Mid-Year planning – Rates, Roths and Rules

Checking your income tax planning now is a good idea – tax planning can be done year-round.  As with any planning, acting while you can have an impact is best.  Tax laws may change before the end of 2022, e.g. Secure Act 2.0 may be adopted, but it’s still wise to know where you stand now. 

The IRS seems to have a similar thought about tax planning as they created a website with tools and resources at Steps to Take Now to Get a Jump on Your Taxes – if you check it out, let us know what you think.

First question:  did you get a tax refund, or did you owe? 

Refunds

Some people enjoy seeing a big refund, but as you may have heard, you are giving the government an interest-free loan with your money.  If you want to save, there are better ways, like an auto-debit to an IRA or to a savings account.

Not sure what happened to your refund?  There is a updated IRS tool for “where’s my refund” that now goes back three years at “Where’s My Refund?” 

The tool confirms receipt of your tax return, shows if the refund has been approved and indicates when it will be or has been sent.  If three weeks pass without receiving the refund, then you may want to contact the IRS.

Owed taxes

If you owed a significant amount for 2021, the IRS has another tool that helps make sure you have enough withheld for 2022 at Tax Withholding Estimator.  This way you can avoid penalties and interest for under withholding. 

If you do not get clear answers using the estimator tool, try comparing your 2022 paystub to your 2021 tax return, review the IRS guidance at Publication 505, or contact us for help.  

Second question: what happens if you act now?

Marginal vs. average tax rate

Knowing the rate at which additional net income will be taxed helps you make decisions such as the one in the next section, whether to convert an IRA to a Roth IRA or not. 

The marginal rate is your tax bracket, the rate at which the last portion of your income is taxed.  Any additional income would be taxed at this rate.  Your average tax rate is the percentage of income taxes to total taxable income.  You can have a low average rate but hit a high marginal rate, which may mean that taking more income into the current year would be costly. 

Time to convert to a Roth IRA?

The decision to convert a traditional IRA to a Roth IRA depends on several factors.  One is the rate of tax you pay now compared to the rate you expect to pay in retirement.  If your rate will be the same at retirement as now, then there are many reasons to convert, such as no required minimum distributions at retirement for a Roth IRA.  If your tax rate at retirement will be significantly less than currently, then converting now would be less tax efficient. 

If you want more on this decision, see “To Roth or not to Roth?” or check out Pros and Cons here.

Also, we discussed the back-door Roth IRA in our year-end post on 2021 tax planning.  

Last question:  how with this affect the rest of your finance?

Coordinate with investing and estate planning

Make sure any changes take for tax reasons do not foul your investment or estate planning. For more on estate planning, see estate planning checkup post

Summary

As you review your 2022 tax planning, check your 2021 returns for ideas on what to adjust, consider the impact of future tax rate increases and act when the impact on other planning also makes sense. 

Let us know if you have any questions. 

Good luck

Tax planning while laws are still changing – turn it on its head?

Many of the expected tax law changes have not materialized, but legislation remains in flux.  This means we plan year-end moves while we continue to monitor new legislation.  It is safe to bet that income tax rates will rise over the next several years.  This may mean putting year-end tax planning on its head, where you increase taxable income for 2021.  The goal is to lessen income ultimately taxed in future years.  However, you may not want to delay taking deductions until 2022 (so planning not completely on its head?)  For the standard approach, see our 2020 year-end post.

  • Roth Conversion – One way to increase income now, avoiding future income, is to convert part of an IRA to a Roth IRA, converting from taxable to non-taxable distributions in the future.  Decide on the amount to convert by projecting the impact of the conversion on your marginal tax rate.  Converting to a Roth also saves you from required minimum distributions, RMDs, in future years (but non-spouse beneficiaries still face the 10-year limit from the SECURE Act on IRA distributions). 
  • Back-Door Roth – Along with converting, the “back-door Roth” is still available, at least for 2021, so you can put more retirement funds aside with no tax on future distributions.  That is, for those who cannot contribute to a Roth due to income limits, they can contribute to a non-deductible IRA and then convert that IRA to a Roth IRA. If you have other IRAs, that may affect the amount that is taxed, so review this carefully first to see if it still makes sense.
  • More income – Other ways to increase income for 2021 include billing more for your S Corp., LLC or partnership in 2021, exercising stock options, and selling ESPP shares. 
  • Capital gains – You probably do not want to accelerate capital gains, as those should still be tax at a lower rate in future years. 

On to other considerations: first, SALT deductions

The limit on state and local taxes, or SALT, may increase from $10,000 to $80,000.  Also, a number of states have created pass-through entity elections so that the S Corp., LLC or partnership pays the tax and deducts against the income of the shareholder/member/partner.  This way, their net federal taxable income is reduced, and they get a credit for the payment on their personal tax returns. 

The SALT changes may affect your itemized deduction strategy if you are bunching.  

Check the details

  • Declare Crypto – If you had any crypto currency transactions during the year, selling, buying or receiving, be sure to declare on your federal 1040 filing.
  • Unemployment tax – Remember, unemployment benefits are fully taxable for 2021, so be sure you withheld taxes or paid estimates. 
  • Charities – If you cannot itemize, you still get up to $300 as an above the line charitable deduction, and up to $600 for a married couple. 
  • Child credits – There are changes in the credits for children and dependent care.  Let us know if you have questions on the benefits and strategies for maximizing.
  • Kiddie tax – The so-called kiddie tax has been restored to pre-TCJA terms, so you may want to review filings for the last two years.  
  • Address change – You will want to file form 8822B to indicate the change of address if your corporation, LLC or partnership moves.  On that form, you can also change the responsible party so that the IRS knows whom to contact – this is quite important if you sell your business!
  • IT PIN – If you are concerned about identity theft, consider obtaining an IT PIN as discussed in our post on IRS scams.  
  • Flex and retirement accounts – Check to see if you have any flex account balances that expire; contribute the maximum to your qualified plans; and setup a new qualified plan if you have a new business. 

Before you finish, check withholdings and estimates paid

Especially if you increase income in 2021, 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.

IRS disaster relief 

Have you received a penalty notice from the IRS?  The Pandemic was declared a federal disaster.  This means it may provide an exemption to the penalties if you can show that you suffered from the Pandemic. 

And remember your estate plan review

While you review your taxes, review your estate plan as well.  The federal gift and estate tax credit  is close to $12 million for 2021, but that may change in 2022.  So, 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, that may no longer be permitted in future years.  For more on estate planning updates, see our estate planning checkup post

Update: the annual exclusion for gifts rises from $15,000 per person, per year to $16,000 next year.

  • 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 2021-2022 tax planning, consider the impact of future tax rate increases: will bringing future income into 2021 avoid taxes on future income?  Then follow through on the details. 

Let us know if you have any questions. 

Good luck and best wishes for happy and healthy holidays!

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!

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!

Okay then, what is a financial plan?

You may hear some argue that robo-planners will not replace individual, human planners. I call them the “There’s no app for that” group.

We do believe that “There is an app for that.”
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Well, that is not what I had in mind.

But exactly what is “a financial plan”? Finding a good, workable definition is a challenge.

Wikipedia says:

Textbooks used in colleges offering financial planning-related courses also generally do not define the term “financial plan.” For example, Sid Mittra, Anandi P. Sahu, and Robert A Crane, authors of Practicing Financial Planning for Professionals[8] do not define what a financial plan is, but merely defer to the Certified Financial Planner Board of Standards’ definition of ‘financial planning’.

Can’t we define “financial plan”?

Yes. Investopedia offers this broad definition:

While there is no specific template for a financial plan, most licensed professionals will include knowledge and considerations of the client’s future life goals, future wealth transfer plans and future expense levels. Extrapolated asset values will determine whether the client has sufficient funds to meet future needs.

And Wikipedia gives more detail:

In general usage, a financial plan is a comprehensive evaluation of an individual’s current pay and future financial state by using current known variables to predict future income, asset values and withdrawal plans. This often includes a budget which organizes an individual’s finances and sometimes includes a series of steps or specific goals for spending and saving in the future.

So you need to project where your assets can take you to be sure you meet your future in good shape. Makes sense

And what is my definition?

A to do list or “action plan” that tells you what you need to change now so you optimize the use of all your resources to achieve your major, long term goals in the future.         

So what does a financial plan look like?

If you paid to have a financial plan prepared, and have a complicated situation, you may get a glossy, bound book filled with projections, charts and graphs, plus text. While much of it may be boilerplate, it will tell you where you are going from now until you die, how your money will follow if you invest according to the plan, and what you need to change on taxes, insurance, and your estate plan.

At the other extreme, you can glean the essential steps and write them all on a PostIt note, which you then place in a spot you see often enough to remind you what to do:

  • Maximize my 401(k) contributions,
  • Set up and contribute to a Roth IRA,
  • Review my investment allocation, use ETFs,
  • Steer clear of any major credit card debt,
  • Review my beneficiary designations,
  • Sign an medical directive, and
  • Save enough for a fun (not too expensive) vacation next summer!

In the end, it doesn’t matter how many pages or what the plan looks like; what matters is that you learn from reviewing your finances and change how you manage your resources so that improve your finances.

So, yes, a simple to do list could be enough, if you follow it!