FROM http://time.com/money
Many don't see themselves as small business owners and aren't ready to deal with one of the great two certainties in life: taxes.
In the “gig economy,” millions of people provide services and resources using online platforms. Get on the right software, pay the going rate, and you can find a bed in Tuscaloosa, get a ride in Piedmont, have your screen door repaired in Scranton, and wait for dinner to be delivered to your door in Walla Walla.
But as more people turn to software platforms to supplement their income or provide full-time revenue, there’s a problem. Many of those involved don’t see themselves as small business owners and aren’t ready to deal with one of the great two certainties in life: taxes.
A lack of sophistication may keep them from realizing that they have tax reporting obligations — and may also keep them from taking advantage of deductions that could potentially reduce the overall amount they owe in taxes, including that from a full-time job. Furthermore, current tax laws create a loophole in which many of the gig workers have income not reported to the IRS, which may leave them thinking they have no obligations.
According to a study from the National Association for the Self Employed and American University’s Kogod Tax Policy Center, many gig workers don’t realize that they have to file as a small business. “They don’t see themselves as self-employed,” said Katie Vlietstra, NASE vice president for government relations and public affairs. “They see this as a side hustle.” They may think that “taxes were taken out, because they don’t know better.”
“Everything is taxable unless [Congress tells] you that it’s not,” said Manuel Pravia, a CPA and principal of Morrison, Brown, Argiz & Farra. “If you find $20 in the middle of the street, you’re supposed to think, ‘I’ve been enriched by this and have to report it as income.'”
Many self-employed people come to their senses when they receive a 1099 form at the end of a tax year from every company that paid them $600 or more. But there is a loophole. Many of the platforms pay people through a third-party system. In that case, the necessary form is a 1099-K. But the third-party payer only has to send one to the worker, with a copy to the IRS, if the person made more than $20,000 and took part in at least 200 transactions over the year. Miss the threshold and you might not get that 1099-K reminder, and neither will the IRS.
In the study, 74% of people said that they had earned $5,000 or less in 2015. Although some companies like Uber send 1099-K forms to all their workers, many don’t, which means plenty of people who don’t get that annual reminder to think about taxes. And even some who make more than $20,000 might slip under the radar. If you rent out a space on Airbnb for $150 a night, $20,000 is just over 133 transactions for the year, not enough to trigger 1099-K reporting. It becomes practically impossible in such cases for the IRS to know if people are reporting their full income.
The scary part is the potential magnitude of the problem. The survey was self-selecting, contacting only NASE members, so isn’t representational of the working public as a whole. But you might expect that people who join an organization of self-employed persons would be more likely to view themselves as owning their own businesses. If people who identify as small business owners are so behind in understanding their tax obligations, what is the average driver, house cleaner, or pet sitter going to think?
The growth of gig work is massive. According to a 2015 study by Lawrence Katz of Harvard and Princeton’s Alan Kreuger, workers providing services through online platforms were 0.5% of all workers in 2015. That would translate into nearly 7.5 million people.
“A lot of the debate [about gig work] has been about whether these are really classified as employees,” said Caroline Bruckner, managing director of the Kogod Tax Policy Center. “Those issues are going to be settled by the courts. But in the meantime these folks have real tax challenges.”
The gig platform companies are reluctant to step in, say experts, because they are concerned about workers being seen as employees, not business owners. Keeping a strict distance and being wary of offering too much advice protects them.
Not only do workers miss tax obligations, but also opportunities. There is a “variety of tax benefits and tax deductions they can avail themselves of,” according to Mark Steber, chief tax officer of tax preparation chain Jackson Hewitt. Smart use of tax laws could even create a loss for many that could help reduce overall taxes. “If you don’t get help or educate yourself, you can leave money on the table.”
And yet, most of these people don’t even realize that they need to do research and their low income may make tax help seem unrealistically expensive — if they even knew to look for it.
“The IRS needs to come out with guidance immediately for the 1099 issue,” Bruckner said. And perhaps an easier way for people to account for the small amounts they make. Until then, billions in earnings may be going unreported.
Wednesday, July 6, 2016
Tuesday, July 5, 2016
What are the tax-advantage incentives of retirement plans?
FROM http://www.readingeagle.com/
Whether you've saved enough money for retirement is a question best answered by a financial adviser.
But for anyone considering retirement, having your investments in accounts that will keep your post-retirement taxes low is the best policy.
If you don't have a 401(k) plan with your employer, or if you want to take advantage of more investment options, opening an individual retirement account is a sound policy.
According to Kevin J. Miller, an accredited asset management specialist at Berkshire Investment Group, Wyomissing, traditional IRAs allow for an upfront tax deduction on your income tax return for the year of contribution. The maximum in 2016 is $5,500, and $6,500 for an individual over the age of 50.
"The money grows tax-deferred and is taxed on the withdrawals once the IRA owner reaches age 59½," said Miller. "There are some exceptions for early withdrawals without penalty."
Individuals must pay an additional 10 percent early-withdrawal tax unless an exception applies. Some of the exceptions include qualified higher education expenses, qualified first-time home buyer costs and unreimbursed medical expenses.
Miller said Roth IRA contributions are made with after-tax money, but the earnings and growth are tax deferred along with tax-free withdrawals after age 59½ and a five-year holding period. The same maximum contribution limits apply as with a traditional IRA.
"In addition, there is no requirement to withdraw assets after age 70½ as compared to the traditional IRA that has required minimum distributions after age 70½," he said.
Paul L. Marrella, a financial adviser with Marrella Financial Group LLC, Spring Township, said, "These distributions begin at just under 4 percent of the IRA's value, with the percentage increasing over time."
A Roth IRA does not mandate minimum distributions.
"Roth IRAs may be more suitable for longer-term intergenerational wealth planning, where the money can be invested for many years on a tax-free basis," Marrella said. "In addition, spending your Roth IRA during retirement may keep your income lower, potentially reducing the percentage of your Social Security being taxed."
Given the flexibility of the Roth IRA, investors may want to consider converting their traditional IRA accounts into Roth IRA accounts.
"There are normally no fees involved when converting a traditional IRA to a Roth IRA," Miller said. "However, you may be liable for a large tax consequence when converting from a traditional to a Roth because of the transition from a pretax account of a traditional to a post-tax account of a Roth. One way to combat the large tax liability is to transition a traditional IRA to a Roth IRA over a period of years."
Planning strategy
The best way to lower taxes in retirement years is by planning your income tax strategy while you are still working, according to Marrella.
"For some Americans, you are better off having higher taxable income every other year, with lower years in between," he said. "This may help lower your Social Security taxation. For others, it may make sense to begin taking IRA distributions from the year following retirement up to the time they must take required minimum distributions. This can be done by either withdrawing money from the IRA account or converting to a Roth IRA. In some cases, tax-free municipal bonds may make sense."
Miller noted that municipal bonds distribute tax-free income but are subject to capital gains and losses when the bonds are sold at a gain or loss. The holding period of assets also plays a role.
"When assets are held for longer than one year and sold, they are considered long-term capital gains and losses and are taxed at a favorable tax rate," he said, "as compared to assets held and sold in one year or less, considered short-term capital gains and losses, and can be taxed as ordinary income."
Pensions are taxed at ordinary income rates. "That means you include the taxable pension along with any other wages, interest, dividends, etc.," Marrella said. "In addition, if your income is high enough, up to 85 percent of your Social Security could be taxed. The formula used is somewhat complex, but essentially begins taxing $1 of your Social Security for every $2 of income you have over a certain threshold."
Reduce tax liability
Miller said that tax loss harvesting, the practice of selling stocks and securities that are now worth less than an investor paid for them, can provide investors with the opportunity to reduce their tax liability because realized losses on investments can be used to first offset taxable gains and then to reduce ordinary income up to $3,000 per year.
"Starting in 2006, Congress allowed for Roth 401(k) contributions into employer-sponsored retirement plans to allow employees to take advantage of the Roth taxation benefits," Miller said. "This is further evidence that the federal government is encouraging people to save even more through tax-advantage incentives."
Whether you've saved enough money for retirement is a question best answered by a financial adviser.
But for anyone considering retirement, having your investments in accounts that will keep your post-retirement taxes low is the best policy.
If you don't have a 401(k) plan with your employer, or if you want to take advantage of more investment options, opening an individual retirement account is a sound policy.
According to Kevin J. Miller, an accredited asset management specialist at Berkshire Investment Group, Wyomissing, traditional IRAs allow for an upfront tax deduction on your income tax return for the year of contribution. The maximum in 2016 is $5,500, and $6,500 for an individual over the age of 50.
"The money grows tax-deferred and is taxed on the withdrawals once the IRA owner reaches age 59½," said Miller. "There are some exceptions for early withdrawals without penalty."
Individuals must pay an additional 10 percent early-withdrawal tax unless an exception applies. Some of the exceptions include qualified higher education expenses, qualified first-time home buyer costs and unreimbursed medical expenses.
Miller said Roth IRA contributions are made with after-tax money, but the earnings and growth are tax deferred along with tax-free withdrawals after age 59½ and a five-year holding period. The same maximum contribution limits apply as with a traditional IRA.
"In addition, there is no requirement to withdraw assets after age 70½ as compared to the traditional IRA that has required minimum distributions after age 70½," he said.
Paul L. Marrella, a financial adviser with Marrella Financial Group LLC, Spring Township, said, "These distributions begin at just under 4 percent of the IRA's value, with the percentage increasing over time."
A Roth IRA does not mandate minimum distributions.
"Roth IRAs may be more suitable for longer-term intergenerational wealth planning, where the money can be invested for many years on a tax-free basis," Marrella said. "In addition, spending your Roth IRA during retirement may keep your income lower, potentially reducing the percentage of your Social Security being taxed."
Given the flexibility of the Roth IRA, investors may want to consider converting their traditional IRA accounts into Roth IRA accounts.
"There are normally no fees involved when converting a traditional IRA to a Roth IRA," Miller said. "However, you may be liable for a large tax consequence when converting from a traditional to a Roth because of the transition from a pretax account of a traditional to a post-tax account of a Roth. One way to combat the large tax liability is to transition a traditional IRA to a Roth IRA over a period of years."
Planning strategy
The best way to lower taxes in retirement years is by planning your income tax strategy while you are still working, according to Marrella.
"For some Americans, you are better off having higher taxable income every other year, with lower years in between," he said. "This may help lower your Social Security taxation. For others, it may make sense to begin taking IRA distributions from the year following retirement up to the time they must take required minimum distributions. This can be done by either withdrawing money from the IRA account or converting to a Roth IRA. In some cases, tax-free municipal bonds may make sense."
Miller noted that municipal bonds distribute tax-free income but are subject to capital gains and losses when the bonds are sold at a gain or loss. The holding period of assets also plays a role.
"When assets are held for longer than one year and sold, they are considered long-term capital gains and losses and are taxed at a favorable tax rate," he said, "as compared to assets held and sold in one year or less, considered short-term capital gains and losses, and can be taxed as ordinary income."
Pensions are taxed at ordinary income rates. "That means you include the taxable pension along with any other wages, interest, dividends, etc.," Marrella said. "In addition, if your income is high enough, up to 85 percent of your Social Security could be taxed. The formula used is somewhat complex, but essentially begins taxing $1 of your Social Security for every $2 of income you have over a certain threshold."
Reduce tax liability
Miller said that tax loss harvesting, the practice of selling stocks and securities that are now worth less than an investor paid for them, can provide investors with the opportunity to reduce their tax liability because realized losses on investments can be used to first offset taxable gains and then to reduce ordinary income up to $3,000 per year.
"Starting in 2006, Congress allowed for Roth 401(k) contributions into employer-sponsored retirement plans to allow employees to take advantage of the Roth taxation benefits," Miller said. "This is further evidence that the federal government is encouraging people to save even more through tax-advantage incentives."
Monday, July 4, 2016
How to save money on next year’s tax bill — by making changes now
It's inevitable — the day on the calendar every year when you will have to file your income tax returns. It's a day you dread because you know you will owe taxes.
Your accountant has assured you that you are taking advantage of all the deductions and tax credits you are eligible for, but you will still owe money.
As you write the check to the United States Treasury or to your state tax department, you promise yourself you will not let this happen again next year. Instead, you will increase the amount of tax you pay throughout the year so come next April you won't owe so much.
You may even toy with the idea of paying in a bit more than your accountant recommends so you may wind up with a small refund. Emotionally this may make you feel better.
Fast forward two months later and chances are you still haven't increased the amount of tax you are paying.
Summer is approaching; your vacation is imminent (so is the final bill for the airfare) and the last thing on your mind is paying more taxes.
So, what should you do?
The first thing would be to check with your accountant and see if there are any additional deductions or tax credits you may be entitled to this year. Tax laws are always changing, and they may affect your personal tax situation.
Getting a head start on tax planning for 2016 is a good idea and you may find that you can save some money on taxes due to these changes.
If you have taken advantage of all the tax breaks, then you may want to change your withholdings now and spread out the additional amounts over the rest of the year. This will reduce your take-home pay, which no one likes.
However, for many, it is easier to do this then come up with a lump sum next April or try to put aside money each pay period to pay taxes.
An advantage to paying all the state tax through withholdings before the year ends is that it may also reduce your federal taxes if you itemize your deductions (and are not subject to AMT tax).
Finally, you may decide that you'll pay all or most of it on April 15 of next year. If that's the case, be aware that the IRS and your state tax department may impose a penalty for underpayment of taxes.
To avoid an underpayment penalty, the amount of tax you owe for the year must be less than $1,000 (after subtracting withholding and estimated taxes), or you must pay at least 90% of the current year tax or 100% (110% for higher income taxpayers) of the prior year's tax.
The determination of an underpayment penalty for state income taxes varies by states, although state guidelines typically are similar to the IRS.
Any way you decide to handle it, it is always best to know ahead of time whether next April will bring you comfort in knowing your tax liability has been previously satisfied or leave you scrambling to find the funds needed to pay your taxes.
Thursday, June 30, 2016
When tax-loss harvesting isn’t the best idea
FROM http://www.financial-planning.com/
Tax-loss harvesting isn’t like harvesting corn.
Harvesting corn results in cash. But when a tax loss is harvested, it is replaced by a somewhat similar holding with a newer lower basis.
This means that the harvester is actually just pushing a future gain down the road, a potentially greater gain that will inevitably be taxed at some point.
As Michael Kitces, partner and director of research at Pinnacle Advisory Group in Columbia, Md., says, such deferrals can make sense and even save investors money, but he adds that many advisers “continue to overstate the benefit of tax-loss harvesting” by “confusing tax savings with tax deferral.”
Harvesting tax losses can make sense, for instance by converting a loss into a long-term gain that doesn’t have to be realized or taxed for years later when the taxpayer might be in a lower income bracket. But the process also can add costs, such as transaction fees or the bid-asked spread, he says.
“There is also certainly a question about the optimal frequency for harvesting losses,” Kitces says. “If you only harvest annually, for example, in a volatile market you can miss some great tax loss harvesting opportunities, but if you harvest losses weekly, you can end up doing needless trades with greater transaction costs.”
Kitces’ suggestion for those who use the strategy: “Harvest losses on a quarterly basis.”
However, he warns tax loss harvesting isn’t for everyone.
“Anyone in the 10% to 15% tax rate income bracket has a capital gains rate of zero, so tax loss harvesting doesn’t make sense. At that income level, you should be harvesting gains, not losses, and it’s completely irrelevant for people who only have tax-advantaged portfolios,” Kitces says.
Alex Benke, vice president for financial advice and planning at Betterment, agrees.
“Anyone in the lower tax brackets should not be tax loss harvesting,” he says.
But, “if you’re young and earning less than you will be in the future, you do get to take up to $1,500 per year [$3,000 per couple] in losses and deduct that from your income,” Benke says.
Even in the case of wealthy clients for whom tax loss harvesting would ordinarily be advantageous, “if they have assets all over the place, some not being handled by the adviser, they should avoid tax-loss harvesting,” he says.
“They won’t know what the risks are of running afoul of [Internal Revenue Service] rules against wash sales,” Benke says. “An adviser is responsible for avoiding violating the IRS wash rule for portfolios he manages, but any monitoring of accounts outside the adviser’s control is the responsibility of the client.”
Wednesday, June 29, 2016
Which Tax Documents Do I Need to Keep?
FROM FOOL.COM
Preparing your tax returns is an ordeal for millions of Americans. Yet even after you've finished your returns, you also need to know which records you should hold onto just in case the IRS comes back to you with questions. Below, we'll take a look at the rules governing documentation and which tax documents you should keep.
Documents you used to prepare your tax return
In general, the most important tax documents to keep are the ones that you used to justify the numbers on your final tax returns. The most common of those documents is your Form W-2, which shows your job income along with a record of taxes withheld from your paychecks. The W-2 is important because for most people, it has the bulk of their taxable income, and it also represents the lion's share of the money that goes to the IRS on your behalf to cover your income tax liability.
For investors, 1099 forms have most of the information you'll need, including records of interest received, dividend income, and the basis and sales proceeds from investments that you've sold so that you can calculate your taxable capital gain or loss. Brokerage statements can also confirm these items, as well as contributions to IRAs and other retirement plans.
On the deduction side, you'll want to hang onto forms you used to justify deductible expenses. Form 1098 is the most common, relating to home mortgage interest. But other records, such as payments for state and local real estate taxes or documentation of charitable donations, can also be valuable to prove to the IRS that you deserved all the deductions you claimed.
One of the newer requirements related to your taxes is related to the Affordable Care Act. In order to avoid a penalty, you need to establish that you had creditable health insurance coverage or qualified for an exemption. Keeping the records that prove your coverage with your tax records will ensure that if the IRS challenges your decision not to pay a penalty, you can establish why.
Finally, keeping your tax returns as filed can be extremely valuable in the future. By doing so, you can prove that you haven't taken inconsistent positions in future years, and that can save you a lot of trouble if the IRS questions your handling of various income items over the years.
How long should you hang onto your records?
The length of time you need to keep these tax documents depends on the nature of the document. The key question is how long the IRS will have to challenge you on the figures that each document contains.
For most tax returns, the statute of limitations is three years from the due date of the return or the filing date, whichever comes later. Therefore, many of the supporting documents that went toward preparing the return are no longer necessary once that time has run, because the IRS can't come back and make a challenge.
However, there are different statutes of limitations that apply in different situations. If you underreport your income by at least 25%, then the IRS can audit the return up to six years after the date of filing. Cases involving fraud don't have any statute of limitations, so you'll need to hold onto your records indefinitely if you fear that the IRS might allege you've taken a fraudulent position on your return.
In addition, you should hold onto some records for longer simply because of the nature of the record itself. For instance, with records of investment purchases and sales, keeping statements that document the gains and losses you claimed can be valuable not just now but for future investments as well. Especially in situations in which you make repeated investments in a particular stock or fund, such as with a dividend reinvestment plan or automatic investments in a mutual fund, the complexities of dealing with tax basis make it extremely useful to keep your own records of which shares you sold at what time.
Be smart with your tax documents
Holding onto paper records can be a hassle, and ensuring that you keep access to electronic records can be even more challenging. It's generally safer to keep all your tax documents, but by knowing for certain which documents you'll absolutely need and which are arguably less important, you can use your judgment to decide the best course of action for your situation.
Preparing your tax returns is an ordeal for millions of Americans. Yet even after you've finished your returns, you also need to know which records you should hold onto just in case the IRS comes back to you with questions. Below, we'll take a look at the rules governing documentation and which tax documents you should keep.
Documents you used to prepare your tax return
In general, the most important tax documents to keep are the ones that you used to justify the numbers on your final tax returns. The most common of those documents is your Form W-2, which shows your job income along with a record of taxes withheld from your paychecks. The W-2 is important because for most people, it has the bulk of their taxable income, and it also represents the lion's share of the money that goes to the IRS on your behalf to cover your income tax liability.
For investors, 1099 forms have most of the information you'll need, including records of interest received, dividend income, and the basis and sales proceeds from investments that you've sold so that you can calculate your taxable capital gain or loss. Brokerage statements can also confirm these items, as well as contributions to IRAs and other retirement plans.
On the deduction side, you'll want to hang onto forms you used to justify deductible expenses. Form 1098 is the most common, relating to home mortgage interest. But other records, such as payments for state and local real estate taxes or documentation of charitable donations, can also be valuable to prove to the IRS that you deserved all the deductions you claimed.
One of the newer requirements related to your taxes is related to the Affordable Care Act. In order to avoid a penalty, you need to establish that you had creditable health insurance coverage or qualified for an exemption. Keeping the records that prove your coverage with your tax records will ensure that if the IRS challenges your decision not to pay a penalty, you can establish why.
Finally, keeping your tax returns as filed can be extremely valuable in the future. By doing so, you can prove that you haven't taken inconsistent positions in future years, and that can save you a lot of trouble if the IRS questions your handling of various income items over the years.
How long should you hang onto your records?
The length of time you need to keep these tax documents depends on the nature of the document. The key question is how long the IRS will have to challenge you on the figures that each document contains.
For most tax returns, the statute of limitations is three years from the due date of the return or the filing date, whichever comes later. Therefore, many of the supporting documents that went toward preparing the return are no longer necessary once that time has run, because the IRS can't come back and make a challenge.
However, there are different statutes of limitations that apply in different situations. If you underreport your income by at least 25%, then the IRS can audit the return up to six years after the date of filing. Cases involving fraud don't have any statute of limitations, so you'll need to hold onto your records indefinitely if you fear that the IRS might allege you've taken a fraudulent position on your return.
In addition, you should hold onto some records for longer simply because of the nature of the record itself. For instance, with records of investment purchases and sales, keeping statements that document the gains and losses you claimed can be valuable not just now but for future investments as well. Especially in situations in which you make repeated investments in a particular stock or fund, such as with a dividend reinvestment plan or automatic investments in a mutual fund, the complexities of dealing with tax basis make it extremely useful to keep your own records of which shares you sold at what time.
Be smart with your tax documents
Holding onto paper records can be a hassle, and ensuring that you keep access to electronic records can be even more challenging. It's generally safer to keep all your tax documents, but by knowing for certain which documents you'll absolutely need and which are arguably less important, you can use your judgment to decide the best course of action for your situation.
Tuesday, June 28, 2016
Top Insurance Strategies For Small Business Owners
FROM http://www.fa-mag.com/
As financial advisors, we've all encountered small business owner clients who are living the American dream: After years of saving and strategizing, all while working very long hours, their small business is finally starting to take off, and the entrepreneur now serves as the primary or sole breadwinner in his or her household.
Now, here’s the bad news: Many other entrepreneurs before them have experienced similar triumphs, only to see all their hard work go up in smoke because they didn’t take the necessary steps to properly insure their success against a range of unexpected turns, from medical emergencies, to acts of God, to, in some instances, just plain bad luck.
So when advising the successful entrepreneur who’s married with children and serving as the primary or sole breadwinner, what are the best ways to help them insure themselves and their business across an array of worst-case scenarios?
The following are the top four areas of insurance each advisor should explore with their small business owner clients:
1) Health insurance. Most people appreciate the importance of having medical insurance. Without it, of course, there’s a tax penalty, but aside from that, a large and unexpected personal medical bill can decimate the finances of even the most successful small business owner, and, thus, their business. But there are specific ways to make the expense of health insurance happen in a tax-savvy way.
For most small businesses with predictable revenues, it probably makes the most sense to pursue a group medical plan. Such plans not only allow the owner to gain coverage for themselves and their family but typically offer money-saving tax incentives as well.
Also, as we all know, even with insurance, prescriptions for medication, visits to the doctor and hospital stays aren’t free. A health savings account (HSA) is a good way to complement existing insurance coverage, particularly for those enrolled in a high-deductible plan, which are less expensive but cover fewer costs.
HSA contributions are tax deferred, and though they have yearly caps of approximately $3,350 for individuals and $6,650 for families depending on the plan, the balance rolls over, year over year, and can be invested in market-based solutions like ETFs and mutual funds to maximize growth. Because of this, HSAs are an ideal vehicle for both tax planning and preparing for future medical costs.
2) General liability insurance. If clients rent commercial space, have them check their lease agreement because the property owner may cover minor injuries resulting from slips and falls. But even if that’s the case, every business needs a general umbrella liability policy, whether it utilizes a commercial space or is home based. It’s far from a guarantee that a personal home policy will cover business-related liabilities if the owner or any of their employees are injured in a work-related accident—even if the accident happens in one's garage or basement.
Also, as part of any umbrella liability policy, consider business interruption insurance. Large snowstorms, earthquakes, floods and other acts of God can shut down operations for an extended period, robbing the business of revenue and endangering employee pay. Think of the destructive flooding that occurred in Houston earlier this year. How would your client be compensated if something similar happened in their area?
3) Errors and omissions insurance. If a client runs an advice-driven business, like a consulting practice of any kind, a marketing firm or offers another set of intellectual capital-based services, they will need coverage that keeps operations up and running in the event of negligent acts, including data theft and other cybersecurity lapses.
The risks tend to vary depending on the business type, so the level of coverage will be different in almost each case. Some industries, like our own business of financial advice, will have their own regulatory authorities that require a baseline level of coverage. Other industries, however, operate more in a grey area. But just because an industry may not mandate coverage, doesn’t mean your client can afford to go without protection.
A good rule of thumb: An effective errors and omissions policy should cover losses equal to at least the value of the client's total personal and professional assets. That way, they won’t get wiped out as a result of a lawsuit. While it’s a best practice to review business and personal insurance policies on annual basis, it’s especially critical here. As a small business owner, their net worth will likely fluctuate year-to-year, and it’s imperative to confirm that they will continue to have enough coverage at all times.
4) Life insurance on a business and personal basis. Obviously, this is a concern for people in all walks of life, not just small business owners. If someone has a family and a job, they need life insurance. (What type of policy is highly situational, depending on a client’s age, health, level of income, among many other factors.) But what many people don’t know is that life insurance policies are a common way to fund buy-sell agreements, a key transition and succession-planning tool for small businesses with multiple partners.
There are many ways to accomplish this. For example, partners can take out policies on one another based on the value of the business. Then, if something should happen, not only is the transition smoother and more seamless, but the remaining business partners have the capital to finance a buyout. A disability policy is another option. This approach ensures that if a partner becomes disabled or incapacitated, businesses will have the cash flow to fund a buyout.
Another thing to consider is the purchase of a "key man" policy, which is exactly what the term suggests—coverage that protects the business in case an irreplaceable employee or key man dies. This is typically the owner, with the beneficiary being the business, but such policies are sometimes applicable to other valuable employees, like a top salesperson.
The first few years for almost any small business can be a fight for survival, a grueling uphill climb just to keep your head above water. When fortunes start to turn, however, it can be a bit like finishing a marathon: It’s an exhilarating and, in many cases, life-defining evolution.
But when that happens, it can be easy to relax, pat yourself on the back and forget about potential landmines lurking around the corner, whether it’s a personal medical emergency, a lawsuit or some other event that could upend or, worse, spell a permanent end for the business. Take the step today to make sure that doesn’t happen to your clients.
Monday, June 27, 2016
2 ripple effects a large capital gain can trigger in your financial plan
For investors who make a savvy move and wind up with a sizeable capital gain, there can be few things that are more satisfying. Perhaps the only downside is the tax bill you may face from the gain (those in the 10 percent and 15 percent tax bracket get to enjoy a zero percent tax rate on their capital gains).
If the capital gain is unusually high, you may find that the costs associated with the gain are higher than you expected. A caller to our radio program recently found himself in that predicament and asked us the following question: I had a large capital gain last year, but my taxes are higher than what I expected. What other taxes could a large capital gain trigger?
We often refer to these unexpected costs as "ripple effects." By that, we mean that the primary, expected expense sends ripples throughout your financial plan that can create unintended consequences. We thought we'd cover two of the most common ripples you should be prepared for.
Net Investment Income Tax
One possible tax you may trigger, in addition to the capital gains tax, is the Net Investment Income Tax. This is a relatively new tax that was incorporated as a means to help pay for the Affordable Care Act in 2010. The NIIT is a flat, 3.8 percent surtax that is assessed if you exceed certain modified adjust gross income, or MAGI, thresholds ($200,000 if filing single and $250,000 if filing jointly).
The NIIT isn't assessed on all of your income. It's assessed on the lower of either 1) the amount your MAGI exceeds the NIIT threshold or 2) your Net Investment Income for the year. For example, Maggie files single with a MAGI of $250,000, including $30,000 in Net Investment Income. In this instance, the $30,000 of Net Investment Income is less than the $50,000 that exceeded the MAGI threshold ($250,000 in MAGI minus the $200,000 earnings threshold). Maggie would face an additional tax bill of $1,140 from the NIIT on that $30,000.
Net Investment Income may include interest, dividends, capital gains, rental income and non-qualified annuities. Not all income sources are subject to this tax; wages, self-employment income, Social Security benefits and tax-exempt interest are some common sources of income that are exempt. For a complete list of what is and isn't considered Net Investment Income, you should contact the IRS.
Medicare Premiums
The premiums you pay for Medicare Parts B and D are affected by your MAGI, and a large increase in your MAGI can lead to large increased in your premiums.
Based on this year's Medicare premiums, someone filing single and earning $75,000 will pay $121.80 monthly Part B premiums. If that same person has a $50,000 capital gain, giving them a MAGI of $125,000, their Medicare Part B premiums would double to $243.60. Add to that the fact that your Part D monthly premiums would increase by $32.80, and you're looking at over $1,800 in higher Medicare premiums.
To make matters even more confusing, there's a two-year lag between when your income is reported and when it's reflected on your premiums. For example, the income you earned last year in tax year 2015 will affect your Medicare premiums in 2017. So if you had a large capital gain last year, there may be higher Medicare premiums on the horizon for you next year.
These ripple effects, in many circumstances, translate into unexpected costs, making them an extremely frustrating component of financial planning. That's why if you're expecting higher than usual income this year, it may be beneficial for you to consult with your tax adviser first to make sure you're aware of the potential ripples that may be triggered and begin preparing for them.
If the capital gain is unusually high, you may find that the costs associated with the gain are higher than you expected. A caller to our radio program recently found himself in that predicament and asked us the following question: I had a large capital gain last year, but my taxes are higher than what I expected. What other taxes could a large capital gain trigger?
We often refer to these unexpected costs as "ripple effects." By that, we mean that the primary, expected expense sends ripples throughout your financial plan that can create unintended consequences. We thought we'd cover two of the most common ripples you should be prepared for.
Net Investment Income Tax
One possible tax you may trigger, in addition to the capital gains tax, is the Net Investment Income Tax. This is a relatively new tax that was incorporated as a means to help pay for the Affordable Care Act in 2010. The NIIT is a flat, 3.8 percent surtax that is assessed if you exceed certain modified adjust gross income, or MAGI, thresholds ($200,000 if filing single and $250,000 if filing jointly).
The NIIT isn't assessed on all of your income. It's assessed on the lower of either 1) the amount your MAGI exceeds the NIIT threshold or 2) your Net Investment Income for the year. For example, Maggie files single with a MAGI of $250,000, including $30,000 in Net Investment Income. In this instance, the $30,000 of Net Investment Income is less than the $50,000 that exceeded the MAGI threshold ($250,000 in MAGI minus the $200,000 earnings threshold). Maggie would face an additional tax bill of $1,140 from the NIIT on that $30,000.
Net Investment Income may include interest, dividends, capital gains, rental income and non-qualified annuities. Not all income sources are subject to this tax; wages, self-employment income, Social Security benefits and tax-exempt interest are some common sources of income that are exempt. For a complete list of what is and isn't considered Net Investment Income, you should contact the IRS.
Medicare Premiums
The premiums you pay for Medicare Parts B and D are affected by your MAGI, and a large increase in your MAGI can lead to large increased in your premiums.
Based on this year's Medicare premiums, someone filing single and earning $75,000 will pay $121.80 monthly Part B premiums. If that same person has a $50,000 capital gain, giving them a MAGI of $125,000, their Medicare Part B premiums would double to $243.60. Add to that the fact that your Part D monthly premiums would increase by $32.80, and you're looking at over $1,800 in higher Medicare premiums.
To make matters even more confusing, there's a two-year lag between when your income is reported and when it's reflected on your premiums. For example, the income you earned last year in tax year 2015 will affect your Medicare premiums in 2017. So if you had a large capital gain last year, there may be higher Medicare premiums on the horizon for you next year.
These ripple effects, in many circumstances, translate into unexpected costs, making them an extremely frustrating component of financial planning. That's why if you're expecting higher than usual income this year, it may be beneficial for you to consult with your tax adviser first to make sure you're aware of the potential ripples that may be triggered and begin preparing for them.
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