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Tax Tip of the Week | How to do 1031 Exchanges to Defer Taxes February 5, 2020

Posted by bradstreetblogger in : 2019 Taxes, General, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Taxes , add a comment

Like-kind tax free exchanges aka Internal Revenue Code Section 1031 are one of the most valuable yet underutilized sections of the IRC (the last major tax law change eliminated 1031 exchanges for anything but real estate).  We have prepared thousands of individual income tax returns and only a very small fraction of those with commercial and residential real estate sales use Section 1031.  Why?  I speculate lack of 1031 education is the primary culprit.  Also, the people that are aware simply don’t wish to tackle its complexities.  Its rules are unforgiving and the deadlines are engraved in stone as the accompanying article discusses.  However, it benefits may be significant.

                                    -Mark Bradstreet 

The Definition of Like-Kind Properties Has Changed Over the Years

The time-worn saying “Nothing is certain but death and taxes” is only half true for a savvy American taxpayer who is planning the sale of an investment or business property. Since capital gains tax on your profits could run as high as 15 percent to 30 percent when state and federal taxes are combined, why not take the necessary steps to avoid this loss? A big tax bite could wipe out money you could use for future investments.

Enter the 1031 tax-deferred exchange. To many taxpayers, this is like money dropping from the skies.

1031 Exchanges Defer Taxes

The 1031 Exchange has been cited as the most powerful wealth-building tool still available to taxpayers. It has been a major part of the success strategy of countless financial wizards and real estate gurus. Taking its name from Section 1031 of the Internal Revenue Code, a tax-deferred exchange allows a taxpayer to sell income, investment or business property and replace it with a like-kind property.

Capital gains on the sale of this property are deferred or postponed as long as the IRS rules are meticulously followed. It is a wise tax and investment strategy as well as an estate planning tool. In theory, an investor could continue deferring capital gains on investment property until death, potentially avoiding them all together.

1984 Legislation Changed Some Aspects

In the early days of “like-kind exchanges,” the term was taken quite literally and often posed difficulties. For instance, if you owned a three-story brick apartment building that you wanted to sell through a 1031 exchange, you would have to find another three-story brick apartment building whose owner wanted to swap. Then the two of you would meet, and the exchange would take place.

3 Saving Habits to Steal and 3 to Skip

In the past, there were no time constraints on the exchange. The IRS demanded stricter controls on the process, which resulted in Congress passing in 1984 Section 1031(a). This legislation limited deferred exchanges, further defined “like-kind” property and established a timetable for completing the exchange.

Qualifying

Real estate property held for business use or investment qualifies for a 1031 Exchange. A personal residence does not qualify and, generally, a fix-and-flip property also doesn’t qualify because it fits into the category of property being held for sale. Vacation or second homes, which are not held as rentals do not qualify for 1031 treatment; however, there is a usage test under Paragraph 280 of the tax code that may apply to those properties. A tax expert should be consulted in this case.

Land, which is under development, and property purchased for resale do not qualify for tax-deferred treatment. Stocks, bonds, notes, inventory property, and a beneficial interest in a partnership are not considered “like-kind” property for exchange purposes.

To qualify as a 1031 exchange today, the transaction must take the form of an “exchange” rather than just a sale of one property with the subsequent purchase of another. First, the property being sold and the new replacement property must both be held for investment purposes or for productive use in a trade or a business. They must be “like-kind” properties.

The following types of real estate swaps fit the requirement for a qualified exchange of “like-kind” property:

•    An office in exchange for a shopping center
•    A shopping center in exchange for land
•    Land in exchange for an industrial building
•    An apartment building in exchange for an industrial building
•    A single family rental in exchange for a tenants in common (TIC) property

Today, you could exchange that brick apartment building for raw land, a warehouse, or a small office building. However, there are strict time constraints which must be met, or the 1031 Exchange will not be allowed, and tax consequences will be imposed.

Prior to 1984, virtually all exchanges were done simultaneously with the closing and transfer of the sold property (Relinquished Property), and the purchase of the new real estate (Replacement Property). In addition to the problems encountered when trying to finding a suitable property, there were difficulties with the simultaneous transfer of titles as well as funds. Not so today.

The delayed 1031 Exchange avoids those pre-1984 problems, but stricter deadlines are now imposed. A taxpayer who wants to complete an exchange, lists and markets property in the usual manner. When a buyer steps forward, and the purchase contract is executed, the seller enters into an exchange agreement with a qualified intermediary who, in turn, become the substitute seller. The exchange agreement usually calls for an assignment of the seller’s contract to the Intermediary. The closing takes place and, because the seller cannot touch the money, the Intermediary receives the proceeds due to the seller.

Exchanges Carry Time Restrictions

At that point, the first timing restriction, the 45-day rule for Identification, begins. The taxpayer must either close on or identify in writing a potential Replacement Property within 45 days from the closing and transfer of the original property. The time period is not negotiable, includes weekends and holidays, and the IRS will not make exceptions. If you exceed the time limit, your entire exchange can be disqualified, and taxes are sure to follow.

Types of Replacement Properties to Identify:

1.    Three properties without regard to their fair market value.
2.    Any number of properties as long as their aggregate fair market value at the end of the identification period does not exceed 200 percent of the aggregate fair market value of the relinquished property as of the transfer date.
3.    If the three-property rule and the 200 percent rule is exceeded, the exchange will not fail if the taxpayer purchases 95 percent of the aggregate fair market value of all identified properties.

What Is Boot?

Realistically, most investors follow the three-property rule so they can complete due diligence and select the one that works best for them that will close. Generally, the goal is to trade up to avoid the transfer of “boot” and keep the exchange tax-free.

“Boot” is the money or fair market value of any additional property received by the taxpayer through the exchange. Money includes all cash equivalents, debts, liabilities to which the exchanged property is subject. It is “non-like-kind” property, and the rules governing it during the exchange are complex. Suffice it to say, without expert advice, receiving “boot” can result in taxes.

Subject to the 180-Day Rule

Once a replacement property is selected, the taxpayer has 180 days from the date the Relinquished Property was transferred to the buyer to close on the new Replacement Property. However, if the due date on the investor’s tax return, with any extensions, for the tax year in which the Relinquished Property was sold is earlier than the 180-day period, then the exchange must be completed by that earlier date. Remember, a portion of this period has already been used during the Identification Period. There are no extensions and no exceptions to this rule, so it is advisable to schedule the closing prior to the deadline.

Since the law requires that the taxpayer not touch the proceeds from the first transaction, the Qualified Intermediary acquires the Replacement Property from the seller at closing and after the transaction is completed, then transfers it to the taxpayer.

Are Not for Do-It-Yourself Investors

It is a basic description of how a successful 1031 Exchange works. Depending upon the taxpayer’s situation, the type of property relinquished, and the characteristics of the Replacement Property, other aspects of the Exchange may be involved. Its completion may become complex, and experts should always be consulted. This is no task for a “do it yourself” investor.

Using the power of the 1031 Exchange to build and preserve wealth and assets, generate cash flow from investments, restructure, diversify and consolidate real estate holdings is the right of every owner of investment property in the United States. American taxpayers should never have to pay capital gains taxes on the sale of their investment property if they intend to reinvest those proceeds in more investment property.

Today’s author – Elizabeth Weintraub

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.  

–until next week.

Ohio Income Tax Updates January 29, 2020

Posted by bradstreetblogger in : 2019 Taxes, General, tax changes, Tax Planning Tips, Tax Tip, Taxes, Taxes , add a comment

A filing season approaches, we are often focused on the federal changes to tax law, but one shouldn’t fail to keep their eyes and ears open to the state changes.  For those of us in Ohio, the 2019 tax law changes were fairly mild.  Below are a few of the key changes to Ohio tax law for the 2019 tax year.

Change in Tax Brackets:

Following the example of the Federal government, Ohio has decreased the number of tax brackets and overall tax rates which are applicable to the 2019 tax year.  The change in rates are displayed below:

Ohio Earned Income Credit:

The Ohio Earned Income Credit (EIC) was also expanded and simplified for 2019.  Historically, the credit was calculated utilizing 10% of the Federal EIC, and possibly subject to limitations based on income.  For the 2019 tax year, the credit is simply 30% of the Federal EIC.

Modified Adjusted Gross Income (MAGI):

The 2019 tax law introduces a new term for purposes of means testing.  Means testing is applied to determine exemption amounts and qualifications for certain credits.  Historically, Ohio Adjusted Gross Income (OAGI) was used in means testing.  The primary difference with this new metric is that income which would have been excluded under Ohio’s generous Business Income Deduction is now included for means testing.  Note, that this doesn’t mean that the business income is now taxable.  It simply means that this income will be considered when determining exemptions and credit qualifications.

In the ever-changing world of taxes, the changes take place not only on the Federal level, but on the state, and even local as well.  We strive to stay abreast of these changes, and help you make the best tax-conscious decisions. 

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 – Josh Campbell

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 | Growing up to be Entrepreneurs July 31, 2019

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

While the majority of us will spend most of our careers working for someone else, having an entrepreneurial spirit or background can open up new possibilities and ways to approach everyday life. The following article was published in the Wall Street Journal on April 28, 2019 by Molly Baker.

                              -Brianna Anello

From the very beginning, Bob Burch has exposed his children to entrepreneurship. When his first daughter, Neely, was born, Bob Burch’s first instinct was to introduce Neely to the office. So, he brought her by to show her off on their way back from the hospital. This poses the famous question on whether entrepreneurs are born or made? Throughout the Burch family this can be seen in both aspects. Entrepreneurships started with Mr. Burch and his brother Chris. They are the founders of a successful retail clothing line, Tony Burch. 

Mr. Burch believes a crucial part of becoming an entrepreneur is nurturing a sense of entrepreneurship. Immersion started at an early age for the Burch children, from encouraging local lemonade sales to teaching them what you need to start a business, to going across the country to show his family potential business ventures. They believe that entrepreneurs should be independent, creative and persistent when wanting to start their own business. These experiences have taught the Burch family lessons that they will hold close to their heart for the rest of their lives. 

Today the three oldest children are travelling the same path as their father, in becoming successful entrepreneurs. Roby, Bob’s son, will never forget his dad’s words of wisdom, “I can’t teach you how to be a lawyer, and I can’t teach you how to be a doctor. I can teach you how to be in business for yourself and how to be good at it.” The Burch children believe their parents, Bob and Susan, never really had certain hopes and dreams for their careers. Bob and Susan wanted their children to think beyond what college they wanted to attend or what they wanted to be when they grew up. They encouraged their children to think big. The process to thinking big included engaging and debating at the dinner table over work ideas. Bob explains that there is no such thing as solo effort. This process is a team effort and will enable the children to release their creativity. At the table, the children also absorbed business lingo and the strategies that they may use one day.

Entrepreneurship is about having the “ready for anything” mindset. One example Bob recalls is the most memorable turnaround story. When he was launching his first fashion show, the first truckload of products arrived and the sweaters had sleeves three inches too short. At this time, he didn’t have the time or money to replace them. Bob and his brother were on their toes. They created a design where Oxford shirt sleeves were rolled over the misfit sweater. It allowed them to showcase their go-to fashion and created opportunity to be successful and avoid potential failure. Because of this fashion show the business earned $100 million in annual sales. 

All of these lessons have influenced the Burch children’s careers. In college, Chloe and Neely pursued online ventures separately. Since they have joined forces, their handbags line is in more than 140 retailers nationwide. Their experiences have even helped their younger brother Roby. Roby is currently trying to launch a premium outdoor lifestyle brand. Bob believes that working as a team has not only created a bond between them, but will lead them to a more fulfilling life.

Credit given to:  Baker, M. (2019, April 29). A Generation of Siblings, Raised to Be Entrepreneurs. 

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 | When The Questions Are The Answers June 26, 2019

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

Let’s take a break from tax topics this week. Yes, even I sometimes get tired of talking about income taxes. So, the topic this week is about leadership. All of us lead someone. Of course, the most important person to lead is yourself. And, as the old saying goes, if you can’t lead yourself then how can you lead someone else?

True leaders don’t give out answers. Often, they don’t know the answers. But the good leader knows their staff has inside them the answers that they seek. Good questions from a good leader help reveal these answers.  

This is further explained along with some examples in the following WSJ article, To Be a Better Leader, Ask Better Questions written by Hal Gregersen. It was published on Tuesday, May 14, 2019.  

                               -Mark Bradstreet

It is often said that the definition of insanity is doing the same thing over and over, and expecting a different outcome.

Well, the same can be said of questions: Keep asking the same kind of question, and it is insane to think you are going to get a different kind of answer.

If you want a dramatically better answer, the key is to ask a better question.

In that one simple statement I have found a career’s worth of research, teaching and advisory work. No one raises an objection when they hear it—who could argue with the value of brilliant reframing? But at the same time, that statement alone is rarely enough. Most people want to be handed the five paradigm-smashing questions to ask.

Unfortunately, that isn’t possible. But what is possible is creating the conditions where the right questions are more likely to bubble up. To that end, here are some clear, concrete, measurable steps that any boss—or anyone, for that matter—can take to come up with those paradigm-smashing questions we all seek.

1. Understand what kinds of questions spark creative thinking.

There are lots of questions you can ask. But only the best really knocks down barriers to creative thinking and channel energy down new, more productive pathways. A question that does has five traits. It reframes the problem. It intrigues the imagination. It invites others’ thinking. It opens up space for different answers. And it’s nonaggressive—not posed to embarrass, humiliate or assert power over the other party.

One CEO I know is aware that his position can get in the way of getting honest information that will challenge his view of things. Instead of coming at his managers with something like, “Competitor X beat us to the punch with that move—how did we let that happen?” he gets more useful input with questions like, “What are you wrestling with and how can I help?” He asks customers and supply-chain partners: “If you were in my shoes, what would you be doing differently than what you see us doing today?”

Think about how these questions change the whole equation. People don’t start off defensive. The problem isn’t already tightly framed. The questions are open-ended, and the answers can be imaginative—rather than telling the boss what he wants to hear.

If you want to turn this first point into a trackable activity, how about this: Start noting in a daily diary how many questions you’ve asked that meet the five criteria.

2. Create the habit of asking questions.

Many bosses simply aren’t used to asking questions; they’re used to giving answers. So, in the early stages of building your questioning capacity, it’s helpful to start by copying other people’s questions. It’s the equivalent of practicing your scales. Once you’ve got the scales down, you can start to improvise.

You could do worse than to follow the questions asked by management thinker Peter Drucker, who liked to jump-start strategic thinking by asking: “What changes have recently happened that don’t fit ‘what everyone knows’”?

Another example: A leader in a consumer packaged-goods company constantly asks: “What more can we do to delight the customer at the point of purchase? And what more to delight them at the point of consumption?”

Again, think about what that does. Sure, the CEO could constantly repeat that the company wants to satisfy consumers. But by asking this question, it builds the habit of thinking in questions. And that, in turn, leads to daily inquiry about matters large and small, and an organization that keeps pushing its competitive advantages forward.

3. Fuel that habit by making yourself generate new questions.

Don’t stop with that generic question set, no matter how well you think it covers the bases. It will become just another activity rut reinforcing today’s assumptions if you and others become too familiar with it. Your goal is to generate new and better questions, not to cap your questioning career at the level of playing flawless scales.

New Perspectives, New Solutions

If you or your team are stuck on a problem, stop and spend four minutes generating nothing but questions about it. As in brainstorming, go for high volume and do no editing in progress. This will often yield a new way to look at the challenge and at least one new idea to solve it. Here’s an example of a question burst:

Instead, every day, note something in your environment that is intriguing and possibly a signal of change in the air. Then, restrain yourself from issuing a comment on it—or if it’s your habit, a tweet—and instead take a moment to articulate the questions it raises.

Then share the most compelling of those questions with someone else. Engage with it for a minute. To some extent, this is doing “reps,” exercising your questioning muscles so they’ll be strong enough when the occasion demands. But it’s also more than that, because chances are it will actually be one of these many, seemingly small, questions that yields your next big breakthrough.

Let me offer a well-known example. Blake Mycoskie was in Argentina when by his account he noticed a lot of children running around barefoot. He didn’t need to ask why they didn’t have shoes—obviously they were poor—but here’s the question it brought him to: Is there a sustainable way to provide children with shoes without having to rely on donations? And thus, he launched the social enterprise Toms, with its famous “one-for-one” business model.

4. Respond with the power of the pause.

When someone comes to you with a problem, don’t immediately respond with an answer. This is harder than it sounds, because you have probably internalized a sense long ago that you’re the boss because you’re decisive and have good judgment—in other words, you have the best answers.

Instead, make it your habit to respond with a question—ideally one that reframes the problem, but at least one that draws out more of your colleague’s thoughts on the matter. I’m not talking about the cop-out rejoinder of, “Well, what do YOU think we should do?” Help the person think through how the decision should be made, with questions like: “What are we optimizing for?” “What’s the most important thing we have to achieve with whatever direction we take?” Or: “What makes this decision so hard? What problem felt like this in the past?”

The payoff here comes in two forms. You’re teaching the colleague the value of pausing to get the question right before rushing to the answer. And nine times out of 10, you’re going to wind up with a better answer than the one you would have blurted out with less deliberation.

5. Brainstorm for questions.

This is an idea that is so simple, and involves an exercise so fast, that it constantly surprises me how effective it is. Whenever you or your team is at an impasse, or there is a sense that some insight is eluding you regarding a problem or opportunity, just stop and spend four minutes generating nothing but questions about it. Don’t spend a second answering the questions, or explaining why you posed a certain one. As in brainstorming, go for high volume and do no editing in progress. See if you can generate at least 15-20.

Eighty percent of the time, I find, the exercise yields some new angle of attack on the problem, and it virtually always re-energizes people to go at it with renewed gusto.

Here’s an example from an innovation team in a consumer-goods company. Struggling to come up with a new concept to test, we tried one of those question bursts. It started with, “What if we launched a response to [a competitor’s product] and did it better?” But soon enough it arrived at, “Are we stuck on assuming a certain price range? What if a customer was willing to give us 10 times that—what could we deliver that would be that valuable to them?” Bingo—the team zeroed in on that question as having real juice in it, and started generating more exciting ideas.

6. Reward your questioners.

Finally, keep track of how you respond when someone in the room asks a question that challenges how you’ve been approaching a problem or feels like it threatens to derail a solution train already leaving the station.

I remember hearing from executives at one company that the boss always surprised his top team by being willing to hear out even the craziest ideas. When others in the room were shaking their heads and hastening to move along, he would be the one to say, “Wait, say more…” to find the part of that flight of fantasy that could work.

If there’s one constant theme here, it’s the idea that bosses should reconceive what their primary job is. They aren’t there to come up with today’s best answers, or even just to get their teams to come up with them. Their job is to build their organization’s capacity for constant innovation.

Their enterprise’s future—and their own career trajectory—depends on their resolve to ask better questions.

Credit given to By Hal Gregersen. Dr. Gregersen is executive director of the MIT Leadership Center, a senior lecturer at the MIT Sloan School of Management and author of “Questions Are the Answer.” 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 | IRS Audits June 19, 2019

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

No one in their right mind would welcome an IRS audit. However, sometime during your life, you may expect to have an IRS audit of some sort, even if only a correspondence audit. Other types of IRS audits include what they call a field audit which occurs at your place of business and an office audit which occurs at the IRS office. From time to time, clients will mention to me that they don’t fear an audit because they have done nothing wrong and have all of the necessary substantiation. Even, in the best of cases, audits are no fun – they are ALWAYS a huge time suck for you and for your professional and, thusly, can be quite expensive.

A further note about correspondence audits – at least half of the tax notices you receive from the IRS are incorrect. Yet, too many taxpayers upon receiving a notice with a balance due simply send the IRS a check. Yes, the IRS loves people like that! Upon receipt of any IRS correspondence, please immediately relay it to your CPA for an appropriate review and response.

It is rare, but not entirely unheard of, for an IRS agent to appear at your home or place of business. If that were to happen and regardless of how friendly they appear your best response is typically very simple. Be polite and inform the agent your CPA will be handling the questions on your behalf. Then, give the agent the name and contact information of your CPA. Ask the agent nicely to call your CPA with any questions that they may have. The same is also true for the receipt of an IRS letter notifying you that your income tax returns are under audit. Get that letter to your accounting firm so they can handle the audit on your behalf. It is not in your best interest to speak to the IRS agent before, during or after the audit. That is the job of your professional.  

The below article written by Jane Hodges – HOW MUCH DO YOU KNOW ABOUT IRS AUDITS? was published in the WSJ on March 25, 2019. It provides further information on the IRS process.

                                          –    Mark Bradstreet

The Internal Revenue Service audits tax returns every year—striking fear in the hearts of many whose accidental or deliberate errors may have led them to underpay the U.S. Treasury.

While the prospect can be terrifying, very few returns are actually audited and many audits are resolved through correspondence. The volume of IRS audits has declined in recent years to 933,785 in 2017 from 1.56 million in 2011, according to IRS data. Some audits even result in a refund. Many, of course, result in tax liabilities.

Still, it never hurts to prepare taxes with care, save records and understand changing tax laws (or work with professionals who do) so your returns will be less likely to raise flags.

What follows is a quiz to help readers hone their smarts about IRS audits.

1. What does the IRS call an audit?

A) Audit
B) Examination
C) Tax year review
D) Tax interview

Answer: B. Audits are referred to as examinations, and a taxpayer being audited corresponds with or meets an “examiner” assigned to his or her case.

2. What percentage of returns were audited during 2017?

A) 0.5%
B) 1.5%
C) 3.8%
D) 6.2%

Answer: A. During fiscal 2017, the IRS audited 0.5% of the 196 million returns it received during the calendar year 2016. That was down from 0.7% the previous year.

3. How does the IRS choose which tax returns to audit?

A) It hires private investigators
B) It looks at tax returns associated with filers undergoing existing audits
C) Computer screening
D) It reviews those whose income has more than doubled in a 10-year period

Answer: B and C. The IRS looks at the company that audit subjects keep. “We may select your returns when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit,” it says in an FAQ about audits on an IRS website. It also uses random computer screening in which algorithms track “norms” for deductions and expenses relative to the filer’s income and other factors.

4. How does the IRS notify a person or business of an audit?

A) By letter
B) By phone
C) Through email
D) Via process server

Answer: A. The IRS typically notifies taxpayers of audits in letters citing what years are under examination and which deductions or aspects of the returns need verification, substantiation or discussion. Once the audit is under way, a representative may call, but the IRS doesn’t initiate audits over the telephone. If you get a call from someone claiming to represent the IRS and notifying you of an audit, it is likely a scam.

5. Where are audits conducted?

A) In an IRS office
B) At the taxpayer’s home or place of business
C) Via correspondence
D) At the office of an authorized representative (tax attorney, CPA, enrolled agent)

Answer: Any of the above, depending on the degree of the inquiry or where the taxpayer stores records or conducts business and other factors. The IRS generally makes the final determination.

6. What percentage of tax audits are conducted by correspondence?

A) 12.6%
B) 32.5%
C) 50.9%
D) 70.8%

Answer: D. During fiscal 2017, when the IRS examined tax returns for the prior year and before, some 70.8% of audits were conducted by correspondence.

7. How long does the IRS expect taxpayers to keep tax records?

A) Forever
B) Five years following the date a return is filed
C) Three years following the date a return is filed or two years from the date a tax is paid
D) Six years, or seven years if the taxpayer is writing off bad debt or worthless securities

Answer: C, and sometimes D. Generally, the IRS suggests taxpayers keep tax records for three years after filing a return or two years from the date they paid tax. In some circumstances, say, if you failed to report income, didn’t file a return, or were flagged for filing a fraudulent return, it’s advisable to keep records longer.

8. Which household income level experiences a 12.5% incidence of audits?

A) $125,000 or more
B) $200,000 or more
C) $250,000 or more
D) $1 million or more

Answer: D. According to Intuit, 1% of taxpayers earning $200,000 or less are audited. Beyond that, the more a taxpayer earns, the more likely an audit is. Some 4% of those earning more than $200,000 are audited, and 12.5% of those earning $1 million or more are audited.

9. When filing taxes, what form of filing is most error-prone, according to the IRS?

A) Electronic filing
B) Returns filed by mail
C) Returns filed from abroad
D) Returns that are filed after an extension request

Answer: B. According to IRS information provided to TurboTax, those who file a return by mail show a 21% incidence of errors, while those who file electronically show only a 0.5% incidence of errors. TurboTax does not cite a reason why online filers have less errors, but presumably online filing software runs math or does automatic calculations which could reduce math-related errors.

10. How far back does the IRS go when choosing returns to audit?

A) 2 years
B) 3 years
C) 6 years
D) 10 years

Answer: B and C. The IRS generally goes back no more than three years in choosing returns to audit, but if it finds a “substantial error,” the agency says it may go back as far as six years.

Credit Given to: By Jane Hodges. Ms. Hodges is a freelance writer in Seattle and has been audited. She can be reached at reports@wsj.com. This appeared in the March 25, 2019, print edition as ‘How Much Do You Know About IRS Audits?’

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 | Whistle Blowers June 12, 2019

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

Aside from what I read in the newspapers; I know little about the world of the tax snitches. On the surface, it seems as though if you are in the right spot at the right time snitching can make you an easy buck. However, the article below explains some of the harsher realities of being a “whistle blower.”

THE PROFITABLE PROSPECTS OF SNITCHING FOR THE IRS was written by Laura Saunders. This article was published in the WSJ in their weekend edition, April 27-28, 2019.  

                                     –    Mark Bradstreet

These are boom times for snitches who turn in tax cheats to Uncle Sam.

The Internal Revenue Service awarded more than $312 million to tipsters last year, according to a little-noticed report released in February. This total far outstrips the previous record of $125 million awarded in 2012. The 2018 rewards, paid in the fiscal year ended Sept. 30, were for additional collected revenue of $1.4 billion, compared with $191 million in fiscal 2017.

And the agency has already paid $115 million to whistle blowers for 2019, according to lawyers Dean Zerbe, Jeffrey Neiman and Gregory Lynam. They expect more to come.

Some recent payouts have been huge.

Last year, one tipster was awarded about $100 million, nearly one-third of the total, for turning in a multinational corporation. The person, a client of Mr. Zerbe, wishes to remain anonymous—as nearly all whistleblowers do.

To date, the largest known IRS whistle blower award of $104 million went to Bradley Birkenfeld, a former private banker for UBS AG who did go public. His 2012 payment was for turning in the Swiss banking giant, which admitted it encouraged U.S. taxpayers to hide assets abroad.

The surge of recent awards shows that a key expansion of the IRS’s whistle blower program is finally taking hold. The change was enacted by Congress in 2006 and pays up to 30% of the revenue collected to tipsters in large cases, those involving more than $2 million of tax. For smaller cases, the payout has typically been a much smaller percentage.

“The large-awards whistle blower program is now hitting on all cylinders,” says Mr. Zerbe, a former aide to Sen. Charles Grassley (R., Iowa), who sponsored the change.

Despite the surge in awards, people who dream of being rewarded for turning in a neighbor with a new Mercedes but no job should consider the many hurdles they face.

For starters, the IRS rejects about three-quarters of whistle blower claims right away. Of the rest, about one in seven gets paid, says Mr. Lynam. The IRS had 29,000 whistle blower claims open in 2018, but many of them are likely to be rejected.

Last year, the IRS says it paid out 186 small-program awards totaling about $12 million. The explosive growth stems from awards in large cases, which rose to 31 last year from 19 in 2015 and totaled $300 million.

This surge is in part due to a favorable 2018 clarification of the law that raised payments in offshore-cheating cases. The IRS then paid out awards that had been in limbo.

Nearly all successful whistle blowers seeking large awards, and many seeking smaller ones, use specialized tax attorneys to prepare their submissions. Their fee is typically 25% to 40% of an award. The attorneys say the package for the IRS needs to include items such as account statements, internal memorandums, emails and perhaps even voice recordings.

Yes, voice recordings. One whistle blower had to wear a wire to get incriminating information—twice, because the device malfunctioned once. She and another person collected an award of nearly $18 million for submitting evidence that led a Swiss bank to plead guilty to encouraging U.S. tax evasion and pay $74 million.

“The key to getting an award is to give the IRS the case on a silver platter,” says Mr. Neiman.

IRS whistle blowers don’t have to be above reproach. The law doesn’t prohibit those convicted of wrongdoing from receiving awards unless they were architects of the cheating. Mr. Birkenfeld, for example, was convicted of conspiring to help a billionaire hide money in UBS accounts and served nearly 30 months in prison. He still got an award because he helped the Treasury recover billions of dollars. Award seekers with accepted cases must be patient. Getting an award often takes at least seven years, according to the 2018 report, and a payout in five years is considered “fast.”

Whistle blowers can receive large awards for reporting corporate cheating, fraudulent gift-and-estate transfers, or cheating by high-net worth individuals. But a big growth area involves reporting offshore cheating, such as by a foreign bank that has assured U.S. officials it has turned over information on all American clients when it hasn’t.

In such cases, says Mr. Neiman, a bank employee or other person can turn in the bank or the customers, collect an IRS whistle blower award, and still remain anonymous. IRS interest in these tipsters, especially from Asia, is on the rise even as its other offshore-enforcement programs have waned.

Whistle blowers who do get awards also owe tax, except for overseas tipsters from some countries. The tax is assessed on awards minus the attorney’s fee, at ordinary income rates—and it is usually withheld. 

Credit Given to: Laura Saunders

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.

Tax Tip of the Week | Real Estate – Tax Basis April 24, 2019

Posted by bradstreetblogger in : Depreciation options, General, Section 168, Section 179, tax changes, Tax Tip, Taxes, Uncategorized , add a comment

In an earlier Tax Tip, different tax categories of real estate were briefly discussed. This week we will discuss how a tax gain or loss is treated upon sale by the various classifications as listed below:

1.    Principal residence – Your gain (loss) is calculated by subtracting your tax basis from your sales price. Your tax basis starts with your original cost, adds in any qualifying improvements, and includes most of the selling expenses you incur when sold. Provided certain tests are met, gain is excludable up to $500,000 on a joint return, or $250,000 for a single filer. Exception: Any depreciation taken after May 6, 1997 is usually taxable. Depreciation may have been taken on an office in the home or any business usage. Any loss upon the sale of a personal residence in non-deductible.

2.    Second home – Your tax basis is calculated in the same manner as a personal residence. Any gain is taxed as capital gain. No exclusion is allowed as with a personal residence. No one may designate more than one property as a personal residence. Just as with a personal residence, any loss upon the sale of a second home is non-deductible.

3.    Rental property – The tax basis is calculated in the same manner as a personal residence with one major exception.   Because rental properties are depreciated over time, basis has to be reduced by the depreciation allowed or allowable. Any gain on the sale of a rental property is taxed as capital gain. However, the gain attributable to the depreciation taken could be taxed as high as 25%. This in known as Section 1250 recapture. Any excess gain is taxed as normal capital gain with a maximum rate of 20%. A loss on the sale of a rental property is normally deductible as an ordinary loss (not subject to the $3,000 per year net capital loss limitation).

4.    Investment property – Depreciation is not normally allowed on investment property. A loss is deductible to the extent of capital gains plus $3,000 per year for joint or single filers, and $1,500 per year for a married filing separate return.

5.    Business property – Same as rental property above if owned individually.

6.    Gifted property – Your tax basis in a property received as a gift is the same as the basis was in the hands of the giver.

7.    Inherited property – Your tax basis in an inherited property is generally the fair market value of the property as of the date of death of the decedent, commonly called a “stepped-up basis”.

As noted above, gains and losses are often treated very differently depending upon the type of property. Please understand what your type of property is and that its character may change for a variety of reasons including your intentions. Being able to substantiate all of this may be important.

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 – Norman S. Hicks, CPA

–until next week.