Blog Archive
More tax moves to make before Christmas
It’s time to take steps to reduce your 2013 tax bill
By Bill Bischoff, TAXGUY Matketwatch.com
With the end of the year approaching, it’s time to make some moves to lower your 2013 tax bill. This column is the first of two installments on that subject. But first, let’s cover some necessary background information.
Income Tax Rates Are Unchanged for All but Higher-Income Individuals
For most individuals, the federal income-tax rates for this year are the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%. However, the American Taxpayer Relief Act (ATRA), passed at the beginning of this year, increased the maximum rate to 39.6%. That rate only affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000, and heads of households with income above $425,000. For 2014, the tax bracket cutoffs are slightly higher, as shown in the table at the end of this column.
Capital Gain and Dividend Tax Rates Are Unchanged for All But Higher-Income Individuals
The federal income-tax rates on long-term capital gains and dividends for this year are also the same as last year for most individuals: either 0% or 15%. However, the ATRA raised the maximum rate to 20% for singles with taxable income above $400,000, married joint-filing couples with income above $450,000, and heads of households with income above $425,000. For 2014, the thresholds for the 20% maximum rate will be $406,750, $457,600, and $432,200, respectively. Folks with taxable income below these levels will pay a 15% federal rate on long-term gains and dividends or 0% for gains and dividends that would otherwise fall within the 10% or 15% brackets (see the tables at the end of this column for the 10% and 15% brackets).
Two New Medicare Surtaxes for Higher-Income Individuals
The 2010 Obamacare legislation included two new Medicare surtaxes that kicked in this year. The new 0.9% surtax hits salary and self-employment income collected by higher-income folks. The new 3.8% surtax hits net investment income collected by higher income folks.
The 0.9% Surtax: The new 0.9% Medicare surtax is charged on salary and/or net self-employment income above $200,000 for an unmarried individual and salary and/or net self-employment income above $250,000 for a married joint-filing couple.
The 3.8% Surtax: If your modified adjusted gross income (MAGI) exceeds $200,000 if you are unmarried or $250,000 if you are married and file jointly, all or part of your net investment income can be hit with the new 3.8% Medicare surtax. The definition of investment income includes long-term capital gains, dividends, interest and a host of other items. The 3.8% surtax applies to the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold. MAGI means “regular” adjusted gross income (AGI), from the last line on page 1 of your Form 1040, increased by certain tax-exempt income from outside the U.S. which you probably don’t have. See my earlier columns for some advice on how to minimize or avoid the 3.8% surtax: How to avoid new 3.8% tax on investment income and Tips for avoiding 3.8% investment income tax
Strategy: Time Investment Gains and Losses for Tax Savings
As you evaluate investments held in your taxable brokerage firm accounts, carefully consider the tax impact of selling appreciated securities (currently worth more than you paid for them). For most people, the federal income-tax rate on long-term capital gains is still much lower than the rate on short-term gains. For that reason, it often makes sense to hold appreciated securities for at least a year and a day before selling in order to qualify for the lower long-term capital gains rate.
Selling some loser securities (currently worth less than you paid for them) before year-end can be a tax-smart move. The resulting capital losses will offset capital gains that you racked up earlier this year, including high-taxed short-term gains from securities that you owned for one year or less. This year’s maximum federal rate on short-term gains is 39.6%, and the new 3.8% Medicare surtax may apply too — which can result in a combined federal rate as high as 43.4%. Ouch! But you don’t have to worry about paying a high rate on short-term gains that you’ve successfully sheltered with capital losses. You’ll pay 0% on those gains, and 0% is good!
If your capital losses for this year exceed your capital gains, you’ll have a net capital loss for 2013. You can use it to shelter up to $3,000 of this year’s high-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately). Any excess net capital loss is carried over to 2014 and beyond until you use it up. So it won’t go to waste. In fact, selling enough loser securities to create a bigger net capital loss to carry over to next year and beyond might make perfect sense. You can use it to shelter both future short-term gains and future long-term gains that might otherwise be taxed at higher rates than those that apply this year.
Strategy: Set Up Loved Ones to Pay 0% Rate on Investment Income
The federal income-tax rate on this year’s long-term capital gains and dividends is still 0% for gains and dividends that fall within the 10% or 15% rate brackets (see the table at the end of this column for the brackets). While your income may be too high to take advantage of the 0% rate, you probably have loved ones who can benefit. Consider giving them some appreciated stock or mutual fund shares. They can sell the shares and pay 0% federal income tax on the resulting long-term gains. Remember: the gains will be long-term as long as your ownership period plus the gift recipient’s ownership period equals at least a year and a day. Giving away dividend-paying stocks is another tax-smart idea. As long as the dividends fall within the gift recipient’s 10% or 15% rate bracket, they too will qualify for the 0% federal rate.
Warning: If your gift recipient is under age 24, the Kiddie Tax rules could potentially cause some of his or her capital gains and dividends to be taxed at the parent’s higher rates. That would defeat the purpose. Contact your tax adviser if you have questions about how the Kiddie Tax works.
Strategy: Convert Traditional IRA into Roth Account
The best scenario for the Roth conversion deal is when you expect to be in the same or higher tax bracket during retirement. While some higher tax rates have already kicked in for this year, there’s certainly no guarantee that more tax hikes are not in our future.
Of course, there is a current tax cost for doing a Roth conversion. That’s because the conversion is treated as a taxable liquidation of your traditional IRA followed by a non-deductible contribution to the new Roth account. Here’s the advantage: after the conversion, all the income and gains that accumulate in your Roth account, and all your withdrawals, will be federal-income-tax-free — assuming you only take qualified withdrawals. Qualified withdrawals are those taken after: (1) you’ve had at least one Roth account open for more than five years and (2) you’ve reached age 59 1/2. With qualified withdrawals, you avoid having to pay higher tax rates that may exist during your retirement years. Put another way, the current tax hit from a Roth conversion is unwelcome, but it could be a very reasonable price to pay for the future tax savings. But please talk to your tax pro before pulling the trigger on a conversion. There are lots of variables to consider.
Standard Federal tax parameters
10% tax bracket |
$0-8,925 |
$0-17,850 |
$0-12,750 |
Beginning of 15% bracket |
8,926 |
17,851 |
12,751 |
Beginning of 25% bracket |
36,251 |
72,501 |
48,601 |
Beginning of 28% bracket |
87,851 |
146,411 |
125,451 |
Beginning of 33% bracket |
183,251 |
223,051 |
203,151 |
Beginning of 35% bracket |
398,351 |
398,351 |
398,351 |
Beginning of 39.6% bracket |
400,000 |
450,000 |
425,000 |
Standard deduction |
$6,100 |
$12,200 |
$8,950 |
Personal/dependent exemption |
$3,900 |
$3,900 |
$3,900 |
Estimated 2014 Federal tax parameters (IRS has not yet released official numbers
10% tax bracket |
$0-9,075 |
$0-18,150 |
$0-12,950 |
Beginning of 15% bracket |
9,0766 |
18,151 |
12,951 |
Beginning of 25% bracket |
36,901 |
73,801 |
49,401 |
Beginning of 28% bracket |
89,351 |
148,485 |
127,551 |
Beginning of 33% bracket |
186,351 |
226,851 |
206,601 |
Beginning of 35% bracket |
405,101 |
405,101 |
405,101 |
Beginning of 39.6% bracket |
406,751 |
457,601 |
432,201 |
Standard deduction |
$6,200 |
$12,400 |
$9,100 |
Personal/dependent exemption |
$3,950 |
$3,950 |
$3,950
|
Feds change “use it or lose it” rule on FSAs
By Jonnelle Marte
MarketWatch, October 31, 2013
The Treasury Department and the Internal Revenue Service are giving taxpayers more time to use their pre-tax medical spending accounts.
New rules put an end to the 30-year old “use it or lose it” restrictions on health-care flexible spending arrangements, allowing taxpayers to carry over up to $500 of unused balances to the following year. Employees can contribute up to $2,500 a year into the tax-deferred accounts and then use the money to cover qualified out-of-pocket medical expenses. “Today’s announcement is a step forward for hardworking Americans who wisely plan for health care expenses for the coming year,” Treasury Secretary Jacob Lew said in a statement.
Before Thursday’s change, plan participants would have to forfeit any cash they didn’t use by the end of the year. Some employees may have been hesitant to use the accounts out of fear that they might overestimate their medical expenses for the year and have to lose those savings.
Some plan sponsors will let taxpayers take advantage of the carryover option as early as this year. Some employers have been giving their workers a grace period of up to 2 ½ months the following year to use the rest of the funds but going forward they will only be able to allow a carryover or a grace period, not both, the Treasury Department said on Thursday.
Grab These 8 Individual Tax Breaks Expiring Year End 2013
TAXES 10/15/2013
It may be your last chance to snag a tax credit for making green home renovations or buying an electric vehicle, or to partake in other popular tax breaks that are expiring at year-end 2013 if Congress doesn’t act to extend them. Sound familiar? It’s a story played out over and over as Congress dithers on tax reform and leaves taxpayers and their tax advisers hanging.
In its 2013 Year-End Tax Planning Special Report, tax publisher CCH, a Wolters Kluwer business, lists these sunsetting “ tax extenders” and says that taxpayers should consider acting now, before year-end 2013, whenever possible, to take advantage of these breaks. “Whether Congress will extend them again is questionable,” the report says. “While all have their supporters, Congress appears likely to take an extremely budget-conscious approach toward any tax provision it may consider.”
At least there’s certainty for 2013. When Congress passed the American Taxpayer Relief Act in January, it included renewing these extenders through year-end 2013–and retroactively for 2012. Let’s hope we don’t have to wait until 2015 for clarity on their fate for next year.
That said, here’s a rundown for your consideration before the New Year.
Remodeling your home for energy-efficiency. There’s a $500 tax credit (that’s a dollar for dollar savings) for making certain energy-efficient improvements to your home like putting in a new front door, added insulation or a corn stove. The credit is 10% of the cost of building materials, so if the cost is $5,000 you get $500 back courtesy of Uncle Sam. One big caveat: The $500 credit applies to cumulative claims for the credit dating back to 2006. For details, see Fiscal Cliff Deal Helps Pay For Green Home Remodels.
Get an electric vehicle. A tax credit for certain 2 or 3 wheeled electric vehicles expires at year-end. A separate tax credit of $7,500 is available for 4-wheeled electric vehicles including the 2012-2014 Ford Focus Electric, the 2013 Ford Fusion Energi, the 2013 Ford C Max Energi and the 2011-2012 Nissan Leaf and will be phased out once a manufacturer’s has sold 200,000 vehicles.
Commuter benefits. The transit parity tax break—putting train commuters on the same footing as car commuters who park so they can defer $245 a month of pretax salary to use for commuting expenses—is in danger yet again. If you commute and your employer offers the benefit, make sure you’re taking advantage of it for the rest of the year. And then for 2014, sign up through your employer, and if Congress extends the break retroactively, you’ll be more likely to be able to get money back.
Donate conservation property. Through year-end conservationists who donate property or easements on their property to conservation organizations like the Nature Conservancy or a local land trust get an enhanced tax break that’s helped modest-income landowners; these enhancements are good through year-end.
Charitable contributions from your IRA. If you’re 70 and a half or older, you can transfer up to $100,000 out of your Individual Retirement Account to charity. For some taxpayers, this is more tax-efficient than taking the required IRA distributions, paying income tax on those distributions and then giving to charity and getting an income tax deduction for the charitable gift. I described how the math works in the Forbes story Charity Strategy when the technique first became available in 2006.
State and local sales tax. CCH pegs this one as “the most politically-backed extender” so you probably don’t have to worry about it going away. But to be safe, if you’re a taxpayer who deducts state and local sales tax (in lieu of state and local income tax) and you’re contemplating big purchases in the near term you might want to make them in 2013.
Teacher’s classroom expense deductions. For school teachers who buy school supplies out of pocket, they get an above-the-line deduction of up to $250 for unreimbursed expenses. So it might pay to stock up on classroom supplies for the whole school year before year-end.
Exclusion of cancellation of indebtedness on principal residence.Taxpayers who are seeking debt modification or facing a short sale or foreclosure can exclude from income cancellation of mortgage debt of up to $2 million on their home. Forbes contributor Tony Nitti describes how this works here.
Would You Prepare Your Home For A Disaster If It Were Tax Deductible?
|
10/17/2013
Wherever you may stand on the climate change debate (cue the angry comments!), it’s undeniable that Mother Nature has grown a bit unpredictable in exacting her revenge for hairspray and Styrofoam. Superstorms in New Jersey. Mudslides in Colorado. Cyclones in India. But while we may not know where the next natural disaster is going to hit, one House Republican is doing his best to encourage people to be prepared.
Dennis Ross (R-FL) recently sponsored H.R. 3298, a bill that would permit taxpayers to deduct the cost of amounts contributed to a savings account to help ready their homes for the next natural disaster.
It works like this: Each year, an “eligible individual,” would be permitted to deduct up to $5,000 contributed to a designated “disaster savings account.” An eligible individual is defined as any individual who owns a home in the U.S. that is insured. A disaster savings account would be a trust created in the U.S. exclusively for the purpose of paying disaster mitigation expenses of the trusts beneficiary.
The definition of “disaster mitigation expenses” is where things get interesting. The proposed law defines the term as expenses for any of the following:
-
Safe rooms.
-
Opening protection, including impact and wind resistant windows, exterior doors, and garage doors.
-
Reinforcement of roof-to-wall and floor-to-wall connections for wind or seismic activity.
-
Roof covering for impact, fire, or high wind resistance.
-
Cripple and shear walls to resist seismic activity.
-
Flood resistant building materials.
-
Elevating structures and utilities above base flood elevation.
-
Fire resistant exterior wall assemblies/systems.
-
Lightning protection systems.
-
Whole home standby generators.
-
Any activity specified by the Secretary as appropriate to mitigate the risks of future hazards (including earthquake, flood, hail, hurricane, lightning, power outage, tornado and wildfire) and other natural disasters.
Any amounts withdrawn from the account and used for a qualifying expense would not be included in taxable income. Obviously, amounts distributed for other purposes would be included in taxable income, with an extra 20% excise tax tacked on for good measure.
While the bill is certainly well-intentioned, good ol’ Gov Track is not optimistic, giving H.R. 3298 a 0% chance of being enacted.
Fed shutdown and your retirement: Remain calm
By Robert Powell,
MarketWatch, Oct. 11, 2013
Shutdown, shmutdown.
Retirees and those saving for retirement may be worried about their investments, taxes and retirement plans as the federal government shutdown drags on, and lawmakers argue about extending the debt ceiling. But retirement advisers say you should take a deep breath and hold on. Only if these issues drag on for a seriously extended period should you need to review your investment plans. We’ve been down this road before and the world didn’t end, say some.
That said, there are some other issues, such as taxes and Social Security, you should keep an eye on.
The first order of business, said Steve O’Hara, a principal with CLA Financial Advisors, is to put the government shutdown in perspective. According to O’Hara, there have been 17 government shutdowns since the mid-1970s through the mid-‘90s and during that time the government was shut down for a total of about 110 days. “And none of those shutdowns had any significant impact on the market,” he said. “So the first thought that I would have is ‘just take a deep breath.’ And any quick reaction that anybody might be planning to do probably ought to think twice about doing that.”
Others are in the same camp.
Taxes
As far as taxes are concerned, experts say there is no getting around it. You still have to pay Uncle Sam what he’s owed. Plus, despite the shutdown, the IRS just reminded taxpayers that the Oct. 15 due date for 2012 individual tax returns on extension hasn't been extended, according the Journal of Accountancy. (Of note, the IRS says more than 12 million taxpayers filed for extensions this year.) Read Reminder: Oct. 15 Tax Deadline Remains During Appropriations Lapse.
What’s worse is this: You have to pay Uncle Sam, but the government doesn’t have to pay you. “Refunds are not being processed,” said Barry Picker, CPA, of Picker & Auerbach, as well as the author of Barry Picker’s Guide to Retirement Distribution Planning and the technical editor of 100+ Roth IRA Examples & Flowcharts. The good news? “The law says that if you don’t get your refund within a certain period, the government has to pay you interest, at a 3% rate.”
One bit of good news: IRS recently reminded taxpayers that it isn’t generating liens or levies during the shutdown. The IRS might not generate a lien, but you should still comply with filing anything due the IRS. “I’ve heard a number of people suggesting that there is no point in send replies to IRS notices and the like,” said Marty Shenkman, an attorney with Martin M. Shenkman, PC. “After all there is no one there to receive them. Big mistake.”
If any taxpayer has an IRS notice or tax deadline, Shenkman offered these words of wisdom; “Not only would I make the point of sending in what you have to but I would send it certified or priority mail so you can get a confirmation of delivery from the post office. Not return receipt, because there may be no one to sign. Ignoring deadlines and notices could well be at the taxpayer’s peril.”
Speaking of taxes, Blackwelder advised those with high incomes and who plan to realize capital gains this to evaluate the tax law changes applicable to 2013, and especially the so-called Medicare surtax. For tax years beginning after 2012, new Internal Revenue Code Section 1411 imposes a 3.8% surtax on certain passive investment income of individuals and of trusts and estates based on a mathematical formula, according to a recent Retirement Weekly report. For individuals, the amount subject to the tax is the lesser of 1) net investment income or what some call NII or 2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount, according to the report written by Robert Keebler, CPA, a partner with Keebler & Associates.
Social Security
Social Security beneficiaries are still getting monthly checks, but they will have to wait to find out the size of next year’s cost-of-living adjustment, according to published reports. The date to announce the annual COLA was Oct. 16.
The Social Security Administration is warning Americans public that if the debt ceiling isn't increased, the agency cannot guarantee full benefit payments. Should that happen, retirees are being urged to make sure they have enough cash on hand to make up any shortfall for three to six months if not longer.
A harsh reminder
The shutdown is also a reminder of the need to plan for such events, the importance of having an emergency fund in place, and perhaps the need to have marketable skills.
Frank Paré, an instructor in the personal financial planning program at the University of California at Berkeley and the founder of PF Wealth Management, recently provided—along with other financial planners—pro-bono financial planning services to low- and no-income families.
“We had over 200 individuals show up for the event, and there was a real sense of concern about how the government shutdown and potential default would impact their day-to-day living situation as well as their ability to retire at some later date, he said. “Unfortunately, there was very little we could advise them to do in response to the shutdown or in the event of a default.”
And what made the effort to help low- and no-income people particularly challenging for Paré and his peers was this: His county’s services relies on the federal government for a large portion of its budget. “As result of sequestration, the county resources were cut and as a result of the shutdown, the process of sending the remaining funds (if any) is delayed,” he said. “I would imagine we’re not alone and that cities and counties across the country are having the same challenges.”
Long-term care insurance and your taxes
Qualified policies deliver tax breaks; here are the basics
TAXWATCH Sept. 26, 2013
By Bill Bischoff
If you or a loved one turns out to need long-term care, you don’t want to see a big chunk of hard-earned savings go down the drain to pay for it. Long-term care (LTC) insurance can help. As a bonus, qualified LTC policies deliver some tax breaks. Before getting to the tax angles, let’s first cover the basics on LTC insurance.
Long-Term Care Insurance Basics
Benefits paid under a long-term care insurance policy are usually stated as daily maximums ranging from $50 to $300. While lower benefits translate into lower premiums, don’t get carried away. According to a recent MetLife survey, the national average cost for a semi-private nursing home room in 2012 was $222 a day, which translates to about $81,000 over a full year. The average base rate for a year in an assisted living facility was about $44,000, and additional services cost extra. Most LTC policies also cover at least a portion of home health-care costs, which came to about $21 per hour last year. While these national numbers are interesting, the costs where you live are what really matter, and they can be significantly higher or lower.
You can buy a LTC policy with or without automatic annual inflation adjustments to your benefit maximums. Usually, the annual inflation adjustment rate is 3% to 5%, and that rate can be compounded annually or not. Choosing a 5% compounded inflation adjustment feature is more expensive, but it could be money well spent.
Benefit payments commence after the policy waiting period has been satisfied. Policies with waiting periods of 90-100 days are the most popular.
Finally, you can usually choose benefit periods ranging from two years to lifetime coverage. Most policies have benefit periods of three, four, or five years. The average length of a nursing home stay is about two and a half years, but this statistic doesn’t account for periods of home health care.
When you sign up for LTC insurance, the hope is that you’ll pay fixed monthly premiums. The premiums are based on your age and health factors at the time you enroll. Enrolling at age 65 could cost twice as much or more than enrolling at age 55. Your overall health status needs to be good when you apply for coverage or you won’t be accepted at any age. After you obtain coverage, it will remain in force—regardless of changes in health and advancing age—as long as you pay the premiums. Beware: while the insurance company can’t raise your LTC premiums due to changes in your personal age or health, it can raise premiums for broad classes of policyholders when financial results go south. This has turned out to be an all-too-often occurrence. So be sure to check the overall reputation and premium-raising history of any insurance company you’re considering for LTC coverage.
Tax Breaks for Qualified Policies
Qualified LTC policies are eligible for federal income tax breaks (and maybe state income tax breaks too depending on where you live). Qualified policies must be guaranteed renewable, and they cannot have any cash value. Most policies sold these days are qualified policies, but make certain before signing up if you want to collect the tax breaks I’m about to explain.
Tax-Free Benefits: Benefits received under a qualified LTC policy are generally federal-income-tax-free (and usually state-income-tax-free too) because they are considered insurance reimbursements for medical expenses. For 2013, this tax-free treatment automatically applies to benefits of up to $320 per day. (The tax-free cap is adjusted annually for inflation.) Even if you receive benefits above the cap, they are still tax-free as long as they don’t exceed your actual LTC costs. If you collect LTC insurance benefits during the year, the total amount will be reported to you on Form 1099-LTC, which you should receive early in the following year. You then calculate the taxable amount of benefits (probably zero) on Form 8853, which is attached to your Form 1040.
Tax Deductions for Premiums: Because a qualified LTC policy is considered health insurance for federal income tax purposes, the premiums are treated as medical expenses for itemized medical expense deduction purposes. However, if your premiums exceed the age-based caps listed below, you can only count the capped amount as a medical expense. Don’t forget to count premiums paid for coverage on your spouse as well as premiums paid for any other dependent relative (for this purpose, a dependent relative is someone for whom you pay over half the cost of support during the year).
40 or under
|
$360
|
41 to 50
|
$680
|
51 to 60
|
$1,360
|
61 to 70
|
$3,640
|
Over 70
|
$4,550
|
Take your qualified LTC insurance premium amount (limited to the age-based cap if applicable) and combine that figure with your other medical expenses (health and dental insurance premiums, insurance co-payments, out-of-pocket prescription costs, and all your other unreimbursed medical outlays). If the resulting total exceeds 10% of your adjusted gross income (AGI), you can write off the excess as an itemized medical expense deduction. If you or your spouse will be age 65 or older as of Dec. 31, 2013, you can write off medical expenses to the extent they exceed 7.5% of AGI. (AGI is the number at the bottom of Page 1 of your Form 1040; it includes all taxable income items and is reduced by certain write-offs such as deductible IRA contributions and alimony payments to an ex-spouse.)
If you’re self employed, you can generally deduct premiums for qualified LTC insurance on page 1 of Form 1040 whether you itemize or not. However, the age-based deduction cap applies to you too.
The Cure For Cold & Flu Season: An Alphabet Soup Of Tax Favored Accounts
I wasn’t home an hour today after taking my middle child to the doctor when the nurse called to let me know that my oldest child just vomited at school. That pretty much completed the trifecta since my youngest child was at the doctor over the weekend with a nasty cough and a low-grade fever. Cold and flu season has officially arrived.
Thank goodness for my health reimbursement account (HRA). Without it, I’d feel a lot worse about all of these out-of-pocket expenses that I’m paying while my kids get better.
Most years, we don’t get the benefit of claiming our medical expenses on our federal income tax return. That’s because in prior years, even though we itemized our deductions on Schedule A, we have rarely met the threshold. Until this year, under the Tax Code, you can only claim eligible medical expenses as a deduction to the extent they exceed 7.5% of adjusted gross income (AGI).
You can find your AGI at line 37 of the form 1040:
It’s even worse now. For 2013, we definitely aren’t going to hit the threshold. This year, taxpayers younger than 65 (that’s us!) can only deduct medical expenses to the extent those expenses exceed 10% of AGI; those taxpayers who are 65 and older in 2013 keep the 7.5% threshold through 2016. That new threshold is a pretty high bar – even with a busy cold and flu season.
It’s not just my family: more taxpayers will find that their expense won’t hit the necessary numbers in 2013 to take advantage of the deduction.
According to the most recent census report, median household income, adjusted for inflation, was$51,017 in 2012. Using that number as our example for AGI, to claim the medical expense deduction, a family reporting those kinds of dollars would have had to spend $3,826.27 (7.5% x $51,017) on qualified medical expenses in 2012 before deducting a single dollar: that’s a lot of co-pays. That explains why only about 6% of taxpayers have traditionally claimed the deduction. With Obamacare, that percentage of taxpayers is about to get a lot smaller.
In 2013, the threshold for the same level of income will increase to $5,101.70 (10% x $51,017). That means that the family in the example would have to spend $5,103 on qualifying medical expense before claiming a single dollar of deduction. And I literally mean a single dollar. Remember that you can only deduct expenses over that the threshold amount. If the family spent $5,000 in medical expenses, there would be no deduction ($5,000 – $5,102 = less than zero); if the family spent $6,000 in medical expenses, the allowable deduction would be $898 ($6,000 – $5,102 = $898).
With those kind of hurdles, I asked around about alternatives and landed on the idea of an HRA. It’s one of a handful of special accounts available to taxpayers for medical expenses.
A health reimbursement arrangement (HRA) is a 100% employer-funded spending account. In other words, it’s not an employee savings plan but a tax-favored perk: contributions to the account are available to employees, tax free, as reimbursements. In fact, amounts in the HRAs aren’t even reported on a federal income tax return.
It’s not just current employees who can participate. Under most plans, current or former W-2 employees, as well as qualified dependents, may participate. But read the fine print: each plan is employer-specific.
Here’s how it works. The contribution amount for each employee is determined each year by the employer. The employer also determines which expenses qualify: typically, the HRA is used to help pay for eligible out-of-pocket medical expenses. Eligible expenses are generally the same sort of out-of-pocket costs that qualify for the medical deduction. That includes the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. That tends to include the costs of visiting to medical professionals as well as the purchase of any medicine or drug which requires a prescription of a physician for legal use.
When expenses are incurred – a good example is a co-pay for a doctor’s visit – those expenses can be reimbursed to the employee, assuming that the expense qualifies and is backed up by documentation. In my case, expenses do include co-pays as well as medications and, thankfully, vision and dental. In terms of documentation, a detailed receipt will generally do – I’m allowed to snap a photo of the receipt on my smartphone and send it electronically for processing.
After the expense is approved, the reimbursement shows up in the form of a check – most commonly included on a paycheck – and it’s tax free. That means that the expenses are paid for with the equivalent of pre-tax dollars: these dollars are subtracted from gross pay before any income or payroll taxes are calculated. In other words, if you earn $50,000 in wages and get $1,000 in reimbursement, your form W-2 will reflect just $50,000.
But what if your employer doesn’t offer an HRA? All is not lost. An individual can, without an employer-sponsored plan, create their own health savings account (HSA).
The HSA is a bit like an IRA for medical expenses. Contributions are made by the taxpayer, or a combination of the taxpayer and his/her participating employer. Those contributions are capped: for 2013, the limits are $3,250 for individuals and $6,450 for families and those numbers increase to $3,300 for individuals and $6,550 for families in 2014. Contributions are not subject to federal income tax. Taxes are handled one of two ways: either the contribution is made with pre-tax dollars if related to an employment benefit or made with post-tax dollars subject to a corresponding deduction if made by an individual or family.
As with an HRA, the payment of qualified medical expenses is federal income tax free. Generally, this is accomplished by pulling the dollars straight out of the HSA. Many accounts offer special debit cards or checks to make this easy; alternatively, other HSAs may operate on a reimbursement basis, as with HRAs.
It’s not a spend or lose it account: if the dollars in the HSA aren’t used up in one year, the account can be rolled over from year to year with no penalty. You cannot, however, roll them into another kind of tax-favored account, like an IRA.
Both accounts, HSAs and HRAs, have advantages and disadvantages to taxpayers. And as with all tax-favored breaks, there are rules, exceptions and limitations which apply. The fine print matters. Check with your human resources office for more information – or your insurance or tax professional if you are setting up a plan on your own.
Don’t assume that these plans are for somebody else: there are so many different variations that you’re liable to find one that benefits you either on its own or, occasionally, in tandem with another plan (MSAs and FSAs, for example). This alphabet soup of accounts and plans could be the tax-favored cure for what ails you
The Tax Break You're Missing Out On
By Emily Brandon | U.S.News & World Report LP – Aug 8, 2013
How to avoid taxes on sale of a vacation home
Some may be able to swap one home for another
TAXWATCHAug. 14, 2013
By Bill Bischoff
As real estate prices recover, many vacation properties are once again worth far more than their tax basis (generally the purchase price plus the cost of improvements minus any depreciation deductions you’ve claimed for rental periods). As a result, if you’re looking to sell a vacation home and use the proceeds to buy another one, there could be a big tax hit. But you can avoid it if you swap your vacation home for another in a tax-deferred exchange — as long as it’s a home you’ve rented out most of the time and used as your personal residence some of the time.
In fact, the government has supplied the recipe for how to exchange mixed-use vacation properties. Here’s what you need to know.
Section 1031 Exchange Basics
When available, a tax-deferred Section 1031 exchange is a great tool for real estate owners. It allows you to unload one property (the relinquished property) and acquire another one (the replacement property) without triggering a current income tax bill on the relinquished property’s appreciation (the difference between its fair market value and its tax basis).
The untaxed gain gets rolled over into the replacement property where it remains untaxed until you sell the replacement property in a taxable transaction. But if you still own the property when you die, any taxable gain may be completely washed away thanks to another favorable rule that steps up the tax basis of a decedent’s property to its date-of-death value. So taxable gains can be postponed indefinitely, or even eliminated altogether if you die while still owning the property. Real estate fortunes have been made in this fashion without sharing much with Uncle Sam.
Naturally, there are intricacies to arranging a successful Section 1031 exchange. I’m not going to cover them here, because I don’t want this to turn into a book. That said, you need to understand that you can have a taxable gain even on a successful Section 1031 exchange to the extent you receive cash in the deal. Ditto if you assume a mortgage on the replacement property that is smaller than the mortgage on the relinquished property that is assumed by the new owner. Worse yet, the IRS will treat an exchange that fails to meet all the Section 1031 rules as a garden-variety taxable sale of the relinquished property with the resulting tax hit. Ouch! For these reasons, I recommend hiring a tax pro who is experienced in conducting Section 1031 exchanges before pulling the trigger.
With those thoughts in mind, we are finally ready to talk about special considerations that apply when swapping mixed-use vacation homes.
IRS-Approved Safe Harbor
In Revenue Procedure 2008-16, the IRS opened up a “safe-harbor” that allows tax-deferred Section 1031 exchange treatment for swaps of mixed-use vacation properties. To be eligible for the safe-harbor, you must meet the guidelines explained below for both the relinquished property (the property you give up in the swap) and the replacement property (the property you receive). When you meet these guidelines (along with all the other Section 1031 exchange rules), your swap will qualify for the safe harbor, which means it will automatically pass muster with the IRS.
Relinquished Property Guidelines:
For the relinquished property, you must pass both of the following tests.
First Test: You must have owned it for at least 24 months immediately before the exchange.
Second Test: Within each of the two 12-month periods during the 24 months immediately preceding the exchange: (1) you must have rented out the property at market rates for at least 14 days and (2) your personal use of the property cannot have exceeded the greater of 14 days or 10% of the days the property was rented out at market rates.
Replacement Property Guidelines:
For the replacement property, you must pass both of the following tests.
First Test: You must continue to own it for at least 24 months immediately after the exchange.
Second Test: Within each of the two 12-month periods during the 24 months immediately after the exchange: (1) you must rent out the property at market rates for at least 14 days and (2) your personal use of the property cannot exceed the greater of 14 days or 10% of the days the property is rented out at market rates.
Here’s an Example
Say you have a mixed-use vacation home that’s worth $600,000. It has a tax basis of only $200,000 and no mortgage. If you sold it, you would have to report a $400,000 taxable gain ($600,000 - $200,000) on Form 1040. Yikes! However, if you want to acquire another vacation home, you could arrange a Section 1031 exchange. Say you find another home worth $700,000 that you would love to own. So you swap your old vacation home (the relinquished property) for the new one (the replacement property) and throw in $100,000 cash to equalize the trade. As long as you meet the aforementioned usage guidelines for both properties, you can pull off a tax-deferred Section 1031 exchange and thereby avoid any current income tax hit. Congrats! Your tax basis in the replacement property is $300,000 ($700,000 - $400,000 gain rolled over from the relinquished property).
The Bottom Line
The ability to arrange IRS-approved Section 1031 swaps of appreciated vacation homes is a great tax-saving opportunity. However, you cannot make a Section 1031 exchange of a vacation home that you’ve used strictly for personal purposes. That said, you can set yourself up for a future Section 1031 exchange by renting the property out for enough days over the next 24 months to meet the relinquished property safe-harbor guidelines.
Ten Tax Tips for Individuals Selling Their Home
IRS Summertime Tax Tip 2013-24
From IRS.gov August 26, 2013
If you’re selling your main home this summer or sometime this year, the IRS has some helpful tips for you. Even if you make a profit from the sale of your home, you may not have to report it as income.
Here are 10 tips from the IRS to keep in mind when selling your home.
-
If you sell your home at a gain, you may be able to exclude part or all of the profit from your income. This rule generally applies if you’ve owned and used the property as your main home for at least two out of the five years before the date of sale.
-
You normally can exclude up to $250,000 of the gain from your income ($500,000 on a joint return). This excluded gain is also not subject to the new Net Investment Income Tax, which is effective in 2013.
-
If you can exclude all of the gain, you probably don’t need to report the sale of your home on your tax return.
-
If you can’t exclude all of the gain, or you choose not to exclude it, you’ll need to report the sale of your home on your tax return. You’ll also have to report the sale if you received a Form 1099-S, Proceeds From Real Estate Transactions.
-
Use IRS e-file to prepare and file your 2013 tax return next year. E-file software will do most of the work for you. If you prepare a paper return, use the worksheets in Publication 523, Selling Your Home, to figure the gain (or loss) on the sale. The booklet also will help you determine how much of the gain you can exclude.
-
Generally, you can exclude a gain from the sale of only one main home per two-year period.
-
If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is usually the one you live in most of the time.
-
Special rules may apply when you sell a home for which you received the first-time homebuyer credit. See Publication 523 for details.
-
You cannot deduct a loss from the sale of your main home.
-
When you sell your home and move, be sure to update your address with the IRS and the U.S. Postal Service. File Form 8822, Change of Address, to notify the IRS.
For more information on this topic, see Publication 523. It’s available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Do you owe the self-employment tax?
Commentary: If you do, it can amount to big bucks
By Bill Bischoff
If you’re self-employed as a sole proprietor, partner, or LLC member, you may owe the dreaded self-employment (SE) tax. If so, the bill is on top of any income taxes owed to the Feds and your friendly state tax collector. Here’s what you need to know about the potentially painful SE tax.
SE Tax Basics
The purpose of the SE tax is to collect Social Security and Medicare taxes from self-employed folks. Now, if you’re an employee, the first $113,700 of your wages (for 2013) is hit with the Social Security tax at a rate of 12.4%. All wages up to infinity are hit with the Medicare tax at a rate of 2.9%. An unmarried individual’s wages above $200,000 get hit with the new 0.9% additional Medicare tax. If you’re a married joint filer, the new 0.9% Medicare tax hits the combined wages of you and your spouse in excess of $250,000. In general, half of these federal employment taxes are withheld from your paychecks while the other half gets paid by your employer (however, all of the new 0.9% Medicare tax comes out of your hide). Since you never actually see the portion of Social Security and Medicare taxes paid by your employer, you may be blissfully unaware of how high these taxes really are.
In contrast, self-employed individuals cannot help but notice, because they must pay all Social Security and Medicare taxes themselves via quarterly estimated tax payments. The bottom line is that, for 2013, a self-employed person owes SE tax at a whopping 15.3% rate on the first $113,700 of SE income. Of that 15.3% rate, 12.4% is for Social Security tax, and 2.9% is for Medicare tax. If your SE income exceeds the $113,700 Social Security tax cutoff, the extra income is hit with the 2.9% Medicare tax. Finally, the extra 0.9% Medicare tax applies to SE income above $200,000 for an unmarried individual or combined SE income above $250,000 for a married joint-filing couple.
Unfortunately, the SE tax is only going to get worse if you have a profitable and growing business. That’s because the Social Security tax cutoff point is usually increased annually to account for inflation. Because more and more of your SE income will be taxed at the maximum 15.3% rate, your SE tax bill will probably go up every year. According to Social Security Administration projections, the Social Security tax cutoff point is expected to increase from the current $113,700 to $115,500 for 2014, then to $118,500 for 2015, and to $123,600 for 2016.
If that’s not enough to spike your blood pressure, you can bet that someone in Congress will propose simply doing away with the Social Security tax cutoff, which would make all of your SE income subject to the full 15.3% SE tax rate. I think the odds are pretty good that this idea will become reality in the relatively near future.
Calculating the SE Tax
You must fill out Schedule SE to calculate how much SE tax you owe. Here’s the drill. Take your bottom-line net business income from Schedule C (if you’re a sole proprietor), or Schedule E (if you’re a self-employed business that’s treated as a partnership for tax purposes), or Schedule F (if you’re a farmer). Multiply that bottom-line number by the factor of .9235 (don’t ask the reason for this step; you don’t want to know). The result is your SE income for SE tax purposes. As mentioned earlier, the first $113,700 of your 2013 SE income is taxed at 15.3%, while any remaining SE income will be taxed at either 2.9% or 3.8% if the new 0.9% extra Medicare tax applies.
Example: Say this year’s Schedule C for your sole proprietorship business shows net income of $200,000. Your SE income is $184,700 ($200,000 x .9235 = $184,700). Of that amount, the first $113,700 is taxed at the maximum 15.3% rate. The remaining $71,000 is taxed at 2.9%. So your SE tax bill is $19,455 [($113,700 x .15.3%) ($71,000 x 2.9%) = $19,455)].
Now for a Little Good News
Enough gloom and doom. There are a few rays of sunshine in this SE tax picture.
-
If you have a job and have Social Security tax taken out of your salary, you get credit for that on your Schedule SE. For example, say you have a $100,000 salary and earn $50,000 of SE income from a side business in 2013. You only have to pay the maximum 15.3% SE tax rate on the first $13,700 of the SE income because you get credit for already paying Social Security tax on the $100,000 of salary. However, you must still pay the 2.9% SE tax rate on the entire $50,000 of SE income to cover the Medicare tax. This all gets taken care of automatically when you fill out Schedule SE while preparing your Form 1040.
-
You can deduct 50% of your SE tax bill on page 1 of Form 1040. The write-off is available whether you itemize or not. However, you cannot deduct any portion of the new 0.9% extra Medicare tax.
-
You generally don’t have to pay SE tax on profits from selling business assets that are not considered inventory. For example, say you sell a small office building that has been used for years to house your unincorporated business. You don’t have to put the gain on Schedule SE, so you don’t owe any SE tax on the gain. Instead, you can treat the entire gain as a low-taxed long-term capital gain.