Deducting Services/Goods Your Business Donates
Filed under: General | Tags: charitable deduction, contributions, donating goods, donating services, donating time, donations, services
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
February 15, 2012
Every year I inevitably have a few clients that bring in statements from a charity thanking my client’s business for the donation of my client’s services or goods with a fair market value of X dollars. Of course they want to write it off as a charitable deduction. The first question I have for them is, “Did you include it in your taxable income, otherwise how many dollars did you actually spend to provide the services or buy the goods donated?”
The answer to the first part is always no! At that point, if they provided the services themselves, the answer is no deduction. If they used a hired worker to perform the services – they are already getting a deduction when they deduct the workers’ wage. For goods or materials donated they will get a deduction when they write off the purchase from the supplier or take inventory.
But why can’t they use the fair market value for the deduction? The simple answer is you cannot take a deduction for donating theoretical pretax profits! Compare the woman who donates $100 cash to the man who donates $100 of his time. Besides the the value of the man’s time being subjective and subject to abuse, the woman’s $100 cash started as approximately $130 of services or $130 of markup on goods, and then she paid $30 of tax, leaving her with $100 to donate. When she donates it, the taxing authorities give her a deduction to basically rebate her for the $30 in tax she already paid. The man has not included his $100 in income and has paid no tax, so he has nothing to rebate, and is therefore not entitled to a deduction.
Donations are generally limited to your cost basis in the donation. However, there are exceptions. In a future issue, I will discuss why donating appreciated stock is much more effective than donating goods, services, or cash.
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.
How to Handle Late Documents from Investment Companies This Year
Filed under: General | Tags: cost basis, investment, reporting
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
February 1, 2012
This year, the IRS put a new demand on investment firms to report the cost basis of stock sales that occurred in 2011. Next year they will have to report similar information for mutual funds, and the following year for various other securities. This demand will likely cause these firms to send you their normal tax documents late, or perhaps re-issue documents several times while they sort out this new process. I have seen one large firm that stated they will not be issuing tax documents until the end of February.
The result of this will likely be a further compression of the already compressed time that tax professionals have to complete the returns for their clients. If you want to ensure your return is completed by April 17 (the due date this year), you may wish to assume those documents will come late. Gather everything else and provide to your tax professional early. Include a note asking they prepare your returns except for the straggling investment company tax documents which you will provide later. This gets your return in a great position to get it out the door as soon as the information arrives.
One further step may be to request they not file your returns until March 7th or so to lessen the chances that you will need to file an amendment because your investment company re-issued their tax document in late February. If you are e-filing and sign electronic authorization forms, your tax professional is technically supposed to file the returns within three days of your dated signature. That said, it would make more sense to sign your e-file authorizations later when you want the returns filed.
If you find yourself in the situation where you file the return and then receive a changed document – discuss it with your tax professional. The larger the difference, the more likely you are to get a notice down the road. If you owed more money as a result, you would be subject to interest and penalties at that point (which could be up to three years later and include interest and penalties for the whole time period). You would need to balance that risk with the cost of amending.
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.
Tax Organizers
Filed under: General | Tags: Tax Organizer, Tax Return Preparation
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
January 18, 2012
The use of a tax organizer is a great way to prepare for your income tax return when working with tax professionals. All things considered, it allows the professional to spend more time on important issues, and typically results in a more accurate and less expensive return.
An organizer is essentially a document that prompts you for the vast majority of standard information a tax professional would need to work on your returns in an order that is logical and efficient for the professional. Organizers often contain questionnaires that alert the professional to potential reportable transactions or areas that may need additional planning or questions. It also allows the individual to convey preferences about refunds, the use of estimates, future expectations or anything else that seems appropriate. If you want to get a gold star, sort your supporting tax documents in the same order as the organizer!
Some people think filling out an organizer is a waste of their time because that is what they are paying someone else to do. The “shoe-box” approach is where all documents are thrown in a box and the professional is supposed to grind out a return. This is possible, but the reality of the situation is that you will probably end up with either an inferior result or a lot of questions and a large bill. I have done returns like these over the years – in some cases opening all the client’s mail for the first time including bank statements, bills, and even birthday cards from grandma with a check enclosed!
Better than the “shoe-box” approach is your own ordered approach. My father was an architect and he had his own business. I remember the zippered bags he used for sorting tax documents and his all-important summary sheets where he proceeded to add every expense in two-point hand-written font on yellow notebook paper that only he could fully understand (but of which he was quite proud)! Of course, his CPA – Dan, had to learn parts of it as well. I can assure you that Dan would have preferred my father use his firm organizer instead, and he probably would have charged my dad less for preparation as a result!
Using a firm provided organizer allows the professional to move quickly through the low value process of data collection and entry and think more about high-impact planning or additional deductions. The first year you fill out an organizer for a professional, it will typically be more voluminous with many non-applicable pages. In future years it will often be tailored to you and provide your prior year information for easy comparison – and it helps you know what you may be missing.
In any case, tax organizers are a great tool to help you stay organized from year-to-year. If you have never used an organizer, you can download one for free from my website at www.tlongcpa.com/forms.
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.
Do You Know if You Need to File a 1099-Misc by January 31st?
Filed under: General | Tags: $600, 1099, 1099-Misc, employee, independent contractor, Penalties
Comments (2) Originally Published in the Pacific Grove Hometown Bulletin
January 4, 2012
Happy New Year! Now that the holidays are over and you are starting those New Year’s Resolutions, perhaps you should add one more to the mix – reviewing whether or not you need to file 1099s. Penalties have doubled this year, and if you paid a non-employee over $600 in the course of your business during 2011, you likely need to file a 1099-Misc by the end of this month.
Penalties
Due to the strain of the economy, pressure is being put on taxing authorities to collect revenue wherever they can. One way of collecting this revenue is through penalties for failure to comply with regulations. This year we are witnessing increasing penalties, the creation of new penalties, and the enforcement of old penalties not previously enforced. The filing of 1099s is no exception and is a large target because it also helps the taxing authorities identify people who fail to report income (and pay tax) of their own volition. You may think, “I have never done this before,” but given the increased enforcement, this is a hollow reason for not reconsidering your position.
The federal penalties have doubled this year to $100 per 1099 for failure to provide a 1099 to a recipient, and another $100 for failure to file a copy with the IRS (I am sure you will find it a relief to know that the combined penalties are capped at $3 million for most of us!). California has matching penalties of $50 each and they can also disallow the deduction for the amount you paid the person in question.
Who Gets 1099-Misc Forms
Generally, 1099-Misc forms are filed for service-providers that your business (sole proprietorship, nonprofit, or other business entity) pays to someone other than a corporation over $600 during a year. There are many exceptions and reading through the instructions for form 1099-Misc (available online) is a great way to find out if you have filing requirements. Exceptions include payments to attorneys, medical service providers, royalties, fish payments, direct sellers, and many more. Just because you have a CPA or someone else prepare your taxes does not mean they know all the people for which you need to file 1099s.
When to File
Form 1099-Misc is required to be mailed to recipients by January 31st. You also have to file a copy with the IRS by February 29th. Copies mailed to the IRS have to be filed on specific forms printed in red ink, unless they are electronically filed by professionals or other online service providers. The printed forms and software can be found at your local office supply store.
If you need additional help with a 1099 filing determination or with actually filing the 1099s this year, you should seek professional help as soon as possible.
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.
Do You Buy Online or Via Catalogs? – Use Tax – Merry Christmas to CA!
Filed under: California | Tags: Board of Equalization, BOE, California, Franchise Tax Board, FTB, Sales Tax, Use Tax
Leave a Comment Originally Published in the Pacific Grove Hometown Bulletin
December 21, 2011
If you made any purchases over the Internet or via mail-order catalogs for your holiday shopping (or any time during the year) for business or pleasure, California does not want to be left out of the gift-getting! Due to the strain on California’s budget over the past few years they have been looking high and low for additional revenue – including the enforcement of existing laws that have historically been quite lax.
For decades, California, and many other states have had use tax laws. California use tax is basically sales tax imposed on all those purchases you make online or via mail-order catalogs, or while in no sales tax states like Oregon (you know – all those purchases you made so you could avoid paying sales tax!). If you bring the goods into California and use them here (or give them to somebody in California), you owe California use tax equivalent to the sales tax rate where you reside. This applies to individuals as well as businesses. Certain goods like cold meats, cheeses, crackers and other grocery type foods that are not subject to sales tax are not subject to use tax either.
The California Board of Equalization (BOE) has been aggressively marketing its efforts to pursue this tax including sending letters to tax professionals several times a year, hiring auditors, registering businesses, working with the Franchise Tax Board (FTB) to add a form to your 540 income tax return, and now creating safe-harbor use tax tables based on your income. The downside of not complying is that if audited, they can go back for years looking through your bank statements and credit card statements for purchases from the likes of Amazon.com – and who knows what else they might find…
The new safe-harbor use tax tables are available for use with your individual 540 California tax return (business entities including schedule C businesses cannot use these tables). Instead of collecting all your receipts for non-taxed purchases, California will allow you to pay a predetermined amount based on your adjusted gross income (up to $20K – $7, up to $40K – $21, up to $60K – $35, up to $80K – $49, up to $100K – $63, up to $150K – $88, up to $200K – $123, over $200K – multiply by 0.07%).
If you elect to use the tables, you will be presumed to have met your requirement and they will not ask for more, even if the actual tax based on receipts would have been much higher. Individual purchases over $1,000 are treated separately from the use tax tables. This can be a strategic move. Beware, if you owe money to the FTB for any other reason such as past due taxes, the FTB will not pass the use tax paid to the BOE, and you will get a bill from the BOE with a 10 percent late penalty. Your other option is to file a separate Form BOE-401-DS Use Tax Return, but the safe harbor tables are not available for this return.
All businesses (including schedule C businesses) that have gross receipts over $100K, and do not already have a seller’s permit with the BOE, are required to register with the BOE and file a separate use tax return. Even if they made no qualifying purchases they have to register and file a zero return each year. If you fail to register and file, and the BOE discovers this, they will likely require use tax returns for the past eight years. It is probably in your best interest to register and file simply to avoid the possibility of an eight-year look-back!
So as you open gifts this year and ponder how smart you will look in that new sweater, you may also think, “I wonder if the giver has a use tax issue?!”
For more information on use tax, registering, and filing returns you can go to http://www.boe.ca.gov/sutax/sutprograms.htm.
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.
I’m Having a Baby!
Filed under: General | Tags: baby, baby modeling, child tax credit, earned income credit, exemption, HSA, medical expenses, Roth-IRA, section 529
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
Decembery 7, 2011
Well, not me, technically, but my wife is. After 12 years of wedded bliss, we are entering the baby business. Like most future parents we are excited, but being a CPA takes it to a whole new level of joy! There are so many planning opportunities around children.
Planning can start well before birth or even years before conception. For example, the highly tax savvy high school senior could think, “Someday, I am going to have a family of my own. Knowing the high cost of college I am about to incur, I should really start saving for my future child’s education now to maximize tax-deferred growth! That raucous week in Cancun is really a waste of money, anyway.” Instead this high schooler opens a section 529 plan and names his older sister’s child as a beneficiary. After four years in a frat house, a year traveling after school, a few years bouncing around finding himself, falling in love, getting married, and finally having a child, this new parent then renames the beneficiary to his own child with a ten-year jump start on tax deferred education saving!
What about the expense of having the child? This natural process which has gone on quite successfully for a few million years or so at no cost, mostly outdoors in the dirt, can now be quite pricey, and sterile. It may cost $5,000 if you use a midwife or $25,000 in a hospital! You will likely go over your deductible and insurance will pick up the rest. A great option is to have a high deductible health plan going forward with a health savings account. This setup makes virtually all of your family medical expenses deductible whereas people with traditional plans are stuck itemizing with a 7.5 percent of AGI floor – meaning most people do not get any tax benefit. It also allows the deductibility of more types of expenses and alternative care.
Next, there is the additional exemption deduction to get excited about – we are talking $3,700! You are also eligible for child tax credits – up to a $1,000 per child. And if you are low income, the child may help qualify you for a larger earned income credit: up to $3,094 with one child or $5,751 with three or more! Child tax credits and earned income credits can be refundable – meaning, even if you do not pay a dime in tax, the federal government will “refund” the money to you anyway – but having children is not a great way to get rich. For advanced tax planning, you aim to have your child near the end of December and still receive the exemption and credits for the whole year. No expense, but full benefit – brilliant!
Do not forget about dependent care credits and education credits either. Dependent care credits will save you up to $1,050 for one child or $2,100 for two or more children. Education credits for college age children such as the Hope credit can save you up to $2,500 in tax.
My favorite planning opportunity which I have yet to implement with a client is baby modeling. If you can get your baby into print or TV commercials, then I feel you would have a strong case to say the baby has earned income. Maybe the “talent’s” agent, a.k.a. mom or dad, would need to be paid out a heavy agent fee since it really required a lot of work on their part – but then again, I am sure that many famous actors and actresses have to be babied by their agents too! Once your baby has earned income, you can establish a Roth-IRA for retirement! Think about 18-22 years of additional investment compounding! (Call me if you have a child in this situation – I want to put this in action!!)
So when is our baby due – LATE April…we hope!
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.
The Stale Trust Funding Dilemma
Filed under: Trusts and Estates | Tags: 1041, A trust, A/B Trust, administrative trust, B trust, bypass trust, estate planning, Estate Tax, exemption trust, family trust, Inheritance Tax, living trust, stale trust, subtrust funding, survivor's trust, trust
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
November 17, 2011
The Stale Trust Funding Dilemma
By Kyle A. Krasa, Esq. and Travis H. Long, CPA
A very common Estate Planning technique for married couples is an “A/B Trust.” The ideas behind the A/B Trust are to preserve the Estate Tax Exemption of the first spouse to die and to retain a degree of control over the deceased spouse’s share of the estate, protecting the deceased spouse’s beneficiaries from the whims of the surviving spouse. Upon the death of the first spouse, the trust sub-divides into an “A Trust” (also known as a “Survivor’s Trust”) and a “B Trust” (also known as an “Exemption Trust,” a “Bypass Trust,” or a “Family Trust”).
Many surviving spouses who have A/B Trusts either do not realize that upon the death of the first spouse they need to physically split the assets between the A and B Trusts or consciously neglect to split the assets because they feel it’s unnecessary, expensive, or time consuming. Occasionally, a surviving spouse with an A/B Trust will realize years after the death of the first spouse that the A/B split was never completed. Alternatively, the surviving children of a deceased couple who had an A/B Trust where no A/B split was completed upon the death of the first spouse realize the estate was never settled. In both cases, the A/B split should have been done upon the death of the first spouse and the task at hand is to figure out how to handle the situation.
The question becomes whether the assets should be split between the A and B Trusts now, correcting the mistake of neglecting to split the assets upon the first spouse’s death (known as “stale trust funding”), or whether the A/B provisions of the trust can be ignored.
Many people upon first blush will want to ignore the A/B provisions of the trust. After all, trying to correct a mistake made many years ago will undoubtedly create additional legal fees, accounting and tax preparation fees, time, effort, and complications. It is much easier to sweep these problems under the proverbial rug. However, there are many legal and tax issues that must be carefully considered before deciding to ignore what can be a significant problem.
First, the tax purpose of the A/B split is to preserve the first spouse’s Estate Tax Exemption. If the estate is larger than one spouse’s Estate Tax Exemption, by not performing a stale A/B split, you will be forgoing perhaps hundreds of thousands of dollars in Estate Tax savings.
Second, the beneficiaries of the B Trust might be different than the beneficiaries of the A Trust. If you ignore the A/B split, are you disenfranchising the B Trust beneficiaries?
Third, the Trustee has a fiduciary duty to carry out the terms of the trust and is thus legally required to perform the A/B split if that is what the trust dictates. The Trustee could face serious legal consequences by ignoring the law.
Fourth, the trustee could be held liable for tax returns that were not properly filed.
Normally, an administrative trust tax return is filed for any income generated by the decedent’s assets between the date of death and the date the A and B sub-trusts are funded. After that point, the A trust income gets reported on the surviving spouse’s 1040, and the B trust income is reported on a form 1041 tax return each year going forward.
What happens when the funding is not done for years? Most people in these situations continue to report all the income on their 1040s after their spouse passed away, as if nothing had happened. This is incorrect.
So, do you have to go back and file tax returns for the B trust for all those years? The IRS generally takes the position that since the B trust was never funded, there are no tax returns needed for that trust. Once you fund the trust, then you start filing returns for it, even if years later. However, at the same time, the IRS views the decedent’s share of assets as having belonged to an administrative trust since the date of death – still waiting to be properly distributed. This administrative trust should have had tax returns filed every year. It is further complicated when those assets are used, retitled, sold, and mixed with other assets improperly.
There are generally three different approaches to solving the return filing problem. The first is to go back and file tax returns for the administrative trust dating back to the date of death. This is the safest route, but is probably the most expensive, and may be impossible depending on the records available. You also have the problem of potentially amending all your 1040s that were not properly prepared as a result.
The second approach some practitioners use is to essentially file blank 1041s dating back to the date of death and include a statement with each return that all the income was reported on the surviving spouse’s 1040. The problem with this is that the amount of tax owed, besides being paid on behalf of the wrong taxable entity, is rarely the same. Filing blank 1041s clearly brings the issue front and center to the IRS, but, it could also bring closure to the issue.
The third approach some practitioners take is to not file any administrative trust returns for the past, and just start filing returns for the B trust going forward. This approach has risks because required returns are never filed, and therefore the statute of limitations never begins. The issue could theoretically pop-up at any time in the future without the appearance of being forthright.
It is clear there are many issues to consider in a stale trust administration. If you find yourself in this situation as a surviving spouse or you think you may be the future beneficiary of funds from a stale trust, it would behoove you to seek qualified professional advice to determine if or to what extent you could be affected, and what your options are. The most common reaction is to ignore it and hope it goes away or think someone else will deal with it later. Unfortunately, if there is an issue, it almost always resurfaces upon the death of the second spouse, at which point it gets more expensive to handle, is more likely to cause fighting between beneficiaries, or creates an irreversible financial disaster for the beneficiaries. Fortunately, there are solutions if you act today!
Prior articles are republished on our websites atwww.krasalaw.com and 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.
KRASA LAW is located at 704-D Forest Avenue, PG, and Kyle can be reached at 831-920-0205.
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.
My Spouse Passed Away Years Ago – I Should be Filing Tax Returns for a Trust?
Filed under: Trusts and Estates | Tags: 1041, A trust, A/B Trust, B trust, Estate Tax, health education and maintenance, Inheritance Tax, living trust, remainder beneficiaries, stale trust, trust
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
November 2, 2011
There is a widespread misunderstanding that if you and your spouse had set up a living trust, nothing needs to be done when the first spouse passes away except remove the deceased spouse’s name from bank accounts and real estate deeds. If you were under this impression, you may be leaving a big headache for your heirs and subjecting half of your estate to 35 or 55 percent inheritance tax, unnecessarily. I am sure your heirs would be quite upset to learn you inadvertently “adopted” Uncle Sam, and are making the federal government one of the largest beneficiaries of your estate!
Most trust documents in California set up for married couples have a traditional “A-B” trust formula. Due to community property laws, typically half the assets belong to each spouse no matter who earned them or whose name is on the account or deed. Assuming the husband passes away first, the wife’s half goes to the A trust for her to do as she pleases, and she reports all income related to these assets on her personal 1040/540 tax returns. The husband’s half goes to the B trust. The husband typically gives his wife the right to use the income generated by the assets in his B trust, and if she does not have enough income from her other assets, she can dip into its principal for her health, education, or maintenance.
The B trust is special because the wife generally has limited control over where those assets go when she passes away. The husband typically determines this in the trust document – after all, it was his half. As a result of her limited control, she is not considered the owner of the B Trust assets and they are not included in her taxable estate when she passes away! Starting in 2013, the estate tax exemption reverts back to a measly $1 million; in California, that might be the value of the family home! In order to get this special tax-exempt treatment, the B trust needs to be “funded” (assets properly divided and retitled to new accounts), and you have to file 1041/541 tax returns for it each year thereafter.
Estate taxes aside, the other significant reason to properly set up the B trust and file returns is “remainder beneficiaries.” These are the people or organizations the husband said would receive the remaining assets in the B trust upon the wife’s passing. Any of these beneficiaries could sue her if she does not segregate the assets and properly follow the terms of the B trust. This is often important if there are children from two marriages, or the deceased spouse wanted to make sure mom did not remarry and give all the money to the new spouse instead of his own children.
A final reason is that the IRS can care as well. Most people that fail to fund and file returns for the B trust, treat all the assets as their own, and report all the income on their personal tax returns. The overall tax is never exactly the same compared to filing 1041s even if income is supposed to go to the surviving spouse. Another problem is that capital gains typically do not go to the surviving spouse and are taxed to the trust (although at similar rates). A hard line auditor could say, “Yes, you paid tax, but the trust did not.”
If you failed to fund your B trust, confront the issue by seeking competent professional advice so you can determine if you need to do something and what your options are. If there is a potential impact, it will surely resurface in your estate. If it is not addressed before you pass, it will either get more complicated/expensive to handle or create an irreversible consequence.
In the next article I will expand on this by discussing the tax aspects of “stale” trust funding. 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.
Spouse/Parent Passed Away? Consider “Portability” Due to New Laws
Filed under: Trusts and Estates | Tags: Death Tax, Estate Tax, Form 706, Inheritance Tax, portability
Leave a Comment 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.
Are Social Security Benefits Taxable? If So, Why?
Filed under: Retirement Assets | Tags: benefits, retirement, Social Security, taxable
Leave a Comment 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.
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