Archive for October, 2011|Monthly archive page

Spouse/Parent Passed Away? Consider “Portability” Due to New Laws

Originally Published in the Pacific Grove Hometown Bulletin

October 19, 2011

If your spouse passes away in 2011 or 2012 (or you have a parent that is in this situation), you need to understand and consider the tax concept of “portability,” otherwise it could potentially cost the heirs dearly.   Last month, the IRS released forms and guidance for the 2011 Form 706 – United States Estate Tax Return requiring anyone who wants to reserve a future benefit through portability to file an estate tax return, even if you will owe no estate tax. This could affect people with estates valued as low as $1 million.  IRS news release IR-2011-97 states, “The IRS expects that most estates of people who are married will want to make the portability election, including people who are not required to file an estate tax return for some other reason.”

You may recall the news buzz last year surrounding Congress’ inability to act which led to no estate tax in 2010 – the impossible happened in the eyes of estate and trust attorneys and tax professionals when the estates of several billionaires such as George Steinbrenner paid no estate tax!  When Congress finally took some action after the fact, they could not undue what was done, but they did pass some laws which affect 2011 and 2012 by providing a $5 million estate tax exemption to each spouse.  They also created a new concept that says any unused portion of the first spouse’s exemption could be saved, and used in the surviving spouse’s estate.  This would give the surviving spouse an even higher exemption (protection from paying death taxes).  It also adds protection to people who simply failed to do proper estate planning.

Complications arise because the estate tax exemption will revert to $1 million in 2013 with a 55 percent tax rate.  This means that 55 percent of everything in your taxable estate over $1 million will go to the federal government unless democrats and republicans can actually agree “millionaires” should retain more of their estate during a time when the government desperately needs money.  Yikes!  Certainly you want to avoid this confiscatory tax if possible.

Let us assume you filed a Form 706 when the first spouse passes in 2011 or 2012 simply for portability of the unused exemption to the second spouse.  Technically, portability is set to expire at the end of 2012, but there is discussion that this new concept will be preserved or “grandfathered” to those who file 706s for 2011 or 2012.  If that is the case, then even if the estate tax exemption remains at $1 million, you would have available all the unused exemption from the first spouse’s passing.  This could be a massive benefit.  Assume the second spouse’s estate is worth $1.5 million.  They would pay $275,000 in tax (1,500,000 – $1,000,000 exemption = $500,000 taxable * 55%).  Of course if they had filed the 706 and preserved $500,000 or more of unused exemption from the first estate they would pay $0 tax.

The problem is, we do not really know what is going to happen, and we can only make educated guesses.  Although they are not simple filings, the cost of preparing a 706 in this situation should be thought of as an insurance policy against estate tax: By comparison, a small cost with potential huge savings.  Be aware that many tax professionals have not cultivated a strong interest in preparing this less frequently filed return.  You have nine months from the date of passing to file a 706 and you can obtain a six month extension.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Are Social Security Benefits Taxable? If So, Why?

Originally published in the Pacific Grove Hometown Bulletin

October 5, 2011

If you answered both “No,” and “Partially,” you are correct.  This seemingly simple question actually requires a full page of number crunching to determine the correct answer on your tax returns and will result in anywhere from zero to 85 percent being taxable.  If you go to my website http://www.tlongcpa.com/Financial-Tools and look in the income section there is a calculator that will do it for you!

Otherwise, below is a quick rule of thumb to determine where you fall on the tax ladder.  Stick this in your Social Security file.

First, take half the Social Security benefits you earned for the year and add to that all your other income including tax exempt interest (Add back certain income exclusions such as foreign income and adoption benefits).  We will call this modified income.

“No”

If your modified income is less than $32K and you are married filing joint (MFJ) then none of your Social Security will be taxable.  For everyone else, if your modified income is under $25K, then nothing will be taxable (exception – married filing separate and lived with spouse will always result in 85 percent of all Social Security benefits taxed regardless of other income).

“Partially”

If you do not want to do much head scratching and you want to estimate conservatively, here is my advice: If your modified income is between $32K and $44K as MFJ ($25K-$34K for everybody else), assume 50 percent of your total Social Security benefits are taxable.  If over those ranges, assume 85 percent of your total benefits are taxable.

If you want to be a pencil pushing tax hero here is what you do: If your modified income is between $32K and $44K as married filing joint ($25K-$34K for everybody else), 50 percent of the amount above $32K MFJ ($25K others) is the taxable amount of your Social Security benefits, capped at 50 percent of your Social Security benefits.  If your modified income is above those ranges, then your taxable Social Security benefits will be the lesser of A) 85 percent of your Social Security benefits OR B) 85 percent of your modified income above $44K MFJ, ($34K others) plus the lesser of 1) $6,000 MFJ ($4,500 others) or 2) 50 percent of your Social Security benefits.

Why is it taxed?

Most people want to know why the government taxes Social Security benefits, especially considering that you already paid income taxes on your Social Security contributions through the years.  To an extent, Social Security benefits are double taxed as a result.  We do need to remember, however, that Social Security is not just a retirement plan, but includes Medicare Parts B and D, disability, survivor’s benefits and many other social programs we may benefit from if needed.  Prior to 1983, Social Security benefits were not taxed.  In the late 1970s and early 1980s the government realized the system would soon be bankrupt because of added promises and demographics, so laws were passed to reform Social Security, including taxation of benefits.  Hmmm.  Kind of sounds like the same debate we are having again…  However you slice it, the bottom line is that it is not sustainable in its current form and we will have to cut benefits, raise taxes, or go further in debt.  I surmise it will be a combination of all three.

There may be a few other circumstances and specific rules that affect you, and you should consult with a qualified tax professional regarding your tax situation if you need an exact answer.  Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.