Planning for the 10-year clean out rule and inherited IRAs

Inherited IRAs and RMDs

The SECURE Act of 2019 eliminated the “stretch IRA,” where children could continue to defer taxes on IRA balances inherited from parents, even passing them on to grandchildren.  This had allowed for decades of tax-free asset growth.  Congress decided to curtail the deferral past spouses by requiring that IRAs passed to non-spouses be fully distributed at the end of 10 years, with a few exceptions. 

Confusion has arisen regarding whether all amounts must be withdrawn annually or “cleaned out” in year 10.  The IRS added to the confusion by offering different interpretations after the law was enacted.  To address this confusion, the IRS responded by not penalizing IRA beneficiaries who failed to take distributions while the rules are finalized. 

The IRS proposed rules require that annual distributions continue if the original IRA owner had begun taking required minimum distributions (“RMDs”), while allowing beneficiaries of IRA owners who had not begun taking RMDs to choose to take some distributions or wait until the 10th year. 

An heir will need to plan to minimize the tax hit.  For example, they may be able to keep their total income in a lower tax bracket.  The simplest approach may be to just take 1/10th each year, so they do not end up in a higher bracket.  This may not be best if the beneficiary’s income has significant changes for bonuses, major stock sales, taking their own RMDs or starting social security.  We reviewed possible strategies with Harold Hallstein IV of the Sankala Group who said that, surprisingly, someone in a low tax bracket who expects to be in a higher bracket in the future may benefit from taking the account balance right away, thereby availing themselves of long-term capital gains rates on future investment growth. 

One note of caution: beneficiaries need to be sure to set up the inherited IRA account and not take a check, as that will be fully taxable.   

Let us know if you have any questions. 

Good luck

Steven

Year-end Tax Planning 2022-2023 and Inflation

Why year-end planning?

We are told to act before year end because it is our last chance to have an impact on our 2022 taxes.  Planning throughout the year could be even better, if you recognize when to act, but most of us are pulled in so many directions that it is hard to organize and act until there is an external pressure, such as the looming end to the calendar year.  So, when you are ready to take stock of your situation, you can make the planning effort even more productive by reviewing your investments, estate plan, and finances, not just your taxes – consider it a “financial checkup.” 

Overview

This year, there are changes that occurred due to inflation as well as legislation.  While we had expected tax increases, none materialized (there may still be tax law changes, but legislation such as the “SECURE Act 2.0,” child credit and tax extenders all remain in flux).  We review the changes that did occur before turning to actual year-end tax planning strategies. 

Impact of inflation

Is there ever a good side to inflation?  Perhaps the IRS adjustments to several tax-related thresholds that change for 2023 count, such as these:

The standard deduction MFJ             $27,700                       up from $25,900

The gift and estate tax credit              $12.92 million             from just over $12 million

The annual gift tax exclusion             $17,000                       up from $16,000

401(k) maximum contribution             $22,500                       plus $7,500 (for over 50)

IRA max.                                            $6,500                         plus $1,000

SEP-IRA max.                                    $66,000

The tax brackets at which rates increase have also gone up, so more is taxed at lower the brackets.

Inflation Reduction Act

The Inflation Reduction Act passed this summer and included changes to tax laws regarding energy saving credits.  The Act also contained other provisions, such as the 15% AMT for C corporations and 1% stock buyback tax.  It’s unfortunate that the abbreviation for the act is IRA, as we already have that in our tax lexicon. 

Beginning in 2023, this new law changes conditions for obtaining the $7,500 credit for new electric vehicles (EVs) and adds a $4,000 credit for used EVs (EVs that are 2 or more years old).  The Act also expanded the reporting requirements for the credits on your tax returns.  Finally, EV buyers can monetize the credit at purchase to reduce the sale price, rather than wait for their tax filing.  Remember there is also a credit for installing a home charger.

To obtain a credit for new EVs, the battery’s minerals must be extracted or processed in the US or a free-trade partner.  The battery must also be manufactured or assembled in North America.  Final assembly of the EV must be in North America.  There are price ceilings on EVs and income limits on claiming taxpayers. 

The Act extend and expanded home energy credits but also expanded the reporting requirements.

Tax planning

Start with this goal: to lessen the total tax due in 2022 and 2023 combined.  Usually that means delaying income to 2023 and accelerating deductions to 2022.  For 2022-2023, the jump in the standard deduction could mean losing itemized deductions in 2023, so pay special attention to what you can shift to 2022.  As we pointed out our post for 2021 year-end planning, if you are concerned about future tax rate increases, you can use a Roth Conversions to bring future income into 2022.

Now to the planning:  Can you act at all? 

Each year, we advise that you be practical, focusing on where you can actually make moves.  For many, the high standard deduction (which is even more for over age 65 taxpayers) means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher standard deduction).  And, if you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year.  If you can itemize, you have more tools for planning. 

Tools – income

You can reduce taxable income by maximizing your retirement contributions with your employer via 401(k) or 403(b) plans and IRA contributions if you are below the thresholds.  If you are self-employed, you can contribute to your own qualified plan such as a SEP-IRA. 

You may also be able to contribute to a health savings or flex account.  Be sure to see to use any flex account balances before they expire. 

Review your investments to see if you can take losses to reduce capital gains and up to $3,000 of ordinary income.  ax loss harvesting reduces net taxable capital gains, but be sure not to run afoul of the wash-sale rule.

Tools – deductions

Review your unreimbursed medical expenses, which you can deduct if the total is over 7.5% of your adjusted gross income. 

State and local taxes are capped at $10,000, so you may not be able to shift much between years.  And it is difficult to accelerate mortgage interest on first and second homes.  

Often, the place for the most change is in charitable deductions, where you can bunch two- or three-years’ worth into a single year so you can itemize.  You can use a donor advised fund (“DAF”) to bunch, by contributing all in one year, then having the DAF send annual amounts.  Also, you can transfer up to $100,000 from a traditional IRA directly to charity if you are over 70½.  Note that Congress has not extended the $300 above the line charitable deduction. 

Before you finish, check withholdings and estimates paid

Especially if you increase income in 2022, review your total paid to the IRS and state via withholdings and estimates make sure that you meet the safe harbor rules.  If not, you could owe interest for under-withholding.

And remember your estate plan review

As noted above, the federal gift and estate tax credit  is close to $12 million for 2022 and increases to $12.92 million in 2023.  If you have excess wealth, you may want to gift while you can, especially if you want to use certain trusts, like a GRAT or QPRT.  For more on estate planning updates, see our estate planning checkup post

  • If you do review your estate plan documents, also review beneficiary designations and asset ownership to make sure everything is current and flows correctly. 

Summary

As you review your 2022-2023 tax planning, determine what you can shift and project the impact.  Then follow through on the details. 

Let us know if you have any questions. 

Good luck and best wishes for happy and healthy holidays!

We address the impact of inflation on tax thresholds for 2022 and 2023 that affect your year-end tax planning.  We also review the Inflation Reduction Act and EV credits.  As in the recent years, many taxpayers will not be itemizing because of higher standard deduction (rising to $27,700 for married couples in 2023), unless they bunch charitable deductions from two or more years into one year.

Year-end Tax Planning and the Pandemic

Tax Planning and the Pandemic

We face a challenging time for planning:  The election resulted in a new President while the rate of Covid-19 infections (and deaths) continues to rise.  This has affected the economy, resulted in some tax law changes and may yield more stimulus to restore the economy.  Also, there may be more changes in 2021.  This post is intended to help you make the best tax-efficient moves before 2021 begins.  

2020 year-end tax planning – update on using the tax laws to save you money

In 2018, we provided a three-part series explaining the impact of the new tax law.  In our first part, we discussed the impact of the new law on personal taxes and in our second part, we discussed planning for small businesses.  This update replaces the third part from December 2018, as updated December in 2019 – it is our guide for year-end moves to reduce total taxes between 2020 and 2021.  But, before getting to the planning steps, we address the uncertainty caused by possible tax changes in 2021 and review some recent changes from earlier this year. 

Possible Tax Law Changes under Biden

President-Elect Biden campaigned on raising taxes for corporations and for individuals making over $400,000 of income.  However, even if the Senate seats in Georgia go to Democrats in January, the lack of a “Blue Wave,” a sweeping Democratic mandate, means that the tax hikes are unlikely to pass.  Furthermore, the President-Elect has made clear that controlling Covid-19 and economic recovery are the top priorities of his new administration. 

What did President-Elect Biden propose?  He would restore the 39.6% bracket for couples making $622,050 or more ($518,400 for singles), add a 12.4% social security tax for income over $400,000, place a 28% limit on itemized deductions for high income taxpayers, restore the 20% long-term capital gains rate for high income returns (and even apply ordinary rates on gains of taxpayers over $1 million), and limit the Qualified Business Income Deduction and opportunity zone credits.  For estate taxes, he would reduce the current $11.58 million exemption to a lower amount, perhaps $5 million or even $3.5 million, and eliminate the step-up in basis at death. 

While none of these changes are likely, there may be narrow tax hikes to fund infrastructure building and small tax breaks for lower earners (child/dependent care and elderly long-term care credits).  There may also be more stimulus action, such as more Paycheck Protection Program loans and business tax breaks for worker safety measures, as well as retirement savings incentives, tax extenders for items expiring this year, and tax breaks to encourage US manufacturing.  We will monitor activity on these matters for comment in future posts. 

Changes from the SECURE and CARES Acts for 2020

We wrote about the CARES act earlier this year, which waived the 10% penalty for coronavirus-related distributions from qualified plans of up to $100,000, with three years to pay the taxes due or redeposit as a roll-over, and suspension of required minimum distributions (“RMDs”). The act also allows larger plan loans.

The Secure Act delayed RMDs to age 72 and allowed individuals to contribute to IRAs after age 70 ½ if still working.   But the Act also limited the distribution of IRAs to a 10-year maximum for beneficiaries other than spouses and certain others, thus eliminating the “stretch IRA.” 

The Families First Act created credits for people unable to work due to Covid-19 illness and due to caring for others.  If you are affected, check to see if you are eligible for any of these tax credits. 

A reminder on the mortgage interest deductions

As you may recall, mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase your primary and secondary residences.  Interest on home equity loans is not deductible, except when the home equity indebtedness is used to purchase or improve your primary or secondary residence.

Check taxes already paid

Make sure your total paid to the IRS and state via withholdings and estimates meets the safe harbor rules.  If not, you could owe interest for under-withholding. 

Now to the planning:  Can you act at all?   

Each year, we advise that you be practical, focusing on where you can actually make moves.  For many, the $24,800 standard deduction for married couples (more for over 65 taxpayers, and $12,400 for single taxpayers) means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher standard deduction).  And, if you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year (but you can also stop collecting receipts for those deductions). 

There is one exception from the CARES Act, which provides a $300 above the line charitable deduction for cash contributions.  You get this regardless of itemizing. 

Some possible deduction strategies

One technique for getting around the limit on deductions is to bunch certain deductions from two or more years into one year.  However, the only deduction that you can easily move is for charitable donations, because your state, local and real estate taxes are limited to a $10,000 maximum and you cannot accelerate, or delay, significant amounts of mortgage interest. 

If you do not want any one charity to receive the full amount in one year, you can still use this bunching strategy to donate to a donor advised fund, from which you may be able to designate donations to particular charities in future years.

The tax planning steps

What can you move?  If you are able to itemize, determine what income and deductions you can move from 2020 to 2021 or vice versa.  You want to minimize total taxes for both years.  Make sure your planning includes the 3.8% Medicare tax on high income and a review Roth conversion.  Roth distributions are not taxed, so converting a traditional or roll-over IRA to a Roth could be beneficial, as long as the tax cost now is not too great – see more at Roth or not to Roth?  With the waiver of the 10% penalty for early withdrawals, a Roth conversion may be more attractive.  Business owners will want to review our post on planning under 199A for QBID

What is the effect of moving?  Next, review the impact of moving income and expense to see what happens if you shift any of these amounts from one year to the other year.

The AMT – Finally, watch for the Alternative Minimum Tax (“AMT”).  The AMT affects fewer people, but it is still wise to review so you avoid it. 

Retirement contributions

If you have not maxed-out your 401(k) plan, IRA, Health Savings Account or flex plan account, consider doing so before the end of the year.  The contributions reduce your tax able income while adding to savings.  But check out our post on paying debts vs. investing.

If you are 70½ or older, you have the option of distributing up to $100,000 from your IRA or other qualified plan to an IRS-approved charity and having none of the distribution taxed.  The provision was great when you had an RMD to satisfy, but that was suspended for 2020.  That should not stop you if you still have the charitable intent. 

Business expenses

The deduction of unreimbursed business expenses was terminated by the new tax law.  That hurts many who are working from home this year, as they cannot deduct associated costs. 

We wrote about forming an LLC or S Corp. to report business expenses or taking expenses on Schedule C in our 2018 Part III post, but that applies to expenses for that business and we stressed that you will need a valid business purpose to form the LLC or S Corp. or use Schedule C for self-employment and take expenses.  Be sure to consult with an attorney before trying any of these ideas. 

Capital gains

Review your unrealized losses to see if you can “harvest” those losses to offset or “shelter” realized gains, reducing your total taxable income.  If you have more losses than gains, you can take up to $3,000 of capital losses against other income. 

If you sell an asset that you would prefer to retain, in order to shelter gains in 2020, make sure you do not run afoul of the wash-sale rule (any loss on an asset that you repurchase in 30 days will be disallowed, so you have to either wait 30 days or purchase a similar asset that fits your portfolio while not counting against the wash sale rule).  N.B. – when buying mutual funds late in the year, check for distribution dates so you do not purchase just before dividend and capital gains distributions, as you will owe taxes on those distributions. 

If you have significant unrealized gains, consider using appreciated stock for charitable donations – that way you avoid the tax on the gain while still getting the full fair market value for your charitable donation.  That is very effective tax leverage!

Estate plan review

While you review your taxes, review your estate plan as well.  The federal exemption is over $11 million in 2020, so fewer people will owe any federal estate tax.  However, that may change in 2021; also, many states still impose estate taxes on smaller estates. 

The individual gift and estate tax exemption is due to return to $5 million, adjusted for inflation, in 2026 and could be lowered sooner, as noted above.  That tax rate could also go up. 

If you have “excess wealth” and want to reduce your taxable estate by gifting assets to children or others, you can give $15,000 per person, per year now.  If your spouse joins you, that is $30,000 per person.  This includes funding a 529 plan for education cost – expanded to provide for more than just college – or an ABLE account for disabled dependents.  Note, however, that holding appreciated assets for the step up in basis at death may be better than gifting, but this could be eliminated as noted above. 

If you do review your estate plan documents, also review beneficiary designations to make sure everything is current.  And review your medical directive and durable power of attorney.  

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2020 and 2021. 

Good luck and best wishes for happy and healthy holidays!

Coronavirus – concerns for your health and finances

This is my busy time, working long hours preparing income tax returns, but I wanted to respond to your concerns.

News of the coronavirus spread and its impact on the economy and stock markets is constant.

People ask: “can I get the virus from a package delivered to me from China” (the answer via the CDC is “no”).

As some say, it’s not “if” but “when” in terms of you being in contact.  That is upsetting.

At that same time, experts ask us all not to panic.  And financial people urge us to stay the course.

If you do not already have a plan, here is a good overview with links to CDC posts on making a plan with your family – NY Times prepare for coronavirus

As for the stock market, here is a good NY Times piece discussing the rationale for sticking to your long-term investment plan:  The Market Is Moving. Most People Should Sit Still.

Here is a more sobering assessment:  It’s a ‘Swimming Naked’ Moment: The Financial System Has a Real Test

In the end, if you developed a good long-term investment strategy, staying the course should be the best response as it was in the 2008 financial crisis.

Let me know if you want to talk and I hope you and your family stay healthy!

  • Steven

Year-end tax planning – 2019 update on using the tax laws to save you money

we hope your planning does not look like this!

Last year, we provided a three-part series explaining the impact of the new tax law.  In our first part, we discussed the impact of the new law on personal taxes and in our second part, we discussed planning for small businesses.  In this part, we update the third part posted last year, which is our guide for year-end moves to reduce total taxes between 2019 and 2020. 

Can you act at all?   

Each year we advise that you be practical, focusing on where you can actually take action. 

For many, the new $24,000 standard deduction for married couples, $12,000 for single taxpayers, means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher, standard deduction).  The standard deduction goes up when you reach 65. 

If you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year (but you can also stop collecting receipts for those deductions!). 

Some possible deduction strategies

One technique for getting around the limit is to bunch deductions from two or more years into one year.  The one deduction that you can easily move is for charitable donations.  Your state, local and real estate taxes are limited to a $10,000 maximum and you cannot accelerate, or delay, significant amounts of mortgage interest. 

If you do not want any one charity to receive the full amount in a single year, you can still use this bunching strategy.  Donate to a donor advised fund, from which you may be able to designate donations to particular charities in future years.

IRA donations:  If you are 70½ or older, you have the option of distributing up to $100,000 from your IRA or other qualified plan to an IRS-approved charity and having none of the distribution taxed. 

Capital Gains:  Review your portfolio.  You may be able to “harvest losses” to offset capital gains realized on stock sales or mutual fund capital gains distributions.  If you have substantial unrealized gains, consider donating to a charity.  See below. 

The tax planning steps

If you are able to itemize, determine what income and deductions you can move from 2019 to 2020 or vice versa.  You want to minimize total taxes for both years.  Make sure your planning includes the 3.8% Medicare tax on high income and review Roth conversions (Roth distributions are not taxed, so converting a traditional or roll-over IRA to a Roth could be beneficial, as long as the tax cost now is not too great).  And business owners will want to review our post on planning under 199A for QBID

Next, review the impact of moving income and expense to see what happens if you shift any of these amounts from one year to the other year.

But, watch for the Alternative Minimum Tax (“AMT”):

  • The exemption for the AMT and the threshold above which that exemption gets phased out are now higher than before 2018, so fewer taxpayers will owe the AMT.  

Finally, if you have not maxed-out your 401(k) plan, IRA, Health Savings Account or flex plan account, consider doing so before the end of the year.

Capital gains

Your mutual funds may have large capital gains distributions.  Christine Benz says, “Brace yourself: 2019 is apt to be another not-so-happy capital gains distribution season, with many growth-oriented mutual funds dishing out sizable payouts.”  

Review your unrealized losses to see if you can “harvest” those losses to offset or “shelter” realized gains, reducing your total taxable income.  If you have more losses than gains, you can take up to $3,000 of capital losses against other income. 

If you sell an asset that you would prefer to retain, in order to shelter gains in 2019, make sure you do not run afoul of the wash-sale rule (any loss on an asset that you repurchase in 30 days will be disallowed, so you have to either wait 30 days or purchase a similar asset that fits your asset allocation while not counting against the wash sale rule). 

If you have significant unrealized gains, consider using appreciated stock for charitable donations – that way you avoid the tax on the gain while still getting the full fair market value for your charitable donation.  

Some reminders on itemized deductions

As you may recall, mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase or improve your primary or secondary residence.  Interest on home equity loans will not be deductible, except when the home equity indebtedness is used to purchase or improve the residence.

Also, all miscellaneous deductions were eliminated.  This includes investment and tax preparation fees, safe deposit box charges and unreimbursed employee business expenses.  And moving expenses are no longer allowed (except for military personnel in certain cases). 

Check taxes paid

Make sure your total paid in withholdings and estimates meets the safe harbor rules.  If not, you could owe interest for under-withholding. 

Estate plan review

While you review your taxes, consider reviewing your estate plan and your beneficiary designations.  The federal exemption is just over $11 million in 2019, so fewer people will owe any federal estate tax.  However, many states still impose estate taxes on smaller estates.  If you have “excess wealth” and want to reduce your taxable estate by gifting assets to children or others, you can give $15,000 per person, per year.  If your spouse joins you, that is $30,000 per person.  This includes funding a 529 plan for education costs – expanded to provide for more than just college. 

Note, however, that holding appreciated assets for the step up in basis at death may be better for your heirs than gifting. 

Check on 2018

Check to see if you over-paid a penalty for under-withholding.  If you filed early, the penalty calculation may have over-stated the total you owe, so you will want to review your 2018 filing. 

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2019 and 2020. 

Good luck and best wishes for the holidays!