Category: Tax - PFwise.com

Do You Face "Marriage Penalty" Tax?

2/24/2020

Whether you have been married for decades or are just home from your honeymoon, it's important to understand the tax laws and how they affect married people. The Tax Cuts and Jobs Act of 2017 (TCJA) significantly changed the brackets for taxable income, specifically for couples filing jointly. But the biggest red flag that couples should know is that they may be penalized for filing joint taxes. This is sometimes referred to as the "marriage penalty."

Avoiding the "marriage penalty"
One unintended feature of the United States' income tax system is that the combined tax liability of a married couple may be higher than their combined tax burden if they had remained single. The TCJA offers little relief to married joint-filers if their salaries are not similar.

Unequal salaries: If partners earn salaries that put them in different tax brackets, TCJA can possibly bump the lower earner up into a higher tax bracket. This is an old issue, and TCJA doesn't change it.
Equal salaries: Generally, if both partners fall into the same tax bracket, they won't find themselves in a higher bracket if they file jointly. (One exception: earners in the top income bracket, which starts at $500,000 per year, may face a penalty if they file jointly.)

For example, the TCJA 24 percent federal tax bracket tops out at $84,200 for individuals and exactly doubles at $168,400 for married couples filing jointly. That means if each partner in the couple earns $84,000, they will each pay 22 percent when they file jointly. But, if one partner suddenly gets a raise or a bonus and earns $90,000, together they will be over the $168,400 and will both end up paying 24 percent, which is the next bracket, even though one person is still in the 22 percent bracket.

There are clear benefits and drawbacks of filing as a married couple, as a head of household, or as an individual. And when children and mortgage payments come into play, the details can get more complicated.

Tax Documents Check List - Detailed Look

2/15/2020

In last blogpost, we have a quick check list to file your tax return, now let's look at more details of those tax documents:

Information about your income you need to file taxes
No matter if you work for a large company, are self-employed, or run your own business, you have to have the right forms
for your taxes. These can include a W-2 or self-employment paperwork to prove your income.

Here’s a quick guide to which IRS forms and/or personal documentation you’ll need for the most common income situations:

If you have one or more employers
If you work for someone else—meaning, employment, and income taxes are deducted from your paychecks—you will need at least these two forms:

W-2: Your employer(s) will mail these forms to your house no later than January 31st.
1040*: Depending on the complexity of your taxes, there are three 1040 forms to choose from 1040-EZ, 1040A, or the original 1040. (The different types of 1040 forms are explained below).

If you earn any money on your own (from freelancing/self-employment)
If you worked for yourself at all (full-time or on the side), you will need a few more forms to fill out:

1099: You should receive one 1099 from every company or person you earned income from during the year if it’s greater than $600. (Even if it’s not greater than $600, you still have to report the income.) Generally, this will be a 1099-MISC. These will be included as income earned on your Schedule C form.
Schedule C*: This is the form where you’ll determine whether you and/or your business earned a profit or suffered a loss during the year. No matter if you earned a profit or suffered a loss, this will be added or subtracted from your overall income on your 1040 form. If you earned a profit, you’ll need to pay employment taxes (like FICA, Medicare, Social Security, etc.) because an employer was not deducting those taxes from your paychecks…you were your own employer.
Schedule SE*: If you earned a profit, this form will determine the amount of self-employment taxes you’ll need to pay. In general, you can deduct half of this amount from your total income (line 27 on your 1040 form).
1040 Form*

If you were unemployed

1099G: Unemployment compensation is included in your taxable income, so you must include it in your tax return. You’ll generally receive a 1099G form from the state that paid you unemployment compensation.
1040 Form*

If you paid student loan or mortgage interest

1098: Your student loan or mortgage lender(s) will mail you 1098 forms showing how much interest you paid on your loans in the tax year. This interest could potentially be tax deductible.

If you earned interest from bank accounts or investments

1099-INT: Your bank or investment company will send you these forms for any interest paid to you in cash. Interest income must be reported on your return.

*You only need these forms if you plan on doing your own taxes without software. Other documents you need either way.

Other income considerations
Besides earned income from a job, you also need to make sure you have paperwork showing distributions from things like:

IRAs
Dividends from stocks
Social Security
Interest on accounts
Rental property income
Unemployment

Many people make mistakes when gathering this paperwork for their taxes because they don’t realize items such as Social Security and dividends from stocks all need to be reported and will fall under the “income” category.

Each type of income you have to report will require a different form, too.

Adjustments to your income
It’s also important to have any documents on hand that can reduce how much of your income is taxed. This can either lower the amount you owe (when you need to pay taxes) or increase your tax refund. This is why you need to pay attention and gather these documents.

If you’re a student you can use forms 1098-T and 1098-E to show how much you paid for tuition and how much of your student loan interest you paid, respectively. Teachers can provide canceled checks or copies of receipts that show they paid for classroom supplies, which can help to offset their income.

Other examples of items under this category that can help adjust your income include:

Records of any contributions you made to your IRA
Proof of improving your home with energy-efficient appliances or windows
Records of contributing to a Medical Savings Account

Also keep track of expenses such as:

Moving expenses you incurred
Any alimony you paid to a spouse
Information on self-employed health insurance
Self-employed pension plans

These can be used to adjust your income and help you get a more substantial return.

Explanation of the different 1040 forms

Here’s how to decide which form to use:

1040EZ form
If you’re just starting out, try to use this form if you can. It makes filing your taxes very simple. Here are some of the requirements:

Taxable income less than $100,000
No dependents
Less than 65 years of age
Single or Married Filing Jointly status
Interest income less than $1,500

1040A form
This becomes a popular form for many recent college graduates because this form allows you to deduct student loan interest. If your taxes are still fairly simple but you need to deduct student loan interest (or education expenses, IRA contributions, or higher education expenses), you might be able to use this form.

Additionally, if you own a home, you probably will not be able to use this form since you cannot itemize (e.g. deduct mortgage interest expenses) when using this form.

Taxable income less than $100,000
You take the standard deduction (do not itemize)
Only certain tax credits are allowed

1040 form
If all else fails, you’ll need to file a 1040 Form. The older you get, the more likely you are to file a 1040 Form instead of the A or EZ versions.

From this quick checklist, you think you may qualify for the A or EZ you can check out every detail of qualifying on the IRS website. Even if you qualify for the A or EZ versions of the form, you can still use the regular 1040 if that’s what you feel comfortable with.

Deductions and credits
It’s a great idea to itemize deductions if you want to lower how much taxable income you have. This does take more time and effort than just using standard deductions, but if you’re prepared for the extra work, you can enjoy the benefits.

Here are some quick examples of common deductions and credits that you’ll need documentation for:

Child care credits. If you have children and have to pay for them to receive care while you’re working, you can take this expense off of your taxes. But you need to have information about the provider. Have the provider name, their address, their tax ID, and the amount you paid for the year.
Education expenses. Any education expenses and adoption costs can also be listed here if you have the right forms to document the expenditures.
Adoption. If you want to itemize your adoption costs, then you need to have the social security number of your child and records of all medical, legal, and transportation costs.
Mortgage costs. You can list mortgage interest, points you paid for your mortgage, and private mortgage insurance (PMI).
Rental property. If you have rental property or work from home, then you will want to consider itemizing income/expenses from your rental property and any information regarding home business expenses.

Other itemized expenses you can include here are dental and medical costs, charitable donations, investment interest expense, and insurance reimbursements and amount of damage for theft and casualty losses.

Taxes you’ve paid
It’s also essential to keep track of all taxes you have paid during the year, as you will need to list them on your taxes in April. Unlike some of the other categories of information you need to gather for your taxes, this list is relatively short and should be easy for you to keep track of.

Keep information on your real estate taxes, personal property taxes, the state and local income taxes you’ve paid. You’ll even want to keep the vehicle license fees you have to pay. These will depend on the value of your vehicle so that they will go down each year, but still essential to have this information come tax time.

Health insurance
While you don’t need to prove you have health care coverage, having this information on hand is helpful so you can easily verify coverage if necessary. This can include your insurance cards, statements from your insurer, explanation of benefits, and even a W-2 that shows your deductions for health insurance.

If you get Form 1095-A, then you need to wait to file your taxes until you have it in hand. This form is the Health Insurance Marketplace Statement. Remember that most employers need not provide you with information to prove that you have health care coverage, so you need to show this information on your own if it becomes necessary.

Life changes
It’s crucial that you know all significant life changes that can affect your taxes. Especially if you’ve done your taxes for years, or if you’ve had the same person complete them for you. Making sure that you list all significant life changes you have been through will ensure that your taxes are completed correctly.

Home sale
If you sell a home, you need to report this on your taxes. Single taxpayers can exclude a profit of up to $250,000, and married taxpayers who file joint returns can exclude a profit of up to $500,000. You can use this exclusion more than once in your lifetime as long as you haven’t taken the exclusion within the past two years for another house.

For most people, the sale of a home won’t impact their taxes. But if you are someone who’s affected, you need to report this.

Catastrophic loss
If you’ve unfortunately suffered a catastrophic loss, you need to claim this on your taxes. The IRS will help you by allowing you to itemize casualty losses, which are commonly related to natural disasters.

Marriage or divorce
If you got married or divorced, you need to have this information ready to report to the IRS. While not always required, I’d recommend having at least your marriage certificate handy.

Additional information you need to file taxes
There are a few other key pieces of information you may need when filing your taxes. So I recommend making sure you have this information on hand. They aren’t necessary for everyone but are part of this tax document checklist to ensure everyone gets the help they need.

Self-employed
The first piece of additional information you may need to have is if you are self-employed. You’ll need to have information regarding your estimated tax payments you made throughout the year. This is important to have so you can prove not only that you paid your quarterly taxes, but how much you paid.

Prior year refunds
If you had a refund in the prior year and wanted it applied to your year, then you need that information. Have all the information regarding how much was paid along with your extension to file.

Foreign bank accounts
People with foreign bank accounts need to disclose this information on their taxes. The information includes the name and location of the bank where your accounts are held, the account number, and even the peak value of your account throughout the year.

Not everyone has to report their foreign bank account information, but if your account exceeds certain thresholds, then you need to make sure that you report this information on your taxes. Because there are, according to the IRS, several exceptions and procedures you have to follow, you may be better off getting professional help if you find yourself in this situation.

Make retroactive savings contributions
Finally, one last thing I recommend you do before you finalize and file your taxes is to get all your paperwork together and make any retroactive contributions you can for the last tax year. This is a great way to take advantage of your college savings or retirement account, and smart to make sure you have all your tax information prepared beforehand.

If you didn’t max out either your retirement account or your college savings account, then now is the time to max them out, even though it is technically a new year. You can easily retroactively contribute to several accounts, including your HSA, IRA, 401K, Roth IRA, Coverdell Education Savings Account, and 529 if you claim the contribution for the prior tax year.

You also need to make sure that your payment is received before tax day or you won’t be able to apply it to the preceding year’s taxes and must claim it on this year’s.

Tax Documents Check List - Quick Check

2/14/2020

Here’s a quick tax documents checklist to get your tax filing started:

W-2 – Report of wage and salary information
1040 – U.S. individual income tax return
1099 – Self-employed income report
Schedule C – Used to report income or (loss) from a business
Schedule SE – Used to figure the tax due on net earnings from self-employment
1098 – Tells you how much you paid in mortgage interest
Record of any taxes paid throughout the year (estimated quarterly taxes, etc.)
Prior year tax return
Any info about foreign bank accounts

In our next blogpost, we will have a more detailed discussion of each of the tax documents.

How to Create a Tax Efficient Retirement

2/13/2020

What should you do today to help protect your retirement income?

This document from Lincoln Financial below gives you some good ideas if you haven't thought about this topic before -

2020 Tax Commentary From Lincoln Financial Group

2/12/2020

Last year will go down as one of the quietest years regarding tax developments. The underfunded Internal Revenue Service (IRS) has dramatically reduced the amount of tax changes and is trying fewer tax cases than ever before. Congress has been deadlocked so barely any legislation has passed. For now, all is quiet on the tax front.

For more 2020 tax commentaries, please see the document prepared by Lincoln Financial below, it covers all of the important tax topics you need to be aware of -

Impact of State Estate and Inheritance Taxes on Estate Plans

2/9/2020

There are 19 states that currently impose an estate tax or inheritance tax, these taxes usually have lower threshold for you to qualify which pose a significant challenge for your estate plans.

The article from Prudential below has a very good discussion of this topic and includes a case study as well.

QLAC 101 - Which Carriers Have the Best QLACs?

2/7/2020

In our last blogpost, we discussed factors to consider when purchasing QLAC. Now the question - which carriers have the best QLAC products?

We recommend products from AIG, Lincoln, and Principal.

Below is up-to-date information about AIG's QLAC product, including producer and consumer guides, sales ideas, fact sheets, and more. If you are interested in the other carriers' QLAC products, please contact us.

QLAC 101 - Factors to Consider Before Purchasing QLAC

2/6/2020

In our previous blogposts, we discussed what is QLAC and showed an example of QLAC. Now we will discuss what factors to consider before purchasing QLAC.

The decision to purchase a QLAC is a personal one and should take into account your family's needs and financial goals. For instance, you may not want to take RMDs on the entire pretax balance of your IRA if doing so would provide you with more income than you need. But will your financial standing be as strong 20 or even 10 years from now? A QLAC would allow you to enjoy your earlier retirement years knowing that you have guaranteed income in place when you really might need it.

Specifically, the following QLAC related decisions should be considers.

Single or joint life?
If you are married, you can choose a joint contract, which will provide income payments that will continue for as long as one of you is alive. Choosing a joint contract may decrease your income payments—compared with a single life contract—but may also provide needed income for your spouse should you die first.

Include a cash refund death benefit?
When purchasing a QLAC, the income lasts for your lifetime (joint contracts pay income for you and your spouse, as long as one of you is alive). You may also want to consider adding a cash refund death benefit. This provides for a lump sum paid to your beneficiaries if your lifetime payments do not exceed the dollar amount you invested in the QLAC. While a contract without the cash refund death benefit may provide higher income payments, it does not include beneficiary protection for your heirs.

When to start income?
A QLAC should be part of a broader income plan, to help ensure that your essential expenses like food, health care, and housing are covered during retirement—ideally with lifetime income sources such as Social Security, a pension, or lifetime annuities. Deciding on an income start date will depend on how this income stream will best fit into your overall plan. Here are some hypothetical examples of how someone might choose an income start date:

A 70-year-old retiree with an existing income stream that will stop at age 75 (for example, proceeds end from the sale of a business, the retiree stops working part time, inheritance income ceases) might start income at age 76 for the QLAC to replace the income that is ending.
A couple in their late 60s might like to include an income stream that begins at age 80 or 85 as part of their overall plan, to help cover higher anticipated health costs later in retirement.
A couple at age 65 might be comfortable taking withdrawals from their investment portfolio to cover their expenses at the beginning of their retirement, but they are concerned about the potential need for it to last 30 years or more. They might consider a QLAC that provides lifetime income starting at age 85 to help address these concerns.

Need to change the income start date?
For contracts that include a cash refund death benefit, you typically have the ability to change the income date by up to 5 years in either direction (subject to an age-85 maximum). For example, if you initially select age 78 as your income start date, you could subsequently change this date to any time from age 73 to age 83. Of course, the amount of income that you will receive will typically be adjusted to a lower amount if you decide to change the date to an earlier age, and a higher amount if you change the date to a later age.

In our next blogpost, we will show you some of the best QLAC providers.

QLAC 101 - How to Use QLAC?

2/5/2020

In our last blogpost, we discussed what is QLAC, now we will show how to use QLAC to create steady later in life income streams.

Let's say you own one or more traditional IRAs with a total balance of $200,000 as of December 31 of the previous year. You would be limited to using $50,000, which is 25% of $200,000 and is less than $135,000, to fund the QLAC. But if your total IRA balance is worth $540,000 or more, the maximum you can contribute to a QLAC is $135,000. Keep in mind that in both cases the money that remains in your IRA or 401(k) is still subject to RMDs.

An Example
Let's assume a woman is approaching age 70½ and does not need her full RMD to cover current expenses. By investing a portion of her traditional IRA assets in a QLAC at age 70, she would not have to take RMDs on the assets invested in the QLAC, and she would receive guaranteed lifetime income starting at a date of her choice, up to age 85.

During the deferral period, she would rely on Social Security, RMDs from the remaining money in her IRA, withdrawals from investments, and other income, such as part-time work or a sale of a business, to cover expenses. If she invests the $135,000 in a QLAC and defers to age 80, her guaranteed income would be $15,200 a year no matter what happens over time, and she would receive a total of $228,000 in payments if she lived to age 95—or more if she lived longer.

In our next blogpost, we will discuss what factors to consider if you should purchase QLAC or not.

QLAC 101 - What Is QLAC?

2/4/2020

Q. What is QLAC?

A. A QLAC is a Deferred Income Annuity (DIA) that can be funded only with assets from a traditional IRA or an eligible employer-sponsored qualified plan such as a 401(k), 403(b), or governmental 457(b).

The US Treasury Department issued a rule creating Qualified Longevity Annuity Contracts (QLACs) in 2014. QLACs allow you to use a portion of your balance in qualified accounts—like a traditional IRA or 401(k)—to purchase a deferred income annuity3 (DIA) and not have that money be subject to RMDs starting at age 72.

At the time of purchase, you can select an income start date up to age 85, and the amount you invest in a QLAC is removed from future RMD calculations. QLACs address one of the biggest concerns among individuals in retirement: making sure they don't outlive their savings.

Why Purchase QLAC?
There are two main reasons.

First, you can delay required minimum distributions (RMDs) on the money in your QLAC. Without a QLAC, you would be forced to start taking distributions based on the total value of that retirement account at age 72 (formerly 70 ½) - and paying income tax on those distributions. Many people don’t need distributions at that age, and don’t want to pay tax on that money yet. With a QLAC, you won’t have any RMDs on premiums paid until age 85.

Second, longevity. If you are worried about outliving your funds, a QLAC solves the problem. It provides guaranteed monthly income as long as you live. Plus, you get the amount you were promised at purchase, no matter what’s happened to the stock market or interest rate in the interim. You're effectively transferring that risk to the insurer.

In our next blogpost, we will show you a few QLAC examples about how it works.

What Is IRMAA and Why It's Import to Know About It?

1/28/2020

Q. What is IRMAA and why I should know about it before retire?

A. IRMAA is for Medicare Income Related Monthly Adjustment Amount surcharge, and it refers to the extra premiums for Part B and Part D that higher income beneficiaries pay for Medicare coverage.

In some cases, even a tiny increase in your income can put you in a higher income bracket and trigger the surcharge, a married couple, for example, could suddenly be paying as much as $1,000 a month more than planned. And if you convert a traditional IRA into a Roth account, thinking it’s a smart strategy for avoiding higher taxes later in retirement, your additional income could put you in surcharge territory and wipe out some of your expected savings.

What is the IRMAA trigger?
For 2020, the surcharge is triggered when your modified adjusted gross income - your adjusted gross income plus tax-exempt interest income - exceeds $174,000 for taxpayers who are married and file jointly or $87,000 for individual taxpayers.

Part B premiums combined with premium surcharges for Part B and Part D range from a total of $214.60 to $568.00 per month per person in 2020.

Not only are many pre-retirees unaware of the surcharge, they also don’t understand how it works. For example, the surcharge is calculated based on your tax returns from two years prior.

How to tackle it?
If you are married and one spouse is still working, coordinate your health insurance coverage. You don't need to enroll in Medicare and pay the related IRMAA surcharge as long as your spouse is still working and you are covered under that plan.

Before using this strategy, confirm whether your spouse’s health plan requires you to enroll in Medicare at age 65. In companies with fewer than 20 employees, for example, the employer plan may pay secondary to Medicare when an enrollee is Medicare eligible.

You also can appeal the surcharge. Request a reconsideration by calling the Social Security Administration at 800-772-1213. An inaccurate tax return or a life-changing event, such as divorce or death of a spouse, can qualify for an appeal.

3 Key Changes to Retirement Plans Thanks to SECURE Act

1/27/2020

Q. What are the key changes with the new SECURE act?

A. Changes are coming to retirement rules, following the passage and signing into law of the Setting Every Community Up For Retirement Enhancement Act of 2019 (SECURE Act).

But for most people, there are three general areas addressed in the new law worth considering:

1. Retirement plan access
The new law helps make it easier for more employers, especially smaller ones, to offer 401(k) retirement savings plans. Businesses can get a tax credit to help cover the costs of starting an automatic-enrollment retirement plan. Small businesses can also band together to set up and offer 401(k) plans through a third-party to help them manage fiduciary responsibilities and costs on an easier basis than exists today.If such changes mean your employer will probably start offering a 401(k) plan, you’ll likely want to take advantage of it.

And if you are a business owner, you may want to investigate taking advantage of the law’s provisions as a way of rewarding workers or attracting talent.

2. New age limits for retirement plans
The new law pushes back the age at which you will be required to start withdrawing money from those accounts. It was 70 ½ years of age. But, as the new law takes effect, will be increased to 72 years of age. That means savings can grow longer.

The new law also pushes back the 70 ½-year-old limit on contributing to a traditional IRA to 72.

3. Annuity Considerations
The new law also opens the door for more in the way of annuities to be offered in retirement plans.

Generally, an annuity is a financial contract where, in exchange for a lump-sum payment or a series of payments, the annuity will make payments to you at a future date or series of dates. Annuities tend to appeal to those who may be concerned about outliving their savings and want a guaranteed income stream in retirement.

But annuities can vary widely in type and function. And what is appropriate for one person may not be appropriate for another.

Benefits of Converting Retirement Accounts to Roth

1/23/2020

Q. What are the benefits of converting my retirement accounts to Roth IRA?

A. Here are a few key benefits by converting your retirement accounts to Roth -

Money in traditional 401(k) and IRA is subject to mandatory annual withdrawals after age 70.5. The larger your RMDs, the bigger your tax bills in retirement.
Money is Roth IRA is exempt from RMDs, and when you withdraw money from Roth IRA, it will be tax-free.
Money in Roth 401(k) can also avoid RMD if you roll it into a Roth IRA before you are 70.5, otherwise, there will be an RMD, but there will be no tax on it.
Having access to tax-free money can help manage your tax bill in retirement, for example, whether you will owe tax on your social security benefits, how much your annual premium will be for Medicare Part B.

The only thing you need to be careful is every dollar you convert will be taxed as ordinary income in the year, you don't want your current year's income balloon to a higher tax bracket.

Is Now a Good Time to Save on Roth?

1/17/2020

Contributing to a Roth account makes sense for people who anticipate higher tax rates in the future, as the distributions won't be taxed in retirement, according to this article in CNBC.

In a nutshell, this CNBC article has three main points -

Roth accounts may make more sense than traditional, pre-tax ones when savers believe their tax rate is lower now than it will be in retirement.
Low historical income-tax rates and a large U.S. budget deficit make it likely tax rates will increase in the future, according to some tax policy experts.
It may make sense to split contributions 50-50 to Roth and pre-tax accounts.

In short, experts believe that achieving diversification by saving in accounts with different tax treatments can still be a better strategy, because you can’t predict future tax rates, but you can tax-diversify, hedging your bets by dividing savings between Roth and traditional.

What To Consider When Rollover a Lump Sum Pension Distribution

1/5/2020

If you face a decision of whether to take a lump-sum distribution from your pension or not, and if yes, how, this Forbes article is a very good read, it addresses some of the key factors you should consider and the potential tax traps, for example, you have to do the rollover to a tax-advantaged account within 60 days since you receive the lump-sum payment; you won't owe taxes on the rollover to a traditional retirement account, but will face a tax bill for rolling the money to a Roth account; ...

Top 10 IRS Audit Trends

12/20/2019

The financial planning magazine has a nice article that describes the top 10 IRS audit trends, it's full of data and charts, and is a good read if you have any concerns about being audited by IRS.

Below are the top 10 IRS audit trends -

Most audits are done by mail
The main issue in audits: The EITC
An alarming amount of people do not respond to an audit
The most common IRS challenge to a return is not an audit
The IRS knows who to audit
Field audits are rare, but expensive
Want your business to escape audit? Be an S corp or partnership
Audits on the wealthy are still popular, but have dropped
Audits have dropped, but penalties are still prevalent
Audits have dropped, but penalties are still prevalent

Is Tax-Loss Harvesting Really Beneficial?

12/13/2019

Q. Is tax-loss harvesting really beneficial?

A. Based on this article, the answer is surprisingly that it maybe not!

During year end, one of traditional tax planning strategies is to consider tax-loss harvesting to minimize tax exposure, as losses that are harvested can be immediately and fully offset against other capital gains recognized in the same year.

The caveat, however, is that by harvesting a loss – selling at a lower-than-cost-basis price and buying back again after waiting out the wash sale period – also reduces the cost basis of the investment, effectively stepping the basis down to the re-purchased value, which increases capital gains exposure in the future by the same amount as the loss that was claimed today. Which means in practice, tax loss harvesting isn’t really a tax savings strategy, but merely a tax deferral strategy that reduces capital gains today in exchange for higher (offsetting) capital gains in the future.

Because the value of tax loss harvesting is really only based on the tax deferral – and the ability to grow those tax-deferred dollars until the future – the value of tax loss harvesting is also contingent on the future growth rates themselves, with low-return environments further reducing the value of tax loss harvesting (to as much as 0.57%/year over a 10-year period at 10% returns but only 0.10%/yr at 4% returns).

In addition, it’s notable that by deferring capital gains taxes to the future, there’s also a risk that tax rates will rise (especially given that capital gains are at all-time historical lows), which can actually turn tax loss harvesting from a positive to a negative.

And of course, that’s before considering the costs, including transaction costs (which even without trading commissions, may still include bid/ask spreads), and the risk of tracking error when buying a not-substantially-identical security (where the substitute investment during the wash sale period underperforms, or ends out generating a short-term capital gain that must be recognized at higher tax rates to switch back).

As a result, in the end it turns out that the value of tax loss harvesting is limited at best, and in many decades historically was actually a net negative (even with “just” a 0.1% transaction cost).

Comparison of 4 Major Tax Filing Softwares

12/12/2019

Filing your taxes can be time-consuming and tedious. So it’s always good to get a little help. If you want to make this process as smooth as possible, I recommend using a tax service like TurboTax, TaxAct, H&R Block, Liberty Tax, or E-File.

Here’s a table that shows a comparison between the tax services:

8 Smart Year-end Financial Planning Actions to Take

12/10/2019

Take these eight steps now:

Contribute to your retirement accounts.
If you work for a company that matches your 401(k) contribution, try to contribute at least up to the percentage they match. Otherwise, you’re leaving money on the table.
Make your required minimum withdrawal from your IRA.
Do you have a traditional IRA? Starting at 70 ½, the IRS requires you to withdraw a certain amount each year, known as a required minimum distribution (RMD).
Use up your flexible spending account (FSA).
Find out the deadline for using this money if you have an FSA, since you will lose it if you don’t use it by the deadline.
Think through your holiday spending.
Now is the time to also think about paying down any debt or padding your emergency fund.
Check your credit reports.
If you haven’t checked your credit reports in the last 12 months, the end of the year is a great time to do so.
Consider year‑end charitable giving.
In addition to using your dollars to support a cause you are passionate about; many charitable contributions of money or property are also tax deductible.
Assess the last 12 months.
Reflect on how you did this year from a financial standpoint. Think about what went right and what would you like to adjust.
Plan for the next 12 months.
If your assessment of the past year calls for some changes, use that information to start planning for the new year.

5 IRC Tax Codes That Life Insurance Products Benefit From - Details

12/9/2019

5 IRC Tax Codes That Life Insurance Products Benefit From

12/8/2019

These 5 Internal Revenue Tax Code sections put the power of life insurance to work helping you reach your financial goals:

Keep reading to see more detailed discussions of these 5 Internal Revenue Tax Codes and their applications in Life Insurance Products.

2 Potential IRA Pitfalls to Avoid

11/23/2019

1. Early withdrawal penalties
If you are age 55 or older with a 401(k) plan, you may leave your job and take money out of the 401(k) plan without the 10% penalty. You will still pay tax, but no 10% penalty. However, if you take a 401(k) plan and roll it over to an IRA, you will lose that age 55 exception; you’ll have to wait until age 59½ before you can avoid the 10% penalty unless you meet one of the other exceptions.

2. Taking your first RMD
If you have a traditional IRA, you have to remember that you will be subject to those required minimum distributions (RMDs). These begin during the calendar year in which you become 70½ years old. RMDs do not apply to Roth IRAs.

Which States Have the Highest Income Tax Rates in U.S.?

11/22/2019

Q. If I work in state A but live in state B, which state should I pay income tax?

A. States generally tax the income of nonresidents who generate income in that state. Income subject to tax can include:

Rental income
Gain on the sale of real estate
Employment income

The map below shows income tax rates by different states in U.S.

QLAC FAQs

11/5/2019

What’s a QLAC?
It’s a special type of deferred income annuity (DIA). A DIA provides protected lifetime income starting in the future. A QLAC allows income from a traditional IRA to be deferred from taxation beyond age 70½ without running afoul of the RMD rules.

How does QLAC work?
A DIA, including a QLAC, works much like a qualified SPIA (single premium immediate annuity) — except that the payments do not begin for at least 13 months and may be deferred up to age 85. The income date is selected at issue. Income payments will be made provided the annuitant is alive at the income start date. (If no annuitant survives, no income payments will be made, and no other benefits provided, unless the owner has elected a return of premium (ROP) death benefit.) Funds in an IRA can be transferred tax-free to the insurance carrier for the purchase of a QLAC.

The account value of the QLAC is disregarded for purposes of calculating the client’s RMDs. A QLAC has to meet many requirements, but it can help address longevity risk by reducing the probability of outliving savings by providing an income stream in the later stages of retirement.

How long can income payments – and thus RMDs – be delayed?
Distributions must begin no later than the first day of the month following the annuitant’s 85th birthday. The longer the deferral period, the larger the income payout amount.

Can I access the funds?
No. A QLAC does not have any cash surrender value or commutation benefit. QLACs may allow limited changes to the income date and payment frequency.

What IRS reporting applies to QLACs?
Insurance carriers will report to purchasers and the IRS using Form 1098-Q, Qualifying Longevity Annuity Information. Form 1098-Q must be furnished to individuals by January 31 of the year following the first year of purchase and every following year while the QLAC is in existence.

How much can be contributed?
Contributions to a QLAC are limited to the lesser of either $130,000 (subject to annual cost-of-living adjustment) or 25% of qualified funds, less premiums for other QLACs.

The dollar limit – $130,000, as indexed for 2019 – applies across all qualified funds. The 25% limit applies to each qualified plan separately based on its most recent valuation date. It applies to IRAs on an aggregate basis as of the prior December 31. Roth IRAs and Inherited IRAs are excluded.

Example: Jesse had $260,000 in his 401(k) as of the latest valuation date and had $260,000 in his traditional IRA as of the prior December 31. He can only use 25% of his IRA or $65,000 to purchase a QLAC. If his 401(k) plan allowed for the purchase of a QLAC, he could purchase a QLAC for 25% of his 401(k) or $65,000. Many defined contribution plans do not yet provide for the purchase of QLACs. Thus, Jesse would need to have at least $520,000 in his IRA as of the prior December 31 if he wanted to purchase the maximum QLAC for $130,000. If Jesse elected to roll over any amounts from his 401(k) plan into his IRA, he would need to wait until the following year to purchase a QLAC with those rolled over funds. Remember, the 25% limit is applied to the fair market value of the IRA as of the prior December 31.

What happens if the contribution limit is exceeded?
Any excess premium must be returned by the end of the calendar year following the calendar year in which the excess premium was paid to avoid jeopardizing the contract’s QLAC status. If not returned in a timely manner, the annuity then fails to be a QLAC beginning on the date that the premium payment was made. The value of the annuity contract thereafter cannot be disregarded for purposes of calculating RMDs. It is the client’s responsibility to comply with the contribution limit. Clients should consult with their own tax and legal advisors before purchasing a QLAC.

Can additional premiums be added as the account value increases and/or the indexed limit increases?
More premium may be added to flexible premium QLACs to take advantage of any unused portion of the then-current contribution limit. What if part of the IRA has already been used to purchase a qualified SPIA? Is that value included in determining the fair market value of the IRA? The fair market value of any IRA SPIAs should be included in determining the account value of all aggregated IRAs (except Roth and Inherited) as of the prior December 31 for purposes of calculating the 25% limitation for QLAC contributions. Insurance carriers annually send clients a fair market valuation letter for IRA SPIAs.

What are the QLAC payment options?
Options are limited to single or joint life only and single or joint life with cash refund. Payments, once begun, must satisfy RMD rules.

What happens if the last annuitant dies during the deferral period?
If the ROP death benefit option was not selected and no annuitant survives, no income payments will be made and no other benefits provided.

If the last annuitant dies during the deferral period, can the ROP death benefit be directly rolled over or transferred to an IRA?
It depends. If the annuitant dies after their required beginning date (RBD), the ROP payment is treated as an RMD and cannot be rolled over. Likewise, if the surviving joint annuitant dies after their RBD, the ROP payment will be an RMD and not eligible for rollover. If the annuitant or survivor annuitant dies before their RBD, however, the ROP payment may be rolled over.

6 Tax Saving Strategies Still Available For 2020 - Part D

10/21/2019

In last blogpost, we wrapped up introducing the 6 deductions available. The $12,000/$24,000 standard deduction hurdle — for individuals and married filing jointly, respectively, increasing to $12,200 and $24,400 in 2019 — presents a significant challenge to itemize deductions because only a few deductions in practice are capable of sustaining such a large deduction annually on an ongoing basis.Accordingly, the so-called big six itemized deductions that can actually sustain ongoing itemized deductions include:

1. Big mortgages:
Homeowners with a sizable mortgage used to acquire, build or substantially improve their primary residence or a second home can generate enough in ongoing interest deductions to exceed the standard deduction thresholds.

Notably though, in an environment where mortgage interest rates have long hovered around 4%, it still takes a very sizable mortgage balance to actually generate enough interest to trigger itemized deductions, especially since it’s only the interest portion of the mortgage payment, not the entire mortgage payment, that is deductible. For an individual, generating a $12,000 mortgage interest deduction at 4% would require at least a $300,000 mortgage; for a married couple the trigger is a $600,000-plus mortgage.

2. Big, ongoing charitable deductions:
For higher income individuals it’s not uncommon for annual charitable giving to top the $12,000/$24,000 standard deduction thresholds. And at higher income levels the charitable deduction AGI thresholds are not an impediment to exceeding these targets. Of course, giving away money just to get a tax deduction isn’t necessarily a net positive, as the household still gives more away than it receives back in tax benefits. Still, for those who already engage in sizable, ongoing charitable giving, sustained charitable giving alone can support ongoing itemized deductions.

3. Big SALT deductions:
One of the unique peculiarities of the current tax planning environment is that when TCJA imposed a maximum cap on SALT deductions, it imposed the same cap of $10,000 for both individuals and married couples. This is significant because the standard deduction threshold for individuals is only $12,000, while it is $24,000 for married couples.

This means maxing out the $10,000 SALT deduction is at best only part of the way to the $24,000 threshold for married couples, but gets an individual almost all the way to their $12,000 threshold. Still, it takes a sizable income with the associated tax deductions or a big home with substantial property taxes to reach the individual threshold. Assuming an average state income tax rate of 5% and a 1% property tax rate, reaching the SALT cap still typically requires around a $100,000-plus annual income and a $500,000-plus property, or for those who rent, a $200,000-plus annual income.

4. Big margin investing:
While mortgage deductions are limited as to the amount of debt principal on which interest can be deducted, investment interest is limited only by the amount of interest and dividends generated by the investments themselves and that the interest be taxable — i.e., no investment interest deductions for municipal bonds.

As with the mortgage interest deduction though, generating sufficient interest requires a substantial amount of debt principal. On the other hand, since margin interest rates tend to be higher — currently averaging around 8% — it doesn’t take quite as much debt principal, potentially just on the order of $150,000 for individuals or $300,000 for married couples.

5. Big long-term care events:
Most medical events are covered by health insurance, and while individuals may still have to pay a non-trivial deductible, coverage is usually sufficient to prevent medical expenses alone from triggering the $12,000/$24,000 thresholds, particularly on an ongoing basis.

However, long-term care insurance is adopted far less often than health insurance, and tends to have much larger annual expenditures, whereas semi-private care alone averages $225 per day or over $80,000 per year. Those who have an ongoing long-term care event consequently often trigger more than enough in annual medical expenses — over and above the 10%-of-AGI threshold — to trigger ongoing itemized deductions.

6. Big, IRD-eligible stretch IRAs:
One of the largest and most commonly overlooked itemized deductions is the Income in Respect of a Decedent, or IRD, deduction, which provides beneficiaries of inherited retirement accounts and other inherited pre-tax assets an income tax deduction for any Federal estate taxes that were caused by that IRD asset.

This means the IRD deduction is only available to those who inherit a pre-tax asset like an IRA from someone who actually paid a Federal estate tax — which isn’t many, given the sizable Federal estate tax exemption. Nonetheless, with a top Federal estate tax rate of 40%, those for whom the IRD deduction is available effectively receive an itemized deduction for 40% of their inherited IRA withdrawals.

This in turn means inheriting a big IRA from a big estate can trigger a big IRD deduction and, therefore, ongoing itemized deductions. It will still take an IRA of $1 million or more for an individual, or of $2 million or more for a married couple to generate enough in IRD deductions to claim ongoing sustained itemized deductions — assuming the stretch IRA faces an annual RMD of only about 3% per year.

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IMPORTANT DISCLOSURES
PFwise.com does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.

To the extent that any material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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