jump to navigation

Tax Tip of the Week | The Tax Landmines of Lending to Family Members November 6, 2019

Posted by bradstreetblogger in : Business consulting, General, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

People often lend money to family members, but few think about the IRS when making the “loan”.  In the article that follows, Bob Carlson, Senior Contributor to Forbes, discusses the procedures and consequences one should consider before getting out the checkbook. If you are in this situation as a lender, or as a borrower, the following article does a great job of explaining the “rules” that you need to consider.

                                     –    Norman S. Hicks

Many people are happy to lend money to their loved ones, especially to children and grandchildren. But before stroking the check, review the tax rules. The tax consequences vary greatly depending on the terms of the loan. A small change in the terms can mean a big difference in taxes and penalty. 

Too often, family loans are informal arrangements. They don’t carry an interest rate or have a payment schedule. They essentially are demand notes. Payment isn’t due until the lending parent or grandparent demands it, and that’s not likely to happen unless the lender’s financial situation changes adversely. 

That runs afoul of the tax rules. In a family loan, when there is no interest rate or a rate below the IRS-determined minimum rate, the interest that isn’t charged is assumed to be income to the parent from the child. In other words, there is imputed interest income or phantom income. The parent is to report interest income at the IRS-determined minimum rate as gross income, though no cash is received. The borrower might be able to deduct the same amount if they qualify for the mortgage interest deduction. 

In addition, the lending parent or grandparent is assumed to make a gift of the imputed interest to the borrowing child or grandchild. In most cases, the annual gift tax exclusion is more than sufficient to prevent the gift from having any tax consequences. In 2019, a person can make gifts up to $15,000 per person with no gift tax consequences under the annual gift tax exclusion. A married couple can give up to $30,000 jointly.

To avoid these tax consequences, there should be a written loan agreement that states interest will be charged that is at least the minimum interest rate determined by the IRS for the month the agreement was signed. You can find the minimum rate for the month by searching the Internet for “applicable federal rate” for the month the loan agreement was made. The rate you use will depend on whether the loan is short-term, mid-term, or long-term and on whether interest compounds monthly, quarterly, semiannually, or annually.

The applicable federal rate is based on the U.S. Treasury’s borrowing rate for the month. That means it’s a low rate and is likely to be a lower rate than the child or grandchild could obtain from an independent lender. 

It’s a good idea for the borrower to make at least interest payments on a regular basis. Otherwise, the IRS could argue that there wasn’t a real loan and the entire transaction was a gift.

There are two important exceptions to the imputed interest rules.

A loan of $10,000 or less is exempt. Make a relatively small loan and the IRS doesn’t want to bother with it.

The second exception applies to loans of $100,000 or less. The imputed income rules apply, but the lending parent or grandparent can report imputed interest at the lower of the applicable federal rate or the borrower’s net investment income for the year. If the borrower doesn’t have much investment income, the exception can significantly reduce the amount of imputed income that’s reported.

Suppose Hi Profits, son of Max and Rosie Profits, wants to purchase a home and needs help with the down payment. Max and Rosie lend $100,000 to Hi. They charge 3.22% interest on the loan, which was the applicable federal rate in July 2019 for a long-term loan on which the interest is compounded semiannually. 

If Hi Profits doesn’t make interest payments, Max and Rosie will have imputed income of $3,220 each year that must be included in their gross income. In addition, they will be treated as making a gift to Hi of $3,220 each year. As long as they don’t make other gifts to Hi that put them over the annual gift tax exclusion amount ($30,000 on joint gifts by a married couple), there won’t be any gift tax consequences.

Hi can have the loan recorded as a second mortgage against the property. That might enable him to deduct the imputed interest on his income tax return, though he made no cash payments.

Max and Rosie have two costs to the loan. The first cost is the investment income they could have earned on the $100,000. 

The other cost is the income taxes they’ll owe on the imputed interest income. 

To avoid tax problems with a loan to a family member, be sure there’s a written loan agreement stating the amount of the loan, the interest rate, and the repayment terms. The interest rate should be at least the applicable federal rate for the month the loan is made. Simple loan agreement forms can be found on the Internet.

If the loan calls for regular payment of interest, or interest and principal, those payments should be made and should be documented. The more you make the transaction look like a real loan, the less likely it is the IRS will try to tax it as something else, such as a gift. 

A written loan agreement also can prevent any misunderstandings between the borrower and your estate or other family members after you’re gone. Your will should state whether you want the loan repaid to your estate, forgiven and deducted from the borrower’s inheritance or treated some other way.

Family loans are in wide use. Be sure you take the extra steps needed to avoid problems with the IRS.

Credit given to Bob Carlson, Senior Contributor to Forbes Media.  Bob is the editor of Retirement Watch, a monthly newsletter and web site he founded in 1990.  The above article can be found at: https://www.forbes.com/sites/bobcarlson/2019/10/16/the-tax-landmines-of-lending-to-family-members/#30802295468f.

Thank you for all of your questions, comments and suggestions for future topics. We may be reached in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.  

This Week’s Author – Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | How Divorce Affects Social Security Benefits?? October 2, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes , add a comment

Social Security Benefits experts are difficult to find. I am not one. We understand the calculations of Social Security and Self Employment taxes along with some areas (and entity choices) in which they may be minimized. But, the nuances of Social Security Benefits do not fall directly into our world of income taxes, accounting and business consulting.

Social Security Benefits are complicated and a divorce increases this level of complexity.  Practically 50% of USA marriages end in divorces. The following article explains some of these rules and also walks us through an example of a divorced couple.

                                     -Mark Bradstreet

Here’s how a divorce can affect your Social Security situation.

A whopping 91% of Americans over the age of 50 don’t understand what factors determine the amount they can potentially receive in Social Security benefits, a survey from the Nationwide Retirement Institute found.

There are several factors that can affect how much you receive in Social Security benefits, such as the age at which you claim benefits, whether you continue working after you claim benefits, and how much you earned during the years you paid into Social Security.

One factor that’s easy to overlook, however, is divorce. If you are currently divorced and were married for at least 10 years, you or your ex-spouse could be earning more in Social Security benefits than you think.

How divorce affects Social Security

Not all divorced couples are eligible to receive additional benefits once they start claiming Social Security, and there are certain requirements you’ll have to meet.

The first thing to consider is how your benefits compare to your ex-spouse’s. If you’re receiving more in Social Security benefits than your ex-spouse (or if you haven’t claimed yet but are expected to receive more than your ex-spouse), you’re not eligible for any additional money each month. But if you’re receiving less each month than your ex, you may be eligible for an increase in benefits based on your ex-spouse’s work record.

Assuming you’re receiving less than your ex-spouse in benefits, there are a few other requirements you’ll need to meet. First, you and your former spouse need to have been married for at least 10 years, and you cannot currently be married (although it doesn’t matter whether your ex-spouse has remarried or not). In order to start claiming benefits, you also need to be at least 62 years old.

If you and your ex-spouse are old enough to file for benefits but your ex hasn’t claimed them yet, you can still claim your benefits based on their work record if you have been divorced for at least two years. Also, if you’re eligible for benefits based on your own work record, that money will be paid out first. Then if you’re also eligible to receive extra benefits based on your ex-spouse’s record, you’ll receive an additional amount each month.

Exactly how much extra you’ll receive depends on the age at which you claim. In order to receive the full amount you’re entitled to, you’ll have to wait until your full retirement age (FRA) – which is either age 66, 67, or somewhere in between. If you claim before then (as early as age 62), your benefits will be reduced. By waiting until your FRA, assuming you’re eligible to receive benefits based on your ex-spouse’s record, you can receive half of the amount he or she is receiving in benefits.

One last thing to keep in mind is that regardless of how much someone is receiving in benefits based on their ex-spouses record, it doesn’t affect how much the other person or their current spouse receives in benefits. So, if, say, your ex-wife is receiving benefits based on your record, you and your current wife’s benefits will not be reduced as a result.

Social Security in action: A hypothetical example

Figuring out whether you can claim benefits based on an ex-spouse’s record and calculating what you’d actually receive is complicated and confusing. So, let’s look at a hypothetical example to make it a little easier to understand.

Let’s say you and your husband were married 20 years, and you never remarried after the divorce. Your FRA is 67 years old, and if you claim at that age, you’d be receiving $1,000 per month based on your own work record and earnings. Your ex-husband, however, is currently receiving $2,500 per month in benefits. Because you were married at least 10 years, you’re unmarried now, and you’re eligible to receive less in benefits than your ex-spouse, you can apply for benefits based on your ex-husband’s record.

For simplicity’s sake, let’s say you wait until your FRA to claim. By doing so, you’ll receive the full $1,000 you’re entitled to based on your own record. Based on your ex-husband’s work record, you’re eligible to receive half of what he’s receiving, or $1,250 per month. With ex-spouse benefits, you’re not allowed to “double dip” – meaning you won’t receive your $1,000 plus $1,250 based on your ex-husband’s record. Rather, you’ll receive your $1,000 and an additional $250 per month so that your total benefit amount is equal to half of what your ex-spouse is receiving in benefits.

Also, all the normal Social Security restrictions still apply here. So, if, for example, you claim earlier than your FRA, your benefits will be reduced. And if you continue working after claiming benefits, you may see a (temporary) reduction in benefits as well, depending on how much you’re earning.

Social Security benefits can seem complex, and there are many factors that contribute to how much you’ll receive each month. But by understanding how much you’re entitled to and whether you’re eligible for additional benefits, you can maximize your monthly checks – and enjoy a more financially stable retirement.

Credit given to:  Katie Brockman, The Motley Fool This was published on July 1, 2019

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | Tax Considerations for Working Kids September 18, 2019

Posted by bradstreetblogger in : Deductions, General, Tax Deadlines, Tax Planning Tips, Tax Preparation, Taxes, Taxes , add a comment

When we file children’s income tax returns, nasty surprises are not commonplace BUT on the other hand they are not rare either. Some not so pleasant surprises may result from the Form W-4 that children will complete for their tax withholdings. Being over withheld may create a larger tax refund but a smaller net payroll check each pay period. On the other hand, withholding too little makes each net payroll check look awesome but may create a tax balance when the income tax return is filed. Another surprise situation may occur when the child receives a Form 1099 (no withholding) instead of a Form W-2 (has withholdings). In this instance, their income tax world immediately becomes more complicated as tax estimates will most likely be needed along with accounting for their income and expenses. As soon as you discover that your child will receive a Form 1099, you should contact your CPA for further information concerning estimated amounts and various tax deadlines. Please remember that not making any required estimated income tax payments may create interest and penalties along with the potential for a large balance due with the tax return.

The below article by Bill Bischoff of MarketWatch drills down further into some of my comments above and discusses some additional ones.  

                            -Mark Bradstreet

5 questions and answers about kids and money

Is your kid earning money from a summer job or some other activity? If so, what are the tax implications? And BTW, what kid-related tax breaks can you collect? Good questions. Here are some answers.

Does my kid need to file a tax return?

Maybe. For 2019, a dependent child must file a federal income tax return on Form 1040 in any of the following situations:

* The child has unearned income of more than $1,100. If your child has more than $2,200 of unearned income, he or she may be subject to the dreaded Kiddie Tax. More on that later.

* The kid’s gross income exceeds the greater of: (1) $1,100 or (2) earned income up to $11,650 plus $350.

* The child’s earned income exceeds $12,200.

* The kid owes other taxes such as the self-employment tax or the alternative minimum tax (AMT). Relatively unlikely, but it happens.

The good news is your child can shelter his or her income with the standard deduction. For 2019, the standard deduction for a dependent kid with only investment income is $1,100. If your child has earned income from summer jobs or whatever, the standard deduction equals the lesser of: (1) earned income plus $350 or (2) $12,200. So up to $12,200 of earned income can be sheltered with the standard deduction. Good.

Key Point: Even if no return is required for your child, one should be filed if federal income tax was withheld for any reason and would be refunded if a return is filed. Filing a return is also necessary to benefit from certain beneficial tax elections, such as the election to currently report accrued Savings Bond income that would be sheltered by your kid’s standard deduction.

Who is responsible for filing the kid’s return?

According to IRS Publication 929 (Tax Rules for Children and Dependents), a child is generally responsible for filing his or her own federal income tax return on Form 1040 and for paying any tax, penalties, or interest. If a child cannot file for any reason, the child’s parent, guardian, or other legally responsible person must file for the child. If the child can’t sign the return, a parent or guardian must sign the child’s name followed by the words “By (signature), parent (or guardian) for minor child.” Your child may also need to file a state income tax return. If so, that probably winds up on your plate too.

Key Point: If you sign a return on your child’s behalf, you can deal with the IRS on all matters related to the return. In general, a parent or guardian who doesn’t sign can only provide information concerning the return and pay the child’s tax bill.

Can’t I just report the kid’s income on my own return?

Probably. If your child will be under age 19 (or under age 24 if a full-time student) as of 12/31/19 and his or her only income is from interest and dividends, including mutual fund capital gain distributions, you can generally choose to report the kid’s income on your return by including Form 8814 (Parents’ Election To Report Child’s Interest and Dividends) with your Form 1040. Read the Form 8814 instructions to see if you qualify for this option. If you do, it may or may not result in a lower tax bill for the kid’s income.

What’s that ‘Kiddie Tax’ I’ve heard about?

Good thing you asked. For 2018-2025, the Tax Cuts and Jobs Act (TCJA) revamped the Kiddie Tax rules to tax a portion of an affected child’s or young adult’s unearned income at the higher rates paid by trusts and estates. Those rates can be as high as 37% or as high as 20% for long-term capital gains and dividends. Before the TCJA, the Kiddie Tax rate equaled the parent’s marginal rate–which for 2017 could have been as high as 39.6% or 20% for long-term capital gains and dividends.

If your kid is a student, the Kiddie Tax can potentially be an issue until the year the child turns age 24. For that year and future years, your child is finally Kiddie-Tax-exempt.

To calculate the Kiddie Tax, first add up the child’s net earned income and net unearned income. Then subtract the child’s standard deduction to arrive at taxable income. The portion of taxable income that consists of net earned income is taxed at the regular rates for a single taxpayer. The portion of taxable income that consists of net unearned income and that exceeds the unearned income threshold ($2,200 for 2019) is subject to the Kiddie Tax and is taxed at the higher rates that apply to trusts and estates.
Unearned income for purposes of the Kiddie Tax means income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. So, among other things, unearned income includes capital gains, dividends, and interest. Earned income from a job or self-employment is never subject to the Kiddie Tax.

Calculate the Kiddie Tax by completing IRS Form 8615 (Tax for Certain Children Who Have Unearned Income). Then file Form 8615 with your kid’s Form 1040. Beware: the Kiddie Tax rules are complicated

Here are the most-common ones.

$2,000 tax credit for under-age-17 child

For 2018-2025, the TCJA increased the maximum child credit to $2,000 per qualifying child (up from $1,000 under prior law). Up to $1,400 can be refundable, meaning you can collect it even when you don’t owe any federal income tax. Under the TCJA, the income levels at which the child tax credit is phased out are significantly increased, so many more families now qualify for the credit.

$500 tax credit for over-age-16 dependent child

For 2018-2015, the TCJA established a new $500 tax credit that can be claimed for a dependent child (or young adult) who is not under age 17 and who lives with you for over half the year. Dependent means you pay over half the child’s support. However, a child in this category must also pass an income test to be classified as your dependent for purposes of the $500 credit. According to IRS Notice 2018-70, your over-age-16 dependent child passes the income test for 2019 if his or her gross income does not exceed $4,200.

Two higher education tax credits

The American Opportunity credit can be worth up to $2,500 during the first four years of a child’s college education. The Lifetime Learning credit can be worth up to $2,000 annually, and it can cover just about any higher education tuition costs. Both credits are phased out as your income goes up, but the Lifetime Learning credit is phased out at much lower income levels than the American Opportunity credit.

Head of household filing status

HOH filing status is preferable to single filing status because the tax brackets are wider and the standard exemption is bigger. HOH status is available if: (1) your home was for more than half the year the principal home of a qualifying child for whom a personal exemption deduction would be allowed under prior law and (2) your paid more than half the cost of maintaining the home.

Student loan interest deduction

This deduction can be up to $2,500 for qualified student loan interest expense paid by a parent, subject to phase-out for higher-income parents.

The bottom line

There you have it: most of what you need to know about kids and taxes. As always, kids are a chore and an expense. But they usually turn out to be worth it in the end. Fingers crossed.

Credit given to:  Bill Bischoff  of MarketWatch. Article is titled “When kids make money at a summer job, who files their taxes?”

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | A Retirement Plan Too Often Ignored September 11, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Taxes , add a comment

If your business fits the definition of an owner-only employee business then a Solo 401(k) retirement plan may be a great idea for you.  And, oh yeah, another caveat – you are not allowed to have any employees other than you and your spouse. If your sole proprietorship, partnership, S corporation or C corporation fits the necessary parameters then you may make contributions to a Solo 401(k) plan.

This type of retirement plan allows higher contribution amounts and more investment options than many other retirement plans. The Solo 401(k) even has ROTH options and its account holder may borrow against the plan assets. They are also inexpensive to setup and maintain. Even though created by Congress in 2001 – we still don’t see as many of these plans as I think we should.

If you think you may qualify for the Solo 401(k), please remember that this plan must be formed by year-end for the contributions to be deducted for that same year.

The below WSJ article by Jeff Brown was published on July 9, 2019 and contains additional details.

                                                                                                            -Mark Bradstreet

Millions of U.S. workers rely on employer-sponsored 401(k)s to save for retirement. But what about freelancers, sole proprietors and workers in the mushrooming gig economy, or people who want to leave the corporate cocoon and strike out on their own?

Financial advisers say that far from being left out in the cold, these workers have access to an often-overlooked retirement-savings vehicle that offers some distinct advantages: an “individual” or “solo” 401(k).

Available to self-employed people, as well as business owners and their spouses, solo 401(k)s allow participants to make contributions as both an employer and employee. That means individuals can sock away large sums that dramatically reduce income taxes, among other perks.

Although enrollment data is hard to come by, financial advisers say solo 401(k)s have been slow to get the respect they deserve since they were created by Congress in 2001. Many financial-services firms waited years to start offering the plans, and many business owners who could have them don’t know they exist.

“You’d be surprised how many people don’t know about solo 401(k)s, especially accountants,” says Sean Williams, wealth adviser with Sojourn Wealth Advisory in Timonium, Md.

Perks advisers like

Solo K’s, as some call them, allow participants to avoid the complex rules covering corporate 401(k)s. Not only do solo K’s permit virtually unlimited investing options, they allow participants to choose between making traditional tax-deductible contributions or after-tax Roth contributions. Some advisers prefer them over better-known options for people who work on their own, such as SEP-IRAs (simplified employee pension individual retirement arrangements) and Simples (savings incentive match plan for employees).

“Solo 401(k)s are better than the other options,” says Vincenzo Villamena, a certified public accountant with Online Taxman in New York, “because of the ability to contribute to a Roth and the higher contribution limits.”

Like corporate 401(k)s, the maximum contribution this year for solo K’s is $56,000, including up to $19,000 in pretax individual income, plus an employer contribution. (For people age 50 or older, the maximum is $62,000, due to a catch-up provision.) By comparison, Simples limit employee contributions to $13,000 this year ($16,000 for investors age 50 or over), and employer matches to 3% of compensation up to a maximum of $5,600. SEPs, meanwhile, limit annual employer contributions to $56,000 or 25% of income, whichever is less, and there is no employee contribution.

Contributions to solo K’s cannot exceed self-employment income, which is counted separately from any income earned by working for others.

According to Donald B. Cummings Jr., managing partner of Blue Haven Capital in Geneva, Ill., contributions can come from other sources if regular income from the business is needed to pay ordinary expenses. “Say a 50-plus-year-old business owner inherits $500,000 from a deceased relative. She now has access to better cash flow and can theoretically contribute 100% of her compensation” up to the limit, he says.

An investor also can move cash into a solo K from a taxable investment account, reducing taxable income and getting tax deferral on any future gains.

Opening one up typically takes only a few minutes of paperwork with a financial firm such as Vanguard Group, Fidelity Investments or Charles Schwab Corp. SCHW 1.03% Providers typically don’t require a minimum contribution to open an account, or minimum annual contributions.

Business owners who set up the solo plan as a traditional 401(k) get a tax deduction on contributions, tax deferral on gains and pay income tax on withdrawals after age 59½. (If they withdraw before 59½, they generally will pay both income tax and a penalty.) If they choose to go the Roth route, contributions are after taxes but qualified withdrawals are tax-free, which can be a plus for those who expect to be in a higher tax bracket later in life. And unlike ordinary Roth IRAs, which are available only to people with incomes below certain thresholds, anyone who opens a solo K can pick the Roth option. “The single largest benefit of a solo 401(k) is the ability to contribute Roth dollars,” says Brandon Renfro, a financial adviser and assistant finance professor at East Texas Baptist University in Marshall, Texas. “Since you are the employer in your solo 401(k), you can simply elect that option,” he says. “This is a huge benefit over the other types of self-employed plans.”

Another plus is that account holders can borrow against the assets in a solo 401(k), says Pedro M. Silva, wealth manger with Provo Financial Services in Shrewsbury, Mass. That isn’t allowed with alternatives such as SEPs.

“Business owners often write large checks, and having access to an extra $50,000 for emergencies or opportunities is a valuable feature of the plan,” Mr. Silva says.

Words of caution

A solo 401(k) must be set up by the end of the calendar year for contributions to be subtracted from that year’s taxable income. But, as with an IRA, money can be put in as late as the tax deadline the following April, or by an extension deadline.

Investors who want to change providers can transfer assets from one solo 401(k) to another with no tax bill, as long as the investments go directly from the first investment firm to the second. But if the assets go to the investor first there may be tax consequences, even if they are then sent to the new provider.

Business owners should be aware that the hiring of just a single employee aside from a spouse would require the plan to meet the tricky nondiscrimination test that applies to regular 401(k)s, says Stephanie Hammell, an investment adviser with LPL Financial in Irvine, Calif. That test is designed to make sure executives don’t get a better deal than employees.

Business owners in that situation might do better with a SEP or Simple plan, which don’t have the nondiscrimination hurdle, according to Dr. Renfro.

And as with all financial products, it pays to shop around for the best combination of investment offerings, fees and customer service, experts say.

“Set up your account with an investment provider that either doesn’t charge fees for the administration of the account, or charges very minimal fees,” says Natalie Taylor, an adviser in Santa Barbara, Calif. “Choose an investment provider that offers high-quality, low-cost investment options inside of the individual 401(k) account.”

Credit Given to:  Jeff Brown. This appeared in the July 9, 2019, print edition of the Wall Street Journal as ‘The ‘Solo’ 401(k) Is Often Overlooked.’ Mr. Brown is a writer in Livingston, Mont. He can be reached at reports@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | A Need to Know on Capital Gains Taxes September 4, 2019

Posted by bradstreetblogger in : Business consulting, Depreciation options, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

Generally, capital assets that are held in excess of one year and sold at a profit may be taxed at three (3) possible tax rates: (1) 0%, (2) 15% or (3) 20%. For most people, the rate used depends upon their filing status and the amount of their taxable income. Gains from the sale of capital assets not held for a year are taxed as ordinary income. If capital assets are sold at a loss – generally, only $3,000 ($1,500 married filing separate) may be deducted annually unless other capital gains are available as an offset.

Everyone thinks that Congress designed the zero-percent capital gain rate just for them. That thinking is only natural since so many reporters and so many politicians have over-hyped the catchy expression of “zero-percent rate.” The truth is VERY few taxpayers will ever be in position to take advantage of the zero-percent long-term capital gain rate. To do so, for most single and married couples filing jointly, their taxable income not including the capital gains must be less than $39,375 or $78,750, respectively. Remember your taxable income might include any Form W-2s, interest and dividend income, business and rental income etc. But, it also includes the capital gain itself. So, not a very big window exists for the possibility of qualifying for using the zero-percent rate. If your income other than capital gains, less your deductions exceeds these taxable income ceilings then the window not only shuts but disappears as though it never existed. This capital gain tax calculation is not made the same as the calculation of income taxes which are calculated using the incremental tax brackets. And, depending upon the amount of your regular taxable income not including the capital gains above and beyond the amounts of $39,375/$78,750 – you will then use either the 15% OR the 20% tax bracket for the capital gains rate. Don’t forget the “net investment income tax” of 3.8% which could be an additional tax along with your particular state income tax. Ohio taxes capital gains as ordinary income. Also, technically outside the tax world – various income levels may also affect the amount of your Alternative Minimum Tax (AMT), Medicare insurance premiums and the amount of student loan repayments (if applicable).

More information and explanations follow in the article below by Tom Herman as published by the Wall Street Journal on Monday, June 17, 2019.

                            -Norm Hicks and Mark Bradstreet

By tax-law standards, the rules on capital-gains taxes may appear fairly straightforward, especially for taxpayers who qualify for a zero-percent rate.

But many other taxpayers, especially upper-income investors, “often find the tax law around capital gains is far more complicated than they had expected,” says Jordan Barry, a law professor and co-director of graduate tax programs at the University of San Diego Law School.

Here is an update on the brackets for this year and answers to questions readers may have on how to avoid turning capital gains into capital pains.

Who qualifies for the zero-percent rate?

For 2019, the zero rate applies to most singles with taxable income of up to $39,375, or married couples filing jointly with taxable income of up to $78,750, says Eric Smith, an IRS spokesman. Then comes a 15% rate, which applies to most singles up to $434,550 and joint filers up to $488,850. Then comes a top rate of 20%.

But don’t overlook a 3.8% surtax on “net investment income” for joint filers with modified adjusted gross income of more than $250,000 and most singles above $200,000. That can affect people in both the 15% and 20% brackets. For those in the 20% bracket, that effectively raises their top rate to 23.8%. “That 23.8% rate is the rate we use to plan around for high net-worth individuals,” says Steve Wittenberg, director of legacy planning at SEI Private Wealth Management.

There are several other twists, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Among them: a maximum of 28% on gains on art and collectibles. There are also special rates for certain depreciable real estate and investors with certain types of small-business stock. See IRS Publication 550 for details. There also are special rules when you sell your primary residence.

State and local taxes can be important, too, especially in high-tax areas such as New York City and California. This has become a much bigger issue in many places, thanks to the 2017 tax overhaul that included a limit on state and local tax deductions. As a result, many more filers are claiming the standard deduction and thus can’t deduct state and local taxes. But some states, including Florida, Texas, Nevada, Alaska and Washington, don’t have a state income tax. Check with your state revenue department to avoid nasty surprises.

How long do I typically have to hold stocks or bonds to qualify for favorable long-term capital-gains tax treatment?

More than one year, says Alison Flores, principal tax research analyst at The Tax Institute at H&R Block. Gains on securities held one year or less typically are considered short-term and taxed at the same rates as ordinary income, she says. The rules are “much more complex” for investors using options, futures and other sophisticated strategies, says Bob Gordon, president of Twenty-First Securities in New York City. IRS Publication 550 has details, but investors may need to consult a tax pro.

The holding-period rules can be important for philanthropists who itemize their deductions. Donating highly appreciated shares of stock and certain other investments held more than a year can be smart. Donors typically can deduct the market value and can avoid capital-gains taxes on the gain. But don’t donate stock that has declined in value since you purchased it. “Instead, sell it, create a capital loss you can use, and donate the proceeds” to charity, Mr. Gordon says. You can use capital losses to soak up capital gains. Investors whose losses exceed gains may deduct up to $3,000 of net losses ($1,500 for married taxpayers filing separately) from their wages and other ordinary income. Carry over additional losses into future years.

If you sell losers, pay attention to the “wash sale” rules, says Roger Young, senior financial planner at T. Rowe Price . A wash sale typically occurs when you sell stock or securities at a loss and buy the same investment, or something substantially identical, within 30 days before or after the sale. If so, you typically can’t deduct your loss for that year. (However, add the disallowed loss to the cost basis of the new stock.) Mr. Young also says some investors may benefit from “tax gain harvesting,” or selling securities for a long-term gain in a year when they don’t face capital-gains taxes.

While taxes are important, make sure investment decisions are based on solid investment factors, not just on taxes, says Yolanda Plaza-Charres, investment-solutions director at SEI Private Wealth Management. And don’t wait until December to start focusing on taxes.

“We believe in year-round tax management,” she says.

What if I sell my home for more than I paid for it?

Typically, joint filers can exclude from taxation as much as $500,000 of the gain ($250,000 for most singles). To qualify for the full exclusion, you typically must have owned your home—and lived in it as your primary residence—for at least two of the five years before the sale. But if you don’t pass those tests, you may qualify for a partial exclusion under certain circumstances, such as if you sold for health reasons, a job change or certain “unforeseen circumstances,” such as the death of your spouse. See IRS Publication 523 for details. When calculating your cost, don’t forget to include improvements, such as a new room or kitchen modernization.

Credit given to Tom Herman. This article appeared in the June 17, 2019, print edition as ‘A Need to Know on Capital-Gains Taxes.’ Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA & Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | Ohio Small Business Deduction – TAKE IT! August 28, 2019

Posted by bradstreetblogger in : Business Consulting, Deductions, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

We work with many attorneys for a myriad of reasons. Some specialize in business dealings such as mergers, acquisitions, etc. Mr. Jeff Senney, a prominent business attorney with Pickrel, Schaeffer and Ebeling, wrote the following article which discusses a deduction that owners, or equity investors, of an Ohio business who file an Ohio individual income tax return may be eligible to take each year. The deduction is commonly known as the Ohio Small Business Deduction (SBD) and began in its earliest form in 2013. The SBD allowed the taxpayer to deduct 50% of up to $250,000 of Ohio business income, for a maximum deduction of $125,000. In 2014, the deduction increased to 75% of $250,000 for a maximum deduction of $187,500. Adjustments were required also, such as add-backs for retirement contributions, the self-employment tax deduction, and the self-employed health insurance deduction that were reported on the taxpayer’s federal return for both 2013 and 2014. The deduction remained at 75% for 2015 and the requirement to add back the above-mentioned adjustments was eliminated. In its current form, the deduction is for 100% of $250,000. We hope you enjoy Jeff’s article as reproduced below.

      – Norman S. Hicks, CPA

For 2016 (and subsequent years), each individual small business owner filing single or married filing jointly is eligible for a “small business” income tax deduction (SBD) against their state income tax liability equal to 100% of the first $250,000 of business income the owner receives or is allocated from a sole proprietorship or pass-through entity (“PTE”). Married filing separate taxpayers will be able to deduct 100% of business income in 2016 but only up to $125,000. Any remaining business income above these threshold amounts is taxed at a flat 3% rate.

For tax years 2014 and 2015, the SBD percentage for all taxpayers was only 75%.

PTEs include partnerships, “S” corporations and limited liability companies (“LLCs”). Income generated by the business and passed through to the owners/investors is subject to personal income tax. The deduction was originally applicable only for Ohio-sourced business income. But beginning in tax year 2015, the deduction was expanded to include eligible business income from all sources.

Individuals who directly or indirectly through a tiered structure own at least a 20% interest in profits or capital of a PTE may also include their wages and guaranteed payments from that PTE in the calculation of the SBD. It was not originally clear whether the direct or indirect ownership included constructive ownership from family members. But the Ohio Department of Taxation has recently made clear that stock attribution among family members (such as husband to wife) does not count in determining whether the individual owns the requisite 20% interest.

Taxpayers who failed to claim the SBD on their originally income tax returns should give serious thought to filing amended returns to claim the SBD for all open years. While the SBD is referred to as the “small business deduction,” there is no limit on gross receipts or assets that the PTE can have.

The SBD can be taken not only by Ohio residents on all their business income received, but also by Ohio nonresidents and part-year residents.

While electing to be included in a composite tax return makes financial sense in most states, taxpayers could be missing out on the SBD tax savings available in Ohio. A PTE cannot deduct the SBD on a composite tax return filed on a taxpayer’s behalf, and the SBD cannot be claimed on any other non-individual tax return, such as a trust return and even a nonresident withholding return. Accordingly, if an individual taxpayer has been included in a composite return or has had withholding performed by a PTE, the taxpayer may be paying more Ohio tax than necessary.

Many taxpayers may not have taken the SBD because they mistakenly thought they were required to own 20% or more of a PTE in order to qualify for the SBD. But that is not the case. The 20% ownership requirement only applies to deduction of compensation and guaranteed payments. Taxpayers owning less than 20% are still eligible to claim the SBD on their share of other qualifying business income.

Many taxpayers also do not realize that the 20%-or-more requirement only needs to be met once during a tax year. If an individual owner meets the 20% ownership test at any point during the calendar year, the individual’s entire year of compensation or guaranteed payments may qualify as business income. While not entirely clear, it is likely the Ohio Department of Taxation would try to deny the SBD where a husband and wife transferred ownership back and forth during a year in order to make them both 20% owners on at least one day during the year.

Credit given to Jeff Senney. He can be reached at 937-223-1130 or Jsenney@pselaw.com or https://www.pselaw.com/attorneys/jeffrey-senney. Jeff’s article can be found at: https://www.pselaw.com/ohio-small-business-deduction-take-it/ 

Thank you for all of your questions, comments and suggestions for future topics. We may be reached in Dayton at 937-436-3133 and in Xenia at 937-372-3504. Or visit our website.  

This Week’s Author – Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | Can S Corporations Save Taxes? Apparently, Some Politicians Think So. August 21, 2019

Posted by bradstreetblogger in : Business consulting, Deductions, Depreciation options, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes , add a comment

In an effort to save federal income taxes, many people and not just some politicians route their business income through S corporations.  Their profits which may be retained by the S corporation and/or distributed to the shareholder(s) are typically the result of keeping the shareholder’s reasonable wages at a level that assures a corporate profit.  Keeping these reasonable wages below the FICA ceiling ($132,900 for 2019) may save taxes of 15.3% from FICA and Medicare, combined.  If, these wages exceed the FICA ceiling then the potential tax savings drop to only the Medicare tax of 2.9% plus another .9% if individual’s wages are over $200,000 ($250,000 married filing jointly).

The point to be made here is that at the right income levels, significant tax savings may exist with the proper use of an S corporation.  However, these savings come along with the possibility of additional IRS scrutiny.  And, since you may be paying less social security taxes, your future social security benefits may be dinged ever so slightly; but these tax savings are now in your own pocket.

The below WSJ article authored by Richard Rubin covers a portion of this age-old tax saving strategy along with some interesting commentary.

               -Mark Bradstreet

Democratic presidential candidate Joe Biden used a tax loophole that the Obama administration tried and failed to close, substantially lowering his tax bill.

Mr. Biden and his wife, Dr. Jill Biden, routed their book and speech income through S corporations, according to tax returns the couple released this week. They paid income taxes on those profits, but the strategy let the couple avoid the 3.8% net investment income tax they would have paid had they been compensated directly instead of through the S corporations.

The tax savings were as much as $500,000, compared to what the Biden’s would have owed if paid directly or if the Obama proposal had become law.

“As demonstrated by their effective federal tax rate in 2017 and 2018—which exceeded 33%—the Biden’s are committed to ensuring that all Americans pay their fair share,” the Biden campaign said in a statement Wednesday.

The technique is known in tax circles as the Gingrich-Edwards loophole—for former presidential candidates Newt Gingrich, a Republican, and John Edwards, a Democrat—whose tax strategies were scrutinized and drew calls for policy changes years ago. Other prominent politicians, including former President Barack Obama and fellow Democrat Hillary Clinton, as well as current contenders for the 2020 Democratic nomination Sens. Elizabeth Warren and Bernie Sanders, received their book or speech income differently and paid self-employment taxes.

Some tax experts have pointed to pieces of President Trump’s financial disclosures and leaked tax returns to suggest that he has used a similar tax-avoidance strategy.

Unlike his Democratic rivals and predecessors in both parties, Mr. Trump has refused to release his tax returns, and his administration is fighting House Democrats’ attempt to use their statutory authority to obtain them. Democratic presidential candidates have released their tax returns and welcomed criticism to draw a contrast with Mr. Trump.

“There’s no reason for these to be in an S corp—none, other than to save on self-employment tax,” said Tony Nitti, an accountant at RubinBrown LLP who reviewed the returns.

Mr. Biden, who was vice president from 2009 to 2017, has led the Democratic field in polls since entering the race. He is campaigning on making high-income Americans pay more in taxes and on closing tax loopholes that benefit the wealthy.

Mr. Biden has decried the proliferation of such loopholes since Ronald Reagan’s presidency and said the tax revenue could be used, in part, to help pay for initiatives to provide free community-college tuition or to fight climate change.

“We don’t have to punish anybody, including the rich. But everybody should start paying their fair share a little bit. When I’m president, we’re going to have a fairer tax code,” Mr. Biden said last month during a speech in Davenport, Iowa.

The U.S. imposes a 3.8% tax on high-income households—defined as individuals making above $200,000 and married couples making above $250,000. Wage earners have part of the tax taken out of their paychecks and pay part of it on their returns. Self-employed business owners have to pay it, too. People with investment earnings pay a 3.8% tax as well.

But people with profits from their active involvement in businesses can declare those earnings to be neither compensation nor investment income. The Obama administration proposed closing that gap by requiring all such income to be subject to a 3.8% tax, and it was the largest item on a list of “loophole closers” in a plan Mr. Obama released during his last year in office. The administration estimated that proposal, which didn’t advance in Congress, would have raised $272 billion from 2017 through 2026.

Under current law, S-corporation owners can legally avoid paying the 3.8% tax on their profits as long as they pay themselves “reasonable compensation” that is subject to regular payroll taxes. S corporations are a commonly used form for closely held businesses in which the profits flow through to the owners’ individual tax returns and are taxed there instead of at the business level.

The difficulty is in defining reasonable compensation, and the IRS has had mixed success in challenging business owners on the issue. The Bidens’ S corporations—CelticCapri Corp. and Giacoppa Corp.—reported more than $13 million in combined profits in 2017 and 2018 that weren’t subject to the self-employment tax, while those companies paid them less than $800,000 in salary.

If the entire amount were considered compensation, the Bidens could owe about $500,000. An IRS inquiry might reach a conclusion somewhat short of that.

“The salaries earned by the Bidens are reasonable and were determined in good faith, considering the nature of the entities and the services they performed,” the Biden campaign statement said.

For businesses that generate money from capital investments or from a large workforce, less of the profits stem from the owner’s work, and thus reasonable compensation can be lower. For businesses whose profits are largely attributable to the owner’s work, the case for reasonable compensation that is far below profits is harder to make.

To the extent that the Bidens’ profits came directly from the couple’s consulting and public speaking, “to treat those as other than compensation is pretty aggressive,” said Steve Rosenthal, a senior fellow at the Tax Policy Center, a research group run by a former Obama administration official.

Mr. Nitti said he uses a “call in sick” rule for his clients trying to navigate the reasonable-compensation question: If the owner called in sick, how much money could the company still make?

“The reasonable comp standard is a nebulous one,” Mr. Nitti said. “This is pretty cut and dried. If you’re speaking or writing a book, it’s all attributable to your efforts.”

The IRS puts more energy into cases where the business owners pay so little reasonable compensation that they owe the full Social Security and Medicare payroll taxes of 15.3%, Mr. Nitti said.

In a statement released Tuesday along with the candidate’s tax returns, the Biden campaign noted that the couple employs others through its S corporation and calls the companies a “common method for taxpayers who have outside sources of income to consolidate their earnings and expenses.”

Credit given to: Richard Rubin. This article was written July 10, 2019. You can write to Richard Rubin at richard.rubin@wsj.com—Ken Thomas contributed to this article.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This week’s author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | Are You Considering Early Retirement? Maybe You Should Reconsider… July 10, 2019

Posted by bradstreetblogger in : General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes , add a comment

Effects of Early Retirement

While many people look forward to retirement, after years of hard work and dedication, most people do not think about the potential physical, emotional and cognitive issues arising from the cessation of their life filled with the routine of working every day. Research suggests that early retirement may even kill you. You may think: How can that be? How can working longer be better for your health?

Early retirement offers many positive benefits. People have more time to pursue other passions and interests that they may have been longing to try. This gives them time to step away from stressful work and the high demand of work. 

Early retirees do not consider their potential unhealthy behaviors. These include being uninvolved with others, being too sedentary, over eating, and consuming too much alcohol. These factors arise because the retirees no longer have the purpose to fulfill work duties. Life as they have known it is suddenly gone.  This can lead to depression, lack of engagement, or even death. According to Richard W. Johnson, work and the work environment creates intellectual stimulation, while retirement can accelerate cognitive decline. He explains that it is important to keep the brain stimulated. 

Another risk to retirement is the possibility of becoming socially isolated. Many people do not realize the impact that a work environment can have on a person. Colleagues are there to engage and support each other, which adds significant social fulfillment to one’s life. Research suggests that avoiding social isolation by working even part time or volunteering may give retirees a longer life. Social isolation can reduce life satisfaction and affect your physical and mental health. Johnson discovered that only one-third of Americans age 55 and older will actually participate in community groups or unpaid activities. Being involved in activities or even having a part time job can provide stimulation and social interaction similar to that experienced by those who are engaged in full-employment.

Retiring early also has a significant financial impact. Some believe that this is the biggest danger to retirement. Being financially secure is something that people worry about each day while in paid employment. How much time do people think about it when they are in actual retirement? At age 62, you are eligible to receive Social Security, however, it will only cover about 40% of your paycheck. Johnson suggests that workers who remain in their careers can save some of their additional earnings for retirement and will accumulate more Social Security in the long run. 

When you turn 62…

At age 62 everyone thinks about the possibility of retiring. It is like a light bulb that goes off to indicate that you should consider taking the long break you have earned. A study by Maria Fitzpatrick at Cornell University and Timothy Moore at the University of Melbourne shows that there is a correlation between an increase in mortality rates and retirement. It states the risk factors include smoking and lack of physical activity, which are downfalls to early retirement. Many people believe they should retire by a certain age or they feel the pressure to retire early, which is a psychological effect. Johnson explains that as a society we should be encouraging older workers to stay on the job. This can boost long term health, longevity and the emotional and physical strength of the brain. Older workers are protected from age discrimination by Federal law. By allowing older workers to work longer the companies can not only benefit from the skilled workers but will enable the workers to live a longer healthier life. 

Credit given to:  Johnson, R. W. (2019, April 22). The Case Against Early Retirement. 

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Brianna Anello

–until next week.

Tax Tip of the Week | Retirees July 3, 2019

Posted by bradstreetblogger in : General, tax changes, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

Everywhere you turn whether it is your doctor’s office or the WSJ or wherever, we see thought-provoking, often mind-numbing articles on the pros and the cons of retiring. Well, the article that follows is one from the WSJ written by Cheryl Winokur Munk. She delves into some of the more commonly made errors made by retirees. We have noticed many of these errors made by our friends and neighbors but of course we would never commit any of them ourselves.

                               -Mark Bradstreet

There are almost as many paths to retirement as there are retirees. But when it comes to financial mistakes that can derail their retirement, familiar patterns often emerge. Many retirees tend to invest too conservatively, spend too much too soon, pay too much in taxes or fall for too-good-to-be-true investments.

Retirees could ensure their nest egg lasts longer by avoiding these common mistakes:

Mistake No. 1: Investing too conservatively

A number of retirees try to eliminate risk by stashing their savings in cash, certificates of deposit or municipal bonds of very short duration. Though taking a more conservative approach in retirement can be prudent, playing it too safe can severely limit retirees’ earning potential, increasing the chances they’ll run out of money.

“It’s important to build a portfolio that incorporates an appropriate mix of fixed income and equities based on their other assets—including Social Security and rental income—their spending requirements and their life expectancy,” says David Savir, chief executive of Element Pointe Advisors, a registered investment adviser in Miami. The average American man will live to age 76, and the average American woman to age 81, according to the Centers for Disease Control and Prevention.

Mr. Savir recommends retirees build a portfolio to match their spending habits and estimated life expectancy—taking into account the national averages as well as their own health and family history—and test it using forward-looking simulations. Those simulations should take into account bear-market scenarios and the chance that returns may be lower—and volatility higher—than historical norms. “This will help a client determine whether they need to spend less, invest slightly more aggressively, or both,” he says.

Mistake No. 2: Spending mishaps

Some retirees shell out significant sums of money early in their retirement, often to pay off debt or enjoy leisure activities they couldn’t do while working. The problem with spending so much in the beginning is that it can be detrimental to a retiree’s long-term financial security, says Tim Sullivan, chief executive of Strategic Wealth Advisors Group, a registered investment adviser in Shelby Township, Mich.

While eliminating debt can be a good thing, large cash outlays can harm retirees’ long-term financial security. It may make even less sense when a retiree’s investments are earning far more than the rate of interest on the debt, Mr. Sullivan says. And while it’s understandable to want to buy a second house, take a pricey European vacation or remodel a home, retirees need to map out the potential lasting effects such hefty spending can have on their finances, Mr. Sullivan says.

He tells of a client in his late 50s who enjoyed a $25,000 African safari so much that upon his return he immediately booked another $20,000 trip. These purchases put such a dent in his nest egg that he risked running out of money six years earlier than expected and had to follow a strict budget to try to minimize the damage, Mr. Sullivan says.

Of course, retirees have to find the right balance, because being too strict with their spending early in retirement can lead to significant regrets later on. Beyond that, there’s a risk for some retirees that by being so frugal they’ll leave so much behind when they die that they will be over the federal or state estate-tax exemption limit, says Alison Hutchinson, senior vice president of private wealth management at Brown Brothers Harriman. They could also end up leaving more to their heirs than they are comfortable with, she says.

Mistake No. 3: Underestimating expenses

Advisers say it’s typical for retirees to underestimate their expenses in retirement, particularly health-care and other periodic, rather than regular, expenses. These incremental expenses—if not built into the budget—can derail a retiree’s financial security, advisers say.

Leslie Thompson, managing principal at Spectrum Management Group, a registered investment adviser in Indianapolis, recommends that people approaching retirement keep track of their expenses for at least a year, ideally two or three, before they leave the workforce, so they have a baseline to work with. They should then make the necessary tweaks to account for expenses they will no longer have and new expenses they may incur during retirement. “A well-thought-out plan should be based upon actual spending needs and future desires, with contingencies for nonrecurring items such as car purchases, major home repairs and remodels, and rising health-care costs,” she says.

Financial support for adult children and grandchildren is another expense that many retirees will want to build into their budget. Many retirees are happy to assist on an as-needed basis, but, to their detriment, they don’t consider the aggregate annual cost, says Alicia Waltenberger, director of wealth planning strategies at TIAA. “A lot of times when they see that collective number, it is eye-opening,” she says.

Mistake No. 4: Creating unnecessary tax expenses

When retirees have both tax-sheltered and taxable accounts, they commonly withdraw exclusively from their taxable account at first. The danger is that growth within the tax-sheltered account could bump the retiree to a higher tax bracket once required minimum distributions kick in, says Paul Lightfoot, president of Optima Asset Management, a registered investment adviser in Dallas. This could also affect the retiree’s Medicare premiums, he says.

Mr. Lightfoot recommends retirees perform yearly assessments using different tax scenarios to determine how best to optimize their accounts. One option may be to take some withdrawals from their tax-deferred account before they turn 70½, provided this doesn’t push them to a higher tax bracket. They might also consider converting some of their taxable-account savings to a Roth IRA because of anticipated tax rates in the future. While there are taxable consequences in the year of conversion, there may be longer-term tax benefits in a conversion, he says.

Mistake No. 5: Falling for investment pitches that are too good to be true

Many retirees are easily swayed by the prospect of finding high-returning investments that have little to no risk, but chasing yield can easily derail the savings they’ve worked hard to build, advisers say. Some advisers are particularly skeptical of products like indexed annuities for retirees, because many people don’t understand the products and think they are getting something they are not.

Dennis Stearns, founder of Stearns Financial Group, a registered investment adviser in Greensboro, N.C., also cautions retirees to pay attention to the fees they pay for investment management. Generally, clients with $500,000 to $5 million in assets should pay in the range of 0.5% to 1% in adviser fees, and keep other custodial fees and ETF and mutual-fund fees low, he says. If they’re paying more for investment management, it might be advisable to rethink the relationship. “The fees can really eat into your retirement savings,” he says.

Credit Given to: Cheryl Winokur Munk. Ms. Winokur Munk is a writer in West Orange, N.J. She can be reached at reports@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | 529 Plans June 5, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

529 PLANS are confusing! And, that is an understatement…especially since on the surface they seem sooooooooo straightforward. But once you look behind the curtain one can start to see their turns and twists along the way with some far-reaching complications that are rarely considered. Personally, I think their tax savings feature is overrated in many cases…BUT having said that, I am not sure of many better ways to save for someone’s education including that of your grandchildren. American families currently have $329 billion in 529 Plans. Hopefully, these 529 Plans will reduce the need for students’ loans. That would be a blessing!  

Chana R. Schoenberger wrote the following article (The 6 Biggest Questions about ‘529’ Plans) for the WSJ as published on Monday, March 4, 2019.  

                                      –    Mark Bradstreet

Four years ago, we started answering readers’ questions on saving and paying for higher education, especially about how best to use tax-advantaged “529” accounts.

In all, we have answered more than 200 questions, with the help of experts. But readers’ questions continue to pour in, in part because the rules about 529s are so confusing—and keep changing. For instance, families are now allowed to use 529 money to pay for private K-12 schooling, not just college. And the Fafsa financial-aid process now looks back two years, not one, at student income when determining aid.

To mark this column’s fourth anniversary, we revisited six recurring 529 questions that we receive in readers’ emails. We asked two experts to help answer these greatest-hits questions: Michael Frerichs, the state treasurer of Illinois and vice chairman of the College Savings Plans Network, an association of state 529 plan administrators; and Mark Kantrowitz, the publisher and vice president of research at Miami-based Savingforcollege.com.

What is the advantage of 529s over other ways of saving for college?

Experts say that 529 accounts are still one of the best ways to save for college, mainly because of the tax benefits.

When you deposit money in a 529 account, it is considered a gift to the beneficiary. It grows tax-free in the account until you withdraw it for the beneficiary’s qualified educational expenses, which can include tuition, room and board, a computer and certain expenses. If you follow these rules, you don’t incur any tax, state or federal, on withdrawals. Some states also offer tax deductions or credits for investing money in a 529, Mr. Frerichs says. (In some cases, residents must invest in their own state’s plan; other states confer these benefits on any resident contributing to any plan.)

There are other benefits. Anyone can contribute, putting in up to $15,000 annually before paying taxes. You can also pre-fund an account, putting in up to $75,000 ($150,000 for married couples filing jointly) at one time and choosing to use up to five years’ worth of your annual pretax limit, Mr. Frerichs says.

What’s more, “most plans have very low minimum-contribution limits, and most accounts are protected from creditors’ claims in bankruptcy, making them attractive to families regardless of income level,” says Mr. Frerichs.

If my child ends up not using all the money in the 529 for educational purposes, how can we withdraw it or use it?

This is one of the most advantageous features of a 529 account: “There is no time limit on when the money in a 529 plan must be used, so you could just keep the money in the 529 plan account, earning tax-free returns,” Mr. Kantrowitz says.

Your child may wish to go to graduate school later on. You also have the option to switch the beneficiary of the account to any of the original beneficiary’s direct relatives, including siblings, cousins or even yourself.

“You don’t need to be pursuing a degree or certificate, so you can use 529 plan money to pay for continuing education,” Mr. Kantrowitz says.

If you leave the money in the account, your grandchildren could one day use it—even if they aren’t yet born today.

“A 529 plan is a great way of leaving a legacy for future generations,” he says.

If you choose to take the money out of the account without using it for qualified educational purposes, you will incur a 10% federal penalty on the gains portion of any withdrawals, plus federal and state income tax on gains, says Mr. Frerichs. Some plans may also charge extra fees or penalties if you withdraw money in this manner, he says.

You won’t have to pay the penalties if you withdraw the money because your child has received a scholarship or because you’re using the American Opportunity Tax Credit for higher education, Mr. Kantrowitz says. But you may have to repay any state-tax benefits you’ve received if you make a nonqualified withdrawal.

What is the best way to have a 529 account for financial-aid purposes: owned by the grandparents or owned by the parents?

“From a financial-aid perspective, it is generally better to have a 529 plan be owned by the student’s parents than the grandparents,” Mr. Kantrowitz says. You can work around this, but it is complex.

The key here is understanding the way that financial aid is computed. Most colleges use the federal government’s standardized Fafsa (Free Application for Federal Student Aid) online application to decide how much money a family can afford to pay for college—the Expected Family Contribution, or EFC—and how much they will need in scholarships or loans. (Some colleges use a different form, the CSS Profile.)

$329 billion?

The amount that American families have in ‘529’ plans, or an average $24,153 an account.

—College Savings Plans Network

“The smaller the percent value included in the EFC, the greater the potential financial aid,” Mr. Frerichs says.

Colleges make this decision by scrutinizing a family’s income and assets as well as their obligations, such as the number of other children they have in college. When they look at 529s, they note the ownership of the account. If a parent owns the account, or if it is a custodial 529 with the parent as custodian, the account is considered at 5.64% of its value. That is much lower than an account the student owns outright, such as an UGMA or UTMA savings or brokerage account, which would be considered at 20%, Mr. Frerichs says.

If anyone else owns the 529 account, whether it is a grandparent or any other person, that account doesn’t show up on the FAFSA as an asset at all. But when the student begins withdrawing money from the account to pay for school, the money is considered untaxed income on the following year’s FAFSA. That will cut financial-aid eligibility by as much as half of the withdrawal, Mr. Kantrowitz says.

For instance, he says, $10,000 in a parent-owned 529 plan might reduce aid eligibility by as much as $564, which is a lot less than the $5,000 reduction in financial aid for $10,000 in a grandparent-owned 529 plan when the student begins making withdrawals.

If you have a grandparent-owned account and want to get around this problem, there are some fixes. You can switch the account owner to the parent, although some plans don’t allow this unless the original owner has died.

You can wait until you’ve filed the FAFSA, then roll over a year’s worth of distributions from your grandparent-owned 529 into a parent-owned one in the same state’s plan (otherwise, you risk sparking state-tax consequences).

“If you wait until after the FAFSA is filed and use the money before the next FAFSA, it will have no impact on aid eligibility,” Mr. Kantrowitz says.

You can also withdraw money for a qualified expense after Jan. 1 of the student’s sophomore year (if the student plans to finish in four years; otherwise, do this two years before the student intends to graduate). The FAFSA looks back two years, so this will mean that the grandparent-owned plan won’t affect financial aid for college at all. However, this strategy won’t work if the student plans to apply for financial aid for graduate school right after finishing college, he warns.

You always have the option to take the money out of a grandparent’s 529 after college is finished and use it to pay off student loans, but that is an unqualified expense, so expect to pay the penalties and taxes on the earnings portion, he says.

How can we maximize our child’s eligibility for financial aid while still saving as much as we are able to pay for college?

Your best bet here is to use a 529 with the parent as the owner and the student as the beneficiary. “In particular, the money is reported as a parent asset on the FAFSA, so you’re no worse off from a financial-aid perspective than if you had saved in a taxable account in the parent’s name, though you do have significant tax savings,” Mr. Kantrowitz says.

One way to save for college without any impact on financial aid is to open a Roth IRA or qualified annuity in the student’s name. These are treated like grandparent-owned 529s: They’re not counted as assets on the FAFSA, but once you withdraw money to pay for college, it is considered untaxed income to the student, and counted at up to 50%, even if your withdrawal is a tax-free return of Roth IRA contributions, Mr. Kantrowitz says.

The benefit of a Roth IRA for this purpose is it hedges against the possibility that your student won’t go to college; this way, at least you’ll have started saving for the student’s eventual retirement in a tax-advantaged manner.

If your student comes into a large amount of money suddenly, and you’d like to get it out of the FAFSA’s view, annuities are the easiest way. Qualified annuities are ignored as assets on the Fafsa.

“Or invest the money in a small business that is owned and controlled by the family, taking advantage of the small-business exclusion on the Fafsa,” Mr. Kantrowitz says.

Note that these considerations don’t mean that you are better off not saving for college, on the hope that the college will give your student a scholarship. Scholarships are unusual, and full scholarships extremely rare. If you want to avoid student loans, to the extent possible, you should save as much as you can, even if it means your EFC is a bit higher than it would otherwise be.

“It is important to note that saving for college is highly beneficial and will have very limited impact on any potential financial aid,” Mr. Frerichs says.

Is it advisable to use 529 money for K-12 schooling, or should we save it for college?

It is certainly your option, under the new tax law, to use the money for private kindergarten-to-12 tuition and some expenses (though some states aren’t yet conforming to that federal change, as far as state taxes). But this negates the main benefit of 529s.

“529 plans are most attractive to parents because they can save for a longer period of time and prepare for the rising costs of higher-education expenses,” Mr. Frerichs says.

Some people think that sending their children to private school will help their chances of winning a college scholarship. But that is only partially true, Mr. Kantrowitz says. Private-high-school graduates win on average about $1,000 more in scholarships to college, but they’re also more likely to enroll at private colleges, which are more expensive than public colleges. This means that spending family 529 money to pay for private school won’t necessarily mean that the student will face smaller tuition bills for college.

Because your earnings will compound over time, you should start by saving for college first so your money will have time to grow, he says. You would also want a different mix of investments for K-12 school and for college, since you might wish to downshift the riskiness of your investments as tuition bills get closer. If you choose to use 529 money for a K-12 school, you might consider opening two separate 529 accounts for your student, so you can change the investment mix, Mr. Kantrowitz says.

The Savingforcollege.com site has a calculator you can use to explore the trade-offs.

What are the consequences if I change the owner of a 529 account?

Most plans permit the owner to name a successor in case of death, and some also allow a joint account owner.

If your plan permits you to change ownership, note that such a change might affect your student’s eligibility for financial aid (see question above). The owner is the person who holds full control over the beneficiary’s money in the account, so be careful to choose an owner you trust if it isn’t yourself, Mr. Kantrowitz says.

For plans that don’t allow ownership changes, you could roll over the balance of your 529 into a different 529 for the benefit of the same student or a member of the beneficiary’s family. It is also possible to do this manually, by taking a distribution from the original account and contributing it to another account within 60 days, Mr. Kantrowitz says. You may need to locate both accounts in the same state for tax purposes.

Be careful that the new account represents the rollover money correctly, with the new statement showing what money you contributed and what was gains, he says.

Credit Given to:  Chana R. Schoenberger. Ms. Schoenberger is a writer in New York. She can be reached at reports@wsj.com. This appeared in the March 4, 2019, print edition as ‘What You Need to Know About the New Tax Law and The 6 Biggest Questions About ‘529’ Plans.’

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.