Is Your Will or Trust Up-to-Date?

When was the last time you or your attorney reviewed or updated your will or trust? If it was before the passage of the 2017 tax reform legislation, or the Tax Cuts and Jobs Act (TCJA), your documents may be out of date. Among the many changes in that law was a more than doubling of the estate tax exemption. Prior to the TCJA, if the value of an individual’s estate at his or her death was about $5.5 million or more, it was subject to the estate tax. For deaths in 2020, and based on the TCJA inflation-adjusted amounts, just over $11.5 million is exempted from estate tax. So, if your will or trust was premised on the lower value, it may need to be revised so that it provides the appropriate estate tax results for your situation.

No doubt your will or trust was prepared with not just estate taxes in mind but so that your assets will be distributed after your death according to your wishes. However, certain events besides the tax laws being revised can cause these documents to become outdated.

Life’s ever-changing circumstances make estate planning an ongoing process. If you don’t keep your will or trust up to date, your money and assets could end up in the wrong hands. That’s why a periodic review of your will or trust is an essential part of estate planning. Here is a partial list of occurrences that could cause your will or trust to be outdated:

  • Your marital status has changed.
  • Your heirs’ marital status has changed.
  • You have relocated to another state.
  • You’ve had or adopted children.
  • Your children are no longer minors.
  • Your children are now mature enough to handle their own financial matters.
  • Your assets have significantly changed in value.
  • You have sold or acquired a major asset(s).
  • Your personal representative (executor, trustee) has changed.
  • You wish to delete or add heirs.
  • Your health status has changed.
  • Estate laws have changed.

Are your named beneficiaries up to date on your life insurance policies, IRA accounts, and pension plans? For example, did you forget to remove your ex-spouse or a deceased relative as your beneficiary?

You should never overlook or put off these issues because once you pass on, it will be too late to make changes.

If you have questions about how your changed circumstances may impact your estate taxes, please give our office a call.

Understanding Tax Lingo

When discussing taxes, reading tax related articles or interpreting instructions, one needs to understand the lingo and acronyms used by tax professionals and authors to be able to grasp what they are saying. It can be difficult to understand tax strategies if you are not familiar with the basic terminologies used in taxation. The following provides you with the basic details associated with the most frequently encountered tax terms.

  • Filing Status – Generally, if you are married at the end of the tax year, you have three possible filing status options: married filing jointly, married filing separately, or, if you qualify, head of household. If you were unmarried at the end of the year, you would file as single, unless you qualify for the more beneficial head of household status. A special status applies for some widows and widowers.

    When using the married joint status, the income, deductions and credits of the spouses are combined for reporting on the tax return. If the spouses file using the married separate status, they each file a separate tax return, and if they reside in a separate property state, each spouse includes just his or her own income and deductions on their individual return. In community property states, generally the incomes and deductions of the spouses are combined and then split 50%/50% for married separate tax return reporting purposes.

    Head of household is the most complicated filing status to qualify for and is frequently overlooked as well as incorrectly claimed. Generally, the taxpayer must be unmarried AND:

    • pay more than one half of the cost of maintaining as his or her home a household that was the principal place of abode for more than one half of the year of a qualifying child or certain dependent relatives, or
    • pay more than half the cost of maintaining a separate household that was the main home for a dependent parent for the entire year.

A married taxpayer may be considered unmarried for the purpose of qualifying for head of household status if the spouses were separated for at least the last six months of the year, provided the taxpayer maintained a home for a dependent child for over half the year.

Surviving spouse (also referred to as qualifying widow or widower) is a rarely status used only for a taxpayer whose spouse died in one of the prior two years and who has a dependent child at home. Joint rates are used. In the year the spouse passes away, the surviving spouse may file jointly with the deceased spouse if not remarried by the end of the year. In rare circumstances, for the year of a spouse’s death, the executor of the decedent’s estate may determine that it is better to use the married separate status on the decedent’s final return, which would then also require the surviving spouse to use the married separate status for that year.

  • Adjusted Gross Income (AGI) – AGI is the acronym for adjusted gross income. AGI is generally the sum of a taxpayer’s income less specific subtractions called adjustments (but before the standard or itemized deductions). The most common adjustments are penalties paid for early withdrawal from a savings account, and deductions for contributing to a traditional IRA or self-employed retirement plan. Many tax benefits and allowances, such as credits, certain adjustments, and some deductions are limited by a taxpayer’s AGI.
  • Modified AGI (MAGI) – Modified AGI is AGI (described above) adjusted (generally up) by tax-exempt and tax-excludable income. MAGI is a significant term when income thresholds apply to limit various deductions, adjustments, and credits. The definition of MAGI will vary depending on the item that is being limited.
  • Taxable Income – Taxable income is AGI less deductions (either standard or itemized). For years 2018 through 2025, another item that is subtracted when figuring taxable income is the deduction for qualified business income (generally 20% of qualified income from pass-through businesses such as partnerships, rentals and sole proprietorships). Your taxable income is what your regular tax is based upon using a tax rate schedule specific to your filing status. The IRS publishes tax tables that are based on the tax rate schedules and that simplify the tax calculation, but the tables can only be used to look up the tax on taxable income up to $99,999.
  • Marginal Tax Rate (Tax Bracket) – Not all of your income is taxed at the same rate. The amount equal to your standard or itemized deductions is not taxed at all. The next increment is taxed at 10%, then 12%, 22%, etc., until you reach the maximum tax rate, which is currently 37%. When you hear people discussing tax brackets, they are referring to the marginal tax rate. Knowing your marginal rate is important because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your marginal rate is 24% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $240 in federal tax ($1,000 x 24%). Your marginal tax bracket depends upon your filing status and taxable income. You can find your marginal tax rate using the table below.

    Keep in mind when using this table that the marginal rates are step functions and that the taxable incomes shown in the filing-status column are the top value for that marginal rate range.

2019 MARGINAL TAX RATES
TAXABLE INCOME BY FILING STATUS
Marginal Tax Rate Single Head of Household Joint* Married Filing Separately
10% 9,700 13,850 19,400 9,700
12% 39,475 52,850 78,950 39,475
22% 84,200 84,200 168,400 84,200
24% 160,725 160,700 321,450 160,725
32% 204,100 204,100 408,200 204,100
35% 510,300 510,300 612,350 306,175
37% Over 510,300 Over 510,300 Over 612,350 Over 306,175

 

* Also used by taxpayers filing as surviving spouse

  • Capital Gains Tax Rates – Lower tax rates apply for gains upon sale of most property, such as stocks and real estate, held for over one year. These rates are 0%, 15% and 20%. Which rate applies depends on the amount of your taxable income.
  • Taxpayer & Dependent Exemptions – Prior to the changes made by the 2017 tax reform you were allowed to claim a personal exemption for yourself, your spouse (if filing jointly), and each individual qualifying as your dependent. The deductible exemption amount was adjusted for inflation annually; the amount for 2019 is $4,200. However, the tax reform suspended the deduction for exemptions for 2018 through 2025.
  • Dependents – To qualify as a dependent, an individual must be the taxpayer’s qualified child or pass all five dependency qualifications: the (1) member of the household or relationship test, (2) gross income test, (3) joint return test, (4) citizenship or residency test, and (5) support test. The gross income test limits the amount a dependent can make if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you pay over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support.
  • Qualified Child – A qualified child is one who meets the following tests:

(1) Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences;
(2) Is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual;
(3) Is younger than the taxpayer;
(4) Did not provide over half of his or her own support for the tax year;
(5) Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and
(6) Was unmarried (or if married, either did not file a joint return or filed jointly only as a claim for refund).

  • Deductions –  A taxpayer generally can choose to itemize deductions or use the standard deduction. The standard deductions, which are adjusted for inflation annually, are illustrated below for 2019.
Filing Status Standard Deduction
Single $12,200
Head of Household $18,350
Married Filing Jointly $24,400
Married Filing Separately $12,200
  • The standard deduction is increased by multiples of $1,650 for unmarried taxpayers who are over age 64 and/or blind. For married taxpayers, the additional amount is $1,300. The extra standard deduction amount is not allowed for elderly or blind dependents. Those with large deductible expenses can itemize their deductions in lieu of claiming the standard deduction. The standard deduction of a dependent filing his or her own return will oftentimes be less than the single amount shown above.

    Itemized deductions generally include:

  • (1) Medical expenses which are limited to those that exceed 10% of your AGI for 2019.
    (2) Taxes consisting primarily of real property taxes, state income (or sales) tax, and personal property taxes, but limited to a total of $10,000 for the year.
    (3) Interest on qualified home acquisition debt and investments; the latter is limited to net investment income (i.e., the deductible interest cannot exceed your investment income after deducting investment expenses).
    (4) Charitable contributions, generally limited to 60% of your AGI, but in certain circumstances the limit can be as little as 20% or 30% of AGI.
    (5) Gambling losses to the extent of gambling income, and certain other rarely encountered deductions.
  • Alternative Minimum Tax (AMT) – The Alternative Minimum Tax is another way of being taxed that has often taken taxpayers by surprise. The Alternative Minimum Tax (AMT) is a tax that was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments pay at least a minimum tax. However, even taxpayers whose only “tax shelter” is having a large number of dependents or paying high state income or property taxes were being affected by the AMT. Your tax must be computed by the regular method and also by the alternative method. The tax that is higher must be paid. The following are some of the more frequently encountered factors and differences that contribute to making the AMT greater than the regular tax.
    • The standard deduction is not allowed for the AMT, and a person subject to the AMT cannot itemize for AMT purposes unless he or she also itemizes for regular tax purposes. Therefore, it is important to make every effort to itemize if subject to the AMT.
    • Itemized deductions:

      Interest in the form of home equity debt interest that cannot be traced to a deductible use. For years 2018–2025, interest paid on home equity debt is also not allowed for regular tax purposes.

    • Nontaxable interest from private activity bonds is tax free for regular tax purposes, but some is taxable for the AMT.
    • Statutory stock options (incentive stock options) when exercised produce no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) is income for AMT purposes in the year the option is exercised.
    • Depletion allowance in excess of a taxpayer’s basis in the property is not allowed for AMT purposes.

A certain amount of income is exempt from the AMT, but the AMT exemptions are phased out for higher-income taxpayers.

 

AMT EXEMPTIONS & PHASE OUT – 2019
Filing Status Exemption Amount Income Where Exemption Is Totally Phased Out
Married Filing Jointly $111,700 1,467,400
Married Filing Separate $55,850 $797,100
Unmarried $71,700 $733,700

 

AMT TAX RATES—2019
AMT Taxable Income Tax Rate
0 – $194,800 (1) 26%
Over $194,800 (1) 28%

(1) $97,400 for married taxpayers filing separately

Your tax will be whichever is the higher of the tax computed the regular way and by the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation, and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom-line tax and raise a question of possible AMT. Fortunately, due to tax reform that the increased AMT exemption amounts and set higher thresholds before the exemption is phased out, fewer taxpayers are now paying AMT. Tax Tip: If you were subject to the AMT in the prior year, you itemized your deductions on your federal return for the prior year, and had a state tax refund for that year, part or all of your state income tax refund from that year may not be taxable in the regular tax computation. To the extent that you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not included in the subsequent year’s income.

  • Tax Credits – Once your tax is computed, tax credits can reduce the tax further. Credits reduce your tax dollar for dollar and are divided into two categories: those that are nonrefundable and can only offset the tax, and those that are refundable. In addition, some credits are not deductible against the AMT, and some credits, when not fully used in a specific tax year, can carry over to succeeding years. Although most credits are a result of some action taken by the taxpayer, there are some commonly encountered credits that are based simply on the number or type of your dependents or your income. These and another popular credit are outlined below.
    • Child Tax Credit –  Thanks to tax reform the child tax credit has been increased to $2,000 per child (up from $1,000 in 2017). If the credit is not entirely used to offset tax, the excess portion of the credit, up to the amount that the taxpayer’s earned income exceeds a threshold of $2,500, but not more than $1,400, is refundable. The credit begins to phase out at incomes (MAGI) of $400,000 for married joint filers and $200,000 for other filing status. The credit is reduced by $50 for each $1,000 (or fraction of $1,000) of modified AGI over the threshold.
    • Dependent Credit – A nonrefundable credit is available to taxpayers with a dependent who isn’t a qualifying child, and like the increased child tax credit is designed to offset the loss of the exemption deduction as a result of tax reform. The dependent credit is $500. A qualifying child, the taxpayer, and if married, the spouse are not eligible for this credit. A child who isn’t a qualifying child but who qualifies as a dependent under the dependent relative rules would qualify the taxpayer to claim this credit.
    • Earned Income Credit – This is a refundable credit for a low-income taxpayer with income from working either as an employee or a self-employed individual. The credit is based on earned income, the taxpayer’s AGI, and the number of qualifying children. A taxpayer who has investment income such as interest and dividends in excess of $3,600 (for 2019) is ineligible for this credit. The credit was established as an incentive for individuals to obtain employment. It increases with the amount of earned income until the maximum credit is achieved and then begins to phase out at higher incomes. The table below illustrates the phase-out ranges for the various combinations of filing status and earned income and the maximum credit available.
2019 EIC PHASE-OUT RANGE
Number of Children Joint Return Others Maximum Credit
None $14,450 – $21,370 $8,650 – $15,570 $529
1 $24,820 – $46,884 $19,030 – $41,094 $3,526
2 $24,820 – $52,493 $19,030 – $46,703 $5,828
3 $24,820 – $55,952 $19,030 – $50,162 $6,557
  • Residential Energy-Efficient Property Credit – This credit is generally for energy-producing systems that harness solar, wind, or geothermal energy, including solar-electric, solar water-heating, fuel-cell, small wind-energy, and geothermal heat-pump systems. These items qualify for a 30% credit with no annual credit limit. Unused residential energy-efficient property credit is generally carried over through 2021.The credit rate reduces to 26% in 2020 and 22% in 2021. The credit expires after 2021.
  • Withholding and Estimated Taxes – Our “pay-as-you-earn” tax system requires that you make payments of your tax liability evenly throughout the year. If you don’t, it’s possible that you could owe an underpayment penalty. Some taxpayers meet the “pay-as-you-earn” requirements by making quarterly estimated payments. However, when your income is primarily from wages, you usually meet the requirements through wage withholding and rely on your employer’s payroll department to take out the right amount of tax, based on the information shown on the Form W-4 that you filed with your employer. To avoid potential underpayment penalties, you are required to deposit by payroll withholding or estimated tax payments an amount equal to the lesser of:

1) 90% of the current year’s tax liability; or

2) 100% of the prior year’s tax liability or, if your AGI exceeds $150,000 ($75,000 for taxpayers filing as married separate), 110% of the prior year’s tax liability.

If you had a significant change in income during the year, we can assist you in projecting your tax liability to maximize the tax benefit and delay paying as much tax as possible before the filing due date.

Please call if our office can be of assistance with your tax planning needs.

Understanding Your Annual Social Security Letter

If you are receiving Social Security, then you have just recently received your annual letter from the Social Security Administration letting you know that your Social Security benefits for 2020 have increased by 1.6 percent as a result of a rise in the cost of living. The letter also lets you know how much will be withheld from your monthly retirement benefit for Medicare Parts B (medical insurance) and D (Prescription Drug Plan).

Not everyone realizes their Part B and Part D benefits are based upon their modified adjusted gross income (MAGI) from two years prior. This means the premiums for 2020 are actually based on your MAGI for 2018. The MAGI for making the adjustment is the federal AGI plus the following:

  • Tax-exempt interest income;
  • United States savings bonds interest used to pay higher education tuition and fees, if the interest was excluded from income;
  • Excluded foreign earned income and housing costs;
  • Income derived from sources within Guam, American Samoa, or the Northern Mariana Islands; and
  • Income from sources within Puerto Rico.

 

2020 MEDICARE PREMIUMS
TAXPAYER FILING STATUS Medicare Part B Monthly Premiums Medicare Part D**
Individual* Married Filing Joint MAGI Increase Total Surcharge
2018 MAGI less than or equal to $87,000 2018 MAGI less than or equal to $174,000 $0.00 $144.60 $0.00
2018 MAGI greater than $87,000 and up to $109,000 2018 MAGI greater than $174,000 and up to $218,000 $57.80 $202.40 $12.20
2018 MAGI greater than $109,000 and up to $136,000 2018 MAGI greater than $218,000 and up to $272,000 $144.60 $289.20 $31.50
2018 MAGI greater than $136,000 and up to $163,000 2018 MAGI greater than $272,000 and up to $326,000 $231.40 $376.00 $50.70
2018 MAGI greater than $163,000 and less than $500,000 2018 MAGI greater than $326,000 and less than $750,000 $318.10 $462.70 $70.00
2018 MAGI greater than or equal to $500,000 2018 MAGI greater than or equal to $7500,000 $347.00 $491.60 $76.40

*The increases for a married taxpayer who lived with his or her spouse at any time during the year and files a separate return are:

  • If 2018 MAGI was $87,000 or less: no surcharge for either Part B or Part D
  • If 2018 MAGI was $87,001 to $412,999: Part B $462.70 and Part D $70.00
  • If 2018 MAGI was $413,000 or above: Part B $491.60 and Part D $76.40

**The monthly Part D surcharge is in addition to the drug plan’s premium.

So, you might discover that even though your monthly Social Security benefits increased because of inflation, the net amount you receive may actually be less per month because of increases in Medicare Part B and D premiums. Such increases are attributable to increased MAGI in 2018, but one might encounter a hidden source of income. This applies to recreational gamblers whose winnings are included in their MAGI but whose losses are an itemized deduction. Thus, even though the overall result may be a loss, the MAGI is increased by the full amount of the gambling winnings, thus possibly causing increases in the Medicare Part B and D premiums.

On the other hand, if 2017 had been a high-income year and your income in 2018 was substantially less, your 2020 Medicare Part B and D premiums may be less than they were in 2019, resulting in a larger net monthly check.

The letter you received from the Social Security Administration does include an appeal process if you disagree with the Social Security Administration’s decision to increase your premiums. However, this appeal must generally be made within 60 days after receipt of the letter. Unfortunately, an increase in your 2018 MAGI that put you into the surcharge range for 2020 and was a result of capital gains due to a one-time sale of real property or stock isn’t a valid reason for an appeal.

If you have questions related to your Social Security benefits and their taxation, please give our office a call. There are often planning strategies that may lessen the tax bite and premium costs.

Congress Passes Last-Minute Tax Changes

Congress, at almost the last minute, has passed a large number of tax changes, including retirement plan issues that will become effective in 2020, as well as extensions through 2020 of a number of tax provisions that had expired or were about to end. The list of changes is quite large, so we have only included those that are most likely to affect individual tax returns. Here is a run-down on some of the new tax provisions:

TAX EXTENDERS

The tax changes retroactively revive a number of provisions that had previously expired or were going to at the end of 2019, and extend them through 2020. So, review them carefully to see if any of them provide you with an opportunity to amend your return for a refund.

Discharge of Qualified Principal Residence Indebtedness – When an individual loses his or her principal residence to foreclosure, abandonment, or short sale or has a portion of their loan forgiven under the HAMP mortgage-reduction plan, they will generally end up with cancellation-of-debt (COD) income. COD income is equal to the amount of debt on the home that is forgiven by the lender. To the extent that the mortgage debt becomes COD income, it is taxable income unless the taxpayer can exclude it based on specific provisions in the tax code.

After the housing market crash a few years back, Congress added the qualified principal residence COD exclusion, which allowed taxpayers to exclude up to $2 million ($1 million if married filing separately) of COD income, to the extent it was discharged debt used to acquire the home, termed acquisition debt. Equity debt was not eligible for the exclusion. However, equity debt is deemed to be discharged first, thus limiting the exclusion if both equity and acquisition debt are involved in the transaction.

This COD exclusion was temporarily added in 2007, was extended, and then expired at the end of 2017. Under the current legislation, the exclusion for qualified principal residence indebtedness is retroactively extended through 2020. Thus, if you paid taxes on principal residence COD income in 2018, be sure to call attention to that fact so your return can be amended for a refund.

Mortgage Insurance Premiums – For tax years 2007 through 2017, taxpayers could deduct the cost of premiums for mortgage insurance on a qualified personal residence as an itemized deduction. The premiums were deducted as home mortgage interest on Schedule A. To be deductible:

  • The premiums must have been paid in connection with acquisition debt (note: acquisition debt includes refinanced acquisition debt).
  • The mortgage insurance contract must have been issued after Dec. 31, 2006.
  • It must be for a qualified residence (first and second homes).
  • The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s adjusted gross income (AGI) exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000).

Qualified mortgage insurance means mortgage insurance provided by the:

  • Dept. of Veterans Affairs (VA),
  • Federal Housing Administration (FHA), or
  • Rural Housing Services (RHS), as well as
  • Private mortgage insurance.

This deduction was previously allowed through 2017 and has retroactively been extended through 2020.

Above-the-Line Deduction for Qualified Tuition and Related Expenses – An above-the-line deduction for qualified tuition and related expenses for higher education has been available since 2002 and was previously extended through 2017. For purposes of the higher education expense deduction, “qualified tuition and related expenses” has the same definition as for the American Opportunity and Lifetime Learning credits for higher education expenses – that is, with certain exceptions, tuition and fees paid for an eligible student (the taxpayer, the taxpayer’s spouse, or a dependent) at an eligible higher education institution. The deduction – up to $2,000 or $4,000, depending on AGI – is not allowed for joint filers with an AGI of $160,000 or more ($80,000 for other filing statuses), except no deduction is allowed for taxpayers using the married filing separate status. The phase-out amounts are not inflation-adjusted. The same expenses can’t be used for both an education credit and the tuition and fees deduction.

This deduction was previously allowed through 2017 and has retroactively been extended through 2020.

Medical AGI Limits – For 2017 and 2018, individuals could claim an itemized deduction for unreimbursed medical expenses, to the extent that such expenses exceeded 7.5% of their AGI. For post-2018 years, the percent of AGI has been increased to 10%. The provision retroactively extends the lower threshold of 7.5% through 2020.

Residential Energy (Efficient) Property Credit – This non-refundable credit has been available in one form or another since 2006 and through 2017, with credit amounts varying from 10% to 30% and the maximum credit ranging from $500 to $1,500. Most recently, the credit percentage was 10%, with a lifetime credit amount limited to $500. This credit is best described as an energy-saving credit since it applies to improvements to the taxpayer’s existing primary home to make it more energy efficient. Generally, it applies to insulation, storm windows and doors, and certain types of energy-efficient roofing materials, energy-efficient central air-conditioning systems, water heaters, heat pumps, hot water systems, circulating fans, etc., but the expenses eligible for the credit do not include installation costs.

The recent legislation extends this credit through 2020, with a lifetime credit cap of $500.
Caution: The lifetime credit extends to returns going all the way back to 2006.

Employer Credit for Paid Family and Medical Leave – This credit provides an employer with credit for paid family and medical leave, which permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The maximum amount of family and medical leave that may be taken into account for any qualifying employee is 12 weeks per taxable year. The credit is variable and only applies if the leave wages are at least 50% of the individual’s normal wages. The credit percentage is 12.5% and increases by 0.5%, up to a maximum of 25%, for each percentage point that the payment rate exceeds 50%.

The credit was originally only for 2018 and 2019 but has been extended through 2020.

RETIREMENT PLAN AND IRA CHANGES

Maximum Age Limit for Traditional IRA Contributions – The legislation repeals the maximum age for making traditional IRA contributions, which, prior to this legislation, prohibited traditional IRA contributions after an individual reached the age of 70½. The provision is effective for contributions made for taxable years beginning after December 31, 2019.

Penalty-Free Pension Withdrawals in Case of Childbirth or Adoption – The legislation allows a penalty free but taxable distribution of up to $5,000 from a qualified plan made within one year of birth or in the case of a finalized adoption of an individual aged 18 or younger or an individual who is physically or mentally incapable of self-support. Distributions can later be repaid to avoid the tax on the distribution.

Increase in Age for RMDs – For decades, individuals were required to begin taking distributions from their traditional IRAs and qualified plans once they reached age 70½. These distributions, commonly referred to as a required minimum distribution or RMD, have never been adjusted to account for increases in life expectancy. The legislation changes the required beginning date for mandatory distributions to age 72, effective for distributions required to be made after December 31, 2019, with respect to individuals who attain the age of 72 after this date.

Special Rule – Difficulty of Care Payments – Many home health-care workers do not have a taxable income because their only compensation comes from “difficulty of care” payments that are exempt from taxation under Code Section 131. Because such workers do not have taxable income, they cannot save for retirement in a defined contribution plan or IRA. This provision will allow home health-care workers to contribute to a qualified plan or IRA by amending the tax code so that tax-exempt difficulty of care payments are treated as compensation, for purposes of calculating the contribution limits to defined contribution plans and IRAs. This is effective for plan years after December 31, 2015, and IRA contributions after the act’s date of enactment (December 20, 2019).

Sec. 529 Plan Modifications – Sec. 529 plans (also referred to as qualified state tuition plans) were originally created to allow tax-free accumulation saving accounts for a child’s education but generally limited the funds’ use to post-secondary education tuition and certain college fees. Since then, Congress has continued to expand the use of funds to include supplies, books, equipment, and reasonable room and board expenses for attending college. With the passage of the tax reform at the end of 2017, Congress allowed up to $10,000 a year to be used for elementary and secondary school tuition expenses. This new legislation adds the following to the list of qualified expenses:

  • Qualified higher education expenses associated with registered apprenticeship programs certified by the Secretary of Labor under Sec. 1 of the National Apprenticeship Act
  • Payment of education loans, up to a maximum of $10,000 (reduced by the amount of distributions so treated for all prior taxable years), including those for siblings

These changes are effective for distributions made after December 31, 2018.

RMDs for Designated Beneficiaries – The legislation modifies the required minimum distribution rules with respect to defined contribution plan and IRA balances upon the account owner’s death. Under the legislation, distributions to individuals other than the surviving spouse of the employee (or IRA owner), disabled or chronically ill individuals, individuals who are not more than 10 years younger than the employee (or IRA owner), or a child of the employee (or IRA owner) who has not reached the age of majority must generally be distributed by the end of the tenth calendar year following the year of the employee’s or IRA owner’s death. A special rule for children requires any remaining undistributed funds to be distributed within 10 years after they reach the age of maturity.

This is a major change since beneficiaries previously had options to take certain lifetime payouts. This will require careful planning to minimize the tax on the distributions. The change applies to distributions with respect to employees or IRA owners who die after December 31, 2019.

Penalty for Failure to File – The legislation increased the minimum penalty for failure to file a tax return within 60 days of the return’s due date to $435, up from $330, for returns with a due date (including extensions) after December 31, 2019. Thus, the $435 penalty will apply to 2019 returns and will be inflation adjusted for future years.

Kiddie Tax – The tax reform enacted late in 2017 changed how the income of dependent children is taxed, causing a child’s unearned income to be taxed at fiduciary rates that very quickly reach the maximum tax rate of 37%. That change created an unintentional tax increase for survivors of service members and first responders who died in the line duty. This last-minute change reverts the kiddie tax computation to the pre–tax reform method for years beginning in 2020. It also allows taxpayers to choose whichever method provides the lowest tax for 2018 and 2019. Taxpayers can amend their 2018 return if doing so will provide a better outcome.

The changes are extensive and, in many cases, open the door to amending prior years’ returns. If you have any questions or think any of these changes might benefit you for a prior year, please give our office a call.

It is Time to Start Tax Planning Now

Have you heard the old expression it is pointless to close the stable door after the horse has bolted? Even if you don’t have a horse or a barn, this expression is very relevant to your tax planning.

The expression refers to the idea that trying to prevent a problem after an event has occurred is pointless – closing the door won’t bring the horse back.

The same is true for your business tax planning and preparation. Waiting until the first quarter to start thinking about taxes is too late because you may have missed several opportunities to reduce your tax obligations. The horse is gone; there is no need to close the door.

Start Your Tax Planning Today

Now is the perfect time to work with a tax planning professional to analyze your financial situation, identify opportunities to reduce your tax liability, and select appropriate investment strategies.

By the early part of the fourth quarter, you have a fairly good idea of how your year is shaping up.  You should be working with your CPA to evaluate the timing of income and purchases, as well as planning for capital expenditures.

For example, the purchase of new computers or office furniture will have the same impact on your cash flow if it occurs on December 31 or January 1.  However, the timing will have a dramatically different impact on your tax burden.

Invest in Yourself

An important part of your tax planning is how you compensate yourself as an owner.  Of course, you should plan how much to pay yourself, how much to treat as pass-through income, and how much you should set aside for IRAs or other qualified plans.  Keep in mind the tax laws change and the best course of action a year ago may not be the best strategy this year.

For example, the Qualified Business Income Deduction, which became available in 2018, may allow up to a 20% deduction for qualified business income, real estate investment trust (REIT) dividends and qualified publicly traded partnerships. While you can read the tax code, understanding the fine points of how this law applies to you and how to maximize this deduction can be tricky.

Gain or Loss Harvesting

As a savvy investor, you know that some portions of your portfolio will make money while others may lose money in any given year. Harvesting allows you to use some of your portfolio’s losses to offset capital gains. This strategy will take some time to apply correctly because it will involve the coordination of transactions.  You will want to identify potential investments and plan the timing of the transactions.

Who Can You Turn To?

Your tax preparation firm is not necessarily a tax planning firm. A good tax preparation firm will know the ins and outs of the current tax code and apply it to whatever you have done.  (They are very good at closing the barn door).

Your tax planning firm will proactively help you manage your tax liability. They will present creative strategies to reduce your tax burden. The goal is to take action today to prevent surprises during filing season.

Need a trustworthy and knowledgeable tax planning firm to help you navigate tax code and make the best decisions to manage your tax burden? For over 35 years, Slattery & Holman has built a strong reputation for quality service and sound financial advice to help our clients make the best decisions. We would love to do the same for you.

How Long Should Business Owners Hold on to Tax Documents?

Every year, tax season comes and goes leaving a flurry of tax documents, receipts and other financial paperwork behind. Couple that with all the rest of the paperwork that comes along with running the day-to-day operations of your business and it can quickly feel like you are buried under a mountain of paper.

With storage space at a premium for many businesses, reducing clutter can help you run your business more smoothly and be better organized, allowing you to provide the best service to your clients. But what about all those tax documents?

The thought of throwing out tax documents can be a little intimidating. After all, you don’t want to be left with missing documents in the event of an IRS audit, and end up in hot water.

However, there may be a way to give yourself some relief from the ever-growing pile of paperwork. Most tax documents and records have a corresponding time period attached to them before they “expire” or otherwise lose relevance. This is known as their individual statute of limitations. Depending on the action, event or expense recorded in the document the statute of limitations can vary from a couple of years to something you will want to keep forever.

Here is a rundown of some important tax document retention guidelines for common and relevant documents that may be helpful as you try and cut down on paperwork clutter.

Tax Returns

To err on the side of caution, we recommend all our clients to keep their tax returns indefinitely. However, the statute of limitations on your annual tax returns can vary depending on several circumstances. Generally, tax returns and all documents containing supporting items carry a retention timeline of 3 years from the date in which they were filed.

But, before you go rushing off to toss out any returns from 3+ years consider some of these conditions that may alter this timeframe. A tax return filed with an understatement in your adjusted gross income by 25% or more will extend the limitation period to 6 years. Any return that went unfiled or filed fraudulently has no statute of limitations and copies need to be kept permanently.

Business Property Costs/Deduction Documents

Certain documents are necessary when determining any gain or loss of business property value in the event of sale or disposal. Therefore, be sure to keep an itemized invoice of equipment or property purchases.

Records that back up any expenses or deductions to your property need to be kept for as long as you own the property associated with the documents plus an additional 7 years.

Employee Records

Current and past employee records are extremely important to retain. This covers W-2s, W-4s, 1099s, and other relevant tax forms and documents. However, these records will eventually lose some relevance.

Generally, employee records should be kept 3 years after the employee leaves or is terminated from your business. Employee tax records and documents supporting earnings should be kept longer, at least 4 years.

Travel/Transportation Expenses

During an audit, the IRS may check vehicle mileage logs, receipts and other documents supporting your business travel expenses like plane tickets or hotel bills accrued attending an industry trade show. These kinds of documents need to be kept in your records for the duration of their 3-year statute of limitations.

Sales Tax Returns

Sales tax return document retention is unfortunately not nearly as straightforward and varies from state to state. Here in Indiana, however, the statute of limitations is 3 years following filing. The length of retention can range from 3 to 6 years, depending on the state.

Bank Card Statements

Company bank account and credit card statements and records that support business expenses come with quite a bit of scrutiny and thus carry a much longer retention window. It is the best practice to hold onto these reports and any additional supporting information for 7 years.

These are just a few of the common tax documents in your files that you may be trying to get rid of, but that isn’t all of them. If you have other documents and reports taking up space that you don’t know what to do with, a safe mantra to have is “if you don’t know, save it!” We can help.

Slattery & Holman is a full-service accounting and consulting firm serving business owners throughout Indiana. We can help you determine what tax documents you need to hold on to and how long you need to keep them. Good record retention practices save you a lot of trouble down the road and reduce paper clutter. Allowing for more time to keep your office organized and running smoothly.

Tax Planning 2018: What Small Business Owners Need to Know

Are you a business owner seeking to better understand the implications of the Tax Cuts and Jobs Act (TCJA) on your 2018 taxes? We have identified 4 key areas to discuss with your accountant to create a thoughtful tax planning strategy focused on reducing your business income tax bill.

1. Business Structure

Tax Planning 2018 - Slattery and Holman

The TCJA amplifies tax implications associated with the various structures available for businesses. Many C-corporations will see lower income taxes under the new flat income tax rate of 21%. Since prior rates ranged from 15% up to 39%, the initial reaction to this change has been favorable. However, before changing your business structure, it is important to note that C-corps are still subject to double taxation. After the corporation pays tax on its profits, the owners are also required to pay taxes on any dividends, at a federal tax rate of up to 23.8%.

For businesses structured as an S-Corp, Partnership, Sole Proprietorship, or Limited Liability Company (LLC), the TCJA includes a 20% Qualified Business Income Deduction. This deduction acts like a tax cut to these pass-through entities, whose owners pay tax on business income through their personal tax returns.

  • The deduction is fully realized if income levels are less than $315,000 for joint returns or $157,500 for single filers.
  • In general, the deduction is 20% of business income, subject to limitations based on wages and investment in property and equipment.
  • In general, service businesses do not qualify for the deduction. This includes those in health, law, accounting, performing arts, consulting and athletics, as well as those in financial, brokerage and investment services.
  • When taxable income on the business owner’s 1040 is below $315,000/$157,500, neither the wage limitation nor the provision disallowing the deduction for service businesses apply.

Reviewing your business income, wages and industry sector with your tax accountant can help determine the most favorable structure for your company.

2. Client Entertainment ChangesTax Planning 2018 what small business owners should know
A notable change now impacts the deductions associated with client entertainment. In 2018, client entertainment expenses such as golfing or sporting event tickets are no longer deductible. However, food and beverages shared with clients or potential clients are 50% deductible if the following conditions are satisfied:

  • The expense is an ordinary and necessary expense in conducting business;
  • The expense is not lavish or extravagant;
  • The taxpayer, or an employee of the taxpayer, is present at the furnishing of food or beverages;
  • The food and beverages are provided to a current or potential business customer, client or similar business contact;
  • In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment.

Your tax accountant can offer additional clarification about client meal and entertainment deductions.

3. Acquiring and Depreciating Assets
New TCJA rules make it a good time to invest in some types of assets. Under changes made to bonus depreciation and 179 expensing rules, you can now deduct purchases of qualified property during the year it’s placed in service. ‘Qualified property’ includes the following items when purchased for business use:

  • Equipment / Machines
  • Certain vehicles
  • Computers and non-proprietary / off-the-shelf software
  • Office furniture and equipment
  • Some improvements such as roofing, HVAC, security systems and fire protection systems

The TCJA increased first-year bonus depreciation to 100% of qualified purchases made after September 17, 2017. Unlike previous years, the 2018 Bonus Depreciation can also be applied to used equipment if it’s ‘new’ to you. Your tax accountant can confirm qualifying purchases and provide counsel about potential fourth-quarter activity that will help you get the most out of this tax-saving strategy.

4. Accounting Method

The new tax law allows more flexibility for small businesses to choose the optimal accounting method for their business. Now businesses with revenue up to $25 million can use cash basis accounting. This opens the cash method option up to many businesses not allowed to use it under the old rules.

The cash basis method records revenues when payment is received and when expenses are paid. This method doesn’t require you to record account receivables or payables. Cash basis accounting matches the taxation of the income with the receipt of the cash.

Another benefit to the cash method of accounting is its flexibility. If you are able to work with vendors, you can time the payment of invoices to take the deduction in the year you choose. This is especially helpful in years where tax rates are changing or when you expect large fluctuations in income.

If you decide to shift from accrual to cash accounting, it is often still important to continue to track income and expenses on accrual basis for operational reasons. A long-term perspective about business operations is vital to forecasting, planning and maintaining strong banking relationships.

The team at Slattery & Holman can help you capture the benefits of the 2018 tax changes. We will also work with you to ensure effective business tax planning strategies for 2019.

Contact us today to set up a convenient time to connect.