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Setting Every Community Up for Retirement Enhancement Act (SECURE Act)

Posted by Ben Miller Posted on Jan 20 2020

On December 20, The President signed two spending bills.  Included in those bills was the SECURE Act.  The changes from the SECURE Act have not received much attention so I will shed some light on the more pertinent ones.  Let’s jump right into it.

For taxpayers who have qualified retirement accounts (401ks, Traditional IRAs, etc.), the age at which Required Minimum Distributions (RMDs) must be taken has been pushed out from the year the taxpayer turns 70 ½ to the year the taxpayer turns 72.  This sounds convoluted so let’s simplify it.  The government allows taxpayers to accumulate funds inside these retirement accounts and for those funds to grow tax-free each year.  However, those funds will be taxed in the year distributed.  So, some taxpayers choose to wait and wait and wait if they don’t need the cash which allows the funds to continue to grow.  Well, congress knows this so they added the RMD rules to make sure Uncle Sam would get his bite out of the funds that have had in some cases 50+ years of tax deferred growth.  This new law allows taxpayers to delay taking distributions for an additional 1 ½ years, which allows those accounts additional time to grow without taking a tax hit.  It takes effect for taxpayers who turn 70 ½ in 2020 or later. 

The next piece of the legislation I want to mention also involves qualified retirement accounts.  Typically, if funds are withdrawn from these accounts prematurely (before reaching age 59 ½ - remember the government wants to see these funds used for retirement) there is a 10% penalty on the amount distributed in addition to income tax generated.  The new law exempts distributions up to $5,000 from the 10% penalty if the taxpayer gave birth within the past year or finalized a child’s adoption.  Remember, income tax will still be due on the distribution, but the taxpayer can avoid the penalty ($500 if $5,000 is the amount distributed).

The biggest change affecting taxpayers are the changes made to the “stretch” retirement accounts.  What is a “stretch” retirement account?  These are qualified retirement plans, again as mentioned above, that are inherited by heirs of the deceased taxpayer.  Under the old law the heirs could then take distributions over their life expectancy, which could be 50+ years.  This means that Uncle Sam also gets its tax revenue from the account over 50+ years.  Congress wants taxpayers to pay the tax much sooner.  The new law stipulates that inherited retirement accounts must now be withdrawn over a maximum 10-year period.  Of course, this means Uncle Sam gets his bite over the 10-year period versus the 50+ year period.  However, the “stretch” provision is still available to surviving spouses, minor children (not grandchildren), and disabled individuals.

There are other tax provisions in the new law, but these discussed above will impact the biggest group of taxpayers.  If you would like more details about what else is in the law, message me.  As always, if there is a tax subject you are curious about send me a note and I will try to use for my next blog.

Casualty loss tax deduction and the Lawrence area tornado

Posted by Ben Miller Posted on June 30 2019

Today’s post is about the casualty loss deduction specific to individual taxpayers (not businesses) and how it works.  Typical situations involve an expensive set of golf clubs getting stolen out of the back of a car or damage sustained from an event such as a tornado.  When these things happen and the taxpayer isn’t reimbursed by insurance this is called a casualty loss.

The Internal Revenue Service (IRS) has the following definition for a casualty loss: Damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.  The key thing to remember here is the event has to be sudden – not gradual.  Termite damage is a common example.  Termite damage can result in a big loss and taxpayers try to deduct it, only to have the IRS challenge the deduction because in the IRS’s eyes, termite damage is not a ‘sudden’ event.  So in that fact pattern, generally taxpayers lose and the deduction gets thrown out.

Starting in 2018, when the new Trump tax law took effect, the casualty loss deduction is restricted to losses sustained in a presidentially declared disaster area.  On May 28th areas around Lawrence, Eudora, Linwood, and Bonner Springs sustained damage due to a massive tornado. 

On June 20th the President approved a Kansas Disaster Declaration.  See the press release here: https://www.fema.gov/news-release/2019/06/21/president-donald-j-trump-approves-major-disaster-declaration-kansas.  The tornado, among other very recent weather events, resulted in personal property damage.  Damage sustained from any of these events is eligible for a casualty loss tax deduction.

Example 1: The taxpayer incurred damage from a tornado in 2018.  The taxpayer’s house was just purchased for $250,000.  The next day, before any personal effects were moved in, a tornado destroyed the house.  The insurance company only reimbursed the taxpayer $220,000.  This resulted in a $30,000 loss.  The area was not declared a federal disaster area.  The taxpayer is not eligible for any tax loss deduction.

Example 2: Assume the same facts except the area was declared a federal disaster area.  In this case the $30k the taxpayer is out would be eligible for a tax deduction because of the declaration.  Here’s the calculation:

$30,000  -  Loss

   ($100)  -  Casualty loss floor per loss occurrence

($7,000)  -  10% AGI limitation (this is 10% of your Adjusted Gross Income, assume AGI is $70,000)

$22,900   -  Casualty loss deduction on 2019 tax return – Schedule A

Additionally, the tax code allows taxpayers the option to deduct the casualty loss in the prior year by amending the prior year return (2017 in the example).  By deducting the loss in the prior year it gets cash in the taxpayer’s hands more quickly than waiting to file the current year’s return.

What about the golf clubs?  Again, all casualty and theft losses are not deductible unless they occur in a presidentially declared disaster area.  So if the clubs were destroyed in the tornado or were stolen in the declared disaster area the loss would then be deductible.

In conclusion, these sorts of events are rare but they do happen.  Although congress has limited casualty losses to presidentially declared disaster areas, they are a last a remedy when the insurance company does not make the taxpayer whole after a catastrophic event.  Message me with any questions.

Three choices when you can't pay the tax

Posted by Ben Miller Posted on May 29 2019

This past spring when 2018 tax returns were due, because of changes from the new Trump tax law, some taxpayers were left with jaw-dropping tax liabilities they were not expecting.  What happens if they can’t pay the tax?  There are options for individual taxpayers and we will take a look at each of them.

The first thing to note is tax returns should always be filed even if the funds to pay the bill are not available.  Why?  There are penalties that can be levied because the returns are not filed, separate from interest and penalties from not having paid the tax due shown.  So the lesson here is to always file the returns regardless of whether the tax can be paid.  Ok, let’s get onto the show.

Taxpayers that have a small balance due that can be paid in full within 120 days, should pay whatever they can when the returns are filed.  The IRS will send the taxpayer a bill for the remaining tax due plus a small amount of interest.  The Internal Revenue Service (IRS) refers to this as a Full Payment Agreement.  This is the easiest and most time efficient of the choices.

The second choice is submitting an Installment Agreement (IA) with the IRS.  If the balance due cannot be paid off over the short period of time mentioned above then an IA is an option.  There are some formalities to an IA: 

     1. During the past 5 years the taxpayer (and spouse if married filing jointly) have timely filed                 their returns and paid any tax due

     2. The taxpayer agrees to pay the full amount owed within 3 years 

     3. The taxpayer is unable to pay the liability in full with the return

     4. Administrative fees under $100 are required to be paid when setting up an IA

The IA option is generally accepted by the IRS if the above requirements are met.

 

The IRS will review the above payment options and if those options have been exhausted they will consider an Offer in Compromise (OIC) as the final option available.  The OIC is just that – an offer to compromise on the tax owed.  By choosing this route, the taxpayer hopes the IRS will take less than the full amount owed to satisfy the tax obligation.  There are 5 requirements necessary for the IRS to consider an OIC:

     1. The taxpayer has not filed for bankruptcy

     2. From 656, the OIC package must be submitted and is 27 pages long!

     3. $186 application payment must be included

     4. If the taxpayer chooses a lump-sum (6 or fewer installment payments) offer to the IRS, that                 offer must include a 20% payment of the offer

     5. If the taxpayer chooses a longer payment period (> 6 installment payments) the taxpayer                   must comply with the taxpayer’s own proposed payment schedule while the OIC is being                 considered

Typically, taxpayers in this position are in a tough spot financially and don’t see any way to pay the full tax due.  The IRS will look at all the facts and circumstances surrounding the OIC application to determine ‘doubt as to collectability’.  When the IRS receives the completed 27 page OIC, they will use it to figure out how able the taxpayer is to pay the tax.  Then the IRS determines whether to accept the OIC for less tax than was due on the returns.  The IRS has accepted roughly 40% of the OIC requests it has received over the last few fiscal years so it’s not a given an OIC will be accepted.

Actually, there is a 4th option.  That involves not paying the tax which leads to having property confiscated, wages garnished, or getting thrown in jail but those are not advisable.  Though the taxpayer may not have the funds to pay the tax due right away, there are options available to them in this situation.  Message me with any questions.

The magic of Health Savings Accounts

Posted by Ben Miller Posted on May 12 2019

As health insurance premiums rise, health savings accounts (HSA) are becoming more prevalent.  Why?  Health insurance premiums for high deductible health insurance plans (HDHP) are generally cheaper than traditional health insurance plans.  In many cases, in tandem with HSAs, HDHPs are becoming the only affordable health insurance option for many individuals.  In this post I provide the nuts and bolts of why HSAs are so beneficial from a tax perspective.

HSAs were established in 2003 with the intent of putting more responsibility into the individual’s hands.  Congress’s thought was, “if individuals have more control over how their health dollars are spent, those dollars would be more wisely spent”.  When individuals participate in a HDHP they have the option of also contributing pre-tax dollars to an HSA.  When distributions, used to pay for medical expenses of the individual, the spouse, and their dependents, are distributed from the HSA account they are 100% tax free.

When an individual signs up for HDHP insurance through work and contributes to their HSA, both amounts are taken out pre-tax.  What does this mean?  This means that the amounts income and payroll taxes are calculated on are reduced first before the taxes are calculated.  In the examples assume Ross is a single, non-married individual and has HDHP coverage the entire year.

Example 1 – Ross works as a bouncer in 2018, removing unruly patrons.  Ross’s gross wages were $52,000.  His total HDHP premium is $1,300 and his total HSA contribution is $2,500.  Instead of calculating the income tax and payroll tax (FICA) withholding on $52,000 it was instead calculated on $48,200 ($52,000 – $3,800).  Say Ross’s total income tax rate was 30% and his FICA tax rate is 7.65%.  Ross saved $1,431 ($3,800 x 37.65%) in overall tax. 

Another positive aspect of HSAs is the ability to make after-tax contributions into the account.

Example 2 – The following spring Ross gives his CPA his tax information.  Ross’s CPA notices he is in the 30% overall income tax bracket.  Before Ross’s CPA finalizes the tax returns the CPA recommends Ross contribute $950 to his HSA to max it out for 2018.  Ross has until April 15th, 2019 to make this contribution for the 2018 tax year.  Ross sees tax savings of $285 ($950 x 30%).

An item to note: In the two examples above do you see a difference?  It is the FICA tax.  Ross making contributions through his employer avoids the FICA tax.  When he writes the $950 check to the HSA he only gets the income tax deduction not the FICA tax deduction.

Flexible Savings Accounts (FSA) are another way to put away pre-tax dollars for medical expenses.  Much like HSA accounts the individual specifies how much they’d like taken out of their paycheck and these amounts avoid income and payroll tax similar to HSA contributions.  FSAs, however, are a “use it or lose it” account.  If the individual has not spent the funds inside the FSA by the end of the tax year those funds are lost forever.  The individual’s employer may allow a grace period of March 15th of the following year, but again the funds have to be spent.  Amounts contributed to an HSA are the individual’s money forever, sort of like a contribution to a 401k retirement account.  The tax law forbids the individual from contributing to both an FSA and HSA in the same tax year i.e. no double-dipping.

Speaking of retirement let’s address that advantage.  Depending on who the custodian (banks for example) is for the HSA account the individual may be able to invest the funds residing inside the HSA.  This allows the individual to earn an investment return on funds sitting inside the account.  This sounds like a 401k doesn’t it?  Everyone reading this will have medical expenses at some point in their life.  If possible, it makes sense tax-wise to fully fund these each year.

HSAs are the rare unicorn found in the tax code.  Nowhere else in the code does the government allow pre-tax contributions, tax-free investment growth, and tax-free withdrawals from the same account.

If medical premiums continue their ascent each year, an increasing amount of individuals will be trying to find ways to reduce their exposure and HDHPs combined with HSAs are a viable option to combat the increases.  Message me with any questions.

Married Filing Joint versus Married Filing Separate.

Posted by Ben Miller Posted on May 07 2019

About once a year, typically during tax season, I get asked if it is better to file jointly or separately.  As my answer is to many things tax – it depends.  There are reasons for filing as married filing separate (MFS) but most taxpayers will see more financial benefit filing as married filing jointly (MFJ).  In this post I will explore some advantages and disadvantages of each filing status.

The tax law is written in a way that penalizes taxpayers who choose to file separately.  Some credits are cut in half, such as the child tax credit and the credit low-income workers receive for making retirement plan contributions.  The earned income credit, American Opportunity tax credit, and Lifetime Learning credit are not available to MFS taxpayers at all.  Taxpayers filing as MFS are only allowed a $1,500 capital loss deduction instead of $3,000, and cannot deduct student loan interest.  These are just some of the limitations placed on taxpayers filing MFS.

An important choice impacting this discussion is the role itemized and standard deductions have.  If Fred, who itemizes, choosing MFS status Wilma must also itemize.  By the same token if Fred uses the standard deduction Wilma must also, but the standard deduction for both is cut in half.  Do you see the game here?  Say together the couple has $30k of itemized deductions.  If Fred itemizes and deducts the $30k you might think Wilma could utilize the $12k standard deduction (remember the standard deduction ($24k) is cut in half for MFS taxpayers).  Congress was keen to this when the law was made which is why both taxpayers must use the same itemized or standard deduction choice i.e. no double dipping. 

There are many reasons for filing as MFS.  If Fred’s income is low and has significant itemized deductions that are phased out by adjusted gross income (AGI) and Wilma has few itemized deductions but high income it can make financial sense to file separately.  In this scenario Fred would get to deduct more of his itemized deductions than he would filing jointly because if Wilma’s income was included with Fred’s return, (MFJ), Fred’s deductions may get phased out.  The term “phased out” means benefits in the tax code that are taken away as the taxpayer’s income climbs.  This is the government’s way of saying, “the more money you made in a given tax year, the fewer deductions you need which results in more tax we think you can afford to pay”. 

Taxpayers may choose to file separately to keep their finances separate.  Some couples prefer to keep their income and the resulting taxation distinct.  Fred may believe in his mind that having Wilma’s income included with his would cause Fred to unjustly pay some of Wilma’s tax bill.  Another reason for the MFS status is one spouse doesn’t trust the other spouse.  If Fred believes Wilma is hiding illegally obtained forms of income Fred might feel more comfortable not signing a MFJ tax return he believes to be inaccurate or fraudulent. 

Sometimes income driven repayment plans on student loans can cause an advantage using MFS.  If Fred has high income and Wilma low income, if they file separately, it may benefit Wilma since the student loan repayment plan would look at her income only since the return only included her income.

When asked which filing status is better there is a report available within the software I use that shows the analysis between both filing statuses for that tax year.  It is very clear and lists both scenarios in a column format that is easy to understand.  This gets reviewed each year with the processing of the returns.

All of this sounds complex and it is.  Sometimes there are reasons outside of pure financial benefit that causes a taxpayer to go down the MFS route.  In rare cases the overall tax might be lower filing as MFS.  For a majority of taxpayers MFJ is the route to go.  Contact me if you have any questions.

The down and dirty of Opportunity Zones

Posted by Ben Miller, CPA Posted on May 03 2019

Opportunity Zones are a tax incentive created by the Tax Cuts and Jobs Act otherwise known as the Trump tax law.  These incentives are meant to provide an avenue for the taxpayer to defer capital gain income while encouraging investment in economically depressed areas.  If the taxpayer jumps through the necessary hoops significant tax savings is possible.

Great!  Now how do I go about reducing my tax bill?  

First, within 180 days of the sale that generated the capital gain, the capital gain is plowed into a qualified opportunity fund.  There are companies out there that administer qualified opportunity funds and ensure the necessary requirements are met.  The qualified opportunity fund will then invest in one of the qualified Opportunity Zones.

Kansas Opportunity Zones can be found here: https://www.kansascommerce.gov/programs-services/federal-opportunity-zones/opportunity-zones-map/.  The Missouri Opportunity Zones are found here: https://ded.mo.gov/content/opportunity-zones.  When looking at both maps you will see urban and rural areas that are qualified Opportunity Zones.  There are more than 8,700 designated Opportunity Zones across the country.

The law spurs taxpayers to leave the investment in the qualified opportunity fund.  The longer the investment is left in the fund, the more tax the taxpayer is able to avoid.  When the deferred capital gain is contributed to the qualified opportunity fund there is no basis in that initial investment.  Basis is what’s deducted from the selling price to determine the capital gain.  So the basis is zip, zero, nada up to the 5 year mark. 

Example 1 – Patrick sells his PayPal stock for a gain of $10,000 on July 2, 2018.  He then turns around on October 5, 2018 and invests the $10,000 into a qualified opportunity fund.  He decides to exit and sell his investment in the qualified opportunity fund on February 5, 2023 for $18,000.  Remember, if the investment in the fund has been held less than 5 years the basis is zero.  So, his gain would be $18,000.

Once the investment has been in the qualified opportunity fund for 5 years the taxpayer is eligible to exclude 10% of the original gain from tax.  After another 2 years another 5% of the original gain escapes tax. 

Example 2 – Same scenario as Example 1.  Instead, Patrick sells his investment in the qualified opportunity fund on December 20th, 2026 for $18,000.  After 7 years Patrick is able to use 15% of his original investment as basis.  His original investment/gain was $10,000 so $1,500 would be his basis.  So his total gain would be $16,500 ($18,000 less $1,500 basis).

Finally, after another 3 years, which is 10 years total, the taxpayer may sell their investment in the qualified opportunity fund and the sales proceeds are 100% tax free.  

Example 3 – Same scenario as Example 1.  Now, Patrick sells his investment in the qualified opportunity fund on August 5, 2028 for $18,000, meeting the 10 year holding requirement.  The $18,000 sale proceeds will result in $0 tax.

As you can see keeping the investment in the qualified opportunity fund for at least 7 years but not quite 10 years only gets you a relatively small tax savings when waiting until 10 years gets you the full 100% tax savings.

It’s clear that the tax code wants the taxpayer to keep the investment in the fund for at least 10 years.  This keeps investment in those distressed areas and as a carrot, gives the taxpayer an exclusion from tax when their interest in the qualified opportunity fund is sold.

The Opportunity Zone incentive hasn’t received a lot of attention.  As shown in the examples above there is tremendous opportunity available to avoid capital gains tax while increasing investment in the desired Opportunity Zone areas.  Contact me if you have any questions.

If Kansas de-couples from U.S. tax code will you be impacted?

Posted by Ben Miller, CPA Posted on Apr 30 2019

With passage of the Trump tax law in December 2017, states have a decision to make.  The new law impacts not only the Federal side but also the Kansas side for individuals filing returns.

Many states, including Kansas, “conform” to the Internal Revenue Code (IRC).  What this means, generally speaking, is the states follow the IRC with regard to what income is taxable and nontaxable, treatment of deductions, etc.  The more differences there are, the more difficult and fragmented the income tax return filing process becomes.  By “conforming” the states are trying to simplify the process.

One area where “conforming” is important is making the yearly choice of choosing the standard deduction or itemized deductions.  This past tax season (for tax year 2018) Kansas taxpayers felt this discrepancy.  The Kansas tax law states that if the taxpayer chooses the standard deduction on the Federal return, the standard deduction must be used on the Kansas return.  This may not sound like a big deal until you start to analyze the numbers.

Say a married couple has $23,500 of itemized deductions on their Federal return.  The new Trump tax law has bumped up the Federal married filing joint (MFJ) standard deduction to $24,000 for 2018.  Clearly the taxpayer will choose the larger standard deduction.  Kansas law states that because standard deduction was used on the Federal return, it must also be used on the Kansas return which is $7,500 for 2018.  Here’s the kicker: in some situations, depending on which itemized deductions were included in the $23,500 itemized deduction total, the couple might have owed less overall tax if the standard deduction was used on the Federal return and itemized deductions were used on the Kansas return.

Since some Kansas taxpayers are unable to use the itemized deductions on their Kansas return because the standard deduction was used on the Federal return, Kansas has seen a surge in income tax revenue.  The legislature in Topeka realized this after tax season started this spring.  A bill made its way through the Kansas legislature to de-couple from the U.S. tax code but was vetoed on March 25th.

There is talk around the capital that a bill to de-couple will come up again in May.  If a de-coupling bill passes with the retroactive language making it available to amend 2018 Kansas returns, all Kansas taxpayers should analyze if there is any advantage in amending their 2018 Kansas income tax returns.  Under these circumstances, many taxpayers would benefit from amending their returns.

There’s no way to know what the legislature will do when the bill comes up again.  If a bill is passed, taxpayers who thought they were done with taxes until next year will need to break out their trusty calculator again for the 2018 tax year.

 

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