Category: Tax - PFwise.com

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.

How to Use Life Insurance to Help Your Business Grow

4/25/2020

As a business owner, your first concern is growing your business. You face tough financial questions. Securian has developed the Business Owner Life-stage Design (BOLD) process to help business owners like you.

With BOLD, we can help address the unique and complex challenges you face. So you can stay focused on your business – and achieving the goals that matter most to you.

Using Life Insurance as a Financial Tool (LIFT) - Part G

4/23/2020

In last blogpost, we had a case study for a "stuck" couple. Now we will show you how a "smart" couple use life insurance to lower taxes.

Case 2: "Smart" Couple Use Permanent Life Insurance to Lower Taxes

The second married couple has the ability to design a tax-sensitive distribution strategy because they are using permanent life insurance to protect their family and their wealth.

Just like the previous couple, their desired income is $100,000 and their required income is $78,950. However, they have the flexibility to take out $21,050 from any of the three financial toolboxes.

This year, they decide they want to be as tax-efficient as possible and will take dollars from a tax-advantaged toolbox to fill their income gap.

Net worth: Includes assets from all three financial tools: capital assets, retirement income and tax-advantaged Achieving desired income The taxpayers with a tax-sensitive distribution strategy desire to be as tax-efficient as possible.

Taxes for tax-sensitive couple
This couple will pay taxes in the first two tax brackets only. Their total taxes due will be $9,086, and their effective tax rate is 9.1 percent.

Results
In this case, the second "smart" or tax-sensitive couple has a tax savings of $4,631 and a decrease in the effective tax rate of 4.6 percent compared to the other couple:

Using Life Insurance as a Financial Tool (LIFT) - Part F

4/22/2020

In our last blogpost, we discussed withdrawals and tax. Now we will use 2 case studies to show how to use permanent life insurance to lower taxes.

1. One couple is stuck in their tax bracket
2. Another couple has a tax-sensitive distribution strategy

Each couple puts away the same amount for retirement, but they allocate assets differently among the tools. Some contributions were made to qualified plans.

Couple 1: Stuck in their tax bracket
The first couple chooses to protect their family’s dreams, aspirations and accumulated wealth with term life insurance until it runs out. They focus solely on capital assets and retirement income assets to fund their retirement.

Desired income: $100,000
Required income: $78,950; required income includes income this couple are obligated to receive due to automatic payments, like pensions, or tax law (e.g., Required Minimum Distributions – RMDs, starting at age 70½)
Retirement income gap: $21,050; which will be filled using their capital asset or retirement income toolbox
Net worth: Includes only capital assets (e.g., investments and real estate) and retirement income assets, or qualified assets

Achieving desired income
The taxpayers stuck in their tax bracket decide to take dollars out of their retirement income toolbox to cover their income gap.

Taxes for “stuck” married couple
This couple will pay taxes on the first two tax brackets and some ($21,050) in the 22 percent brackets. Their total taxes due will be $13,717 and effective tax rate is 13.7 percent.

In our next blogpost, we will show you how the second couple use life insurance to lower taxes.

Using Life Insurance as a Financial Tool (LIFT) - Part E

4/21/2020

In last blogpost, we showed you the difference between policy surrender and policy loan. Now we will discuss how withdrawals are taxed.

How Are Withdrawals Taxed?
In general, withdrawals from a policy’s cash value are not taxed until the owner’s entire investment in the contract has been withdrawn. There are four exceptions to this rule:

The policy doesn’t fit within the definition of life insurance.
The policy is a modified endowment contract.
A withdrawal occurs in the first 15 years with a reduction in benefits.
If all contributions to the contract have been withdrawn, any future withdrawals will be subject to income tax.

How are policy loans taxed?
Policy loans taken from a life insurance policy are not taxable unless the policy is a modified endowment contract.

If the insured dies while the loan is outstanding, the loan will be repaid out of the death benefit and no taxation should occur. Remember, there may be tax ramifications if the policy is surrendered, lapses or is exchanged while a loan is outstanding.

What are the tax ramifications if the policy is surrendered?
If the policy is surrendered, then the cash value will be taxable as ordinary income to the extent it exceeds the owner’s contributions to the contract. Any loss incurred is non-deductible and a personal expense. In addition, loan balances in excess of the owner’s contribution to the policy may also be taxed upon a full surrender.

How is the internal cash value buildup taxed?
Generally, any increase in the cash value of a life insurance policy is not subject to current income taxation as long as the policy meets the statutory definition of life insurance. However, if a policy does not meet the definition, any increase in the cash value will be taxed as ordinary income annually as received or accrued by the policyholder.

In our next blogpost, we will use 2 case studies to illustrate how to use life insurance to lower tax.

Using Life Insurance as a Financial Tool (LIFT) - Part C

4/19/2020

In last blogpost, we discussed 5 questions you should ask about your life insurance policy. Now we will show you the tax advantages of life insurance.

Tax Advantages of Life Insurance
Permanent life insurance can be a key asset for many individuals due to its tax-advantaged treatment. No other financial tool becomes an instant asset upon the death of the insured. There are three key aspects of life insurance you should understand:

Premium payments
Death benefit
Cash value

1. Premium Payments
A life insurance policy is purchased with premium payments you makes to a life insurance company. The following are several key questions and answers related to premium payment.

Are there contribution limits for life insurance policies?
Unlike other tax-advantaged assets like Roth IRAs, there are no contribution limits based on your income. However, there is a limit set by the IRS determined in large part by the amount of death benefit being purchased.

What are the benefits of a well-funded policy?
A well-funded policy is funded close to the legal limits in order to achieve the most amount of premium growing tax-deferred. This reduces the risk the policy will lapse or will require additional premium payments, and potentially produces higher cash values.

How do charges and fees impact accumulation value?
While permanent life insurance does offer growth potential, you should understand several charges are assessed to your premiums before contributions reach the cash value portion of their policy:

In many cases, charges and fees associated with premium payments may be higher than the purchase payments for a capital asset or a 401(k)
There are charges associated with maintaining the death benefit that do not exist in capital assets or many retirement income assets
Life insurance is priced around a mortality charge determined by age, gender and general health of the insured

2. Death Benefit
Your’ premiums pay for a life insurance policy’s income tax-free death benefit – the primary purpose of this tool. If the insured dies, the death benefit can provide:

Money for beneficiaries at a time when they need it the most — for income replacement and debt reduction or estate planning
Replacement value for assets going to a charity
Estate equalization for a family business
A strategy to transition a business to someone else

3. Cash Value
While you see the value in a life insurance policy’s death benefit, you might not fully understand the cash value component of permanent policies. Understanding cash value accumulation is key to realizing the full value of life insurance as a financial tool. A well-funded policy that has good performance throughout the life of the contract can potentially:

Act as an “opportunity reserve” when you need additional funds
Provide supplemental retirement income
Potentially lower your average tax rates in retirement

In our next blogpost, we will discuss the distributions from permanent life insurance policies.

Why Life Insurance Trusts Are Better For Multi-generational Planning

3/24/2020

Q. Why life insurance trusts are better for multi-generational planning?

A. This is because the new Secure Act!

Consider this scenario
Someone is leaving a $1 million IRA to a conduit IRA trust for his grandchildren.

Under the old stretch IRA rules, if the trust qualified as a see-through trust, RMDs could be based on the age of the oldest grandchildren, say, 19-year old. RMDs would be paid to the trust and from the trust right through to the grandchildren over 64 years (the life expectancy of a 19-year old), leaving the bulk of the inherited IRA funds protected in trust for decades.

Meanwhile, the grandchildren receive only about 1.6% to 2% of the account for the first 14 years, with the percentage increasing very slightly each year. That percentage of IRA funds being released to the grandchildren would stay under 10% for 50 years. Those smaller RMDs would keep tax bills lower for many years and keep balance of the nondistributed trust funds protected.

Why it won't work anymore
But not anymore! Under the new Secure Act, if the plan stays as is, all the funds will be released to the grandchildren and taxed by the end of the 10th year after death. Even if a discretionary trust was used to keep more funds protected, the entire inherited IRA balance would still have to be paid out to the trust by the end of 10 years - and taxed at trust rates for any funds retained in the trust for continued protection.

That's why the person with $1 million IRA could instead withdraw the IRA funds over time using today's low tax rates and use them to buy a life insurance policy. Due to the life insurance leverage, the payout after death can far exceed the $1 million balance in the IRA, depending on the person's health and age.

The caveat?
In order for the new life insurance strategy works, the person has to qualify for life insurance.

A Common Tax Error Made By Freelancers

3/19/2020

What's the most common tax error made by freelancers?

Did not pay quarterly estimated taxes!

With more freelancers than ever before, this also means more taxpayers will be required to pay quarterly estimated taxes for the tax year. Unfortunately, some people are not aware they have to do this, or don’t know how and when to make their payments.

What are the consequences?
A failure to pay quarterly estimated taxes does a couple of things.

It leaves the taxpayer with a massive tax bill come April.
It can trigger late fees and interest on top of the base tax figure. For high earners, this could amount to thousands of dollars in additional taxes.

The IRS has a pretty good resource on self-employment and how to pay taxes. It explains who is required to pay quarterly taxes, how to make the payments, when to submit the payments, and how these payments impact the annual return. Freelancers and self-employed professionals should read it to ensure they don’t run into problems come April.

How Smart Use of Permanent Life Insurance Can Help Reduce Tax At Retirement Time - Part B

3/8/2020

In our last blogpost, we showed the first couple how they use term life and stuck in their current tax bracket.

Couple 2: Has tax-sensitive distribution strategy

The second married couple has the ability to design a tax-sensitive distribution strategy because they are using permanent life insurance to protect their family and their wealth.

Just like the previous couple, their desired income is $100,000 and their required income is $78,950. However, they have the flexibility to take out $21,050 from any of the three financial toolboxes.

This year, they decide they want to be as tax-efficient as possible and will take dollars from a tax-advantaged toolbox to fill their income gap.

Net worth: Includes assets from all three financial tools: capital assets, retirement income and tax-advantaged

Achieving desired income

The taxpayers with a tax-sensitive distribution strategy desire to be as tax-efficient as possible.

Desired income of $100,000 Sources of income
Required income $78,950 Social Security and RMDs
Income gap $21,050 Filled with income from a tax-advantaged asset (cash value life insurance)

Taxes for tax-sensitive couple

This couple will pay taxes in the first two tax brackets only. Their total taxes due will be $9,086, and their effective tax rate is 9.1 percent.

Results

In this case, the second couple has a tax savings of $4,631 and a decrease in the effective tax rate of 4.6 percent compared to the other couple:

How Smart Use of Permanent Life Insurance Can Help Reduce Tax At Retirement Time - Part A

3/7/2020

This is a case study, we have two couples, each couple puts away the same amount for retirement, but they allocate assets differently among the tools. Some contributions were made to qualified plans.

Couple 1: Stuck in their tax bracket

The first couple chooses to protect their family’s dreams, aspirations and accumulated wealth with term life insurance until it runs out. They focus solely on capital assets and retirement income assets to fund their retirement.

Desired income: $100,000

Required income: $78,950; required income includes income clients are obligated to receive due to automatic payments, like pensions, or tax law (e.g., Required Minimum Distributions – RMDs, starting at age 70½)

Retirement income gap: $21,050; which will be filled using their capital asset or retirement income toolbox

Net worth: Includes only capital assets (e.g., investments and real estate) and retirement income assets, or qualified assets

Achieving desired income: The taxpayers stuck in their tax bracket decide to take dollars out of their retirement income toolbox to cover their income gap.

Desired income of $100,000 Source of income
Required income $78,950 Social Security and RMDs
Income gap $21,050 Filled with only retirement income assets (taxed at ordinary income rates)

Taxes for “stuck” married couple: This couple will pay taxes on the first two tax brackets and some ($21,050) in the 22 percent brackets. Their total taxes due will be $13,717 and effective tax rate is 13.7 percent.

In our next blogpost, we will look at the second couple that uses permanent life insurance smartly.

How Are Life Insurance Withdrawals Taxed?

3/6/2020

Q. How are life insurance withdrawals taxed?

A. In general, withdrawals from a policy’s cash value are not taxed until the owner’s entire investment in the contract has been withdrawn.

There are four exceptions to this rule:

1. The policy doesn’t fit within the definition of life insurance.

2. The policy is a modified endowment contract.

3. A withdrawal occurs in the first 15 years with a reduction in benefits.

4. If all contributions to the contract have been withdrawn, any future withdrawals will be subject to income tax.

How are policy loans taxed?

Policy loans taken from a life insurance policy are not taxable unless the policy is a modified endowment contract. If the insured dies while the loan is outstanding, the loan will be repaid out of the death benefit and no taxation should occur. Remember, there may be tax ramifications if the policy is surrendered, lapses or is exchanged while a loan is outstanding.

What are the tax ramifications if the policy is surrendered?

If the policy is surrendered, then the cash value will be taxable as ordinary income to the extent it exceeds the owner’s contributions to the contract. Any loss incurred is non-deductible and a personal expense. In addition, loan balances in excess of the owner’s contribution to the policy may also be taxed upon a full surrender.

How is the internal cash value buildup taxed?

Generally, any increase in the cash value of a life insurance policy is not subject to current income taxation as long as the policy meets the statutory definition of life insurance. However, if a policy does not meet the definition, any increase in the cash value will be taxed as ordinary income annually as received or accrued by the policyholder.

What To Do When Stretch IRAs Are Eliminated?

3/3/2020

Q. What can I do with "stretch IRA" is eliminated due to the new rules?

A. First, what is a "stretch IRA"?

Before 2020, you could bequeath your IRA to anyone you wanted. The recipient has to take "required minimum distributions" every year. But those distributions, which are taxable, could be stretched out based on the recipient's presumed life span. The younger the recipient, the smaller the distributions the inheritor has to take.

So a "stretch IRA" is a perfect tool could be used to pass assets to people two or three generations younger, no estate tax.

However, from January 1, 2020, under the new rules, stretch IRAs for non-spouses were pretty much eliminated - it limits the life of bequeathed IRAs to 10 years if you give them to anyone but a surviving spouse or sick or disabled beneficiaries.

The Solution
So what you can do? If you have the money, you can create a "synthetic stretch IRA" by setting up a trust to which you bequeath your IRA, with the trust instructed to pay lifetime income to whomever you choose on whatever terms you like.

Backdoor Roth IRA - What Are the Downsides?

2/29/2020

In last blogpost, we compared backdoor Roth IRA with Roth conversion. Now let's discuss what's the downside of backdoor Roth IRA.

The pro-rata rule

The pro-rata rule states that any withdrawals you take from IRAs be equally divided between taxable and non-taxable funds. Under the pro-rata rule, ALL of your IRA holdings will affect the tax consequences of opening a Backdoor Roth.

For example, let’s say:

You have $45,000 in a rollover IRA created from an old 401(k).
Then you put $5,000 in a new nondeductible IRA.
You have a ratio of 9:1 of taxable to non-taxable money.
When you convert the $5,000 nondeductible IRA to a Roth, you will actually owe taxes of $4,500. That’s because 90% of your available IRA funds have never been taxed.

If you have a sizable existing IRA balance — be they traditional IRAs, rollover IRAs, or SEPs — this could create a large tax burden for the conversion year. One solution, if you can afford to pay the taxes, is to convert all of your IRAs to Roths at the same time.

Backdoor Roth IRA versus Roth Conversion

2/28/2020

In last blogpost, we discussed what is backdoor roth IRA, now let's discuss Roth conversion.

In a straightforward Roth conversion, you can take any existing IRA balance — be it a traditional IRA, SEP, etc. — and convert it into a Roth IRA. When you do this, you are responsible for paying taxes on the amount you convert. You pay taxes on both the principal (the amount you contributed) and any earnings since the account was opened.
With a Backdoor Roth IRA, it’s sometimes possible to avoid this large tax responsibility because you’re not deducting the amount you contribute to the nondeductible traditional IRA. There is an exception, however: If your nondeductible traditional IRA earns any income (interest, dividends or capital gains) before you convert it to a Roth IRA, you will have to pay taxes on those earnings.

In next blogpost, we will discuss the downside of backdoor Roth IRA.

Backdoor Roth IRA - What Is Backdoor Roth IRA?

2/27/2020

What is backdoor Roth IRA?

Assume you’re a single-filer who makes more than $133,000, if would seem that you’re out of tax-advantaged luck, beyond your employer’s 401(k) plan (or other tax-advantaged employer-sponsored plan).

But, in 2010 a change was made to the IRS tax code to remove the income limit for making a contribution to a traditional IRA, establishing a non-deductible traditional IRA. This created a back door loophole for high income earners (those above IRS limits) who cannot deduct the contribution amount from their tax bill.

Once the non-deductible traditional IRA is opened, an account owner can then roll their traditional IRA balance into a Roth IRA. Basically, it’s a two-step process that allows high-income earners to access the benefits of the Roth IRA, despite the program’s income limits.

1) Open Traditional IRA => 2) Roll Traditional IRA to Roth IRA => You now own a Roth IRA (and all earnings grow tax-free)

In next blogpost, we will compare backdoor Roth IRA with Roth Conversion.

3 Scenarios to Determine Tax Deductions for Retirement Plan Contributions

2/26/2020

Q. How do I know if I qualify for tax deduction for my retirement plan contributions?

A. Here are a 3 possible scenarios and see which one fits you -

1. If you’re not covered by an employer sponsored retirement plan, you can make an IRA contribution of up to $5,500 per year ($6,500 if you’re 50 or older) that is fully deductible regardless of your income.

2. If you’re covered by an employer retirement plan, your IRA deductibility is determined by your income, and looks like this:

Single—with a modified adjusted gross income (MAGI) of between $63,000 and $73,000, after which the contribution is completely non-deductible
Married filing jointly—with a MAGI of between $101,000 and $121,000, after which the contribution is completely non-deductible

3. If you’re not covered by an employer plan yourself, but your spouse is, the income phase-out looks like this:

Filing jointly—with a MAGI of between $189,000 and $199,000, after which the contribution is completely non-deductible

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.

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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.

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