Prince’s Million Dollar a Mile Mistake
Filed under: General, Trusts and Estates | Tags: $5.45 million, 10 years, 12 months, 4 years, 706, appraisal, Bremer Trust, Carlin Williams, Estate Tax, Extension, Gift Tax, heirs, Inheritance Tax, John, M706, Minnesota, musician, nine months, Norman Yates Carthens, Norrine, Prince, Prince Rogers Nelson, Sharon, Tyka Nelson
Comments (1) Originally published in the Cedar Street Times
June 10, 2016
Unless you have been living under a rock, you have certainly heard by now that musician, Prince Rogers Nelson, passed away on April 21, 2016. Unfortunately, he did no advance estate planning which means it is going to be an expensive, public, and litigious affair that will probably last for years.
I have seen estimates of his net worth in the media ranging from $250-$800 million. Obviously, there is all the easy stuff to value – cash, stocks, bonds, real estate, and personal property. But putting a value on things like his future royalties on music sales, video sales, his brand image, licensing of his lyrics or music to other artists to cover his songs, etc. is quite a task.
And what about the purported 2,000 or so unreleased songs he is said to have. How many hits are in there? Do you think an appraiser is going to sit in a room and listen to songs or read sheet music and put a value on each of them? And once they come up with a dollar figure, then they have to discount it to the present value, so they would really need to consult their crystal ball for future interest rates, etc.
At one point in my career I worked with the family of a famous deceased musician, and I can tell you first hand that a lot of future value will be determined by how well his heirs maintain or expand the “Prince business machine” that will continue to promote his music and keep it alive, and keep people buying it. And if the estate gets split up between multiple heirs that do not know each other, there will certainly be a decrease in value. The last I checked, there was a sister, three half-siblings, and two people claiming to be his son, one of which is in prison, all vying for a piece of Prince’s estate. So you might have to work with all of these people to buy the rights you need!
Prince certainly is not the first musician to have his estate valued, and there are accepted norms of how appraisers come to values, but I can tell you this much, whatever number they come to will not even be close to correct! And there will certainly be a lot of negotiating between IRS appraisers and appraisers hired by Bremer Trust, the wealth management firm appointed to handle his estate.
And by the way, all of this is supposed to be done and estate taxes calculated and paid within nine months…in a perfect world. The Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return, which will list every single asset in his estate, (right down to the change in his pockets) with descriptions, values, and support for valuations is due January 21, 2017. It is the mother of all tax returns.
The administrator of the estate can file a six month extension for the return, and the IRS can grant an additional year to pay the tax, but interest will start accruing on any unpaid tax after January 21st. In situations with reasonable cause, the IRS can grant additional one year extensions for up to four and sometimes up to 10 years to pay the tax. Although, they could also be assessed additional penalties. The estate could also do an installment agreement for up to 14 years to pay the tax over time.
The extensions of time to pay, although not granted easily, are designed to protect the interests of the heirs and the IRS. With a massive estate and so many unknown quantities and litigation, you would have to have a fire sale to generate enough cash to pay the estate tax within nine months.
So how much estate tax will be paid?
The federal return will provide for a $5.45 million exemption for people dying in 2016. That assumes that he made no lifetime gifts over the annual exclusion amount (currently $14,000 per person per year, and less in prior years). It would be silly to assume someone of his wealth made no large gifts to individuals during his lifetime. From what I have read about Prince, he probably made quite a few. Any gifts he made in excess of the annual exclusion amounts would reduce his $5.45 million exemption. For simplicity, though, let’s assume he made none. So the first $5.45 million is tax free. The rate of tax then slides from 18 percent on value in excess of $5.45 million to the top rate of 40 percent on everything over $6.45 million. So for the first $6.45 million of his estate, a tax of $345,800 will be paid, and then 40 percent on everything over that.
Let’s assume his estate ends up being valued at $550 million and there ends up being $50 million in litigation and estate expenses leaving $500 million potentially taxable. His federal estate tax would be $197,765,800.
Ahh, but Prince lived in Minnesota! He was unfortunate enough to make his home in one of the 19 states (plus Washington DC) that have their own estate and/or inheritance tax.
Due to his residency the estate will also need to file a Form M706, the Minnesota equivalent of the federal Form 706. Minnesota will have a $1.6 million exemption. The rate of tax then slides from ten percent on value in excess of $1.6 million to the top rate of 16 percent on everything over $10,300,000. So for the first $10,300,000 of his estate a tax of $1,080,000 will be paid, and $1,600,000 for each additional $10,000,000. So his Minnesota estate tax will be $79,432,000.
The Minnesota estate tax paid will fortunately be an additional deduction on the federal return. So 40 percent of $79,432,000 will reduce the federal estate tax bill by $31,772,800, resulting in a $165,993,000 balance.
That will bring his total estate tax bill to $245,425,000, or roughly 49 percent, leaving his heirs with $254,575,000 to split up.
Besides all of the typical and sometimes fancy estate planning that could have been done to avoid costly litigation, and perhaps save tax through things like irrevocable life insurance trusts and other tricks up an estate planners sleeve, I wonder if he ever simply considered setting up shop 45 miles away across the St. Croix river in Wisconsin? It might have saved his estate $47 million – that is over $1 million per mile!
Although most people do not have $245 million estate tax bills for their heirs to worry about (or any estate tax at all), planning in advance and understanding the rules surrounding your tax and financial life is always important. Sometimes even little things, learned early, can make a big difference. And building a relationship with someone that can keep you on the right track is certainly of value.
Prior articles are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Why I am a Tax Accountant?
Sometimes people ask me why I am a tax accountant. This question seems to have different colors to it when asked. Sometimes it is an interest in me – what things I find enjoyable about the profession or how my particular career path led me to where I am. Sometimes it is an interest in themselves as they are “trying on” my work clothes to see if this field may be of interest to them in some capacity. And other times it is an interest in the general human condition probing for answers to: “How in the world could anyone in their right mind, voluntarily do what you do?”
Prior articles are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Do You Know What a Mortgage Really Is?
Filed under: General | Tags: deed of trust, escrow, mortgage, mortgagee, mortgagor
Leave a Comment Prior articles are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
It’s Friday April 15 and Taxes Aren’t Due?
Filed under: General | Tags: Abraham Lincoln, April 15, April 18, District of Columbia Compensated Emancipation Act, due date, Emancipation Day, Emancipation Proclamation, IRS, slavery, slaves, tax returns
Leave a Comment Originally published in the Cedar Street Times
April 15, 2016
If you were (or still are!) a last minute tax return filer, you may have some pleasant news this year – you have three more days to procrastinate! If you are reading this article on April 15, you might be wondering, “Why is it a normal workday, and my taxes are not due?”
The answer is “Emancipation Day.” No, we are not talking about emancipation from taxation, but emancipation from slavery. On April 16, 1862, President Lincoln signed the District of Columbia Compensated Emancipation Act. This act freed slaves in Washington, D.C., and compensated the prior slave owners for having to give up what was perceived as a financial loss. This was the only instance were prior slave owners were compensated by the federal government.
The importance of the District of Columbia Compensated Emancipation Act is that it was seen as the first major victory that led to the abolition of slavery. There had been attempts in the past to accomplish similar feats, but they had all failed. In fact, when Abraham Lincoln was still a Senator, he tried in 1849 to accomplish this task, but it did not get enough votes to pass the legislature. Even the decade prior to that saw several failed attempts spearheaded by others.
The District of Columbia Compensated Emancipation Act served as a precursor to the much broader Emancipation Proclamation, nine months later, that freed all slaves in Confederate territories. Whereas the District of Columbia Compensated Emancipation Act freed about 3,000 enslaved people, the Emancipation Proclamation freed about three million enslaved people!
The Emancipation Proclamation, although often thought of as abolishing slavery, did not actually do so. It was a wartime power instituted by Lincoln (not voted on by Congress), and it only freed slaves in the Confederate territories that were rebelling. There were still four non-Confederate states in the South where slavery was legal, even after the Emancipation Proclamation. It was not until the 13th Amendment to the Constitution was passed, and then ratified on December 6, 1865, that slavery was officially abolished in the United States.
The District of Columbia Compensated Emancipation Act, although celebrated in various capacities since 1862, did not become an official legal holiday in Washington D.C. until 2005. The first year the tax return filing deadline was changed was for the 2006 tax returns due April 17, 2007. Since the Emancipation Day Celebration fell on a Monday, and the IRS deadline is always the next business day if the 15th falls on a nonbusiness day, the due date was bumped to Tuesday the 17th. That year, only Washington D.C. residents received an extra day, and everybody else still had to file on April 16.
Tax year 2011 was the next conflict, and the first time the whole country received an extra day, and is just like this year where April 15 falls on a Friday. Whereas, the IRS moves their due date to the next business day when April 15 falls on a nonbusiness day, the Emancipation Day celebration moves to the prior business day. Since April 16 was a Saturday in 2011, as it is now, Emancipation Day moves its celebration to Friday April 15, and then the IRS turns around and says, “Okay, today is a holiday, so we move our due date to the next business day,” which results in Monday the 18th! Phew! And fortunately California says, “We will just do whatever the IRS does,” – a rare but appreciated concession in a state that enjoys nonconformity.
Prior articles are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics – Part XXXVI – Form 9465 Installment Agreement
Filed under: Back to Basics, Tax Collections | Tags: 433-F, Form 3537, Form 9465, installment agreement, interest, offer in compromise, Penalties
Leave a Comment Originally published in the Cedar Street Times
April 1, 2016
After more than a year, our Back to Basics series has come to an end. We covered the 1040, all the major Schedules (A, B, C, D, E, and F) and 27 of the most common forms. To access any articles from the past you can read them on my website atwww.tlongcpa.com/blog .
For our last article, we have some wonderful news! The IRS recently announced that starting next year, on a three-year trial basis, they are moving to a voluntary income tax system. You will be asked to pay what you feel is fair and what you can afford, but there will be no requirement to actually pay income tax.
If you haven’t picked up on the date of this publication yet, it is April Fool’s Day; this utopian ideal will have to sit on the shelf a little longer! But, if you do find yourself in a situation where you owe more than you can manage to part with by the due date of April 18th, there are some options for you. Remember that even if you file an extension, the tax is still due by April 18th this year.
The IRS says that if you can pay your balance due in full within four months of the April 18 due date you can simply call them at 800-829-1040 and advise them of this. You will still have to pay interest (currently 3 percent per annum) and penalties (0.5 percent of the unpaid balance per month – effectively another 6 percent per annum) until paid in full, but you will not have to setup an installment agreement…which is your next option.
If you think you will need more than four months to pay off the balance, then you need to set up an installment agreement to avoid letters threatening actions such as liens, asset seizure, and taking your first-born child. Well, maybe the first-born child part is a little overdramatic. Even the concept of seizing assets, although splashed across notices relatively early in the collection phase, is hardly ever a reality, and you would likely have to have a $100K or more tax bill before they would consider taking and selling off your assets. Wage garnishments and liens do happen more often, however.
An advantage to an installment agreement, is that it cuts the late payment penalty in half – from 0.5 percent per month to 0.25 percent per month. There is a $120 charge from the IRS to setup and installment agreement, but I recommend you have direct debit setup to take the payment directly out of your bank account each month. This reduces the fee from $120 down to $52. It also prevents you from accidentally missing a payment. If you fail to make a payment, you can be kicked out of the program, and have to reapply, and pay a new fee. Also, if you have a balance from an old year, and you need to add to it, you generally have to setup a new installment agreement as well.
You can file for an installment agreement using IRS Form 9465. This can be e-filed with your tax returns, or mailed by paper. Or, you can set it up online at http://www.irs.gov. If you owe less than $25,000, you will generally be approved without any hassle, as long as you have a good filing history. You can take the balance owed and divide by up to 72 months. I generally recommend that you keep the monthly commitment low so you know you will not fail to be able pay some month and then get kicked out – but go ahead and make extra payments whenever you can to pay it down faster. Even if you owe up to $50,000, you can still get automatic approval, but you will need to fill out page two of the 9465 that asks a few more financial questions.
If you owe over $50,000, then you also have to send in a 433-F Collection Information Statement. This has a lot more specific questions about your finances, and is pretty much like providing personal financial statements.
California has a similar installment agreement process, but the amounts and rules differ a bit. California generally only allows an automatic installment agreement if you have up to $10,000 of unpaid tax liability. You can go up to $25,000, but you have to show that you have a financial hardship (not by your definition, however!).
The late payment penalties are five percent of the total unpaid tax liability during the first month, and then 0.5 percent each month thereafter until paid in full (capping at 25 percent like the federal does.) The interest rate is currently the same as the federal three percent rate. The fee to apply is $34, and you must pay off the balance in less than three years. I typically recommend just paying the FTB off, if possible, and then only dealing with the IRS on one installment agreement.
The California installment agreement request is made on Form 3567. You can also fill it out online at ftb.ca.gov by choosing “Installment Agreement” under the “Pay” section. Your other option is to call the FTB at 800-689-4776.
Finally, there are also options for an offer in compromise, if you clearly will not be able to pay off your tax debts in the future based on your income and certain expenses. The process is fairly mechanical, and you generally will either qualify or you will not. It is not like you sit around and negotiate the amount.
Be wary of ads you see on TV or on the radio that talk about getting rid of your tax debts. A retired collection officer at the IRS of 30 years once told me that many of these groups charge you fees go through all the work to fill out the forms and gather the information whether or not you even have a remote chance of qualifying. Then you simply get rejected, and you are in a worse position than when you started. Instead, they could do some preliminary analysis, and not generate a lot of busy work for themselves.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics Part XXXV – Form 8959 Additional Medicare Tax and Form 8960 – Net Investment Income Tax
Filed under: Back to Basics | Tags: 0.9%, 3.8%, 500 hours, Additional Medicare Tax, alimony, Capital Gains, capital gains distributions, compressed bracket, dividend income, estates, fiduciary expenses, Form 8814, Form 8959, Form 8960, interest income, investment advisory fees, Investment Interest Expense, material participation, Net Investment Income Tax, NIIT, real estate professional, retirement plan distributions, Social Security, state taxes, tax preparation fees, tax-exempt interest income, trusts, unemployment, wages
Leave a Comment Originally published in the Cedar Street Times
March 25, 2016
Forms 8959 and 8960 are two relatively new forms that started with the 2014 tax year. These are two of quite a number of tax increases that are being used to help fund ObamaCare. Both of these forms affect people with income in excess of $200,000 for Single filers or 250,000 for Married Filing Jointly.
Form 8959 is the Additional Medicare Tax. It is an additional 0.9% Medicare Part A tax on combined W-2 and self-employment wages in excess of the above stated thresholds. Note that it is not based on W-2 box 1 taxable wages, but on Medicare wages which are often higher for most people. Pretax deductions such as contributions to retirement plans are included in Medicare wages, whereas they are not included in box 1 taxable wages.
Employers have to start collecting this additional tax once your wages hit the thresholds. However, if you changed jobs during the year, the second employer will not withhold until the wages your earn with that employer reaches the thresholds. This means that you could owe additional tax when you file your tax returns for the shortfall, since the new employer and old employer do not communicate to coordinate this tax. For self-employed people, you would of course be sending in quarterly estimates of your income and self-employment tax liability, and the calculation of this new tax would be made on your income tax returns at year-end.
The Form 8960 is the Net Investment Income Tax (NIIT). Once your income meets the thresholds previously discussed, you will also have an additional 3.8% tax on all investment related income. This would include income sources such as interest income, dividend income, annuities, rents, royalties, capital gains distributions from mutual funds and capital gains from the sale of investments such as stocks and bonds. Even real estate professionals would be subject to NIIT on their own rental real estate activities, unless they meet the material participation test specifically in rental real estate, which is a separate test from time spent in real estate sales activities, for instance.
If you own an interest in a business and you are not materially participating in the business, this income will also be subject to the net investment income tax. Material participation generally means 500 hours or more during the year. The sale of rental property and even second homes are also subject to NIIT. If you sell an interest in a partnership or s-corporation and do not materially participate in the business, you will also be subject to NIIT on any gains from those sales. Investment income from your children that are taxed on your returns through Form 8814 are also subject to NIIT.
Wages, unemployment compensation, alimony, Social Security benefits, tax-exempt interest income, income subject to self-employment taxes, and income from qualified retirement plan distributions are specifically excluded from the tax.
There are also some deductions that can be used to offset NIIT. These expenses included investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes.
Regarding trusts and estate, it is important to note that the thresholds for NIIT are much lower. Due to the compressed income tax bracket structure, NIIT kicks in when the trust or estate reaches the highest income tax bracket at only $12,300 of income (2015). This provides additional incentive for trustees to push income out to the beneficiaries since many trusts will be subject to NIIT, but the beneficiaries are often not subject due to the much higher thresholds for individuals.
Planning can be an important tool to lower the impact of NIIT.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics Part XXXIV – Form 8938 – Statement of Specified Foreign Financial Assets
Filed under: Back to Basics, Foreign Reporting | Tags: FBAR, FinCen 114, foreign income, Form 8938, Statement of Specified Foreign Financial Assets, TD F 90-22.1
Leave a Comment Originally published in the Cedar Street Times
March 4, 2016
For those of you living in the US (not just US citizens) with foreign bank accounts, foreign securities accounts, ownership interests in foreign corporations, partnerships, or other foreign potentially income generating assets, you may have a reporting requirement on Form 8938 – Statement of Specified Foreign Financial Assets. Failure to report on this form carries with it significant penalties, so you want to be sure you are in compliance if you have assets of this type.
You may have heard about the Report of Foreign Bank and Financial Accounts (FBAR) which is currently filed on a Form FinCen 114 with the US Treasury Department (a few years ago the form was called a TD F-90-22.1) each year. That form received a lot of press a few years ago as some of the large banks overseas cooperated with the US government to release the names of account holders living in the US, and is also tied to some of the amnesty programs you may have read about. This often conjures up images of mutli-millionaires hiding money overseas to avoid paying US taxes. Although this may be a component of it, I can assure you that it touches “normal” people as well that just happened to have foreign accounts, perhaps from living in a foreign country years ago, and still have the account, or maybe just living in the US for a few years and on a US work visa.
If you are reading this article, and thinking, “I have never heard of this before,” you likely have a relatively easy solution for the FBAR that will not result in huge monetary fines. This often consists of filing amended tax returns for the past three open tax years to report any income generated on these accounts, and filing FBARs for the past six years. But you must do this before the IRS discovers it – so do not bury your head in the sand.
Whereas the FBAR can attribute its roots in the Bank Secrecy Act passed by Congress in 1970 and is filed separately from your tax returns with the US Treasury Department, the Form 8938 has only been around since 2011, and is filed as a form with your tax returns. The Form 8938 has different reporting requirements as well. Whereas the FBAR is focused on foreign bank and securities accounts whose aggregate value of all accounts exceeds $10,000 at any point during the year, the Form 8938 is broader and includes more foreign income generating assets, and is only required if the aggregate value at year end is over $50,000 or if the maximum value at any point during the year is over $75,000 for single and married filing separate filers or $100,000 at year end/$150,000 maximum value if married filing jointly.
Since the US taxes people residing in the US on worldwide income, (and so does California), the IRS wanted a way to ensure that the income from foreign accounts was being properly included on the US tax returns. The FBAR does not do this, so the 8938 was created.
Parts I and II of the Form 8938 are a summary of the various types of specified foreign financial assets that you are reporting. Part III is a cross-reference to the forms and line numbers in the tax return where any income generated by these assets is included. Part IV is a cross-reference to foreign assets whose detail is not reported on the 8938 itself, but on other form specifically designed for those types of assets. Parts V and VI are the specific details of each account listed in parts I and II, and include things like account numbers, addresses, amounts, foreign currency conversions, etc.
You can easily download the instructions to the Form 8938 online if you would like to learn more about the reporting requirements. Even if you do not have a Form 8938 or FBAR filing requirement, you are still required to report on your US tax returns any foreign income earned by the accounts. With many countries there are also tax treaties in place to prevent double taxation.
Please keep in mind, there are complex issues involved with these reportings, and depending on the assets, you may require the assistance of an accountant or attorney.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics Part XXXIII – Form 8889 – Health Savings Accounts (Cont.)
Filed under: Back to Basics, Healthcare Costs | Tags: beneficiary, custodian, death, directly paid, estate, Form 8889, health savings account, HSA, itemized deductions, medical expenses, nonqualified distribution, over 65, prohibited transactions, qualified distribution, reimbursement, Schedule A, Section 4975, self-dealing, separate HSA accounts, spouses
Leave a Comment Originally published in the Cedar Street Times
February 19, 2016
Two weeks ago we started a discussion on Health Savings Accounts. We discussed why they are so valuable, how you qualify for an HSA, what type of an account it is, how you contribute to it, whether or not you can fund it with an IRA transfer, and what you can spend the money on and for whom. If you would like to read the article, you can find it on my website at www.tlongcpa.com/blog .
Do Expenses Have to Be Paid Directly From the HSA?
Another important tip is that technically you do not have to pay the medical expenses directly from the HSA account. You can reimburse yourself if needed. In fact, you can reimburse yourself at any point in the future from your HSA account for qualified expenses that were incurred at any point after you first established the HSA. It could be ten years later or more, and you can still reimburse yourself as long as you keep really good records, and can prove you did not deduct those expenses somewhere else, such as on Schedule A, or pay for them out of the HSA account in the past. Then you can reimburse yourself for them in the current year and treat the reimbursement as a qualified distribution, and not be subject to any tax or penalties.
This could come in very handy if some year you have a big expense, but do not have enough money in the account to cover it all. You could pay yourself back over a period of years. Remember, by paying the expenses out of this account, you have been able to use pretax dollars to pay for or reimburse yourself for medical expenses you incurred. That said, I would recommend always paying directly from the HSA account unless it is impossible to do so.
Should Spouses Have Separate HSA Accounts?
Here is an important pointer, if you have family coverage, you should consider setting up an HSA account for each spouse. You can only make the additional contribution for your 55 plus spouse if he has his own HSA account. There are a few other advantages to having separate accounts as well. As mentioned before, people over 65 can pay their health insurance and Medicare premiums out of their HSA, unlike people under 65. They can also pay these expenses for their spouse, or dependents, if each is over 65. However, if you were under 65 and were the only HSA account holder, and your spouse or dependent was over 65, you would not be able to pay the premiums. You would need your 65+ spouse to have an HSA account and have money in it in order to pay the premiums. You also cannot transfer money from one spouse’s HSA account to another. So you need to contribute over the years to each spouse’s account in order to prepare for this.
Another advantage of each spouse having an HSA account is for the payment of long-term care insurance. It is clear that if each spouse has an HSA, they can each pay their respective long-term care insurance subject to the normal caps. Without separate accounts, the instructions to the Form 8889 seem to imply you cannot take the deduction for a spouse.
What Happens When I Pass Away?
When you pass away, your spouse can take over the account and use it like his or her own. However, if it is left to a beneficiary other than a spouse, or is undesignated and goes to your estate, then it is considered an immediate distribution, and the entire balance is included in taxable income. It is not, however, subject to the 20 percent penalty tax. Whoever is the named beneficiary and receives the HSA money, pays the tax. If an estate receives it, it is taxable income on the decedent’s final 1040. If some other person receives it, then it is taxable to that person’s 1040. If any final medical expenses are paid from the account within one year of death, those would be qualified distributions and reduce the taxable portion.
Any Pitfalls?
Be alert to prohibited transactions covered by IRC Section 4975 – these are basically self-dealing transactions where you or someone or an entity related to you receives a special benefit in some way from the account. For instance, if you could borrow money from the account, that could be self-dealing. Fortunately, the custodian buffer will prevent you from doing a lot of things that might happen otherwise, but there are still some things you could do that would be considered self-dealing that the custodian would not know about. For instance, if you named your HSA as collateral for a personal loan. That would be a prohibited transaction, and the entire balance would be deemed distributed immediately, and it would trigger taxable income and a 20 percent penalty on the entire balance.
Form 8889
The Form 8889 itself is a fairly simple two page form. Part I deals with determining your current year deduction for contributing money to the HSA, and making sure you did not overcontribute. You add up the contributions from yourself, your employer, plus contributions to any MSAs which count toward the HSA cap, plus if you happen to do a once in a lifetime rollover from your IRA, that would get added in as well.
Part II deals with the distributions from the HSA. Here you essentially list the total distributions, and then subtract any rollovers to other HSA custodians, and subtract any qualified medical expenses. Anything left over would generally be a nonqualified distribution subject to the 20 percent penalty unless one of the exceptions applies – turning 65, becoming disabled, or passing away.
Part III calculates the penalty for overcontributing due to changes in your health insurance coverage status.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics Part XXXII – Form 8889 – Health Savings Account
Filed under: Back to Basics, Healthcare Costs | Tags: 2015, COBRA insurance, contribution limit, custodial parent, dependent, disabled, distribution, divorce, earnings, exemption, health insurance, health savings account, high deductible health plan, HSA, IRA, long-term care, Medicare, penalty, rollover, Roth-IRA, Schedule A
Leave a Comment Originally published in the Cedar Street Times
February 5, 2016
Why Would an HSA Be Valuable to Me?
A Health Savings Account, or HSA for short, is a fantastic vehicle to pay for out-of-pocket qualified medical expenses which insurance does not cover in-part or in-full. It effectively allows you to get a tax deduction for nearly all of your unreimbursed expenses whether or not you itemize deductions. It also works great for those who itemize, but do not have enough medical expenses to get over the 7.5 percent or 10 percent (depending on your age) of adjusted income threshold before those deductions are counted. Many people assume they are receiving a tax benefit for these expenses when they are not. Simply look at your Schedule A, line 4. If it says $0, or if you do not even have a Schedule A, you are not benefitting from your itemized medical deductions. Even if you have a number there, line three will show you how much you are getting zero benefit from due to the threshold.
How do I Qualify and What Kind of Account Is It?
In order to qualify for an HSA, you must have a “high deductible” health insurance plan. For 2015, this means you have to have a minimum annual deductible of $1,300 for self-only coverage, or $2,600 for family coverage (or approximately the cost of breathing the air in a hospital lobby). Your plan must also have a maximum annual out-of-pocket limit of $6,450 for self-only coverage or $12,900 for family coverage. If you meet these requirements, you are eligible to set up an HSA account for yourself.
An HSA account is kind of like having a checking account just for qualified medical expenses, but is shares characteristics with an IRA account. A lot of people think the accounts are married to the health insurance providers, but they are not. Lots of banks and investment companies offer them. The account is a custodial account held for your benefit, and you get to choose the company that is the custodian, and you can move the money from one custodian to another, just as you could move your IRA from Fidelity to Vanguard, for instance. You often get a checkbook and/or a debit card. The custodian follows certain rules laid out by the IRS, and reports to the IRS at the end of each year the total contributions to and distributions from your account. The custodian is not responsible, however, for verifying that your expenses are qualified medical expenses, as that responsibility falls to you.
If you have health insurance through an employer and the plan qualifies, often your employer and its health insurance representative are instrumental in getting this account established, and they will select an initial custodian. Many employers will even contribute a monthly amount to your HSA account since the high deductible aspect often saves the employer money on the premiums. But even if your employer does not set an HSA up, you can do it. And as long as your health insurance plan qualifies, you can contribute to it.
How Do I Put Money Into the HSA?
Anyone is actually allowed to contribute to your HSA account (if you should be so lucky!), but there is a total contribution limit of $3,350 per year for self-only plans, and $6,650 for family plans in 2015. And you get an above-the-line tax deduction for the amount put into the account each year. Unlike IRAs, there are not even any income phaseouts that would prevent you from getting the tax deduction if you are a high-income earner. If your employer does not contribute enough to max out the contribution limit, you can always write a check to the account for the difference. You even have until April 15 (18 this year) to make the contribution for the prior year (similar to an IRA). If you are over 55 years old (IRAs are 50), you can make an additional $1,000 contribution each year.
If you are enrolled in Medicare or are being claimed as a dependent on someone else’s return, you cannot contribute to an HSA. In years where you change from self-only coverage to family coverage, or if you get married, or go through a divorce, stop insurance, start insurance, etc. be aware that there are special rules and limitations on contributions during those years, and you could subject yourself to a penalty if handled incorrectly. If you find that you have overcontributed for any reason, you generally have until the extended due date of your tax returns to get the money out without penalty. You do have to take out any earnings it generated as well, and those would be taxable in the year you physically take the money out of the account.
Can I Transfer Money Into My HSA from an IRA?
If you are desperate to get some additional money into your HSA, you can make a once in a lifetime transfer from your Traditional or Roth IRA to the HSA via a trustee to trustee transfer. However, it is still limited to the annual contribution cap, and it would be reduced by any other contributions you made to the account during the year! So it has very limited usefulness. If you were going to do that, your first choice would almost inevitably be the traditional IRA since the Roth IRA is already a tax-free account.
What/Who Can I Spend the Money On?
All medical expenses that would normally qualify for a deduction on Schedule A, would be a qualified HSA distribution, except for insurance. Generally, you cannot pay your health, vision, dental premiums, etc. from your HSA. Exceptions to this which you could pay from your HSA include long-term care insurance for the HSA account holder (subject to normal limits on long-term care insurance deductions found in the Schedule A instructions), COBRA insurance premiums for you, your spouse, or your dependents, or health insurance paid while you, your spouse, or dependents are receiving federal or state unemployment compensation. Also, if you are 65 or older, you can pay your Medicare and other health insurance premiums (except supplemental Medicare policy premiums) from your HSA.
For the bulk of the qualified medical expenses, you can deduct them for yourself, your spouse, your dependents, or for someone you could have claimed as a dependent except that they were disqualified simply because they filed a joint return, had gross income over $4,000, or were married filing jointly and one of the spouses could have been claimed as a dependent. If you are divorced with children, you can also pay for your children’s medical expenses whether or not you are a custodial parent or claim a dependency exemption, as long as least one of you qualifies to claim the dependency exemption.
If you take money out of the account and do not use it for medical expenses, it will be taxable income, and you will hit a 20 percent tax penalty as well. When you reach age 65, however, you can take the money out and use it for any purpose with no penalty (as opposed to 59.5 for most IRA owners). So in a lot of ways, should you never use it for medical expenses, it acts like another IRA.
Also for people that become permanently disabled, they can escape the 20 percent penalty tax even if used for nonqualified expenses.
In two weeks we will conclude the discussion on HSA accounts and discuss topics such as whether or not you have to pay qualified medical expenses directly from your HSA, strategy for large bills that exceed your HSA balance, having separate accounts for spouses, what happens to the account when you pass away, pitfalls to avoid, and a discussion of the Form 8889 itself.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.
Back to Basics Part XXXI – Form 8863 Education Credits
Filed under: Back to Basics, Education | Tags: 1098-T, American Opportunity Credit, dependent, education credits, fees, felony, Form 8863, Lifetime Learning Credit, Modified Adjusted Gross Income, Obama, refundable, student, tuition
Leave a Comment Originally published in the Cedar Street Times
January 29, 2016
There are two main tax credits for qualified spending on degree seeking higher education: 1) the American Opportunity Credit (AOC), and 2) the Lifetime Learning Credit (LLC). The AOC is generally the more valuable of the two. It is a tax credit of up to $2,500 with $1,000 of that refundable to you even if you paid no tax and have no tax liability. You get 100 percent of the first $2,000 spent, and 25 percent of the next $2,000 spent. Whenever your hear “refundable credit,” think potential fraud. So it is not only an opportunity for college kids, but an opportunity for criminals to make up false returns and claim fake credits. Naturally increased scrutiny follows on behalf of the IRS. But I digress.
The AOC is available to you only during your first four years of college as defined by the educational institution – so a 5th or 6th year senior would still qualify, except that you are only allowed to take the credit for a total of four times no matter how long it takes you to get through school! With that in mind you may even choose to forgo claiming the credit in a particular year if for instance you were attending a community college and had less than the $4,000 of expenses to max out the credit, but knew you would be transferring to a more expensive school, and would still have the opportunity to claim the credit four times before graduating.
The AOC allows you to include tuition and required fees of the school, like athletic fees, and student activity fees (but not health fees or room and board) for the tax year at hand plus the first three months of the next year if paid in the current year, plus the cost of any books or school supplies whether or not bought from the school or any other seller. You have to be enrolled half time in at least one academic period such as a semester or quarter in the tax year, or during the first three months of the next year if the payment was made in the current year for the following year school.
If your modified adjusted gross income (for most people this is the same as their AGI) is between $160,000 and $180,000 for married filing jointly ($80,000 – $90,000 for other statuses), the credit phases out. If a parent is claiming you as a dependent, then you are not allowed to deduct it on your tax returns – only the parent would. Even if a third party paid the fees for a student’s benefit (such as a relative, or an institution), as long as the parent is still claiming the child as a dependent, then the parent is eligible to claim the credit as well. You would need a copy of the 1098-T to claim the credit (this is a new requirement signed into law by Obama in 2015 – all filers must have in their possession a 1098-T when filing their taxes to claim education credits). Another interesting tenant is that you cannot claim the credit if you have been convicted of a felony possession or distribution of a controlled substance.
The Lifetime Learning Credit (LLC) is a nonrefundable credit of 20 percent of the first $10,000 spent – capping out the credit at $2,000. The LLC is available to anyone in their life for an unlimited number of years for post secondary education – even if you just take one course at a time – so you don’t even have to be seeking a degree. You just can’t claim the LLC and AOC in the same year for the same person.
The LLC is eligible for the same expenses as the AOC, except that books and supplies that are not absolutely required to be bought from the school, do not count. The modified adjusted income phaseout is between $110,000 – $130,000 for married filing jointly and $55,000 – $65,000 for other statuses. Also, it is nice to know that you can still smoke crack and deal heroin and be eligible for the credit, as there are no denials of the credit for felony possession or distribution of controlled substances with the LLC!
The form used to claim the expenses, Form 8863 – Education Credits (American Opportunity and Lifetime Learning Credits), is a two page form. You start with the second page, which is basically a flow chart questionnaire determining what you are eligible for, and it also has you transfer some numbers to the first page. The AOC is handled in Part I of page one and the LLC is handled in part II of page one, and these walk you through the credit calculation and limitations.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 