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Factor in state and local taxes when deciding where to retire

Many Americans relocate to another state when they retire. If you’re thinking about such a move, state and local taxes should factor into your decision.

Income, property and sales tax

Choosing a state that has no personal income tax may appear to be the best option. But that might not be the case once you consider property taxes and sales taxes.

For example, suppose you’ve narrowed your decision down to two states: State 1 has no individual income tax, and State 2 has a flat 5% individual income tax rate. At first glance, State 1 might appear to be much less expensive from a tax perspective. What happens when you factor in other state and local taxes?

Let’s say the property tax rate in your preferred locality in State 1 is 5%, while it’s only 1% in your preferred locality in State 2. That difference could potentially cancel out any savings in state income taxes in State 1, depending on your annual income and the assessed value of the home.

Also keep in mind that home values can vary dramatically from location to location. So if home values are higher in State 1, there’s an even greater chance that State 1’s overall tax cost could be higher than State 2’s, despite State 1’s lack of income tax.

The potential impact of sales tax can be harder to estimate, but it’s a good idea at minimum to look at the applicable rates in the various retirement locations you’re considering.

More to think about

If states you’re considering have an income tax, also look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. Others offer tax breaks for retirement plan and Social Security income.

In the past, the federal income tax deduction for state and local property and income or sales tax could help make up some of the difference between higher- and lower-tax states. But with the Tax Cuts and Jobs Act (TCJA) limiting that deduction to $10,000 ($5,000 for married couples filing separately), this will be less help — at least through 2025, after which the limit is scheduled to expire.

There’s also estate tax to consider. Not all states have estate tax, but it can be expensive in states that do. While under the TJCA the federal estate tax exemption has more than doubled from the 2017 level to $11.18 million for 2018, states aren’t necessarily keeping pace with the federal exemption. So state estate tax could be levied after a much lower exemption.

Choose wisely

As you can see, it’s important to factor in state and local taxes as you decide where to live in retirement. You might ultimately decide on a state with higher taxes if other factors are more important to you. But at least you will have made an informed decision and avoid unpleasant tax surprises. Contact us to learn more.

 

 

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Save tax on restricted stock awards with the Sec. 83(b) election

Today many employees receive stock-based compensation from their employer as part of their compensation and benefits package. The tax consequences of such compensation can be complex — subject to ordinary-income, capital gains, employment and other taxes. But if you receive restricted stock awards, you might have a tax-saving opportunity in the form of the Section 83(b) election.

Convert ordinary income to long-term capital gains

Restricted stock is stock your employer grants you subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it.

At that time, you pay taxes on the stock’s fair market value (FMV) at your ordinary-income rate. The FMV will be considered FICA income, so it also could trigger or increase your exposure to the additional 0.9% Medicare tax.

But you can instead make a Sec. 83(b) election to recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

The Sec. 83(b) election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly. With ordinary-income rates now especially low under the Tax Cuts and Jobs Act (TCJA), it might be a good time to recognize such income.

Weigh the potential disadvantages

There are some potential disadvantages, however:

  • You must prepay tax in the current year — which also could push you into a higher income tax bracket or trigger or increase the additional 0.9% Medicare tax. But if your company is in the earlier stages of development, the income recognized may be relatively small.
  • Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or sell it at a decreased value. However, you’d have a capital loss in those situations.
  • When you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8% net investment income tax.

It’s complicated

As you can see, tax planning for restricted stock is complicated. Let us know if you’ve recently been awarded restricted stock or expect to be awarded such stock this year. We can help you determine whether the Sec. 83(b) election makes sense in your specific situation.

The TCJA changes rules for deducting pass-through business losses

It’s not uncommon for businesses to sometimes generate tax losses. But the losses that can be deducted are limited by tax law in some situations. The Tax Cuts and Jobs Act (TCJA) further restricts the amount of losses that sole proprietors, partners, S corporation shareholders and, typically, limited liability company (LLC) members can currently deduct — beginning in 2018. This could negatively impact owners of start-ups and businesses facing adverse conditions.

Before the TCJA

Under pre-TCJA law, an individual taxpayer’s business losses could usually be fully deducted in the tax year when they arose unless:

  • The passive activity loss (PAL) rules or some other provision of tax law limited that favorable outcome, or
  • The business loss was so large that it exceeded taxable income from other sources, creating a net operating loss (NOL).

After the TCJA

The TCJA temporarily changes the rules for deducting an individual taxpayer’s business losses. If your pass-through business generates a tax loss for a tax year beginning in 2018 through 2025, you can’t deduct an “excess business loss” in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

  • Your aggregate business income and gains for the tax year, and
  • $250,000 ($500,000 if you’re a married taxpayer filing jointly).

The excess business loss is carried over to the following tax year and can be deducted under the rules for NOLs.

For business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes, the new excess business loss limitation rules apply at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on the owner’s personal federal income tax return for the owner’s tax year that includes the end of the entity’s tax year.

Keep in mind that the new loss limitation rules apply after applying the PAL rules. So, if the PAL rules disallow your business or rental activity loss, you don’t get to the new loss limitation rules.

Expecting a business loss?

The rationale underlying the new loss limitation rules is to restrict the ability of individual taxpayers to use current-year business losses to offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains.

The practical impact is that your allowable current-year business losses can’t offset more than $250,000 of income from such other sources (or more than $500,000 for joint filers). The requirement that excess business losses be carried forward as an NOL forces you to wait at least one year to get any tax benefit from those excess losses.

If you’re expecting your business to generate a tax loss in 2018, contact us to determine whether you’ll be affected by the new loss limitation rules. We can also provide more information about the PAL and NOL rules.

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Do you need to adjust your withholding?

If you received a large refund after filing your 2017 income tax return, you’re probably enjoying the influx of cash. But a large refund isn’t all positive. It also means you were essentially giving the government an interest-free loan.

That’s why a large refund for the previous tax year would usually indicate that you should consider reducing the amounts you’re having withheld (and/or what estimated tax payments you’re making) for the current year. But 2018 is a little different.

The TCJA and withholding

To reflect changes under the Tax Cuts and Jobs Act (TCJA) — such as the increase in the standard deduction, suspension of personal exemptions and changes in tax rates and brackets — the IRS updated the withholding tables that indicate how much employers should hold back from their employees’ paychecks, generally reducing the amount withheld.

The new tables may provide the correct amount of tax withholding for individuals with simple tax situations, but they might cause other taxpayers to not have enough withheld to pay their ultimate tax liabilities under the TCJA. So even if you received a large refund this year, you could end up owing a significant amount of tax when you file your 2018 return next year.

Perils of the new tables

The IRS itself cautions that people with more complex tax situations face the possibility of having their income taxes underwithheld. If, for example, you itemize deductions, have dependents age 17 or older, are in a two-income household or have more than one job, you should review your tax situation and adjust your withholding if appropriate.

The IRS has updated its withholding calculator (available at irs.gov) to assist taxpayers in reviewing their situations. The calculator reflects changes in available itemized deductions, the increased child tax credit, the new dependent credit and repeal of dependent exemptions.

More considerations

Tax law changes aren’t the only reason to check your withholding. Additional reviews during the year are a good idea if:

  • You get married or divorced,
  • You add or lose a dependent,
  • You purchase a home,
  • You start or lose a job, or
  • Your investment income changes significantly.

You can modify your withholding at any time during the year, or even multiple times within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically will go into effect several weeks after the new Form W-4 is submitted. (For estimated tax payments, you can make adjustments each time quarterly payments are due.)

The TCJA and your tax situation

If you rely solely on the new withholding tables, you could run the risk of significantly underwithholding your federal income taxes. As a result, you might face an unexpectedly high tax bill when you file your 2018 tax return next year. Contact us for help determining whether you should adjust your withholding. We can also answer any questions you have about how the TCJA may affect your particular situation.

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Get started on 2018 tax planning now!

With the April 17 individual income tax filing deadline behind you (or with your 2017 tax return on the back burner if you filed for an extension), you may be hoping to not think about taxes for the next several months. But for maximum tax savings, now is the time to start tax planning for 2018. It’s especially critical to get an early start this year because the Tax Cuts and Jobs Act (TCJA) has substantially changed the tax environment.

Many variables

A tremendous number of variables affect your overall tax liability for the year. Looking at these variables early in the year can give you more opportunities to reduce your 2018 tax bill.

For example, the timing of income and deductible expenses can affect both the rate you pay and when you pay. By regularly reviewing your year-to-date income, expenses and potential tax, you may be able to time income and expenses in a way that reduces, or at least defers, your tax liability.

In other words, tax planning shouldn’t be just a year-end activity.

Certainty vs. uncertainty

Last year, planning early was a challenge because it was uncertain whether tax reform legislation would be signed into law, when it would go into effect and what it would include. This year, the TCJA tax reform legislation is in place, with most of the provisions affecting individuals in effect for 2018–2025. And additional major tax law changes aren’t expected in 2018. So there’s no need to hold off on tax planning.

But while there’s more certainty about the tax law that will be in effect this year and next, there’s still much uncertainty on exactly what the impact of the TCJA changes will be on each taxpayer. The new law generally reduces individual tax rates, and it expands some tax breaks. However, it reduces or eliminates many other breaks.

The total impact of these changes is what will ultimately determine which tax strategies will make sense for you this year, such as the best way to time income and expenses. You may need to deviate from strategies that worked for you in previous years and implement some new strategies.

Getting started sooner will help ensure you don’t take actions that you think will save taxes but that actually will be costly under the new tax regime. It will also allow you to take full advantage of new tax-saving opportunities.

Now and throughout the year

To get started on your 2018 tax planning, contact us. We can help you determine how the TCJA affects you and what strategies you should implement now and throughout the year to minimize your tax liability.

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Casualty losses provide a 2017 deduction; rules tighten for 2018

If you suffered damage to your home or personal property last year, you may be able to deduct these “casualty” losses on your 2017 federal income tax return. For 2018 through 2025, however, the Tax Cuts and Jobs Act suspends this deduction except for losses due to an event officially declared a disaster by the President.

What is a casualty? It’s a sudden, unexpected or unusual event, such as a natural disaster (hurricane, tornado, flood, earthquake, etc.), fire, accident, theft or vandalism. A casualty loss doesn’t include losses from normal wear and tear or progressive deterioration from age or termite damage.

Here are some things you should know about deducting casualty losses on your 2017 return:

When to deduct. Generally, you must deduct a casualty loss on your return for the year it occurred. However, if you have a loss from a federally declared disaster area, you may have the option to deduct the loss on an amended return for the immediately preceding tax year.

Amount of loss. Your loss is generally the lesser of 1) your adjusted basis in the property before the casualty (typically, the amount you paid for it), or 2) the decrease in fair market value of the property as a result of the casualty. This amount must be reduced by any insurance or other reimbursement you received or expect to receive. (If the property was insured, you must have filed a timely claim for reimbursement of your loss.)

$100 rule. After you’ve figured your casualty loss on personal-use property, you must reduce that loss by $100. This reduction applies to each casualty loss event during the year. It doesn’t matter how many pieces of property are involved in an event.

10% rule. You must reduce the total of all your casualty losses on personal-use property for the year by 10% of your adjusted gross income (AGI). In other words, you can deduct these losses only to the extent they exceed 10% of your AGI.

Note that special relief has been provided to certain victims of Hurricanes Harvey, Irma and Maria and California wildfires that affects some of these rules. For details on this relief or other questions about casualty losses, please contact us.

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5 estate planning tips for the sandwich generation

The “sandwich generation” accounts for a large segment of the population. These are people who find themselves caring for both their children and their parents at the same time. In some cases, this includes providing parents with financial support. As a result, estate planning — which traditionally focuses on providing for one’s children — has expanded in many cases to include aging parents as well.

Including your parents as beneficiaries of your estate plan raises a number of complex issues. Here are five tips to consider:

1. Plan for long-term care (LTC). The annual cost of LTC can reach well into six figures. These expenses aren’t covered by traditional health insurance policies or Medicare. To prevent LTC expenses from devouring your parents’ resources, work with them to develop a plan for funding their health care needs through LTC insurance or other investments.

2. Make gifts. One of the simplest ways to help your parents financially is to make cash gifts to them. If gift and estate taxes are a concern, you can take advantage of the annual gift tax exclusion, which allows you to give each parent up to $15,000 per year without triggering taxes.

3. Pay medical expenses. You can pay an unlimited amount of medical expenses on your parents’ behalf, without tax consequences, so long as you make the payments directly to medical providers.

4. Set up trusts. There are many trust-based strategies you can use to financially assist your parents. For example, in the event you predecease your parents, your estate plan might establish a trust for their benefit, with any remaining assets passing to your children when your parents die.

5. Buy your parents’ home. If your parents have built up significant equity in their home, consider buying it and leasing it back to them. This arrangement allows your parents to tap their home equity without moving out while providing you with valuable tax deductions for mortgage interest, depreciation, maintenance and other expenses. To avoid negative tax consequences, be sure to pay a fair price for the home (supported by a qualified appraisal) and charge your parents fair-market rent.

As you review these and other options for providing financial assistance to your aging parents, try not to overdo it. If you give your parents too much, these assets could end up back in your estate and potentially exposed to gift or estate taxes. Also, keep in mind that some gifts could disqualify your parents from certain federal or state government benefits. Contact us for additional details.

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Follow these IRS rules to receive your charitable tax deductions

If reducing your taxable estate is an important estate planning goal, making lifetime charitable donations can help achieve that goal and benefit your favorite organizations. In addition, by making donations during your lifetime, rather than at death, you can claim income tax deductions. But some of your charitable deductions could be denied if you don’t follow IRS rules.

3 things to be aware of

First, the recipient charity must be a qualified charitable organization: It must have a tax-exempt status. The IRS has developed a tool on its website — the Exempt Organizations Select Check — that allows users to search for a specific tax-exempt organization, check its federal tax status and learn about tax forms the charity may file that are up for public review.

Second, the timing of pledging vs. payment of your charitable contributions can affect your deduction. Why? For most taxpayers, contributions are deductible only in the tax year they’re made. So if you pledged $5,000 in October of 2017, but paid only $1,500 of your pledge to the charity by December 31, 2017, you’re allowed to deduct only the $1,500 amount on your 2017 tax return.

Third, if you donate property and receive something in return, it’s important to know the fair market value of each item. For example, if you donate a flat screen TV to your child’s school and receive two tickets to a sporting event in return for your donation, you must first determine the value of your donation. Then you may deduct only the amount exceeding the fair market value of the two tickets.

Substantiate your donations

Be aware that substantiation rules also apply when giving cash or property to charity, and they vary based on the type and amount of the donation. For example, cash gifts of $250 or more require a “contemporaneous” written acknowledgment from the charity that includes information such as the gift’s amount and date and the estimated value of any goods or services received. For smaller gifts, a canceled check or credit card receipt may be sufficient.

If you’ve made substantial charitable donations, their deductibility depends on compliance with IRS rules, which go far beyond what we’ve discussed here. When in doubt, contact us to be sure you’ve dotted all the i’s and crossed all the t’s.

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Only certain trusts can own S corporation stock

S corporations must comply with several strict requirements or risk losing their tax-advantaged status. Among other things, they can have no more than 100 shareholders, can have no more than one class of stock and are permitted to have only certain types of shareholders.

In an estate planning context, it’s critical that any trusts that will receive S corporation stock through operation of your estate plan be eligible shareholders.

Which trusts are eligible?

Eligible trusts include:

Grantor trusts. A grantor trust is eligible provided that it has one “deemed owner” who’s a U.S. citizen or resident and meets certain other requirements. Also, when the grantor dies, the trust remains an eligible shareholder for two years, after which it must distribute the stock to an eligible shareholder or qualify as a qualified subchapter S trust (QSST) or an electing small business trust (ESBT).

Testamentary trusts. These trusts, which are established by your will, are eligible S corporation shareholders for up to two years after the transfer and then must either distribute the stock to an eligible shareholder or qualify as a QSST or ESBT.

QSSTs. These trusts must meet several requirements, including distributing all current income to a single beneficiary who’s a U.S. citizen or resident and filing an election with the IRS. They cannot be used to benefit multiple beneficiaries or to accumulate income, although in effect there can be multiple beneficiaries if they’re treated as each owning a separate share of the trust. A QSST’s income is taxed at the beneficiary’s tax rate.

ESBTs. A trust qualifies as an ESBT if 1) all of its beneficiaries or “potential current beneficiaries” would be eligible shareholders if they held the stock directly, 2) no beneficiary purchases its interest and 3) the trustee files an election with the IRS.

If you have any S corporation stock that will be distributed to a trust, be sure to review its terms carefully to ensure it couldn’t inadvertently disqualify the S corporation. Contact us with further questions.

Be Aware of Tax Consequences Before You Sell Your Home

In many parts of the country, summer is peak season for selling a home. If you’re planning to put your home on the market soon, you’re probably thinking about things like how quickly it will sell and how much you’ll get for it. But don’t neglect to consider the tax consequences.

Home sale gain exclusion

The U.S. House of Representatives’ original version of the Tax Cuts and Jobs Act included a provision tightening the rules for the home sale gain exclusion. Fortunately, that provision didn’t make it into the final version that was signed into law.

As a result, if you’re selling your principal residence, there’s still a good chance you’ll be able to exclude up to $250,000 ($500,000 for joint filers) of gain. Gain that qualifies for exclusion also is excluded from the 3.8% net investment income tax.

To qualify for the exclusion, you must meet certain tests. For example, you generally must own and use the home as your principal residence for at least two years during the five-year period preceding the sale. (Gain allocable to a period of “nonqualified” use generally isn’t excludable.) In addition, you can’t use the exclusion more than once every two years.

More tax considerations

Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, as long as you owned the home for at least a year. If you didn’t, the gain will be considered short-term and subject to your ordinary-income rate, which could be more than double your long-term rate.

Here are some additional tax considerations when selling a home:

Tax basis. To support an accurate tax basis, be sure to maintain thorough records, including information on your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed based on business use.

Losses. A loss on the sale of your principal residence generally isn’t deductible. But if part of your home is rented out or used exclusively for your business, the loss attributable to that portion may be deductible.

Second homes. If you’re selling a second home, be aware that it won’t be eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 exchange. Or you may be able to deduct a loss.

A big investment

Your home is likely one of your biggest investments, so it’s important to consider the tax consequences before selling it. If you’re planning to put your home on the market, we can help you assess the potential tax impact. Contact us to learn more.