SIMPLE IRA Salary Deferrals Due Jan. 30 for Self-Employed
Filed under: Retirement Assets | Tags: due date, employee deferral, Fidelity, January 30, matching contribution, Savings Incentive Match Plan for Employees, Schwab, SIMPLE IRA, sole proprietor, three percent, Vanguard
Leave a Comment Originally published in the Cedar Street Times
January 24, 2014
One commonly used retirement plan by small business owners is a SIMPLE IRA plan. SIMPLE IRA is simply an acronym for “Savings Incentive Match Plan for Employees Individual Retirement Account.” The plan is, well, fairly simple to set up and operate as well. You simply fill out the simple SIMPLE form by October 1 and find a custodian such as Vanguard, Schwab, Fidelity, or others to handle the money and you are in business.
There are generally no costs or nominal costs to setup and operate the plan, depending on the custodian and amounts invested, and there are no required annual plan filings with the government. This has made them appealing for many small companies with employees compared to a 401(k). For 2013, participants can defer up to $12,000 of their earned wages plus another $2,500 catch-up contribution if over age 50.
The employer also agrees to make a three percent maximum matching contribution. For example, if the employee defers nothing into the plan from his or her salary, then the employer has no match requirement. If the employee defers two percent, the employer has to contribute two percent. If the employee defers three percent, then the employer has to match three percent. If the employee defers more than three percent, the employer still only has to contribute three percent. (The employer also has the option to select a two percent nonelective contribution in lieu of the three percent match. This means the employer contributes two percent whether or not the employees contribute anything.)
The employer match portion is in addition to the $12,000 salary deferral and possible $2,500 catch-up contribution. The three percent match also has a salary cap of $255,000. So the maximum employer match is $7,650. I know what most of you are thinking right now…”Gee, that means I will only get a match on the first third of my salary. What a rotten deal!” Ha! If you have one of those jobs paying over $750,000 a year, your company is in the wrong plan!
The employer has to remit the employee’s salary deferral portion to the SIMPLE custodian as soon as reasonably can be done, but in any case no later than thirty days after the end of the month in which the employee’s paycheck was dated. If the deferral is sent to the custodian within seven days of the paycheck date, it is a safe harbor and will always be considered timely deposited. The employer match portion, however, can be paid as late as the tax return due date for the employer, including extensions.
So how does it work with the business owner and his or her deferrals? What about the match? If the business is setup as an entity such as a corporation and the owner receives a paycheck like any other employee, then the same rules apply that apply to the other employees.
If the owner is self-employed however, such as a sole proprietorship, the net earning for the entire year are considered earned/paid on the last day of the year, and the owner must remit the salary deferral portion to the custodian by January 30th (30 days after month end) of the following year. So 2013 salary deferrals for a self-employed individual are due in six days. (This includes the $12,000 plus the $2,500 catch-up if applicable.)
The three percent match is not due until the tax return due date for the owner (generally April 15), including any extensions filed (generally October 15). The employer match of three percent for the owner is calculated based on the amount of Schedule SE, section A, line 4, or Section B, line 6, before subtracting any contributions to the plan for the owner.
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 Run a Business…or a Hobby?
Filed under: General | Tags: arts, business-like manner, Churchman v. Commissioner, hobby loss rules, losses, nine factors, personal pleasure, profit motive, Schedule C, section 183, Treasury Regulation 1.183-2(b)
Leave a Comment Originally published in the Cedar Street Times
January 10, 2014
I remember a number of years ago preparing a tax return for a woman who was employed part-time, but who also had a side business as an artist – a painter as I recall. When I was preparing her Schedule C for the art business there were lots of expenses – art supplies and tools, framing expenses, office expenses, vehicle expenses, postage, dues and subscriptions, a home office deduction, meal and entertainment expenses, and lots of travel expenses. In all it came to over $35,000. When I got to the revenue side, however, only $400 was listed. I thought it was a mistake – maybe missing a few zeroes on the end, so I gave her a call. She said she just had a bad year and sold hardly anything. “Okay,” I thought, “that is a pretty bad year. I wonder what a good year looks like for her?”
As the story unraveled, there was a history of growing expenses from $10,000 to $35,000 a year and a history of revenues in bad years of $0 to a few thousand dollars in the “good years.” I could clearly see now what was going on – she must have had about the same natural talent for painting as me and her paintings were so ugly that they wouldn’t be hung in a dumpster, much less purchased. Actually, that is not what I thought. I believe she had a hobby as an artist, she loved to travel, and she developed an addiction for tax deductions when she married her art and travel on a Schedule C tax form!
The IRS is very much aware of this phenomenon, and section 183 of the Internal Revenue Code and its related regulations deal specifically with this area. The rules are known affectionately as “hobby loss rules.” The basic rule is that if you are not truly engaged in an activity for profit, then your deductions will be limited to your revenue. This takes all the fun out filing a Schedule C in situations like this, since losses generated are disallowed and cannot offset other income on your tax returns. If you get audited on the issue and lose, the IRS can go back and disallow the losses from past years, and then assess the tax you should have owed along with stiff penalties and interest that accrue dating back to the dates you should have paid the tax originally. This can get very ugly.
So how can you safely assume you are engaged in an activity for profit? Section 183 plainly tells us that if you are profitable in three out of every five consecutive years (two of seven for horse breeding), you are generally presumed to be engaged in an activity for profit. Of course, if you have a pattern of reporting $200 of income for three years and then $100,000 of losses for the next two, they will not be that graceful towards you.
The meat of their determinations lie in a list of nine characteristics (albeit non-exhaustive) which they apply to your facts and circumstances. The nine factors are: 1) are you carrying on the business in a business-like manner – records, formalities, changing tactics that don’t work, 2) do you have or did you hire necessary expertise – not only in your subject matter, but in running a successful business, 3) what percentage of your time is devoted to the business (more important with activities that do not have substantial personal or recreational aspects), 4) reasonable expectation that the assets may appreciate in value and offset the expenses, 5) the history of success in similar or dissimilar activities, 6) the history of the activity’s income and losses, 7) if you have occasional profits, how substantial are they, 8) do you have other sources of income, and is this activity providing tax benefits, and 9) how much personal or recreational pleasure is involved in the activity.
People in the arts have a higher level of scrutiny due to the common personal and recreational pleasure often involved. In a 1977 court case (Churchman v. Commissioner) the court said, “[A] history of losses is less persuasive in the art field than it might be in other fields.” They also concluded that music falls in their definition of arts.
As you are preparing for your tax returns this year, and if you know you have a business with a pattern of losses, you may want to examine yourself in light of these nine factors. Keep in mind, however, that even if you lose money for a long time, as long as you can demonstrate over these characteristics, you can still be okay. Oh, and regarding the client I worked with years ago – once I did a calculation and showed her the potential penalties and back taxes she could owe, she completely dropped the Schedule C altogether.
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.
Gifts Given and Received – Taxable?
Filed under: General, Trusts and Estates | Tags: $14000, 709, basis, cost basis, estate tax exemption, Form 709, gift, Gift Tax, inherited, lifetime gifting, noncash
Leave a Comment Originally published in the Cedar Street Times
December 27, 2013
I remember when I was growing up, every year for Christmas, my grandfather would send a check to my brother and I for $75 each. That seemed like an incredible amount of money to me at the time, and it really boosted my treasury each year! One of those years, I can remember going to the bank with my mom to cash the check, and wanting to see what $75 felt like in my own two hands; I asked the teller to give it to me…all in ones. She smiled, pulled some crisp ones from under her drawer, and counted them out for me. I had never felt a wad of bills like that in my hands! I tried folding them over, but I could not get them all in my pocket it was so thick, so I put them in lengthwise, and they just about stuck out the top of my pants pocket – I was a rich man!
After a week or so, we came back and deposited about half of them back into my bank account. My dad had always encouraged us to save half of whatever we received or earned when we were growing up. I admit, that ratio did not quite remain when I got into high school, and discovered a new and expensive hobby called, girls, but saving was ingrained in me. When I left for college I had a measurable chunk of change in my bank account.
Throughout those years, it never occurred to me to wonder about the tax implications of the gifts I received. Now, however, I think a lot about those things!
I do not know anyone that would hesitate to put a gift of $75 into his or her bank account. But if you throw two or three zeroes on the end, then I definitely get questions from people wondering if it they will have to pay tax. As the recipient of a gift, whether it is $75 or $75 million dollars, you do not have to pay taxes or report the receipt of the gift (with one exception that I can think of to be explained later). If you receive something other than cash, such as stocks, real estate, or tangible property, you could have tax if you sell it. The catch is that when you receive noncash gifts, you also receive the giftor’s cost basis, and when you sell you have taxable gain on the difference between the sales price and the cost basis. For example, if someone gives you a share of stock worth $100, and that person bought it for only $10, you have to pay tax on the $90 gain if you sell it.
If you put yourself in the shoes of the person giving the gift, there are different rules you need to follow. As long as you give less than $14,000 (2013 and 2014) a year in combined cash or noncash items to any one person, you have nothing to worry about, except providing the person evidence of your cost basis if the items are noncash items. (You are doing a disservice if you do not provide proof of cost basis, since the person you give the noncash items to could potentially be held liable for tax on the entire amount of the gift if they sell it, and cannot prove your cost basis – this is often overlooked.) You could give $14,000 to every person on earth each year and not have to file a gift tax return.
If you give $14,001 to just one person, then you have to file a Form 709 United States Gift Tax Return. The portion in excess of $14,000 per person is then subtracted from your combined gift and estate tax exemption (currently $5.25 million and indexed for inflation). For most people this is just an informational filing as they will never reach the limits, but it is required (and limits have gone up and down in the past). If you exceed the limits, however, the person giving the gift has a tax liability at a rate as a high as 40 percent. The only possible time I can think of that the IRS could pursue the recipient of a gift for taxes would be if the giftor gave away so much money that he or she had a tax liability and could not pay it. The IRS in that case, could pursue the person receiving a gift for tax.
Keep in mind that a gift is different from inheriting when someone passes away. You generally do not have tax on inherited amounts either, with the exception of tax liability on any earnings the assets you are entitled to accumulate between the date of the peron’s passing, and the date you receive the property. Your cost basis with inherited assets is also generally more favorable as the cost basis you receive is typically the fair market value at the date the person passed away, and not their old, often lower, cost basis.
Crafty minds will sometimes think of schemes to call income a gift since gifts are not taxable. Be careful of this – substance over form will rule the day. Yes, it would be nice if I would do your tax preparation for free, and you also happen to be kind enough to give me money, but it ain’t gonna fly!
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.
Health Insurance Tax Credit for 2014
Filed under: Healthcare Costs | Tags: advance payment, Covered California, dependents, health insurance, health insurance exchange, household income, IRS, Medicaid, MediCal, Medicare, poverty line, tax credit, threshold
Leave a Comment Originally published in the Cedar Street Times
December 13, 2013
You have probably heard that there is a possible tax credit for the new health insurance requirement that takes effect January 1, 2014. If you have health insurance available through your employer that does not exceed 9.5% of your household income (for your single coverage alone, exclusive of your family), or you have certain government plans like Medicare or Medicaid, you are not eligible for the credit. For others that can go through Covered California, our state health insurance exchange, your income will determine your eligibility. It is important to know the income thresholds for your family size because the poorly designed structure of the credit could mean the complete loss of the credit if you are even $1 over the threshold.
For instance, a family of four which includes a mother and father age 45 and two children in high school with total household income of $94,199 (using 2013 figures) in Pacific Grove, California, would qualify for a $629 per month tax credit, or $7,548 for the year. If they made $1 more of income, $94,200, they would receive absolutely nothing. This being the case, they would be better off taking an extra three or four weeks of unpaid time off from work, just to be able to qualify for the credit!
The credit is available to households making as much as four times the federal poverty line. If you make under the poverty line you are not eligible for the credit, but eligible for Medicaid (MediCal in California) instead. If you make between 100% and 400% of the federal poverty line, the credit is determined on a nice sliding scale based on your income, age, zip code, and family size. The problem is that there is a cliff once you get over 400% that makes you completely ineligible for the credit. The 2014 poverty line figures are not yet released, but can be found at http://aspe.hhs.gov/poverty/figures-fed-reg.cfm when available.
Using 2013 information, the critical thresholds at 400% are as follows based on the number of members in the family: one family member – $45,960, two family members – $62,040, three family members – $78,120, four family members – $94,200, five family members – $110,280, and adding $16,080 for each additional family member. California residents can visit https://www.coveredca.com/shopandcompare and enter in their family size, age of adults, zip code, and expected household income to determine the tax credit and premium options for the state healthcare exchange very easily.
The family size includes you, your spouse, and your dependents (whether or not actually related). Household income includes the income for you and your spouse (if married, you must file a joint return to get the credit), as well as any income of dependents IF those dependents had a filing requirement ($6,200 of earned income or $1,000 of unearned income in 2014). Although there is not a lot of clear guidance by the IRS at this point, it appears if they are under the filing requirement, none of their income is counted (this is another cliff!). This means you would need to make sure your dependents do not make over these amounts if it would push you over the threshold. More specifically the income included for you and your dependents is your adjusted gross income modified to include any tax-exempt income, nontaxed Social Security benefits, and any foreign earned income excluded.
Based on your 2012 income, you may be eligible to receive advance payments on your credit. However, this will be reconciled on your 2014 tax return, and you will either have additional funds paid to you, or worse, have to pay back (subject to a cap) some or even all of the credit if it turns out you were ineligible based on your actual income in 2014.
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.
New Tax Impacts for Trusts with Capital Gains – Part III
Filed under: Trusts and Estates | Tags: allocating capital gains to income, Capital Gains, current beneficiary, income, irrevocable trust, principal, Private Letter Ruling 200617004, remainder beneficiary, revocable trust, Treasury Regulation 1.643(a)-3, trust accounting income, trusts, Uniform Principal and Income Act
Comments (1) Originally published in the Cedar Street Times
November 29, 2013
During the past two columns I laid the groundwork of some of the basics on revocable and irrevocable trusts, I discussed the new tax rates that affect many trusts, and I discussed the distinction between income and principal transaction and their relations to capital gains.
In a short summary of the past two articles, revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return. Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns. There are commonly two types of beneficiaries of irrevocable trusts: 1) current beneficiaries – who often receive the trust accounting income (and principal to an extent if needed) during their lifetime, and 2) remainder beneficiaries – who receive the principal upon the death of the current beneficiary.
The trust document has the power to define what type of revenues get classified to trust accounting income or principal, thus determining which beneficiary ultimately receives the money. If the trust document does not define how a particular revenue is to be treated, as is often the case with capital gains, then the state’s principal and income act governs. In California this means capital gains are considered a principal transaction and would not go to the current beneficiary. Federal tax rates on the highest income bracket earners have effectively risen by up to 8.8% on capital gains and 4.6% to 8.4% on other types of income. For irrevocable trusts, the highest bracket sets in at only $11,950 of income, so taxation to the trust is not generally desirable!
Picking up from that point in the last article, we can now discuss how that affects taxation. If trust accounting income is supposed to go to the current beneficiary, then for tax purposes that income will be “pushed out” of the trust and reported on the tax returns of the current beneficiary instead of the trust. To the extent that revenues are considered principal transactions, and are therefore slated for the remainder beneficiaries down the road, the trust pays the taxes instead. Capital gains used to be taxed at the same rate whether the income was pushed out to the current beneficiary, or taxed in the trust. Now, with the potential 8.8% additional tax on capital gains taxed to the trust, it matters a lot!
If there is a genuine concern that the remainder beneficiary should ultimately receive the money from gains due to appreciation, then the 8.8% additional tax would be worth it. For many grantors that set up trusts, however, a big concern is minimizing the tax impact, and they would rather structure the trust to distribute the gains to the current beneficiary to save taxes. This would be especially true when there is a close relation between the current beneficiary and the remainder beneficiary, such as a parent and a child, and even more so if there is a presumption that the parent will eventually give the money to the child anyway either during life or upon death.
If you are in the process of setting up a trust, I think this subject is an essential conversation that should be had between you, your attorney, and your tax professional. The attorney can draft language to allow the trustee the power to allocate the gains on sales to trust accounting income. It is worth mentioning that the underlying Treasury Regulation 1.643(a)-3 examples and Private Letter Ruling 200617004 place heavy emphasis on consistency by the trustee. In other words, you cannot flip back and forth each year between allocating capital gains to income or principal; you pick a method and stick with it. I think there will be resistance from some attorneys out of habit, or rote concern for the remainder beneficiaries in considering something like this. It is true, it may not always be the right choice, but I think given the changed landscape, it could be right for many people.
If you already have a trust, but have no explicit language in the trust document allowing for capital gains allocation to income, Treasury Regulation 1.643(a)-3 provides some leeway to do so anyway if done consistently. But it is questionable whether you can begin treating capital gains as income if you have not been doing so in the past. Perhaps a one-time change with a signed statement by the trustee of the intent from that point going forward would add credence. Another approach would be to amend the trust document providing the power to allocate capital gains to income from that point forward. If the grantor is still alive and consents to the change along with all of the beneficiaries, amending the “irrevocable trust” should not generally be a problem. If the grantor is not living, but all the beneficiaries agree, you may be able to successfully petition the court.
Of course you do all this, and the tax rates could just change again.
Please keep in mind there are many other rules and exceptions surrounding the ideas discussed in this article which I have not space to mention. Consulting with qualified professionals regarding your specific situation is always your best course of action.
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.
New Tax Impacts for Trusts with Capital Gains – Part II
Filed under: Trusts and Estates | Tags: $11950, 1040, 3.8%, B trust, beneficiary, bypass trust, California, Capital Gains, dividends, gifting trust, income, income beneficiary, interest, irrevocable trust, IRS, lawsuit, net investment income, principal, private, remainder beneficiary, revocable living trust, revocable trust, Social Security Number, tax, Uniform Principal and Income Act, UPIA
Comments (1) Originally published in the Cedar Street Times
November 15, 2013
Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013. Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return. Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.
In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint). It also raised the capital gains rate to 20 percent for these same people (up from 15 percent). In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint. Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.
However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away. The problem with irrevocable trusts is that the thresholds to be impacted are so much lower. Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge! One stock sale could easily put you in the top bracket! This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income. That is a big hit every year, and will be something new to battle.
If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!
Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document. Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily. The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive. Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living. Upon death, the remaining principal goes to the remainder beneficiaries.
The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash. I hardly ever see trusts that even mention capital gains, much less defining it as a part of income. In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.
It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules. I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern! This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need! Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.
In two weeks we will conclude our discussion.
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.
New Tax Impacts for Trusts with Capital Gains – Part I
Filed under: Trusts and Estates | Tags: 1040, B trust, bypass trust, Capital Gains, control, credit shelter trust, estate tax exemption, gifting trust, irrevocable trust, petition, portability, private, probate, revocable living trust, revocable trust, Social Security Number, tax, trust administration
Leave a Comment Originally published in the Cedar Street Times
November 1, 2013
In order to discuss the new challenge trustees have regarding capital gains, let us first review some basics regarding revocable and irrevocable trusts.
A revocable living trust is a trust created during your lifetime that spells out what you want to happen with, and who you want to control, your assets if you become incapacitated or pass away. This is the most common type of trust, and many people set these up because it has many advantages over just having a will upon death: the chief reasons are that it provides more control, has more tax advantages, it is more private, it is faster, and it is less expensive than the default court process called probate.
I would say the one major drawback of a trust administration process compared to probate is that you do not have the standardized court oversight and genuine closure that you have with the probate process. If there are difficult problems with trust administration, it often stems from that fact that most people appoint one of the recipients of their assets (beneficiaries) as the person responsible for carrying out the trust terms (the trustee).
Money does strange things to people, and I have witnessed it lead to families ripped apart when the non-trustee siblings start questioning the integrity of the sibling appointed as trustee. Generally, beneficiaries want their money yesterday! And they do not understand that it still takes a good bit of time, effort, and expense to handle everything. That said, I would still choose to have a trust 98 percent of the time, instead of just a will. If there are concerns about the solidarity of the beneficiaries, a corporate trustee could always be a solution.
Another characteristic of a revocable living trust is that it can be changed or even scrapped at anytime while you are alive – hence the name “revocable.” As a result of this control feature, of being able to terminate the trust and retain the assets, the trust is disregarded as a separate taxpaying entity, and you just report all the eligible income and expenses of the trust on your personal 1040. Everything gets reported under your Social Security Number instead of having a separate taxpayer identification number.
Now let us turn the tables and speak about irrevocable trusts. These are trusts that generally cannot be changed once they are created. (Of course, nothing is set in stone, and well drafted trusts with trust protector language can assist in making changes, or if all the beneficiaries agree and the court approves a petition, changes or even revocation of an irrevocable trust are possible!)
An example of an irrevocable trust would be your revocable living trust after you pass away. At that point, your wishes regarding the disposition of your assets are irrevocable – locked-in as you specified – and the trustee must carry out your wishes. Often a revocable living trust will contain provisions to set up other trusts. For married couples, it has been very common to create an irrevocable trust called a bypass trust, (aka credit shelter trust, ‘B’ Trust, etc.).
Prior to some new “permanent” laws passed in January ($5 million indexed-for-inflation estate tax exemption with portability), it was important for estate inheritance tax reasons for many people to create bypass trusts. For most people estate inheritance tax will not be a concern now, but bypass trusts, or similar types of trusts, can still be important for controlling where the deceased spouse’s assets end-up, especially in blended family situations with children from prior marriages. In other words, dad doesn’t want mom to disinherit the children he had from a prior marriage once he dies!
Another type of common irrevocable trust is a gifting trust. These are commonly created by a parent or a grandparent to permanently move assets out of their estate and into a trust for the benefit (or future benefit) of a child or grandchild with certain stipulations and protections governing the assets in the trust. We saw a lot of these set up in 2012 due to the uncertainty of the estate tax laws and the possibility of missing an opportunity to save estate inheritance tax down the road.
Due to the fact that you have relinquished a lot of control with an irrevocable trust, and it will no longer be included in your estate, the taxing authorities view this trust as a separate tax paying entity. This means it has its own tax return each year and gets its own taxpayer identification number.
In two weeks we will begin discussing the new tax rate changes and their impacts on trusts.
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.
Happy 100th Birthday Federal Income Tax?!
Filed under: General, Tax Collections | Tags: 100 years, 16th Amendment, 1913, Abraham Lincoln, apportioned, Civil War, Commissioner of Internal Revenue, Congress, direct taxes, excise taxes, Federal Income Tax, Internal Revenue Service, ratification, Sixteenth Amendment, Supreme Court, tariffs, Tax rates, unconstitutional, Woodrow Wilson
Comments (2) Originally published in the Cedar Street Times
October 18, 2013
On October 3rd, our nation’s federal income tax turned 100 years old. Usually lots of people show up for anyone turning 100, but sadly, for the federal income tax, there was no grand party. In fact, most of its closest friends – the 106,000 employees of the Internal Revenue Service were at home due to the government shutdown! Americans celebrating the federal income tax would be lackluster at best – maybe on par with the excitement of throwing a party for your boss. But let us at least pay some tribute to this system and perhaps gain a little more perspective
The roots of the income tax go deeper than 1913. Abraham Lincoln set up the first income tax in 1862 in order to finance the Union efforts in the Civil War, and he established a position called “Commissioner of Internal Revenue” to handle this job. The tax was a temporary tax and expired in 1872. It provided about 21 percent of the cost of the war efforts, and about 10 percent of Union households were touched by the income tax.
Tariffs and excise taxes were the typical means of generating most revenue before and after the Civil War, but the country was looking for a better system. In 1894, Congress tried to reenact the income tax but it was shot down by the Supreme Court which declared it unconstitutional. The Constitution basically said that direct taxes had to be apportioned to the states based on relative population. An income tax clearly violated that since it was not divided out based on population but different to each person based on each individual’s income.
During the early 1900s, there was a growing movement by the people in support of a permanent income tax that would mainly be levied on wealthy individuals. Tariffs and excise taxes hit low and middle income people squarely on the shoulders since a much higher percentage of their total income was taxed as a result. The only way to have an income tax, however, was by laying the groundwork to make it constitutional via an amendment.
Three main campaign issues defined the election of 1912: monopolies, women’s suffrage, and tariffs. Woodrow Wilson wanted to break up monopolies, he dodged women’s suffrage by saying it should be decided at the state level, and he wanted revenue reform. He was elected with nearly 82 percent of the Electoral College vote and the next year the 16th amendment was ratified which states, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
I have a facsimile on my office wall of the first income tax return in 1913. It was three pages long with one page of instructions (2012 instructions were 214 pages by comparison). Adjusted for inflation in today’s dollars, if you made less than $70,000 as a single individual, you had no income tax liability. If you made between 70,000 and $465,000, you were assessed a one percent income tax! The top bracket was only seven percent, and assessed to those filers making over $11.6 million in today’s dollars.
Compare that to 2013…our bottom tax bracket is 10 percent assessed on single individuals making between $10,000 and $18,925, and our top bracket is 39.6 percent assessed on individuals making over $400,000. In fairness to history, after the first three years tax rates started rising and they skyrocketed during World War I when the top bracket hit 77 percent on earnings over $15 million in today’s dollars.
Since 1975, there have been dozens of court cases from crafty people trying to figure out how they can get out paying income taxes. The cases involve everything from claims that ratification procedures of the sixteenth amendment in certain states were not properly followed right down to claims that differences in punctuation and capitalization marks in versions ratified by the various states means the ratification was null and void. None of the ratification cases have ever been victorious and the courts have ruled ratification arguments are now frivolous or fraudulent.
The federal income tax is quite resilient, and has spent its entire life being pulled in many directions. I am sure it will soon get over any hurt feelings from not having a 100th birthday party as did the Department of Labor, the U.S. Forest Service, and the National Archives. Maybe on its 200th birthday it will get a cake.
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.
IRS Affected by Government Shutdown
Filed under: General, National Debt | Tags: $800, 000, appeals, audit, Congress, essential employees, Exxon, funding, furlough, GM, Google, government shutdown, income tax, interest, IRS, payroll tax, Penalties, refunds, Target, taxpayer advocate
Leave a Comment Originally published in the Cedar Street Times
October 4, 2013
Due to the inability of Congress to come to terms regarding the government shutdown (or just about anything for that matter), I have a pretty good chance that this article will still be worth reading by the time it is published in the newspaper on Friday!
Everyone is aware by now that over 800,000 federal employees are on furlough. I read that this is more than all the employees of Target, General Motors, Exxon, and Google combined. That is a lot of people! Included in these 800,000 are most of the Internal Revenue Service employees.
Many of you may be cheering right now, but certainly not anyone that is waiting on a refund or currently trying to work out any problems with the IRS. Prior to the furlough, telephone wait times to speak with an IRS agent have been 15 – 45 minutes, or sometimes you would get the message that they were too busy to even put you on hold, and then hang up on you. Right now you will have an indefinite wait since the call centers are completely closed. All local IRS offices are also closed to the public as well. The shutdown will of course put even more pressure on wait times when funding is restored, and there is a backlog of problems to resolve.
This is an interesting time to be shutdown considering that extended personal tax returns are due on October 15. The IRS still expects individuals and businesses to file all tax returns on time, keep making income and payroll tax payments, etc. Presumably, they have some essential employees still on-the-clock to let the mailman in and to make deposits! They are encouraging electronic filing since those returns are processed automatically by computers. Paper returns will not be processed, however any payments enclosed will still be processed! All tax refunds are suspended until normal operations resume.
Computer generated IRS notices will continue to be mailed out, but all audits, appeals, and taxpayer advocate cases are suspended. If you had meetings scheduled they will be rescheduled.
The IRS website will still be up and running, but certain services may be unavailable. The IRS automated telephone system will also still be working (800) 829-1040.
I can only assume that penalties and interest will still accrue even if you are waiting on the IRS to resolve an issue.
I called the IRS employee emergency hotline for kicks. They are informing employees that they cannot perform any work, even if they want to volunteer their time to keep certain cases moving, and they cannot use any government computers, equipment, or other resources. If they were en route traveling when the furlough began, they were to immediately return home.
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.
Health Reform Notice to Employees by Sept. 30
Filed under: Healthcare Costs | Tags: Affordable Care Act, Department of Labor, health insurance, Health Insurance Marketplace, Health Reform, notice to employees of coverage options, penalty
Leave a Comment Originally published in the Cedar Street Times
September 20, 2013
Change is challenging, and the current health reform laws are no exception. And it is exceptionally challenging when the laws are constantly changing, vague, impossible to follow, or impossible to enforce! In light of that commentary, I would like to enlighten business owners that they are supposed to notify employees of health care coverage options and the Health Insurance Marketplace by September 30th, even if they do not have or intend to provide health insurance.
The United States Department of Labor website contains two model notices that you can easily adapt and provide to your employees. One of the notices is designed for employers that have a health insurance plan. The other notice is designed for employers that do not have a health insurance plan and do not intend to provide health insurance.
If you go to http://www.dol.gov/ebsa/healthreform/ and look in the section titled “Notice to Employees of Coverage Options,” you will see the two notices and can even download the one you need as an editable Microsoft Word Document. You can then fill out the section that provides contact information for the person in your company that can handle questions. If you pick the notice for employers that have health insurance, then there is also a section to fill out about your health insurance plan. Then you simply give them to your employees.
The notices essentially make people aware that the new law requires people, in most circumstances, to carry health insurance starting January 1, 2014, with an open enrollment period beginning October 1, 2013. It also makes them aware they should be able to purchase health insurance through a Health Insurance Marketplace if their employers do not offer affordable coverage that meet certain standards. The notices also try to explain there could be some tax benefits to assist with paying premiums depending on income levels.
It would be nearly impossible to enforce and unfair to penalize for noncompliance regarding this notice to employees given the mess the country is in trying to implement the Affordable Care Act. Fortunately, the government recognizes this as well, and is saying they will not penalize businesses for failure to notice, even though the businesses should provide notification.
For people that fail to obtain health insurance, a self-imposed penalty is supposed to be reported on your 2014 tax return equal to the greater of two calculations. The first calculation is one percent of the difference between your Adjusted Gross Income (AGI) and the minimum AGI required to file your tax return. The second calculation is $95 for yourself and each of your dependents ($47.50 per person under 18) up to a maximum of $285. Most people will therefore be looking at the one percent penalty. In order to enforce this law, the IRS will be looking for statements from employers reporting details of employee coverages in company plans. This reporting will be voluntary for 2014, which means many businesses will not report, and it will be very difficult for the IRS to enforce the penalty short of discovering it through an audit process. In 2015 and 2016, the penalty is expected to rise substantially.
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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