not have to purchase health insurance until January 2014 and there may be a few exceptions based on income, religious beliefs, and citizenship. You will not see changes to your taxes related to the purchase of health insurance until your 2014 taxes are filed in 2015 if you buy healthcare coverage at a health insurance exchange.
Are unemployment benefits taxable?
The unemployment rate has dipped to 7.9 percent vs. 8.3 percent in January 2013. But that’s little comfort to the jobless who find out their unemployment income is taxable income. The good news is that job search and moving expenses may be tax-deductible. See the next question for more details.
Can I deduct the cost of searching for a job? Are moving expenses for my new job tax deductible?
Job seekers may be able to deduct many expenses related to their search: printing resumes, fees for employment and outplacement agencies, career seminar costs and business-related travel. Moving expenses relevant to your job search may be deductible if you meet the distance and time test.
What are the tax implications of withdrawing money early from a retirement account to pay bills or debt?
In difficult economic times, many people start eyeing their retirement accounts to pay off bills or debt. While it is your money, you may be unaware of the impacts of withdrawing from your nest egg. Withdrawing money early from a retirement account comes with a 10 percent tax penalty in addition to the regular income tax on the amount withdrawn. There can be other consequences, too. The retirement money may bump you into a higher tax bracket, which can result in the taxation of other income, such as social security, that you wouldn’t have been taxed on otherwise.
What are qualified education expenses? And when can I file?
College tuition skyrockets every year, but the U.S. government provides incentives with education credits and deductions. For example, the American Opportunity Credit, which was extended through 2012, benefits full-time and part-time college students with a maximum $2,500 credit per student, provided you meet modified adjusted gross income requirements.
My house foreclosed, how does that impact my taxes?
The Mortgage Forgiveness Debt Relief Act survived the recent ‘fiscal cliff,’ receiving a one-year extension through 2013. This means you don’t have to pay taxes on the loss of your home through foreclosure or short sale, up to $2 million (or $1 million if married filing separately).
I started my own business; can I deduct my home office expenses?
Many entrepreneurs are reluctant to write off the business use of their home for fear of being audited. But home office expenses are a legitimate tax deduction you shouldn’t miss out on. Keep in mind the space you claim as a home office should be used exclusively and regularly for that purpose.
Will January tax law changes impact my taxes?
On Jan. 1, 2013, Congress kept the U.S. from going over the ‘fiscal cliff’ by passing The American Tax Relief Act of 2012. The act includes a permanent extension of the Alternative Minimum Tax (AMT) patch, the permanent reduction of tax rates and the reinstatement of several tax deductions, including the Educator Expense Deduction, the Tuition and Fees Deduction, and state sales taxes in lieu of state income taxes.
I was impacted by a natural disaster in 2012. What tax breaks are available to me?
Hurricane Sandy and other natural disasters last year left many picking up the pieces, filing insurance claims, and wondering how it will affect their taxes. It’s possible to take a tax deduction for property loss claims not compensated by insurance, or in some special cases, when you’re still waiting for compensation. These are known as casualty losses and include hurricanes, floods, earthquakes, tornadoes, fire—even vandalism and shipwrecks
Who can I claim as a dependent?
Your significant other is probably many things to you—but is he or she also a tax deduction? The question of who you can claim as a dependent has confused taxpayers for years.
The short answer: You can claim a “qualifying child” or “qualifying relative” if they meet specific requirements related to residence, relationship to you, age, financial support provided and income. And yes, you may be able to claim a girlfriend, boyfriend, domestic partner or friend as a qualifying relative in some cases. Claiming dependents can give you a tax deduction worth up to $3,800 per dependent and also make you eligible for many other tax deductions like the Earned Income Tax Credit.
What is the Earned Income Tax Credit and How Do I Claim it?
The Earned Income Tax Credit is a tax credit for low to middle income wage earners that has lifted nearly 7 million people out of poverty, however many people still miss it. Why do so many people miss it? Many think they don’t make enough to file their taxes so they don’t claim it. You have to file your taxes to get this valuable tax credit, which may help a family with three dependents receive a credit worth up to $5,891.
Does healthcare reform impact my 2012 taxes?
There’s been a lot of confusion about healthcare reform and taxes. Rest assured, the requirement to purchase healthcare does not impact your 2012 or 2013 taxes. You do not have to purchase health insurance until January 2014 and there may be a few exceptions based on income, religious beliefs, and citizenship. You will not see changes to your taxes related to the purchase of health insurance until your 2014 taxes are filed in 2015 if you buy healthcare coverage at a health insurance exchange.
Are unemployment benefits taxable?
The unemployment rate has dipped to 7.9 percent vs. 8.3 percent in January 2013. But that’s little comfort to the jobless who find out their unemployment income is taxable income. The good news is that job search and moving expenses may be tax-deductible. See the next question for more details.
Can I deduct the cost of searching for a job? Are moving expenses for my new job tax deductible?
Job seekers may be able to deduct many expenses related to their search: printing resumes, fees for employment and outplacement agencies, career seminar costs and business-related travel. Moving expenses relevant to your job search may be deductible if you meet the distance and time test.
What are the tax implications of withdrawing money early from a retirement account to pay bills or debt?
In difficult economic times, many people start eyeing their retirement accounts to pay off bills or debt. While it is your money, you may be unaware of the impacts of withdrawing from your nest egg. Withdrawing money early from a retirement account comes with a 10 percent tax penalty in addition to the regular income tax on the amount withdrawn. There can be other consequences, too. The retirement money may bump you into a higher tax bracket, which can result in the taxation of other income, such as social security, that you wouldn’t have been taxed on otherwise.
What are qualified education expenses? And when can I file?
College tuition skyrockets every year, but the U.S. government provides incentives with education credits and deductions. For example, the American Opportunity Credit, which was extended through 2012, benefits full-time and part-time college students with a maximum $2,500 credit per student, provided you meet modified adjusted gross income requirements.
My house foreclosed, how does that impact my taxes?
The Mortgage Forgiveness Debt Relief Act survived the recent ‘fiscal cliff,’ receiving a one-year extension through 2013. This means you don’t have to pay taxes on the loss of your home through foreclosure or short sale, up to $2 million (or $1 million if married filing separately).
I started my own business; can I deduct my home office expenses?
Many entrepreneurs are reluctant to write off the business use of their home for fear of being audited. But home office expenses are a legitimate tax deduction you shouldn’t miss out on. Keep in mind the space you claim as a home office should be used exclusively and regularly for that purpose.
Will January tax law changes impact my taxes?
On Jan. 1, 2013, Congress kept the U.S. from going over the ‘fiscal cliff’ by passing The American Tax Relief Act of 2012. The act includes a permanent extension of the Alternative Minimum Tax (AMT) patch, the permanent reduction of tax rates and the reinstatement of several tax deductions, including the Educator Expense Deduction, the Tuition and Fees Deduction, and state sales taxes in lieu of state income taxes.
I was impacted by a natural disaster in 2012. What tax breaks are available to me?
Hurricane Sandy and other natural disasters last year left many picking up the pieces, filing insurance claims, and wondering how it will affect their taxes. It’s possible to take a tax deduction for property loss claims not compensated by insurance, or in some special cases, when you’re still waiting for compensation. These are known as casualty losses and include hurricanes, floods, earthquakes, tornadoes, fire—even vandalism and shipwrecks
Wednesday, February 27, 2013
11 Changes You Must Know Before Filing Your Tax Return for 2012
FROM FORBES.COM -
With so many changes looming for 2013, it’s easy to forget that there were some significant tweaks to the Tax Code for 2012. Here’s a list of eleven changes to keep in mind before you file your 2012 tax return, due April 15, 2013:
1. Payroll tax credit will still affect self-employed taxpayers. The expiration of the payroll tax credit for 2013 was big news – but don’t forget that the credit was still in place for 2012. While that means nothing for employees subject to withholding (no additional breaks on your federal income tax return since you’ve already received the benefit of the payroll tax credit in your withholding), if you were self-employed you will receive an adjustment on your self-employment (SE) taxes when you file your federal income tax return. Your SE tax will be reduced by 2%; the SE tax rate of 12.4% is reduced to 10.4%.
2. Forms W-2 have more information this year. Under the Affordable Health Care Act, most employers are required to report the value of health care benefits received by an employee on a 2012 federal form W-2 (a few small businesses are still exempt from reporting under the transitional relief offered by IRS). The amount will be reported in box 12 with Code DD and should include both the portion paid by the employer as well as any amount paid in by an employee. Even though it appears on a W-2, this amount remains federal income tax free for 2012.
3. Roth Conversions May Be Taxable. Taxpayers who converted or rolled over amounts to a Roth IRA in 2010 and did not elect to include the entire amount in income in 2010 may need to report half of that taxable income on their 2012 returns. Favorable tax treatment made conversions in 2010 more appealing than normal: specifically, taxpayers had a three year window to pay the taxes due. That window expires with tax year 2012.
4. Relief For Underwater Taxpayers. With record numbers of taxpayers in foreclosure, Congress enacted the Mortgage Forgiveness and Debt Relief Act of 2007 to provide limited tax relief for taxpayers facing financial difficulties. Under the Act, qualified homeowners who were forced into foreclosure or mortgage restructuring on a principal residence could exclude income of up to $2 million ($1 million for married taxpayers filing separately) on the mortgage forgiveness (the difference between the lower amount received and the higher amount owed to the mortgage company). The fiscal cliff tax deal extended that tax relief through 2013 making it possible for taxpayers to avoid a huge tax bill on 2012 short sales.
5. Increased Standard Deduction.The amount of the standard deduction increased for all taxpayers in 2012. The rates for 2012 were:
6. Increased Personal Exemption. Similarly, the value of the personal exemptions for 2012 also increased. While exemptions were worth $3,700 in 2011, they rose to $3,800 for 2012.
7. Sales Tax Deduction Still An Option. Taxpayers who itemize may deduct state income taxes paid on their federal return putting those taxpayers who live in a state without an income tax arguably at a disadvantage. A federal law which allowed taxpayers the option of choosing to deduct state income taxes paid or sales taxes paid offered temporary relief for those folks – and those who made high dollar purchases but lived in low tax states. That tax break – which debuted in 2005 – expired at the end of 2011. However, the tax deal extended that option through 2013, making it still a viable option for taxpayers in 2012.
8. Tax Breaks for Charitable Donations from IRAs Extended. The new tax deal extended the qualified charitable distribution provisions which were set to expire through 2012 and 2013. Generally, distributions from an IRA are taxable when withdrawn whether payable to an individual or a charity. However, under the special rules, a withdrawal from an IRA (other than an ongoing SIMPLE or SEP) owned by an individual who is age 70½ or over that is paid directly to a qualified charity can be excluded from gross income. Up to $100,000 of distributions be distributed – and that amount can be used to satisfy a taxpayer’s required minimum distributions (RMDs) for the year. Even better? Special rules allow taxpayers to treat donations made before February 1, 2013, as qualifying distributions for 2012.
9. Education Tax Breaks Strengthened. The American Opportunity Credit (the super-charged version of the Hope Credit) was extended through 2012 for expenses paid for tuition, certain fees and course materials for higher education. The maximum credit available is $2,500 in 2012 which includes 100% of qualifying tuition and related expenses not in excess of $2,000, plus 25% of those expenses that do not exceed $4,000. Additionally, the Lifetime Learning Credit sticks around for 2012, capped at $2,000, which applies to 20% of the first $10,000 of qualifying out-of-pocket expenses (but no double-dipping: you can’t claim both credits in the same tax year for the same student). Also getting a boost? The above-the-line Tuition and Fees Deduction was extended so that taxpayers who don’t itemize can continue to benefit.
10. Alternative Minimum Tax (AMT) Relief. The tax deal passed in January 2013 provided significant AMT relief for middle class taxpayers in 2012 – and beyond. The AMT exemption for 2012 was increased to $50,600 for single taxpayers (an increase of nearly $20,000) and $78,750 for married taxpayers filing jointly (an increase of more than $30,000). Even better? Beginning with 2012, AMT relief will be adjusted for inflation each year – no more patches!
11. Adoption Credit Survives – But Is Limited. Under the new tax deal, the adoption credit was saved. Originally, the adoption credit was scheduled to sunset at the end of 2010 but was temporarily extended as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010; it was also made refundable (a nonrefundable credit can reduce the amount of tax you owe to zero while a refundable credit can reduce your tax liability to zero and any remaining credit will be refunded to you). The new tax deal did extend the adoption credit permanently with one significant hit: the credit is no longer refundable. The credit was only refundable in 2010 and 2011. Taxpayers in 2012 can claim the adoption credit but it is not refundable
With so many changes looming for 2013, it’s easy to forget that there were some significant tweaks to the Tax Code for 2012. Here’s a list of eleven changes to keep in mind before you file your 2012 tax return, due April 15, 2013:
1. Payroll tax credit will still affect self-employed taxpayers. The expiration of the payroll tax credit for 2013 was big news – but don’t forget that the credit was still in place for 2012. While that means nothing for employees subject to withholding (no additional breaks on your federal income tax return since you’ve already received the benefit of the payroll tax credit in your withholding), if you were self-employed you will receive an adjustment on your self-employment (SE) taxes when you file your federal income tax return. Your SE tax will be reduced by 2%; the SE tax rate of 12.4% is reduced to 10.4%.
2. Forms W-2 have more information this year. Under the Affordable Health Care Act, most employers are required to report the value of health care benefits received by an employee on a 2012 federal form W-2 (a few small businesses are still exempt from reporting under the transitional relief offered by IRS). The amount will be reported in box 12 with Code DD and should include both the portion paid by the employer as well as any amount paid in by an employee. Even though it appears on a W-2, this amount remains federal income tax free for 2012.
3. Roth Conversions May Be Taxable. Taxpayers who converted or rolled over amounts to a Roth IRA in 2010 and did not elect to include the entire amount in income in 2010 may need to report half of that taxable income on their 2012 returns. Favorable tax treatment made conversions in 2010 more appealing than normal: specifically, taxpayers had a three year window to pay the taxes due. That window expires with tax year 2012.
4. Relief For Underwater Taxpayers. With record numbers of taxpayers in foreclosure, Congress enacted the Mortgage Forgiveness and Debt Relief Act of 2007 to provide limited tax relief for taxpayers facing financial difficulties. Under the Act, qualified homeowners who were forced into foreclosure or mortgage restructuring on a principal residence could exclude income of up to $2 million ($1 million for married taxpayers filing separately) on the mortgage forgiveness (the difference between the lower amount received and the higher amount owed to the mortgage company). The fiscal cliff tax deal extended that tax relief through 2013 making it possible for taxpayers to avoid a huge tax bill on 2012 short sales.
5. Increased Standard Deduction.The amount of the standard deduction increased for all taxpayers in 2012. The rates for 2012 were:
- Single: $5,950, up $150 from 2011
- Married Filing Separately: $5,950, up $150 from 2011
- Head of Household: $8,700, up $200 from 2011
- Married Taxpayers Filing Jointly and Qualifying Widow(er): $11,900, up $300 from 2011
6. Increased Personal Exemption. Similarly, the value of the personal exemptions for 2012 also increased. While exemptions were worth $3,700 in 2011, they rose to $3,800 for 2012.
7. Sales Tax Deduction Still An Option. Taxpayers who itemize may deduct state income taxes paid on their federal return putting those taxpayers who live in a state without an income tax arguably at a disadvantage. A federal law which allowed taxpayers the option of choosing to deduct state income taxes paid or sales taxes paid offered temporary relief for those folks – and those who made high dollar purchases but lived in low tax states. That tax break – which debuted in 2005 – expired at the end of 2011. However, the tax deal extended that option through 2013, making it still a viable option for taxpayers in 2012.
8. Tax Breaks for Charitable Donations from IRAs Extended. The new tax deal extended the qualified charitable distribution provisions which were set to expire through 2012 and 2013. Generally, distributions from an IRA are taxable when withdrawn whether payable to an individual or a charity. However, under the special rules, a withdrawal from an IRA (other than an ongoing SIMPLE or SEP) owned by an individual who is age 70½ or over that is paid directly to a qualified charity can be excluded from gross income. Up to $100,000 of distributions be distributed – and that amount can be used to satisfy a taxpayer’s required minimum distributions (RMDs) for the year. Even better? Special rules allow taxpayers to treat donations made before February 1, 2013, as qualifying distributions for 2012.
9. Education Tax Breaks Strengthened. The American Opportunity Credit (the super-charged version of the Hope Credit) was extended through 2012 for expenses paid for tuition, certain fees and course materials for higher education. The maximum credit available is $2,500 in 2012 which includes 100% of qualifying tuition and related expenses not in excess of $2,000, plus 25% of those expenses that do not exceed $4,000. Additionally, the Lifetime Learning Credit sticks around for 2012, capped at $2,000, which applies to 20% of the first $10,000 of qualifying out-of-pocket expenses (but no double-dipping: you can’t claim both credits in the same tax year for the same student). Also getting a boost? The above-the-line Tuition and Fees Deduction was extended so that taxpayers who don’t itemize can continue to benefit.
10. Alternative Minimum Tax (AMT) Relief. The tax deal passed in January 2013 provided significant AMT relief for middle class taxpayers in 2012 – and beyond. The AMT exemption for 2012 was increased to $50,600 for single taxpayers (an increase of nearly $20,000) and $78,750 for married taxpayers filing jointly (an increase of more than $30,000). Even better? Beginning with 2012, AMT relief will be adjusted for inflation each year – no more patches!
11. Adoption Credit Survives – But Is Limited. Under the new tax deal, the adoption credit was saved. Originally, the adoption credit was scheduled to sunset at the end of 2010 but was temporarily extended as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010; it was also made refundable (a nonrefundable credit can reduce the amount of tax you owe to zero while a refundable credit can reduce your tax liability to zero and any remaining credit will be refunded to you). The new tax deal did extend the adoption credit permanently with one significant hit: the credit is no longer refundable. The credit was only refundable in 2010 and 2011. Taxpayers in 2012 can claim the adoption credit but it is not refundable
Monday, February 25, 2013
Beware of Bogus IRS E-Mails.
The IRS has issued a warning to taxpayers who receive emails claiming to be from the agency.
The agency advises recipients of e-mails claiming to be from the IRS that they should not:
- Reply to the message;
- Open attachments; or,
- Click on any links in a suspicious e-mail or phishing Web site or enter confidential information.
The IRS, which has long warned about phony sites, also points out that it does not initiate contact with taxpayers by e-mail or social media channels to request personal or financial information or ask for detailed personal and financial information such as PINs, passwords or similar access information for credit card, bank or other financial accounts.
“Do not be misled by sites claiming to be the IRS but ending in .com, .net, .org or anything other than .gov,” the warning adds. “If you discover a Web site that claims to be the IRS but you suspect it is bogus, do not provide any personal information on their site and report it to the IRS. If you receive a phone call, fax or letter in the mail from an individual claiming to be from the IRS but you suspect they are not an IRS employee, contact the IRS at 1-800-829-1040.”
The service has also set up sites to help taxpayers and preparers report phishing and protect identity information, and has posted multi-language YouTube videos on phishing malware and self-protection against ID theft. Podcasts in English and Spanish also cover the topic.
Wednesday, February 20, 2013
Clocking Out: Tax Planning for Individuals Near Retirement
For the last 30 or 40 years, clients who are near retirement have been working and saving every dollar possible, and while they’re almost at the finish line, there are still savings to be had.
Clients who are nearing retirement provide a unique tax planning opportunity, as they are likely to have both more income and more income taxes now than they will when they leave full-time employment in the near future.
Here are some important steps advisors should take to reduce their clients’ taxes while they’re working but on the cusp of retirement:
Max Out the 401(k)
Workers on their way out should do whatever they can to increase contributions to a pre-tax retirement plan, like a 401(k) or 403(b). In 2013 the limits are generally the lesser of the employee’s income, or $17,500. That figure rises to $23,000 for contributors over age 50.
Depending on the employee’s tax bracket, every dollar deposited into a 401(k) could save the client about 10 to 40 cents in income taxes for the year in which the contributions are made.
Say the client contributes $10,000 while working, and it would otherwise be taxed at a rate of 35 percent. Then he retires a few years later, and the funds are taxed at 15 percent when pulled out of the retirement account. That gap of 20 percent between tax rates produces a theoretical savings of $2,000.
Don’t Forget the HSA
Employed clients who are eligible and able might want to take out a high-deductible health insurance option, and then make corresponding tax-deductible contributions to a Health Savings Account (HSA). The HSA contribution limits for 2013 are $3,250 for individuals and $6,450 for families, with another $1,000 for those over age 50.
The high-deductible health insurance helps users save money on premiums now and adds some flexibility on how they spend their health care dollars. Any unspent money in the HSA rolls over every year, and can be spent tax-free on future qualifying medical expenses. Once the client reaches age 65, the left-over funds can be withdrawn as taxable income, just as if it were in an IRA.
Refinance the Mortgage
Those increased contributions to tax-advantaged savings vehicles could mean a cash flow crunch for many workers. But your clients may be able to lower total monthly expenses (and taxes) and raise liquidity by re-financing their mortgage—preferably for as much (and as long) as the lender will allow.
There may be new or higher monthly mortgage payments, and the interest cost can’t be ignored. But this might be the last best time for clients to tap the equity in their homes at historically-low rates, relatively-high valuations, and within relatively friendly lending standards.
Those low mortgage rates can be even more advantageous since the interest may be tax-deductible, as long as the clients itemize. Check out Publication 936 at www.irs.gov for more information.
Any cash-out proceeds from the mortgage should be parked in safer savings vehicles, and used for future big expenses that would otherwise cause the client to borrow (i.e. a new car, home improvement, or college costs).
Take Your Losses
When a working, higher-income client experiences investment losses outside of tax-sheltered accounts, make sure you consider making the best of the unfortunate occurrence by realizing the losses, and the ensuing tax benefits.
In 2013 the client can usually use any losses to offset realized gains, and then up to $3,000 of the losses against ordinary, taxable income. Again, depending on the clients’ tax bracket, that amount could save up to $1,000 or so in taxes. Losses over that $3,000 amount that can’t be used this year can be “carried forward” into future years, and potentially used to reduce future taxable income or gains.
Just make sure you avoid the “wash sale” rules by not buying the security within 30 days before or after you sell it for the tax loss.
Wait to Take Gains
Tax concerns usually aren’t enough justification to hold off selling a stock, bond, or fund. But if you can help it, there are at least two thresholds to meet before liquidating an appreciated security, especially for those high-income clients who will soon retire.
Start by waiting at least a year from the date of purchase, so that the gains will be considered “long-term.” Beginning in 2013 the federal tax rate on those gains will be 15 percent for those in the 25 percent through 35 percent federal income tax brackets.
The long-term capital gains tax rate is now 20 percent for those taxpayers in the new 39.6 percent bracket. In addition, high income earners could incur the new additional 3.8 percent “Medicare Tax” on their gains, as well.
Once the clients retire and are (hopefully) in the lower income tax brackets, the long-term federal capital gains tax hit could be as little as 0 percent.
Tax Benefits Today, Charitable Giving Tomorrow
Another aspect of tax planning that retiring clients should consider is their long-term charitable giving. It’s possible to accelerate the tax benefits of giving to now, and delay the actual transfer of the money to the charity until later.
The strategy starts with the clients projecting how much money they may plan to give to qualified charitable organizations over the next decade or longer. The clients then transfer that amount to a “donor advised fund,” or “DAF.” They can get an immediate tax deduction on the donation now, when it’s most useful, since they’re likely in a higher tax bracket now.
The money is then invested among a limited menu of options, and in the future clients can “advise” the account custodians as to the recipients, timing, and amounts of donations.
Those donations will not produce an additional tax benefit at that time
Clients who are nearing retirement provide a unique tax planning opportunity, as they are likely to have both more income and more income taxes now than they will when they leave full-time employment in the near future.
Here are some important steps advisors should take to reduce their clients’ taxes while they’re working but on the cusp of retirement:
Max Out the 401(k)
Workers on their way out should do whatever they can to increase contributions to a pre-tax retirement plan, like a 401(k) or 403(b). In 2013 the limits are generally the lesser of the employee’s income, or $17,500. That figure rises to $23,000 for contributors over age 50.
Depending on the employee’s tax bracket, every dollar deposited into a 401(k) could save the client about 10 to 40 cents in income taxes for the year in which the contributions are made.
Say the client contributes $10,000 while working, and it would otherwise be taxed at a rate of 35 percent. Then he retires a few years later, and the funds are taxed at 15 percent when pulled out of the retirement account. That gap of 20 percent between tax rates produces a theoretical savings of $2,000.
Don’t Forget the HSA
Employed clients who are eligible and able might want to take out a high-deductible health insurance option, and then make corresponding tax-deductible contributions to a Health Savings Account (HSA). The HSA contribution limits for 2013 are $3,250 for individuals and $6,450 for families, with another $1,000 for those over age 50.
The high-deductible health insurance helps users save money on premiums now and adds some flexibility on how they spend their health care dollars. Any unspent money in the HSA rolls over every year, and can be spent tax-free on future qualifying medical expenses. Once the client reaches age 65, the left-over funds can be withdrawn as taxable income, just as if it were in an IRA.
Refinance the Mortgage
Those increased contributions to tax-advantaged savings vehicles could mean a cash flow crunch for many workers. But your clients may be able to lower total monthly expenses (and taxes) and raise liquidity by re-financing their mortgage—preferably for as much (and as long) as the lender will allow.
There may be new or higher monthly mortgage payments, and the interest cost can’t be ignored. But this might be the last best time for clients to tap the equity in their homes at historically-low rates, relatively-high valuations, and within relatively friendly lending standards.
Those low mortgage rates can be even more advantageous since the interest may be tax-deductible, as long as the clients itemize. Check out Publication 936 at www.irs.gov for more information.
Any cash-out proceeds from the mortgage should be parked in safer savings vehicles, and used for future big expenses that would otherwise cause the client to borrow (i.e. a new car, home improvement, or college costs).
Take Your Losses
When a working, higher-income client experiences investment losses outside of tax-sheltered accounts, make sure you consider making the best of the unfortunate occurrence by realizing the losses, and the ensuing tax benefits.
In 2013 the client can usually use any losses to offset realized gains, and then up to $3,000 of the losses against ordinary, taxable income. Again, depending on the clients’ tax bracket, that amount could save up to $1,000 or so in taxes. Losses over that $3,000 amount that can’t be used this year can be “carried forward” into future years, and potentially used to reduce future taxable income or gains.
Just make sure you avoid the “wash sale” rules by not buying the security within 30 days before or after you sell it for the tax loss.
Wait to Take Gains
Tax concerns usually aren’t enough justification to hold off selling a stock, bond, or fund. But if you can help it, there are at least two thresholds to meet before liquidating an appreciated security, especially for those high-income clients who will soon retire.
Start by waiting at least a year from the date of purchase, so that the gains will be considered “long-term.” Beginning in 2013 the federal tax rate on those gains will be 15 percent for those in the 25 percent through 35 percent federal income tax brackets.
The long-term capital gains tax rate is now 20 percent for those taxpayers in the new 39.6 percent bracket. In addition, high income earners could incur the new additional 3.8 percent “Medicare Tax” on their gains, as well.
Once the clients retire and are (hopefully) in the lower income tax brackets, the long-term federal capital gains tax hit could be as little as 0 percent.
Tax Benefits Today, Charitable Giving Tomorrow
Another aspect of tax planning that retiring clients should consider is their long-term charitable giving. It’s possible to accelerate the tax benefits of giving to now, and delay the actual transfer of the money to the charity until later.
The strategy starts with the clients projecting how much money they may plan to give to qualified charitable organizations over the next decade or longer. The clients then transfer that amount to a “donor advised fund,” or “DAF.” They can get an immediate tax deduction on the donation now, when it’s most useful, since they’re likely in a higher tax bracket now.
The money is then invested among a limited menu of options, and in the future clients can “advise” the account custodians as to the recipients, timing, and amounts of donations.
Those donations will not produce an additional tax benefit at that time
Friday, February 15, 2013
Top Red Flags That Trigger an IRS Audit!
The Internal Revenue Service uses a combination of automated and human
processes when selecting which tax returns to audit. All tax returns are
compared with statistical norms, and those with anomalies undergo three layers
of review by personnel.
Audits then occur either by mail or in meetings at taxpayers’ places of business. They can be unpleasant and are sometimes unavoidable. Rice says certain red flags are sure to draw scrutiny. Some are easy to sidestep – unreported income, for example. Others, such as high income, can’t be helped.
Unreported income is perhaps the easiest-to-avoid red flag and, by the same token, the easiest to overlook. Any institution that distributes an individual’s income will report it to the IRS, and the more income sources you have, the greater the difficulty in keeping track.
Old brokerage accounts are commonly overlooked, as are Form 1099s, Rice says. One of Rice’s recent clients took a distribution from a college savings account to pay tuition, exactly as he was supposed to do with those funds. But he forgot to tell the IRS, which had received notification from the institution. “The IRS matches all reportable items to a person’s return,” Rice says. “If they don’t see it they will automatically conduct at least a letter audit.”
The Foreign Account Tax Compliance Act has strict reporting requirements for foreign bank accounts. The law requires overseas banks to identify American asset holders and provide information to the IRS. Individuals must report foreign assets worth at least $50,000 on the new Form 8938.
“It used to be you didn’t have to report it; you just had to check a box that you had one,” Rice says. “Now you have to not only check the box, you have to identify the institution and the highest dollar amount the account was at the previous year.”
The regulations demand openness, which in turn increases the likelihood of an audit. That’s because of a “perception that people with foreign accounts are trying to hide something,” Rice says. But it’s a Catch-22: Compliance with the law increases the likelihood of an audit, and noncompliance can result in stiff penalties and significant legal liabilities.
The IRS will give a close look to excessive business deductions. The agency uses occupational codes to measure typical amounts of travel by profession, and a tax return showing 20 percent or more above the norm might get a second look, Rice says. Also, take-home vehicles aren’t considered strictly business, so a specific purpose should accompany any vehicle-related deduction.
Generally speaking, the IRS can be picky about mixing business and personal expenses. Meals and entertainment can be allowable, but exceeding the occupational norm by a great amount invites an audit. “Meals and entertainment oftentimes can be a blurred line, and the IRS doesn’t like any blurred lines,” Rice says.
Last year the IRS audited about 1 percent of those earning less than $200,000, and almost 4 percent of those earning more, according IRS data. Raise the threshold to $1 million and the percentage of audited tax returns increases to 12.5 percent. The same patterns exist when it comes to business tax returns: 1 percent of corporations with less than $10 million in assets, compared with 17.6 percent above that threshold. Rice says the IRS isn’t arbitrarily picking on high earners. "The IRS is applying the rule of big numbers,"
Rice says. "If people make more money, there is a better likelihood of a higher claim."
For one thing, higher incomes are likely to result in more complex tax returns that are more likely to contain audit triggers. More importantly, the IRS wants to maximize return on investment, something the agency gets better at every year: $55.2 billion was collected through enforcement activities last year, a 63.8 percent increase since 2001 without adjusting for inflation. But enforcement personnel increased only 9.8 percent during that time.
Audits then occur either by mail or in meetings at taxpayers’ places of business. They can be unpleasant and are sometimes unavoidable. Rice says certain red flags are sure to draw scrutiny. Some are easy to sidestep – unreported income, for example. Others, such as high income, can’t be helped.
Not reporting all of your income
Unreported income is perhaps the easiest-to-avoid red flag and, by the same token, the easiest to overlook. Any institution that distributes an individual’s income will report it to the IRS, and the more income sources you have, the greater the difficulty in keeping track.
Old brokerage accounts are commonly overlooked, as are Form 1099s, Rice says. One of Rice’s recent clients took a distribution from a college savings account to pay tuition, exactly as he was supposed to do with those funds. But he forgot to tell the IRS, which had received notification from the institution. “The IRS matches all reportable items to a person’s return,” Rice says. “If they don’t see it they will automatically conduct at least a letter audit.”
Breaking the rules on foreign accounts
The Foreign Account Tax Compliance Act has strict reporting requirements for foreign bank accounts. The law requires overseas banks to identify American asset holders and provide information to the IRS. Individuals must report foreign assets worth at least $50,000 on the new Form 8938.
“It used to be you didn’t have to report it; you just had to check a box that you had one,” Rice says. “Now you have to not only check the box, you have to identify the institution and the highest dollar amount the account was at the previous year.”
The regulations demand openness, which in turn increases the likelihood of an audit. That’s because of a “perception that people with foreign accounts are trying to hide something,” Rice says. But it’s a Catch-22: Compliance with the law increases the likelihood of an audit, and noncompliance can result in stiff penalties and significant legal liabilities.
Blurring the lines on business expenses
The IRS will give a close look to excessive business deductions. The agency uses occupational codes to measure typical amounts of travel by profession, and a tax return showing 20 percent or more above the norm might get a second look, Rice says. Also, take-home vehicles aren’t considered strictly business, so a specific purpose should accompany any vehicle-related deduction.
Generally speaking, the IRS can be picky about mixing business and personal expenses. Meals and entertainment can be allowable, but exceeding the occupational norm by a great amount invites an audit. “Meals and entertainment oftentimes can be a blurred line, and the IRS doesn’t like any blurred lines,” Rice says.
Earning more than $200,000
Last year the IRS audited about 1 percent of those earning less than $200,000, and almost 4 percent of those earning more, according IRS data. Raise the threshold to $1 million and the percentage of audited tax returns increases to 12.5 percent. The same patterns exist when it comes to business tax returns: 1 percent of corporations with less than $10 million in assets, compared with 17.6 percent above that threshold. Rice says the IRS isn’t arbitrarily picking on high earners. "The IRS is applying the rule of big numbers,"
Rice says. "If people make more money, there is a better likelihood of a higher claim."
For one thing, higher incomes are likely to result in more complex tax returns that are more likely to contain audit triggers. More importantly, the IRS wants to maximize return on investment, something the agency gets better at every year: $55.2 billion was collected through enforcement activities last year, a 63.8 percent increase since 2001 without adjusting for inflation. But enforcement personnel increased only 9.8 percent during that time.
Tuesday, February 12, 2013
IRS Warns of Delays with Child Tax Credit Claims
The Internal Revenue Service is cautioning tax preparers about
delays in processing tax returns claiming the Child Tax Credit because
of incorrectly filled out forms.
“We have observed instances in which the Schedule 8812 is attached to form 1040 and 1040A and is not filled out correctly,” the IRS wrote in an email to tax professionals Monday. “These instances are causing downstream processing delays.”
The IRS noted that it has experienced the following two conditions: (1) The Schedule 8812 Part 1 checkboxes A, B, C, and D are checked when taxpayers list a dependent child with a Social Security Number qualifying for the Child Tax Credit; and (2) the Schedule 8812 Part 1 checkboxes A, B, C, and D not being checked when taxpayers have a child with an Individual Taxpayer Identification Number, or ITIN, on Form 1040 and 1040A line 6c identified as qualifying for the Child Tax Credit in column 4.
The Schedule 8812 instructions direct the taxpayer, the IRS noted, to “use Part I of Schedule 8812 to document that any child for whom you entered an ITIN on Form 1040, line 6c; Form 1040A, line 6c; or Form 1040NR, line 7c; and for whom you also checked the box in column 4 of that line, is a resident of the United States because the child meets the substantial presence test and is not otherwise treated as a nonresident alien.”
The IRS said it is working to implement business rules to reject these incorrectly completed returns, but the date of the fixes has yet to be determined.
In the meantime, the IRS is requesting tax prep software providers to include an alert to help tax preparers identify inconsistencies when they are completing the Schedule 8812. It also asked for communication with the tax practitioner community to avoid delays in processing tax returns.
An Accounting Today reader also warned Monday evening that the IRS has been sending letters to tax practitioners informing them that Form 8867 was not completed correctly, resulting in unnecessary processing delays in client refunds because either questions 22 or 23 were not answered. However, if the children in question are the taxpayer’s son or daughter, this question does not apply, the reader noted. Practitioners may also be informed that questions 26 a or b were not answered, or the box labeled "no qualifying child" or the box labeled "no disabled child."
“We have observed instances in which the Schedule 8812 is attached to form 1040 and 1040A and is not filled out correctly,” the IRS wrote in an email to tax professionals Monday. “These instances are causing downstream processing delays.”
The IRS noted that it has experienced the following two conditions: (1) The Schedule 8812 Part 1 checkboxes A, B, C, and D are checked when taxpayers list a dependent child with a Social Security Number qualifying for the Child Tax Credit; and (2) the Schedule 8812 Part 1 checkboxes A, B, C, and D not being checked when taxpayers have a child with an Individual Taxpayer Identification Number, or ITIN, on Form 1040 and 1040A line 6c identified as qualifying for the Child Tax Credit in column 4.
The Schedule 8812 instructions direct the taxpayer, the IRS noted, to “use Part I of Schedule 8812 to document that any child for whom you entered an ITIN on Form 1040, line 6c; Form 1040A, line 6c; or Form 1040NR, line 7c; and for whom you also checked the box in column 4 of that line, is a resident of the United States because the child meets the substantial presence test and is not otherwise treated as a nonresident alien.”
The IRS said it is working to implement business rules to reject these incorrectly completed returns, but the date of the fixes has yet to be determined.
In the meantime, the IRS is requesting tax prep software providers to include an alert to help tax preparers identify inconsistencies when they are completing the Schedule 8812. It also asked for communication with the tax practitioner community to avoid delays in processing tax returns.
An Accounting Today reader also warned Monday evening that the IRS has been sending letters to tax practitioners informing them that Form 8867 was not completed correctly, resulting in unnecessary processing delays in client refunds because either questions 22 or 23 were not answered. However, if the children in question are the taxpayer’s son or daughter, this question does not apply, the reader noted. Practitioners may also be informed that questions 26 a or b were not answered, or the box labeled "no qualifying child" or the box labeled "no disabled child."
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