Category: Tax - PFwise.com

How to Harvesting Investment Tax Losses - Part G

8/8/2020

In last blogpost, we discussed the importance of keeping tax loss harvesting in mind when develop your investment strategies. Now we will discuss the cost basis for tax loss calculation.

Select the most advantageous cost basis method
Finally, take a look at how the cost basis on your investments is calculated. Cost basis is simply the price you paid for a security, plus any brokerage costs or commissions.

If you have acquired multiple lots of the same security over time, either through new purchases or dividend reinvestments, your cost basis can be calculated either as a per-share average of all the purchases (the average-cost method) or by keeping track of the actual-cost of each lot of shares (the actual cost method).

For tax-loss harvesting, the actual-cost method has the advantage of enabling you to designate specific, higher-cost shares to sell, thus increasing the amount of the realized loss.

How to Harvesting Investment Tax Losses - Part F

8/7/2020

In last blogpost, we discussed wash sales and tax loss harvesting. Now we will discuss how to make tax loss harvesting part of your year round tax and investing strategies.

Make tax-loss harvesting part of your year-round tax and investing strategies
The best way to maximize the value of tax-loss harvesting is to incorporate it into your year-round tax planning and investing strategy.

In managing the asset allocation for your taxable portfolio, don't use big pieces like a large cap fund of funds. Instead, use more individual investments pieces that can help you create tax efficiency. For example, invest in individual large cap value, core and growth funds. This allows you the opportunity to tax loss harvest as individual securities and styles go in and out of favor.

Tax-loss harvesting and portfolio rebalancing are also a natural fit. In addition to keeping your portfolio aligned with your goals, a periodic rebalancing provides an opportunity to reexamine lagging investments that could be candidates for tax-loss harvesting.

In next blogpost, we will discuss cost basis to choose.

How to Harvesting Investment Tax Losses - Part E

8/6/2020

In last blogpost, we discussed some practical tips about tax loss harvesting. Now we will focus on wash sales.

Wash sales and Tax loss harvesting
After you have decided which investments to sell to realize losses, you'll have to determine what new investments, if any, to buy. Be careful, however, not to run afoul of the wash-sale rule.

The wash-sale rule states that your tax write-off will be disallowed if you buy the same security, a contract or option to buy the security, or a "substantially identical" security, within 30 days before or after the date you sold the loss-generating investment.

One way to avoid a wash sale on an individual stock, while still investing in the industry of the stock you sold at a loss, would be to consider substituting a mutual fund or an exchange-traded fund (ETF) that targets the same industry.

In next blogpost, we will discuss how to make tax loss harvesting part of your year round tax and investing strategies.

How to Harvesting Investment Tax Losses - Part D

8/5/2020

In last blogpost, we discussed gains and losses in mutual funds. Now we will discuss tax loss harvesting details.

Harvest losses to maximize your tax savings
What to look for?
When looking for tax-loss selling candidates, consider investments that no longer fit your strategy, have poor prospects for future growth, or can be easily replaced by other investments that fill a similar role in your portfolio.

When you're looking for tax losses, focusing on short-term losses provides the greatest benefit because they are first used to offset short-term gains—and short-term gains are taxed at a higher marginal rate.

According to the tax code, short- and long-term losses must be used first to offset gains of the same type. But if your losses of one type exceed your gains of the same type, then you can apply the excess to the other type. For example, if you were to sell a long-term investment at a $15,000 loss but had only $5,000 in long-term gains for the year, you could apply the remaining $10,000 excess to any short-term gains.

What to avoid?
If you have harvested short-term losses but have only unrealized long-term gains, you may want to consider saving them for the future. The least effective use of harvested short-term losses would be to apply them to long-term capital gains. But, depending on the circumstances, that may still be preferable to paying the long-term capital gains tax.

Also, keep in mind that realizing a capital loss can be effective even if you didn't realize capital gains this year, thanks to the capital loss tax deduction and carryover provisions. The tax code allows you to apply up to $3,000 a year in capital losses to reduce ordinary income, which is taxed at the same rate as short-term capital gains.

If you still have capital losses after applying them first to capital gains and then to ordinary income, you can carry them forward for use in future years.

In next blogpost, we will discuss wash sale and tax loss harvesting.

How to Harvesting Investment Tax Losses - Part C

8/4/2020

In last blogpost, we discussed the important differences between short term and long term losses. Now we will discuss the gains and losses in mutual funds.

Gains and losses in mutual funds
If you're a mutual fund investor, your short- and long-term gains may be in the form of mutual fund distributions. Keep a close eye on your funds' projected distribution dates for capital gains. Harvested losses can be used to offset these gains.

Short-term capital gains distributions from mutual funds are treated as ordinary income for tax purposes. Unlike short-term capital gains resulting from the sale of securities held directly, the investor cannot offset them with capital losses.

In next blogpost, we will discuss how to harvest losses to maximize your tax savings.

How to Harvesting Investment Tax Losses - Part B

8/3/2020

In last blogpost, we discussed what is investment tax loss harvesting, now we will discuss some details.

Short-term vs Long-term gains and losses
There are 2 types of gains and losses: short-term and long-term.

Short-term capital gains and losses are those realized from the sale of investments that you have owned for 1 year or less.
Long-term capital gains and losses are realized after selling investments held longer than 1 year.

The key difference between short- and long-term gains is the rate at which they are taxed.

Short-term capital gains are taxed at your marginal tax rate on ordinary income. The top marginal federal tax rate on ordinary income is 37%.

For those subject to the net investment income tax (NIIT), which is 3.8%, the effective rate can be as high as 40.8%. And with state and local income taxes added in, the rates can be even higher.

But for long-term capital gains, the capital-gains tax rate applies, and it's significantly lower.

In next blogpost, we will discuss gains and losses in Mutual Funds.

How to Harvesting Investment Tax Losses - Part A

8/2/2020

What is investment tax loss harvesting?
The strategy that changes an investment that has lost money into a tax winner is called tax-loss harvesting.

Tax-loss harvesting may be able to help you reduce taxes now and in the future. It can also help boost your investment returns.

Tax-loss harvesting allows you to sell investments that are down, replace them with reasonably similar investments, and then offset realized investment gains with those losses. The end result is that less of your money goes to taxes and more stays invested and working for you.

2 ways to harvest tax losses
An investment loss can be used for 2 different things:

The losses can be used to offset investment gains
The losses can offset $3,000 of income on a joint tax return in one year

Unused losses can be carried forward indefinitely. But there are some important details to know as you see how tax-loss harvesting might help lower your tax bill.

In next blogpost, we will discuss short-term versus long-term gains and losses.

7 Jaw-Dropping Stats about Social Security

7/30/2020

Fool.com has an article that compiles some interesting facts about social security:

Some of the interesting facts include: the average Social Security check is $1,507 per month. Also, the breakdown of men versus women: a man’s average Social Security check is $1,627 per month while a woman’s is $1,297 per month.

Another article from Fool.com also has some surprising numbers, including social security's average benefits may cover just over 1/3 of household expenses!

Tax Reduction in Retirement Maximizes Social Security Benefits

7/29/2020

Do you know the government intends to net $650 billion in tax revenue over the next decade from retirees Social Security? Would you appreciate strategies that could prevent your Social Security from being income taxed?

There is no inflation protection on the thresholds to determine if your Social Security is taxable. If your modified adjusted gross income and half your Social Security benefits exceed $25,000 and you are single, your Social Security becomes taxable. If married that number begins at $32,000. Up to 85 percent of Social Security benefits can be income taxed.

Title: Surprise! Social Security Will Net $650 Billion Over the Next Decade by Taxing Its Beneficiaries
https://www.fool.com/retirement/2020/06/13/surprise-social-security-will-net-650-billion-over.aspx

Title: 50% of seniors don’t keep their Social Security benefits: Here’s why
https://www.foxbusiness.com/money/50-of-seniors-dont-get-to-keep-their-social-security-benefits-in-full-heres-why

Do You Believe Tax Will Be Higher In The Future?

7/28/2020

Here are two articles about higher taxes for Americans in the future.

One article from ThinkAdvisor gives highlights from a discussion at The American College. Professor Laurence Kotlikoff, professor at Boston University and co-writer of the book about Social Security “Get What’s Yours” made it clear that governments will require more revenue and will probably raise rates.

The other article from FinancialAdvisor magazine said they might raise rates or reduce deductions to raise revenue. Either way, government at every level will require additional revenue. That Means Higher Taxes!

What's the implication if tax will be higher in the future? Roth IRA conversions and irrevocable trusts will be good ideas!

How Does 7-Pay Test Work for Cash Value Life Insurance Policies

7/16/2020

Cash value life insurance has always provided consumers with the opportunity for tax-deferred growth within the policy that could be accessed when the policy value is sufficient, for any reason, subject to surrender charges and withdrawal fees.

However, in addition to the guideline premium test (GPT) or cash value accumulation test (CVAT), which qualifies a policy as life insurance under the Internal Revenue Code, a cash value life insurance policy is also subject to the 7-pay test. This test determines the amount of premiums that can be paid into a policy and still receive favorable tax treatment of cash withdrawals and loans. Life insurance policies that fail the 7-pay test are called modified endowment contracts (MECs).

Why Open A Roth IRA Account For Your Child Who Has Income?

7/9/2020

Helping a young person fund an IRA—especially a Roth IRA—can be a great way to give them a head start on saving for retirement. That's because the longer the timeline, the greater the benefit of tax-free earnings.

Use Gift Money to Open A Roth For Your Child
Although it might be nearly impossible to persuade a teenager with income from mowing lawns or babysitting to put part of it in a retirement account, gifting money to cover the contribution to a child or grandchild can be the answer—that way they can keep all of their earnings and still have something to save. The contribution can't exceed the amount the child actually earns, and even if you hit the maximum annual contribution amount of $6,000 (for 2019 and 2020), that's still well below the annual gift tax exemption ($15,000 per person in 2019 and 2020 or with gift splitting, a married couple could gift their child $30,000 a year.)

It Will Be a Custodial IRA Account
You can open a custodial IRA for a minor. This type of account is managed by an adult until the child reaches the appropriate age for the account to be transferred into a regular Roth IRA in their name. This age varies by state. Funds in the custodial IRA do not count toward assets when considering Expected Family Contributions for college. Bear in mind that once the account has been transferred, the account's new owner would be able to withdraw assets from it whenever they wished, so be sure to educate your child about the benefits of allowing it to grow over time and about the rules that govern Roth IRAs.

The Power of Tax Diversification

7/4/2020

Do you know how much tax rate will be in the future? The truth is no one can predict that.

This makes tax diversification important. The document from AIG below explains what is tax diversification and how it might work.

Can I Still Have an IRA If I Don't Qualify for Tax-deductible Contribution?

6/28/2020

Q. I don't qualify for tax-deductible contributions, can I still have an IRA?

A. If you're covered by a retirement savings plan at work - like a 401(k) or 403(b) - and your modified adjusted gross income (MAGI) exceeds applicable income limits, your contribution to a traditional IRA might not be tax-deductible.

But getting a current-year tax deduction isn't the only benefit of having an IRA. Nondeductible IRA contributions still offer the potential for your money and earnings to grow tax-free until the time of withdrawal. You also have the option of converting those nondeductible contributions to a Roth IRA.

If you have no other traditional IRA assets, the only tax you'll owe is on the account earnings—if any—between the time of the contribution and the conversion.

However, if you do have any other IRAs, you'll need to pay close attention to the tax consequences. That's because of an IRS rule that calculates your tax liability based on all your traditional IRA assets, not just the after-tax contributions in a nondeductible IRA that you set up specifically to convert to a Roth. For simplicity, just think of all IRAs in your name (other than inherited IRAs) as being a single account.

How Can I Estimate My Tax Liability on an IRA Conversion?

6/27/2020

To figure out how much of a conversion from a traditional IRA to a Roth IRA may be taxable, you'll need to know the types of contributions you made to any one of your traditional IRAs (not just the one that's being converted). There are 2 types of contributions.

Deductible contributions. These are contributions that are deducted from your taxable income for the tax year in which the contributions were made.
Nondeductible contributions. Any contribution for which you do not take a tax deduction is known as a nondeductible contribution. Such contributions create what is sometimes called "basis" in your traditional IRA.

Your tax liability is based on 2 things:

the taxable income generated by the conversion, and
your applicable tax rate.

Estimating the taxable income from a conversion is straightforward if you've never made nondeductible contributions to any traditional IRA. If that is the case, whatever amount you convert will all be taxable income.

Note that earnings are always taxable when converted, whether they come from deductible or nondeductible contributions, so for purposes of figuring out taxes on a conversion, you can think of your balances as falling into just 2 categories:

nondeductible contributions, and
everything else

According to IRS rules, you cannot cherry-pick and convert just nondeductible contributions, leaving deductible contributions and earnings in the account, in order to avoid taxes. Instead, you must figure out the proportion of your total traditional IRA balances that is composed of nondeductible contributions, then use that percentage to find out how much of your conversion will not be taxable. Note that inherited IRAs are excluded in this calculation.

Keep state taxes in mind too. A Roth IRA conversion is a taxable event. If your state has an income tax, the conversion will generally be treated as taxable income by your state as well as by the federal government.

If your spouse has IRAs with mostly nondeductible contributions and you have IRAs with mostly deductible contributions, you might consider converting your spouse's IRAs before yours to reduce the potential tax impact of conversion.

The Top 6 Most Impactful SECURE Act Changes for Consumers

6/26/2020

The SECURE Act became effective January 1, 2020. This flyer from AIG summarizes the top 6 most impactful changes for consumers to take notice:

How to Use Annuities in Trusts to Create a Legacy and Save Taxes

6/21/2020

Irrevocable non-grantor trust is taxed at trust rates, see table below.

Benefits of Non-grantor irrevocable trusts –

Credit shelter trusts
Revocable living trusts upon death of the grantor

A case study
Ann Weston has two children

Jon – son of Ann’s second husband, Robert, and his first wife
Julie – daughter of Ann and her first husband
Wish to leave a legacy for their two children
Upon Robert’s death, trust was funded with $6M

Trustees discusses benefits of using a nonqualified deferred annuity.

What are the benefits?

Avoids higher trust income taxes until distributed
Avoids 3.8% net investment income tax, if applicable

How does it work?

Trustee buys nonqualified annuity contract to benefit trust beneficiary
Trust is owner and beneficiary of annuity
Trustee names annuitant

There are two options to consider.

Option 1. Purchase one nonqualified deferred annuity for $1M with Ann as the annuitant

Trust purchases one $1M annuity
50% of death benefit distributed and taxed to Jon at Ann's death
50% of death benefit distributed and taxed to Julie at Ann's death

Option 2. Purchase two nonqualified deferred annuities for $500K each

Jon named as annuitant on one
Julie named as annuitant on the other
Trust purchases two $500K annuities
Jon and Julie each is named as the annuitant of one annuity contract
Trustee distributes annuity contract to Jon and Julie respectively at Ann's death - no taxation

How to Use Nonqualified Stretch to Stretch Out An Annuity's Tax and Income

6/20/2020

Upon death of owner of Non-Qualified (NQ) deferred annuity, there are potentially four options –

Lump-sum payment
Annuitization
Five-year deferral
NQ stretch

Lump sum election –

Distribution of contract value: $248,000
$110,000 gain*: ($25,505)
Net after-tax benefit: $222,495

* Part taxed at 22% and the balance at 24%.

Five-year deferral –

Entire amount must be distributed before the fifth anniversary of date of owner’s death
Partial withdrawals or a full withdrawal permitted

NQ stretch –

Distributions taken over life or a period not longer than their life expectancy
Distributions must be taken at least annually
First distribution must begin within one year of owner’s death
No regulations under Section 72(s) • Only private letter rulings

PLR 200303016 – outlined three methods for satisfying requirements: 1) RMD calculation method 2) Amortization calculation method 3) Annuitization method
PLR 201330016 – permitted a non-spousal beneficiary to do a 1035 exchange of one inherited NQ deferred annuity for another one

How to Use Qualified Charity Distribution to Ensure Tax Benefits

6/19/2020

A taxpayer over age 70½ may transfer up to $100,000 per year from their pre-tax IRA directly to most charities – it's not included in income and can satisfy RMD.

Charitable contribution limit for cash contributions to charity increased from 50% to 60% of AGI. Unfortunately, the charitable deduction is a “below-the-line” deduction, a taxpayer must itemize in order to get the deduction. The reality is fewer taxpayers will be eligible to itemize today.

The following example illustrates how to use qualified charity distribution (QCD) to ensure a tax benefit.

Adam is single and 72
Lives in a low-tax state and has no mortgage
Only significant itemized deduction in 2020 would be $10,000 charitable contribution
No tax benefit because Adam is better off using the standard deduction of $12,400, plus $1,650 for being over age 65

If Adam directly transfers from his IRA to a qualified charity as a QCD, he gets income exclusion for the $10,000 distribution and still gets the $14,050 standard deduction.

A few caveats:

QCD must be made from pre-tax IRAs only
Must occur after IRA owner turns 70½
IRA owner must receive timely written acknowledgment of receipt of IRA distribution from charity
Will be reported as a taxable event on 1099-R
Burden on taxpayer and tax preparer to report distribution as non-taxable

What happened after the SECURE Act?

Age for eligibility to take QCDs remains at 70½
Deductible IRA contributions after 70½ reduce QCDs
Example: Under new law, Jason makes deductible contribution of $7,000 to his traditional IRA in 2020 when he is 70½. He makes another deductible contribution of $7,000 in 2021. When Jason turns 72 in 2022, he decides to make QCD of $20,000. Amount of QCD that will be tax-free is reduced by previous post-70½ deductible contributions. Result: Only $6,000 of QCD will be excluded from his 2022 income.

How to Leave a Legacy? A Case Study

6/18/2020

How is legacy defined? There are two definitions:

Money or property left to a person by someone who has died
Something that is a result of events in the past

Life insurance can combine these two legacy definitions and make sure your plan is complete. But if leaving an IRA was part of the plan, the SECURE Act changed the ability of some beneficiaries to stretch the money in the account over their lifetime.

If your legacy plan involved a “stretch IRA”, it’s a good idea to do a beneficiary review and see how you might be affected by the SECURE Act.

Here is a case study about how to leave a legacy.

IRS Proposes New Rules for Retirement and Annuity Payments

6/17/2020

The Internal Revenue Service and the Treasury Department issued proposed regulations recently to update the income tax withholding rules for periodic retirement and annuity payments made after Dec. 31, 2020.

Before Congress passed the Tax Cuts and Jobs Act in late 2017, if no withholding certificate was in effect for a taxpayer’s periodic retirement and annuity payments, the amount to be withheld from the payments was determined by treating the taxpayer as a married individual claiming three withholding exemptions.

The TCJA changed that rule so the rate of withholding on periodic payments when no withholding certificate is in effect would instead be determined under rules prescribed by the Treasury.

Earlier this year, in Notice 2020-3, the IRS said that, for 2020 the default rate of withholding on periodic payments will continue to be based on treating the taxpayer as a married individual claiming three withholding allowances when no withholding certificate is in effect. But now, under the proposed regulation issued Wednesday for 2021 and future years, the Treasury and the IRS will be providing the rules and procedures for determining the default rate of withholding on periodic payments when a taxpayer has no withholding certificate in effect in applicable forms, instructions, publications and other guidance.

The Treasury and the IRS have issued several sets of regulations over the years going back to at least 1982 to provide guidance regarding withholding on periodic payments, non-periodic distributions and eligible rollover distributions under section 3405 of the Tax Code. This appears to be the latest iteration, and probably not the last as most of the individual tax provisions of the TCJA are set to expire in 2025.

How to Use Life Insurance Instead of Stretch IRA to Transfer Wealth - Part B

5/16/2020

In last blogpost, we discussed what happened to stretch IRA. Now we will discuss the next topic.

Drawbacks of the New 10-Year Rule

So…what’s so bad about these changes? The kids or grandkids still get the money, right?

Well, yes, but many parents and grandparents would prefer their kids to wait before they access that money. Maybe they don’t want the kids getting full access until they hit a particular age – 35 instead of 18, for example. But even if the kids wanted to obey those wishes, without a stretch provision, they'll be forced to empty the account within 10 years – perhaps before they’re responsible enough to use it wisely, as the parents or grandparents intended.

And here’s another drawback.

If your heirs inherit a traditional IRA, that money hasn’t been taxed yet. When they start withdrawing money, it could have a significant impact on the amount of income tax they owe. If, for example, a grandchild is in her 40s and in her peak earning years, adding extra income via forced IRA withdrawals is probably going to bump up her tax bracket, forcing her to pay more.

Most parents and grandparents don’t want to leave behind a tax burden.

But that’s exactly what could happen with the elimination of the stretch provision.

Next blogpost, we will discuss why life insurance becomes a better opportunity with the changes.

A Practical Guide on Kiddie Tax

5/14/2020

How to Determine if Kiddie Tax Applies
The kiddie tax applies to dependents under age 19 and full-time students under 24. To determine if a dependent child is subject to the kiddie tax, do the following:

Add up the child’s net earned income and net unearned income.
Then subtract the child’s standard deduction to arrive at taxable income.
The portion of taxable income consisting of net earned income is taxed at regular rates while the portion of taxable income consisting of net unearned income over $2,200 this year is taxed at the parents’ marginal federal income tax rate.

Strategy to Gifting to Children
Thus, if you have kids, tax planning would focus on keeping investment interest, dividends and capital gains below $2,200, where taxes will be low.

Once the kiddie tax no longer applies, more investment income can be taxed at lower rates. Gifting highly appreciated shares to adult children who are not subject to the kiddie tax, while staying under the $15,000 annual gift tax exclusion limit, can be a good strategy if the children are in very low income tax brackets.

2 Ways to Use Upstream Gifting to Save on Tax

5/13/2020

Aid to aging parents is termed “upstream” gifting, it usually involves making gifts to parents or adult children who are in much lower tax brackets.

There are two popular ways to do so.

1) Gift dividend-paying stocks or funds
You can gift your dividend-paying stocks or stock funds to your parents. The payouts of dividend-paying stocks usually are qualified dividends, on which you might owe 15% or 20% in tax. In the hands of taxpayers — including retirees — with 2020 taxable income up to $80,000 on a joint return ($40,000 for single filers), such income falls into a 0% tax rate. Ultimately, you might inherit them in the future with a basis step-up, effectively removing any tax on all prior appreciation.

2) Gift appreciated stocks
Another plan is to give appreciated securities to seniors, who can sell them for needed cash. Again, if taxable income is up to the amounts mentioned previously, there will 0% tax on profits treated as long-term capital gains. Helping your parents with their financing can be vital, as many retirees live on tight budgets. This creates a win-win situation and reduces taxes.

How to Use Life Insurance As a Financial Tool To Lower Taxes

4/30/2020

As you prepare for retirement, you’re probably concerned about protecting the value of your assets, retiring comfortably and leaving a legacy for your family. Many people think preparing for retirement involves saving as much money as possible and investing it wisely by diversifying. However, in addition to diversifying investments, smart retirement savers also consider how taxes will affect their retirement dollars.

Below is a brochure from Securian to shows you how to use life insurance policy as a financial tool to plan your retirement.

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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.

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