Archive for the ‘HSA’ Tag

Back to Basics Part XXI – Form 5329 – Penalties on Retirement Accounts

Originally published in the Cedar Street Times

August 21, 2015

The official name for Form 5329 is “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.”  In other words, “penalties on incorrect contributions to or withdrawals out of retirement accounts, education accounts, and medical accounts.”

Most people are familiar with the fact that retirement accounts such as 401(k)s, 457 plans, IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, etc. have limits on the amount of money you can contribute each year.  They also limit your ability to withdraw money from those accounts until you are generally 59.5 years old, or meet one of a handful of limited exceptions.

Most people are also familiar with fact that you MUST begin taking distributions by the time you reach 70.5 years old (with a few exceptions such as for Roth IRAs, certain employees that have not yet retired from their job, or non-spouse inherited IRAs).  You can delay the distribution in the year you turn 70.5 until April 1st of the following year, but if you do that, then you have to take two distributions that year.  IRS instructions are often very poorly worded on this particular matter, and often people misunderstand this important point.

Education savings accounts such as 529 plans or Coverdell ESAs as well as tax favored medical spending accounts such as HSAs and Archer MSAs also have annual contribution limits.  In addition, you must use the funds for qualified education or medical expenses, respectively.

If you fail to follow the rules, either by accident or out of necessity, you will generally incur penalties, which are calculated using Form 5329 for most of these infractions.

So, how much are the penalties?  If you over-contribute to a retirement plan, education account, or medical spending account there is a six percent penalty on excess contributions if you do not withdraw the excess contribution (plus any related investment earnings)  within six months of the original due date of the return, excluding extensions (so by October 15 for almost everybody).  Any earnings generated by the over-contribution will be treated as distributions of cash to you in the tax year the correcting withdrawal actually occurs.  The rules governing distributions (discussed later) will apply and you may be subject to penalties on that portion.    The custodian of the account will calculate the related earnings that need to be pulled out of the account when you inform them of the need to withdraw funds.

If you over-contribute for multiple years in a row before realizing it, the penalty compounds.  So you would file a Form 5329 for each of the past years (no 1040X needed) and pay six percent on the excess contributions for the year of the 5329 you are filing, plus any prior excess contributions that still had not been taken out.  In other words, you pay six percent every year on the excess contribution until you take it out.  Interest would also be assessed on top of the penalties.

If you fail to take a Required Minimum Distribution (RMD), the penalty is 50 percent of the amount that was supposed to be taken out, but was not.  Unlike the six percent over-contribution penalty that applies every year until you take the funds out, the 50 percent penalty only applies once.  But you would need to withdraw the funds and file a 5329 for each past year you failed to take an RMD.  Interest would also be assessed on top of the penalties.  Fortunately, the IRS has been pretty lenient with the steep 50 percent penalty, and you can often get them to waive the penalty for reasonable cause once you withdraw the money.

Early distributions for all retirement accounts that do not qualify for an exception are subject to a ten percent penalty, (plus inclusion as taxable income for the portion related to original contributions for which you received a tax deduction as well as on any earnings generated while in the account).  SIMPLE IRAs have a special rule that increases the penalty to 25 percent if the date of your first contribution to the SIMPLE IRA was less than two years ago.

Distributions from education savings accounts for nonqualified purposes are subject to a ten percent penalty.

Distributions from medical spending accounts that are not used for qualified purposes are generally subject to a 20 percent penalty.  These 20 percent penalties, however, are calculated on different forms (8889 for HSAs and 8853 for MSAs).  With HSAs when you reach 65, you can use the money for whatever purpose you want, without penalty.  You can also rollover an MSA into an HSA.

Regarding the Form 5329 itself, the first two parts deal with distribution penalties for retirement accounts and education accounts (health account distribution penalties are calculated on other forms).  The third through seventh parts deal with excess contribution penalties for each different type of account.  The final section, part VIII, deals with penalties on RMDs not distributed.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA 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.

Your Future Tax Return: Romney Versus Obama

Originally published in the Cedar Street Times

November 2, 2012

If tax positions would sway your Tuesday vote, here is what Obama and Romney would like to see.  Keep in mind, however, you don’t always get what you want!

Tax brackets: Romney reduce to 80% of current levels. Obama keep the same as 2012 except allow top bracket to split into two higher brackets like pre-2001. (Romney, Current 2012 Rates, Obama, 2013 rates if no congressional action ) (8%, 10%, 10%, 15%), (12%, 15%, 15%, 15%), (20%, 25%, 25%, 28%), (22.4%, 28%, 28%, 31%), (26.4%, 33%, 33%, 36%), (28%, 35%, 36% and 39.6%, 39.6%)

Capital gains, interest, dividends: Romney reduce tax rate to zero for AGI below $200K.  15% max if AGI above $200K. Obama increase long-term capital gains rate to 20% max and up to 39.6% on dividends – leave interest taxed at ordinary bracket rates.

2013 3.8% Medicare surtax on net investment income and existing 0.9% medicare surtax for married filers over $250K AGI and others over $200K: Romney repeal.  Obama keep.

Itemized deductions: Romney cap itemized deductions (maybe $17,000-$50,000 cap) and maybe eliminate completely for high income.  Obama reduce your itemized deductions by 3% of your AGI in excess of $250K married, $225K HOH, $200K single, and $125K MFS (up to 80% reduction of itemized deductions) and limit the effective tax savings to 28% even if you are in a higher bracket.

Income exclusions: Romney keep as is. Obama cap the effective tax savings to 28% on exclusions from income for contributions to retirement plans,  health insurance premiums paid by employers, employees, or self-employed taxpayers, moving expenses, student loan interest and certain education expenses, contributions to HSAs and Archer MSAs, tax-exempt state and local bond interest, certain business deductions for employees, and domestic production activities deduction.

AMT: Romney repeal. Obama keep but set exclusion to current levels and index for inflation.

2009 expanded Child Tax Credit, increased Earned Income Credit, and American Opportunity Credit: Romney – Allow to expire as scheduled 12/31/12.  Obama – Make permanent.

Buffett Rule: Romney “Not gonna do it.” Obama households making over $1 million should not pay a smaller percentage of tax than middle income families.  This is accomplished by raising the rates on capital gains and dividends as discussed earlier.

Temporary two percent FICA cut you have been enjoying in 2011 and 2012: Both candidates favor allowing to expire at 12/31/12.

Estate tax: Romney repeal.  Obama set at $3.5 million and index for inflation with top rate of 45% on excess.

Top corporate tax rates: Romney 25%. Obama – keep at 35% for 2013 but maybe reduce to 28% in the future.

Corporate international tax: Romney don’t tax U.S. companies on income earned in foreign countries. Obama discourage income shifting to foreign countries.

Corporate tax preferences: Romney extend section 179 expensing another year, create temporary tax credit, expand research and experimentation credit. Obama increase domestic manufacturing incentives, impose additional fees on insurance and financial industries, reduce fossil fuel preferences.

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.

Divorce Taxation – Part III

Originally published in the Pacific Grove Hometown Bulletin

July 4, 2012

Since it is July 4th, and we are discussing divorce, I suppose it would be appropriate to say, “Happy Independence Day!”

Tax Carryforwards

When going through a divorce it is important to realize you may have valuable “tax assets” that need to be divided according to tax law or negotiated between spouses.  Capital loss carryforwards (such as those generated by stock sales) are supposed to be allocated based on whose assets from the past created the losses.   Net operating loss carryforwards (such as those generated by a large business loss) are supposed to be determined by recalculating what the losses would have been if you had been filing separate.  Minimum tax, general business credit, and investment interest expense carryforwards can be negotiated.

Suspended passive activity losses (such as those generated by rental properties) go with the individual receiving the property, however, there are some pitfalls to avoid that could require the passive activity losses to be added to basis, rather than becoming immediately available to the spouse receiving the property.  If you happen to have bought a house with the $8,000 homebuyer credit that has to be repaid, the person who takes the home becomes solely responsible for repayment.

In practice, I have not seen the IRS come down heavily on how carryforwards are divided, but it is important to know what you are entitled to, so you do not miss out on something that could save you money down the road.

Children

Children present a number of planning issues in a divorce.  Tax benefits related to children include the child’s exemption, child tax credits, dependent care credits, exclusion of income related to dependent care benefits, earned income credits, education credits, and head of household filing status.  The custodial parent (defined for tax purposes as the parent who lived with the child most during the year) is generally the one eligible for these benefits, although the custodial parent may release two of those (the exemption and child tax credits) to the noncustodial parent by filing Form 8332, and keep the remaining benefits. As discussed in a previous issue in this series, it is also possible for both spouses to claim head of household if the abandoned spouse rules are met.  If both parents meet certain qualifying child rules, they can also each claim medical and health insurance expense deductions they pay for the child and can distribute money from HSAs, MSAs, etc. for the child’s benefit.  When multiple children are involved, planning can be done to preserve the head of household status for both spouses.

Child support payments are not taxable income to the recipient parent, nor are they deductible by the parent paying the child support.  Alimony on the other hand is income to the recipient, and deductible by the paying parent.  Be sure your divorce decree is clear and specific on the payment of alimony and child support.  Alimony is a tricky area and you must be very careful about how it is paid.

To be continued next issue…

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!

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.