Thursday, May 10, 2018

Life Insurance Trusts

Few people realize that, even though they may have a modest estate, their families may owe hundreds of thousands of dollars in estate taxes because they own a life insurance policy with a substantial death benefit. This is so because life insurance proceeds, while not subject to federal income tax, are considered part of your taxable estate and are subject to federal estate tax.

The solution to this problem is to create an irrevocable life insurance trust (sometimes referred to as an "ILIT") that will own the policy and receive the policy proceeds on your death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in your estate as well as in the estate of your surviving spouse. It also protects the trust beneficiaries from their own "excesses," against their creditors, and in the event of divorce. Moreover, the trust also provides reliable management for the trust assets. Here's how the irrevocable life insurance trust works.

You create an irrevocable life insurance trust to be the owner and beneficiary of one or more life insurance policies on your life. You contribute cash to the trust to be used by the trustee to make premium payments on the life insurance policies. If the trust is properly drafted, the contributions you make to the trust for premium payments will qualify for the annual gift tax exclusion, so you won't have to pay gift tax on the contributions.

The life insurance trust typically provides that, during your lifetime, principal and income, in the trustee's discretion, may be paid or applied to or for the benefit of your spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. On your death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests in the trust, such as the right to income, limited invasion rights, and eligibility to receive principal. On the death of your spouse, the trust assets are paid outright to, or held in further trust for the benefit of, your descendants.

If you own a life insurance policy with a significant death benefit, an irrevocable life insurance trust may be of substantial benefit to you and your loved ones. Please contact us if you would like to discuss this further.

Wednesday, April 18, 2018

The Gift Tax Annual Exclusion

Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees each year through the proper use of this annual exclusion, which is $15,000 for 2018.

The exclusion covers gifts an individual makes to each donee each year. Thus, a taxpayer with three children can transfer a total of $45,000 to his or her children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $15,000, the exclusion covers the first $15,000 and only the excess is taxable. Further, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below). (Note, this discussion is not relevant to gifts made by a donor to his or her spouse because these gifts are gift tax-free under separate marital deduction rules.)

Gift-splitting by married taxpayers: If the donor of the gift is married, gifts to donees made during a year can be treated as split between the spouses, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $30,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $180,000 each year to their children and the children's spouses ($30,000 for each of six donees).

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Because more than $15,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $30,000 exclusion covers total gifts.)

The "present interest" requirement: For a gift to qualify for the annual exclusion, it must be a gift of a "present interest." That is, the donee's enjoyment of the gift can't be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while A is alive and donee B is to receive the principal at A's death, B's interest is a "future interest." Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $15,000 of its total value will not be taxed. However, the gift of the other interest (called a "remainder" interest) is a taxable gift in its entirety.

Exception to present interest rule: If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

"Unified" credit for taxable gifts: Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $11,180,000 (for 2018). However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

Please contact us if you wish to discuss this area further or have questions about related topics.

Saturday, March 10, 2018

Overview of Various Types of IRAs Available

At one time, there was relatively little confusion about IRAs because there was only one type available. Now, however, IRAs have proliferated-there's the "traditional" IRA, which may be funded with deductible and/or nondeductible contributions, Roth IRA, SEP-IRA, and SIMPLE IRA. Some of these IRAs have similar features, but others have features that are unique.

What do all these IRAs have in common? They can help you and your family save significant amounts for retirement on a tax-favored basis. Here's an overview of the different types of IRAs available today.

Traditional IRAs.
Traditional IRAs can be funded with deductible and nondeductible contributions.

Deductible IRA contributions. You can make an annual deductible contribution to an IRA if:

        (1) you (and your spouse) are not an active participant in an employer-sponsored retirement plan, or

        (2) you (or your spouse) are an active participant in an employer plan, and your modified adjusted gross income (AGI) doesn't exceed certain levels that vary from year to year by filing status.

Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax-deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty if you withdraw money before age 59 1/2 , unless one of several exceptions apply). You must begin making minimum withdrawals by April 1 of the year following the year you attain age 70 1/2 .

Nondeductible IRA contributions. You can make an annual nondeductible IRA contribution without regard to your coverage by an employer plan and without regard to your AGI. The earnings in a nondeductible IRA are tax-deferred within the IRA, but are taxed on distribution (and subject to a 10% penalty if you withdraw money before age 59 1/2 , unless one of several exceptions apply).

You must begin making minimum withdrawals by April 1 of the year following the year you attain age 70 1/2 . Nondeductible contributions aren't taxed when they are withdrawn. If you've made deductible and nondeductible IRA contributions, a portion of each IRA distribution is treated as coming from nontaxable IRA contributions (and the rest is taxed).

If you can't make a deductible contribution to a traditional IRA, you should contribute (if eligible) to a Roth IRA instead of making a nondeductible contribution to a traditional IRA. That's because the Roth IRA offers a better package of tax benefits than you'd get by making a nondeductible contribution to a traditional IRA.

Deductible and nondeductible IRA limits. The maximum annual IRA contribution (deductible or nondeductible, or a combination) is $5,500 for 2018 ($6,500 if you are age 50 or over in 2018). Additionally, your IRA contribution for a year (deductible or not) can't exceed the amount of your compensation includible in income for that year. Deductible and nondeductible IRA contributions can't be made once you attain age 70 1/2 .

Roth IRAs.
You can make an annual contribution to a Roth IRA if your AGI doesn't exceed certain levels that vary by filing status. Annual contributions to Roth IRAs can be made up to the amount that would be allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs, but not reduced by contributions to a SEP IRA or SIMPLE IRA (see below). For example, if you don't contribute to a traditional IRA in 2018, you can contribute up to $5,500 to a Roth IRA for that year ($6,500 if you are age 50 or older in 2018).

Roth IRA contributions aren't deductible. However, earnings are tax-deferred within the Roth IRA and (unlike a traditional IRA) are tax-free if certain conditions are met when paid out. And if a Roth IRA payout doesn't meet these conditions, you're treated as first withdrawing nontaxable Roth IRA contributions; the balance (representing earnings) is taxed and is subject to a 10% penalty for pre-age-59 1/2 withdrawals, unless one of several exceptions apply. Thus, for example, if you contribute $6,000 over the years to Roth IRAs and withdraw $9,000 at age 55 to buy a boat, only $3,000 is taxed (and is subject to the 10% penalty).

You can make Roth IRA contributions even after you attain age 70 1/2 (if you have sufficient compensation income), and you do not have to take minimum distributions from a Roth IRA after you attain that age. That makes Roth IRAs an excellent wealth-building vehicle for your family.

You can "roll over" (or convert) a traditional IRA to a Roth IRA regardless of the amount of your AGI. The amount taken out of the traditional IRA and rolled over to the Roth IRA is treated for tax purposes as a regular withdrawal (but it's not subject to the 10% early withdrawal penalty).

Small businesses that want to provide employees with a retirement plan, but keep administrative costs low, may be able to set up a SEP (simplified employee pension) or SIMPLE (savings incentive match plan for employees) plan. In either type of plan, contributions are made to IRA-type accounts in the employees' names. Annual contributions to these plans are controlled by special rules and aren't tied to the normal IRA contribution limits. Distributions from a SEP IRA or SIMPLE IRA are subject to tax rules similar to those that apply to deductible IRAs.

Income tax credit for contributions to IRAs
If your adjusted gross income doesn't exceed specified levels, you may be entitled to a credit (saver's credit) against your income tax equal to a percentage of your contribution to any of the above IRAs. If you are entitled to the credit, you get it in addition to any deduction you may be entitled to for the same contribution.

Please contact us for more information on how you and your family may be able to benefit from IRAs in all their various forms.

Tuesday, February 13, 2018

Substantiating Charitable Contributions by Individuals

If you make charitable contributions and deduct them on your tax return, there are requirements to substantiate such charitable contributions. If the contribution is $250 or more, you'll need a written receipt from the charity. If you donate property valued at more than $500, additional requirements apply. Here are the details.

General rules. For each check that is written for less than $250, a copy of your cancelled check will be considered adequate substantiation of your contribution.  For a contribution of cash or other monetary gift, regardless of amount, you must obtain a written communication from the donee organization showing its name, plus the date and amount of the contribution. Any other type of written record, such as a log of contributions, is insufficient.

For a contribution of property other than money, you generally must maintain a receipt from the donee organization that shows the organization's name, the date and location of the contribution, and a detailed description (but not the value) of the property. If circumstances make obtaining a receipt impracticable, you must maintain a reliable written record of the contribution. The information required in such a record depends on factors such as the type and value of property contributed.

If the contribution is worth $250 or more, stricter substantiation requirements apply. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution with a written receipt from the donee organization. You must have the receipt in hand when you file your return (or by the due date, if earlier) or you won't be able to claim the deduction. If you make separate contributions of less than $250, you won't be subject to the written receipt requirement, even if your contributions to the same charity total $250 or more in a year.

The receipt must set forth the amount of cash and a description (but not the value) of any property other than cash contributed. It must also state whether the donee provided any goods or services in return for the contribution, and if so, must give a good-faith estimate of the value of the goods or services.

If you received only "intangible religious benefits," such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn't reduce the charitable deduction available.

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction isn't allowed.

For donated property with a value of more than $5,000, you're generally required to obtain a qualified appraisal and to attach an appraisal summary to the tax return. However, a qualified appraisal isn't required for publicly traded securities for which market quotations are readily available.

For gifts of art valued at $20,000 or more, you must attach a complete copy of the signed appraisal (rather than an appraisal summary) to your return. IRS may also request that you provide a photograph.

If an item of art has been appraised at $50,000 or more, you can ask IRS to issue a "Statement of Value" which can be used to substantiate the value.

Recordkeeping for contributions for which you receive goods or services. If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70.

If you made a contribution of more than $75 for which you received goods or services, the charity must give you a written statement, either when it asks for the donation or when it receives it, that tells you the value of those goods or services. Be sure to keep these statements.

Cash contribution made through payroll deductions. You can substantiate a contribution that you make by withholding from your wages with a pay stub, Form W-2, or other document from your employer that shows the amount withheld for payment to a charity. You can substantiate a single contribution of $250 or more with a pledge card or other document prepared by the charity that includes a statement that it doesn't provide goods or services in return for contributions made by payroll deduction.

The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Substantiating out-of-pocket costs. Although you can't deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses.

As discussed above, a written receipt is required for contributions of $250 or more. This presents a problem for out-of-pocket expenses incurred in the course of providing charitable services, since the charity doesn't know how much those expenses were. However, you can satisfy the written receipt requirement if you have adequate records to substantiate the amount of your expenditures, and get a statement from the charity that contains a description of the services you provided, the date the services were provided, a statement of whether the organization provided any goods or services in return, and a description and good-faith estimate of the value of those goods or services.

Please contact us if you have any questions about these rules that you would like to discuss to help ensure you get all of the deductions to which you are entitled.

Saturday, January 13, 2018

Net Investment Income Tax

High-income taxpayers face a special tax-a 3.8% net investment income tax. Here's an overview of this tax and what it means to you.

This tax applies, in addition to income tax, on your net investment income. The tax only affects taxpayers whose adjusted gross income (AGI) exceeds $250,000 for joint filers and surviving spouses, $200,000 for single taxpayers and heads of household, and $125,000 for married individuals filing separately. These threshold amounts aren't indexed for inflation. Thus, as time goes by, inflation will cause more taxpayers to become subject to the 3.8% tax.

Your AGI is the bottom line on Page 1 of your Form 1040. It consists of your gross income minus your adjustments to income, such as the IRA deduction.

If your AGI is above the threshold that applies to you, the 3.8% tax applies to the lesser of (1) your net investment income for the tax year or (2) the excess of your AGI for the tax year over your threshold amount. This tax is in addition to the income tax that applies to that same income.

Take, for example, a married couple that has AGI of $270,000, of which $100,000 is net investment income. They would pay a net investment income tax on only the $20,000 amount by which their AGI exceeds their threshold amount of $250,000. That is because the $20,000 excess is less than their net investment income of $100,000. Thus, the couple's net investment income tax would be $760 ($20,000 × 3.8%).

Now assume that the couple's AGI was $350,000. Because their AGI exceeds their threshold amount by $100,000, they would pay a net investment income tax on their full $100,000 of net investment income. Their tax would then be $3,800 ($100,000 × 3.8%).

What is net investment income? The "net investment income" that is subject to the 3.8% tax consists of interest, dividends, annuities, royalties, rents, and net gains from property sales. Income from an active trade or business isn't included in net investment income, nor is wage income.

However, passive business income is subject to the net investment income tax. Thus, rents from an active trade or business aren't subject to the tax, but rents from a passive activity are subject to it.

Income that is exempt from income tax, such as tax-exempt bond interest, is likewise exempt from the 3.8% net investment income tax. Thus, switching some of your taxable investments into tax-exempt bonds can reduce your exposure to the 3.8% tax. Of course, this should be done with due regard to your income needs and investment considerations.

Home sales. Many people have asked how the 3.8% tax applies to home sales. If you sell your main home, you may be able to exclude up to $250,000 of gain, or up to $500,000 for joint filers, when figuring your income tax. This excluded gain isn't subject to the 3.8% net investment income tax.

However, gain that exceeds the limit on the exclusion is subject to the tax. Gain from the sale of a vacation home or other second residence, which doesn't qualify for the income tax exclusion, is also subject to the net investment income tax.

For example, say that a married couple has AGI of $200,000 and in addition sold their main home for a $540,000 gain. The couple qualified for the full $500,000 exclusion of gain on the sale, leaving only $40,000 of taxable gain. As a result, the couple isn't subject to the 3.8% tax, because their total AGI ($200,000 + $40,000) falls below the $250,000 threshold.

But if the gain on the home sale was $680,000, of which $180,000 was taxable, the couple would be subject to the 3.8% tax on $130,000 of the gain. That is the amount by which their total AGI of $380,000 ($200,000 + $180,000) exceeds their $250,000 threshold.

Retirement plan distributions. Distributions from qualified retirement plans, such as pension plans and IRAs, aren't subject to the net investment income tax. However, those distributions may push your AGI over the threshold that would cause other types of investment income to be subject to the tax.

This makes Roth IRAs more attractive for higher-income individuals, because qualified Roth IRA distributions are neither subject to the net investment income tax nor included in AGI. Distributions from traditional IRAs are included in AGI, except to the extent of after-tax contributions, although they aren't subject to the net investment income tax.

How the tax is reported and paid. The net investment income tax is computed on Form 8960, attached to and filed with your Form 1040. The tax must be paid at that time.

The net investment income tax must be taken into account in calculating your quarterly estimated tax. Thus, if you expect to be subject to the tax, you may have to make or increase your estimated tax payments to avoid an underpayment penalty.

As you can see, this tax has a significant effect on your tax picture. If you would like to discuss this tax and how its impact can be reduced, please contact us.

Thursday, December 21, 2017

Tax Changes Coming in 2018

Congress appears poised to enact a major tax reform law that could potentially make fundamental changes in the way you and your family calculate your federal income tax bill and the amount of federal tax you will pay. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it is by no means a sure bet. So keep a close eye on the news and don't swing into action until the ink is dry on the President's signature of the tax reform bill.
Beginning next year, the bill would repeal or reduce many popular tax deductions in exchange for a larger standard deduction. Here's what you can consider doing before year end to maximize your tax benefits:

For taxpayers that itemize:

  • Pay the last installment of estimated state and local taxes for 2017 by December 31 rather than on the 2018 due date and prepay real estate taxes on your home.  They are proposing limiting the taxes that can be included in itemized deductions to $10,000.

  • Because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.

Timing of business income and deductions:

Due to a general reduction in tax rates and new reduced tax rates on business income in the tax reform bill, it will often be advisable (more often than most years) to defer income and accelerate expenses. So if you have purchases you need to make in the near future, accelerating those expenses into 2017 will likely result in greater tax savings than incurring the same expense in 2018. Similarly, income may be deferred by delaying billings (cash-basis taxpayers) or delaying deliveries (accrual-basis taxpayers).

We have included the proposed tax rates for single and married taxpayers below.  If you would like more details about any aspect of how the proposed legislation may affect you, please do not hesitate to contact us. 


If taxable income is:          The tax is:
--------------------           -----------

Not over $19,050               10% of taxable income

Over $19,050 but not           $1,905 plus 12% of the
  over $77,400                   excess over $19,050

Over $77,400 but not           $8,907 plus 22% of the
  over $165,000                  excess over $77,400

Over $165,000 but not          $28,179 plus 24% of the
  over $315,000                  excess over $165,000

Over $315,000 but not          $64,179 plus 32% of the
  over $400,000                  excess over $315,000

Over $400,000 but not          $91,379 plus 35% of the
  over $600,000                  excess over $400,000

Over $600,000                 $161,379 plus 37% of the
                                 excess over $600,000



If taxable income is:          The tax is:
--------------------           ----------

Not over $9,525                10% of taxable income

Over $9,525 but not            $952.50 plus 12% of the
  over $38,700                    excess over $9,525

Over $38,700 but not           $4,453.50 plus 22% of the
  over $82,500                    excess over $38,700

Over $82,500 but not           $14,089.50 plus 24% of the
  over $157,500                   excess over $82,500

Over $157,500 but not          $32,089.50 plus 32% of the
  over $200,000                   excess over $157,000

Over $200,000 but not          $45,689.50 plus 35% of the
  over $500,000                   excess over $200,000

Over $500,000                  $150,689.50 plus 37% of  
                                  the excess over $500,000


Tuesday, December 12, 2017

Health Savings Accounts

For eligible individuals, health savings accounts (HSAs) offer a tax-favorable way to set aside funds (or have their employer do so) to meet future medical needs. Here are the key tax-related elements:

       contributions you make to an HSA are deductible, within limits,

       contributions your employer makes aren't taxed to you,

       earnings on the funds within the HSA are not taxed, and

       distributions from the HSA to cover qualified medical expenses are not taxed.
Who is eligible? To be eligible for an HSA, you must be covered by a "high deductible health plan" (discussed below). You must also not be covered by a plan which (1) is not a high deductible health plan, and (2) provides coverage for any benefit covered by your high deductible plan. (It's okay, however, to be covered by a high deductible plan along with separate coverage, through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care.)

For 2017, a "high deductible health plan" is a plan with an annual deductible of at least $1,300 for self-only coverage, or at least $2,600 for family coverage. For self-only coverage, the 2017 limit on deductible contributions is $3,400. For family coverage, the 2017 limit on deductible contributions is $6,750. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,550 for self-only coverage or $13,100 for family coverage.

An individual (and the individual's covered spouse as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional "catch-up" contributions for 2017 of up to $1,000.

A high deductible health plan does not include a plan if substantially all of the plan's coverage is for accidents, disability, or dental, vision, or long-term care, insurance for a specified disease or illness, or insurance paying a fixed amount per day (or other period) of hospitalization.

HSAs may be established by, or on behalf of, any eligible individual.

Deduction limits: You can deduct contributions to an HSA for the year up to the total of your monthly limitations (1/12 of the annual maximum contribution) for the months you were eligible. Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution.

However, if an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made.

Employer contributions: If you are an eligible individual, and your employer contributes to your HSA, the employer's contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.

An employer that decides to make contributions on its employees' behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer does not make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

An exception to the comparable contribution requirements applies for contributions made on behalf of non-highly compensated employees. Under this exception, an employer may make larger HSA contributions for non-highly compensated employees than for highly compensated employees.

Earnings: If the HSA is set up properly, it is generally exempt from taxation, and there is no tax on earnings. However, taxes may apply if contribution limitations are exceeded, required reports are not provided, or prohibited transactions occur.

Distributions: Distributions from the HSA to cover an eligible individual's qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.

As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved. Please contact us if you would like to discuss this topic further.