Taxation of social security benefits

How are Social Security benefits taxed? That depends on your other income. In the worst case scenario, 85% of your benefits would be taxed. (This doesn't mean you pay 85% of your benefits back to the government in taxes-merely that you would include 85% of them in your income subject to your regular tax rates.)

 

To determine how much of your benefits are taxed, you must first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse, if you file jointly. To this add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:

1. If your income plus half your benefits is not above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.

2. If your income plus half your benefits exceeds $32,000 but is not more than $44,000 (exceeds $25,000 but is not more than $34,000 for single taxpayers), you will be taxed on (1) one half of the excess over $32,000 ($25,000 for single taxpayers), or (2) one half of the benefits, whichever is lower.

Example (1): S and D have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. So, their income plus half their benefits is $32,900 ($20,000 plus $2,400 plus 1/2 of $21,000). They must include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)).

Example (2):  If S and D’s combined Social Security benefits were $5,000, and their income plus half their benefits were $40,000, they would include $2,500 of the benefits in income: 1/2 ($40,000 − $32,000) equals $4,000, but 1/2 the $5,000 of benefits ($2,500) is lower, and the lower figure is used.

3. If your income plus half your benefits exceeds $44,000 ($34,000 for single taxpayers), the computation in many cases grows far more complex. Generally, however, 85% of your Social Security benefits will be taxed if you fall into this category.

Caution: If you aren't paying tax on your Social Security benefits now because your income is below the above floor, or are paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You'll have to pay tax (of course) on the additional income, you'll also have to pay tax on (or on more of) your Social Security benefits (since the higher your income the more of your Social Security benefits that are taxed), and you may get pushed into a higher marginal tax bracket. This situation might arise, for example, when you receive a large distribution from a retirement plan (such as an IRA) during the year or have large capital gains. Careful planning might be able to avoid this stiff tax result. For example, it may be possible to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock whose gain can be offset by a capital loss on other shares. If you should need a large amount of cash for a specific purpose, we would be happy to help you determine what your additional tax cost will be before you liquidate any assets.

If you know your social security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make estimated tax payments.

If you would like us to run some specific numbers for you, or if you would like to discuss this matter further, please contact us.

Mid-year Review of Estimated Taxes

It's not a major disaster if you owed some money when you filed your return – after all, you'd rather have the use of the funds for as long as possible. But what you want to avoid is having to pay the IRS a penalty for underpaying your taxes during the year. If you owe the estimated tax underpayment penalty, which is nondeductible, you're in effect paying the IRS interest for part of the money you should have prepaid during the year for taxes, but didn't. On the other hand, if you got a big refund on last year's return, you made an interest-free loan to the government – something you may want to avoid this year. If that happened, you should consider reducing the amount of withholding taken from your salary and/or the amount of estimated tax payments you make. 

Here are some pointers to keep you on even keel when it comes to estimated taxes.

Basic rules. There is no estimated tax underpayment penalty for the 2019 tax year if the total tax on your return reduced by withholding (but not by estimated tax payments) is less than $1,000. If the amount owed on an individual income tax return comes to $1,000 or more after subtracting withheld tax, the estimated tax underpayment penalty generally won't apply if your "required annual payment" – i.e., the amount that must be prepaid during the year in the form of withheld tax and estimated tax payments – equals at least the smaller of two amounts:

        (1) 90% of your tax bill for 2019, or

        (2) 100% of your tax bill for 2018.

For example, let's suppose your tax bill for 2018 was $12,000, and your tax bill for 2019 will come to $15,000 (90% of which is $13,500). In this case, you must prepay at least $12,000 of your tax bill during 2018 to avoid the underpayment penalty. On the other hand, if the tax you will owe for 2019 will only be $10,000, you will have to make timely estimated tax payment of only $9,000 for 2018 to avoid the penalty.

A tougher rule applies if your adjusted gross income for 2018 exceeded $150,000 ($75,000 for married persons filing a separate return). During 2019, to avoid the underpayment penalty, you must prepay the smaller of (1) 90% of the tax for 2019, or (2) 110% of the tax for 2018.

Note that the IRS can waive an underpayment penalty if you didn't make the payment because of a casualty, disaster, or other unusual circumstance, and it would be inequitable to impose the penalty. The penalty also can be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.

It's a pay-as-you-go system. In general, one-quarter of your required annual payment must be paid by April 15, 2019, June 17, 2019, September 16, 2019, and January 15, 2020. Keep in mind that tax withheld from your salary is treated as an estimated tax payment, and that an equal part of withheld tax generally is treated as paid on each installment date.

You may be able to make smaller payments under the annualized income method, which is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. You may also want to use the annualized income method if a significant portion of your income comes from capital gains on the sale of securities which you sell at various times during the year.

Time for a checkup. Although you now know what your 2018 tax bill came to, you probably don't know what your 2019 tax will be. While it can't be predicted with absolute certainty, we can project what your 2019 tax will be based on your financial picture thus far, as well as on events you anticipate will occur and transactions you anticipate finalizing in the balance of this year. It would be a good idea for us to get together well in advance of the next estimated tax installment to see how your payments are tracking and make any necessary adjustments to your wage withholding and/or estimated tax payments. Keep in mind that our review of your situation may discover that you're withholding too much rather than too little.

Please contact us to help you project your tax owed for 2019.

Charitable Donations of Appreciated Stock

If you are planning to make a relatively substantial contribution to a charity, college, etc., you should consider donating appreciated stock from your investment portfolio instead of cash. Your tax benefits from the donation can be increased and the organization will be just as happy to receive the stock.

This tax planning tool is derived from the general rule that the deduction for a donation of property to charity is equal to the fair market value of the donated property. Where the donated property is "gain" property, the donor does not have to recognize the gain on the donated property. These rules allow for the "doubling up," so to speak, of tax benefits: a charitable deduction, plus avoiding tax on the appreciation in value of the donated property.    

Example: Tim and Tina are twins, each of whom attended Yalvard University. Each plans to donate $10,000 to the school. Each also owns $10,000 worth of stock in ABC, Inc. which he or she bought for just $2,000 several years ago.   

Tim sells his stock and donates the $10,000 cash. He gets a $10,000 charitable deduction, but must report his $8,000 capital gain on the stock.

Tina donates the stock directly to the school. She gets the same $10,000 charitable deduction and avoids any tax on the capital gain. The school is just as happy to receive the stock, which it can immediately sell for its $10,000 value in any case.

Caution: While this plan works for Tina in the above example, it will not work if the stock has not been held for more than a year. It would be treated as "ordinary income property" for these purposes and the charitable deduction would be limited to the stock's $2,000 cost.

If the property is other ordinary income property, e.g., inventory, similar limitations apply. Limitations may also apply to donations of long-term capital gain property that is tangible (not stock), and personal (not realty).

Finally, depending on the amounts involved and the rest of your tax picture for the year, taking advantage of these tax benefits may trigger alternative minimum tax concerns.

If you'd like to discuss this method of charitable giving more fully, including the limitations and potential problem areas, please contact us.

Distributions from Traditional IRAs

Although advance planning is needed to help accumulate the biggest possible nest egg in your traditional IRAs, it is even more critical that you get help in planning for distributions from these tax-deferred retirement planning vehicles. There are three areas where knowing the ins and outs of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:

        (1) Early distributions. If you need to take money out of a traditional IRA before age 59-1/2 (e.g., for education expenses for children, to help make a down payment on a new home, or to meet necessary living expenses if you retire early), any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, distributions before age 59-1/2 may be subject to a 10% penalty tax. However, there are several ways that the penalty tax (but not the regular income tax) can be avoided, including a method that is tailor-made for individuals who retire early and need to draw cash from their traditional IRAs to supplement other income.

        (2) Naming beneficiaries. The decision concerning who you wish to designate as beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must withdraw from the IRA when you reach age 70-1/2, who will get what remains in the account at your death, and how that IRA balance can be paid out. What's more, a periodic review of whom you've named as IRA beneficiaries is vital to assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, and in your personal, financial and family situation.

        (3) Required distributions. Once you attain age 70-1/2, distributions from your traditional IRAs must begin. If you don't withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what should have been paid out, but wasn't. In planning for these required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.

If you think it seems easier to put money into a traditional IRA than to take it out, you're absolutely right. This is one area where expert guidance is essential.

If you would like assistance in reviewing your traditional IRAs or analyzing other aspects of your retirement planning, please contact us.

Election to Deduct/Amortize Start-Up and Organization Expenses

If you've recently started a business, or if you're in the process of starting one now, you should be aware that the way you treat some of your initial expenses for tax purposes can make a big difference in your tax bill.

Generally, expenses incurred before a business begins don't generate any deductions or other current tax benefits.

However, taxpayers, whether they are individuals, corporations or partnerships, are permitted to elect to write off $5,000 of "start-up expenses" in the year business begins, and the rest can be deducted over a period of 180 months that begins with the month business starts. The $5,000 figure is reduced by the excess of total start-up costs over $50,000.

You will be deemed to have made the election unless you opt out.

Start-up expenses include, with a few exceptions, all expenses incurred to investigate the creation or acquisition of a business, to actually create the business, or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product.

A similar $5,000/180-month/over-$50,000-phase-out election is available to corporations and partnerships for their "organization expenses." To qualify as an organization expense, the expense must be incident to the creation of the corporation or partnership, be an expense that, in the absence of the election, would be capitalized, and be an expense that, if it had been incurred in connection with a corporation or partnership that had a limited life, would have been eligible to have been written off over that limited life. Examples of organization expenses are legal and accounting fees for services related to organizing the new entity (such as fees for drafting the corporate charter or partnership agreement) and filing fees (such as fees paid to the state of incorporation).

As you can see, it's important to keep a record of these start-up and organization expenses, and to make the appropriate decision regarding the write-off election. As mentioned above, if you opt out of the election, there is no current tax benefit derived from the eligible expenses covered by the election. Also, you should be aware that an election either to deduct or to amortize start-up expenditures, once made, is irrevocable.

Please contact us to work with you in making any of the elections discussed above and in all other aspects of starting a business.

ABLE Accounts for the Disabled or Blind

There is a tax-advantaged way for taxpayers to save for the needs of family members with disabilities, without losing eligibility for other government benefits to which those individuals are entitled. This can be done though an ABLE account, which is a tax-free account that can be used to save for disability-related expenses. Here are the key features of ABLE accounts:

•       ABLE accounts can be created by eligible individuals to support themselves, by families to support their dependents, or by guardians for the benefit of their wards.

•       Eligible individuals must be blind or disabled - and must have become so before turning 26 - and must be entitled to benefits under the Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) programs. Alternatively, an individual can become eligible if a disability certificate for the individual is filed with IRS.

•       ABLE accounts are established under state ABLE programs. An account may be opened under any state's program (where that state allows out-of-state participants), not just the program of the state where the eligible individual lives. A majority of states have passed legislation to sponsor ABLE programs. Some states that haven't established their own programs allow tax benefits for contributions to a program in another state.

•       Any person may contribute to an ABLE account. While contributions aren't tax-deductible, the funds in the account are invested and grow free of tax. The account's investment directions can be changed up to twice a year.

•       Distributions from an ABLE account are tax free if used to pay for expenses that maintain or improve the designated beneficiary's health, independence, or quality of life. These expenses include education; housing; transportation; employment support; health, prevention, and wellness costs; assistive technology and personal support services; and other IRS-approved expenses.

•       If distributions are used for nonqualified expenses, the portion of the distribution that represents earnings on the account is subject to income tax plus a 10% penalty tax.

•       An eligible individual can have only one ABLE account. The total annual contributions by all persons to that account can't exceed the gift tax exclusion amount ($15,000 for 2018, adjusted annually for inflation). But for tax years beginning after Dec. 22, 2017, for contributions made before 2026, the designated beneficiary can make additional contributions, in excess of this limit, up to the lesser of the federal one-person poverty line or the beneficiary's compensation. To be eligible to make these contributions, the designated beneficiary must be employed or self-employed and must not be covered by an employer's retirement saving plan.

•       There is also a limit on the total balance in the account. This limit, which varies from state to state, is equal to the limit imposed by that state on qualified tuition plans (Section 529 college savings accounts).

•       ABLE accounts can generally be rolled over only into another ABLE account for the same individual or into an ABLE account for a sibling who is also an eligible individual. But for distributions after Dec. 22, 2017, for transfers made before 2026, amounts from qualified tuition programs (529 accounts) are allowed to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 account, or a member of that designated beneficiary's family. These rolled-over amounts are counted towards the overall limitation on amounts that can be contributed to an ABLE account within a tax year, and any amount rolled over in excess of this limitation is includible in the gross income of the distributee.

•       ABLE accounts have no impact on an individual's Medicaid eligibility. However, ABLE account balances in excess of $100,000 are counted toward the SSI program's $2,000 individual resource limit. Thus, an individual's SSI benefits are suspended, but not terminated, when his or her ABLE account balance exceeds $102,000 (assuming the individual has no other assets). In addition, distributions from an ABLE account to pay housing expenses count toward the SSI income limit.

•       If an eligible individual dies, any amount remaining in the account after Medicaid reimbursements goes to the deceased's estate or to a beneficiary and will be subject to income tax on investment earnings, but not to a penalty.

•       For tax years beginning after Dec. 22, 2017, for contributions made before 2026, the designated beneficiary of an ABLE account can claim the saver's credit for contributions made to his or her ABLE account.

We hope this information is helpful. If you'd like more details about establishing an ABLE account, please don't hesitate to contact us.

Importance of Income Tax Planning as Part of your Estate Plan

As a result of the large estate tax exemption amount that was set in 2011 at $5 million (increased to $10 million for estates of decedent's dying in 2018 through 2025), which increases annually for inflation (the amount is $11,180,000 in 2018), many modest estates no longer need to be concerned with federal estate tax. Before 2011, the smaller estate tax exemption amount resulted in estate plans that attempted to avoid the estate tax, but were not concerned with minimizing income tax. Now, because many estates will not be subject to estate tax (thanks to that large exemption amount), planning for such estates can be devoted almost exclusively to saving income taxes. While saving both income and transfer taxes has always been a goal of estate planning, it was more difficult to succeed at both when the estate and gift tax exemption level was much lower. Below are some tax planning strategies you may want to revisit in light of the large exemption amount and other recent changes in the law.

Gifts that use the annual gift tax exclusion. One of the benefits of using the gift tax annual exclusion to make transfers during life is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from the donor's estate. However, because the estate tax exemption amount is so large, estate tax savings may no longer be an issue. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the donee receives the donor's basis upon transfer. Thus, the donee could face an income tax cost, via a capital gains tax liability, on the possible sale of the gifted property in the future. If there is no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then the decision to make a gift should be based on factors other than estate tax savings. For example, gifts may be made to help a family member with making a purchase or starting a business. But a donor should not gift appreciated property because of the capital gain that could be realized on a future sale of the property by the donee. If the appreciated property is held until the donor's death, the heir will get a step-up in basis that will wipe out the capital gain tax on any pre-death appreciation in the value of the property.

Planning that equalizes spouses' estates. In the past, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. Generally, a two-trust (a credit shelter trust and marital trust) plan was established to minimize estate tax. "Portability," or the ability to apply the decedent's unused exclusion amount to the surviving spouse's transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent's applicable exclusion amount (the deceased spousal unused exclusion (DSUE) amount) as calculated in the year of the decedent's death. So, if a spouse dies in 2017, when the estate tax exclusion amount is $5,490,000, without having used any exclusion amount over the course of the deceased spouse's life, the surviving spouse would be able to apply the DSUE amount of $5,490,000 to any taxable transfers made. If the surviving spouse were to die later in 2017, then the surviving spouse will be able to use an exclusion amount of $10,980,000 (both the DSUE and the surviving spouse's exclusion amount). In this example, if the surviving spouse dies in a later year, the DSUE amount remains fixed at $5,490,000, but the surviving spouse's basic estate exclusion amount will increase annually. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Estate exclusion or valuation discounts that do not preserve the step-up in basis. Some strategies to avoid inclusion of property in the estate may no longer be worth pursuing. It may be better to have the property be included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation - the valuation of qualified real property used for farming purposes or in a trade or business on the basis of the property's actual use, rather than on its highest and best use - may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property if the special use valuation is not applied. Also, estates where property was transferred to avoid estate inclusion by limiting the transferor's power or control over the property may now welcome that inclusion because that inclusion would mean a step-up in basis, saving potential future capital gain tax. The gap between the transfer tax rate and the capital gains tax rate has narrowed, making strategies that do not preserve the step-up in basis less desirable.

Keep in mind that the increase in the estate tax exemption is only temporary as of right now, effective for 2018-2025. There are many factors to consider when determining what steps to take when estate planning.

If you would like to discuss these strategies, and see how they may relate to your estate plan, please contact us.