Planning Your RMD and IRA Distributions For 2012

We spend most of our lives saving for retirement by putting funds away in tax-advantaged ways. But many of us forget about planning the withdrawals so that they are tax-advantaged as well.

Although there are exceptions, retirement funds generally cannot be withdrawn until we are age 59.5. If taken out sooner, there is a 10% penalty that applies in most cases. In addition, there may be a state penalty.

A large number of taxpayers do not take distributions until they are forced to do so at age 70.5, not realizing they might benefit tax-wise by taking money out sooner. For example, if you are in a low or zero tax-bracket this year, you can take a certain amount out with no or minimal tax cost. That is where planning your distributions can save a significant amount of tax dollars.

Even if you are under 59.5, if your income for the year is below the taxable income limit, you can withdraw an amount that brings you up just short of the taxable income threshold and only pay the penalty.

If you receive Social Security benefits keep in mind that Social Security income is tax-free for lower-income retirees but becomes taxable as income increases. IRA distributions can sometimes be planned in order to minimize the taxability of the Social Security income.

Once you reach age 70.5, you must start taking the required minimum distribution (RMD) from your Traditional IRA and other qualified pension plans. But you can still withdraw more than the required amount. If your income is low, it may be appropriate to take more than the minimum to save taxes in the future. Unfortunately, many people simply take the IRS-specified minimum amount without considering the tax-planning aspects of the distribution.

The penalty for not taking the RMD after reaching age 70.5 is an additional tax of 50% of the amount that should have been taken that year, based upon the IRS rules. The good news is that the IRS will generally, upon request, waive the penalty, provided that you show a corrective distribution was made in the subsequent year. So if you missed an RMD for the prior year, you should contact this office right away with regard to taking corrective action.

The RMD is determined by taking the IRA balance on December 31 of the prior year and dividing that total by your remaining life expectancy from the IRS table. If you have more than one IRA, figure the RMD for each one and then combine them to get the total required distribution for the year. (An owner of a Roth IRA is not required to take distributions at any age.)

For purposes of determining the minimum distribution, all Traditional IRA accounts, including SEP-IRAs, owned by an individual are treated as one, but the actual minimum distribution can be taken from any combination of the accounts. If the owner chooses not to take the minimum distribution from each account, it is not uncommon for IRA trustees to require written certification that the owner took the minimum distribution from other accounts.

If you have other qualified plans besides Traditional IRA accounts, the RMD for those must be figured separately for each type and withdrawn from those plans and cannot be combined with the distributions from IRAs or other qualified plans.

A taxpayer who fails to take a distribution in the year he or she reaches age 70.5 can avoid a penalty by taking that distribution no later than April 1st of the following year. However, that means the IRA owner must take two distributions in the following year, one for the year in which age 70.5 is attained and one for the current year.

If an IRA owner dies after reaching age 70.5, but before April 1st of the next year, no minimum distribution is required because death occurred before the required beginning date.

As you can see, there is more to the required minimum distribution than meets the eye, and there are some significant planning opportunities. Give our office a call if you have questions or would like to schedule a planning appointment.

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Naming Your IRA Beneficiary – More Complicated Than You Might Expect

The decision concerning whom you wish to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must withdraw from the IRA when you reach age 70-1/2, who will get what remains in the account after your death, and how that IRA balance can be paid out. What's more, a periodic review of whom you've named as IRA beneficiaries is vital to ensure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs and in your personal, financial, and family situation.

The issue of naming a trust as the beneficiary of an IRA comes up regularly. There is no tax advantage to naming a trust as the beneficiary of an IRA. Of course, there may be a non-tax related reason, such as controlling a beneficiary’s access to money; thus, naming a trust rather than an individual(s) as the beneficiary of an IRA could achieve that goal. However, that is not typically the case. Naming a trust as the beneficiary of an IRA eliminates the ability for multiple beneficiaries to maximize the opportunity to stretch the required minimum distributions (RMDs) over their individual life expectancies.

Distributions from traditional IRAs are always taxable whether paid to you or, upon your death, paid to your beneficiaries. Once you reach age 70-1/2, you are required to begin taking distributions from your IRA. If your spouse is your beneficiary, the spouse can delay distributions until the spouse reaches age 70-1/2 if he or she is under the age of 70-1/2 when inheriting the IRA. The rules are tougher for non-spousal beneficiaries, who generally must begin taking distributions based upon a complicated set of rules.

Since IRS distributions are taxable to beneficiaries, beneficiaries usually wish to spread the taxation over a number of years. However, the tax code limits the number of years based on whether the decedent had or had not begun his or her age 70-1/2 required minimum distributions at the time of their death.

If the decedent had begun taking his or her age 70-1/2 minimum required distributions the non-spousal beneficiaries must begin taking distributions in the first calendar year following the decedent’s death. Using the Single Life Table provided by the IRS, the post-death distribution period used to determine the RMD is the longer of: (1) the remaining life expectancy of the deceased IRA owner using the deceased’s attained age in the year of death and subtracting one for each subsequent year after the date of death or (2) the remaining life expectancy of the IRA beneficiary using the beneficiaries' attained age in the year of death and subtracting one for each subsequent year after the date of death. So as long as the beneficiary is younger than the decedent at the date of death, the IRA distributions can be stretched out over the beneficiary’s expected life.

If the decedent had not begun taking his or her age 70-1/2 minimum required distributions, the non-spousal beneficiaries must begin taking distributions in the first calendar year following the decedent’s death over the lifetime of the beneficiary using the Single Life Table. Where there are multiple beneficiaries, the life expectancy of the oldest beneficiary must be used.

In either case, whether the decedent had begun taking the minimum required distributions or not, the beneficiaries have the option to take the entire amount, in any manner desired, within the first five years after the decedent’s death.

To ensure that your IRA will pass to your chosen beneficiary or beneficiaries, be certain that the beneficiary form on file with the custodian of your IRA reflects your current wishes. These forms allow you to designate both primary and alternate individual beneficiaries. If there is no beneficiary form on file, the custodian’s default policy will dictate whether the IRA will go first to a living person or to your estate.

This is a simplified overview of the issues related to naming a beneficiary and the impact on post-death distributions. There are some less frequently encountered rules not covered here, and it may be appropriate to consult with our office regarding your particular circumstances before naming beneficiaries.

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Renting Your Vacation Home

If you own a home in a vacation locale – whether it is your primary residence or a vacation home – and are considering renting it out to others, there are complicated tax rules, referred to as the “vacation home rental rules,” that you need to be aware of.

Generally, the tax code breaks a “vacation rental” into three categories, each with a different treatment for income and expenses:

• Rented Less Than 15 Days – If you rent your home for less than 15 days during the tax year, the tax code says that you do not need to report the income and you can still deduct 100% of the property taxes and qualified mortgage interest as an itemized deduction. Yes, you heard me correctly: the government is actually allowing you to ignore the income, regardless of the amount, if you rent the home for less than 15 days during the year. This rule offers some opportunities for substantial tax-free income, especially for more expensive homes. Here are some examples:
• Rental as a film location – typically, film production companies will pay substantial amounts (thousands per day) for the short-term use of homes as movie sets. Individuals with unique properties can register with a local film location company.
• Home in a vacation locale – individuals with homes in a popular tourist or vacation locales can rent their homes out to vacationers in their area while they are on vacation themselves.
• Home in the area of a special event – when a one-time or special event such as a major sports event (think the Super Bowl) or convention comes to town, hotel rooms may be scarce or even fill up. Homeowners in these locations may want to rent their homes short-term during the activity while getting out of town to avoid the crowds.

However, be careful; if the rental goes over 14 days, the income is no longer tax-free. When calculating the number of days, the definition of a day is generally “the 24-hour period” for which a day’s rental would be paid. Thus, a person using a dwelling unit from Saturday afternoon through the following Saturday morning would generally be treated as having used the unit for seven days even though the person was on the premises on eight calendar days.

• Rented 15 Days or More – When the home is rented 15 days or more, the income must be reported. However the tax treatment depends upon how many days you used the home personally:
• Personal Use More Than 10% of the Rental Days – If your personal use of the home totals more than 10% of the rental days, the expenses are allocated according to personal versus rental days. In figuring your rental profit, the expenses must be deducted in the following order: allocated taxes and interest first, then maintenance and other cash expenses, and, finally, depreciation. However, the net result is limited to zero; i.e., a loss cannot be claimed.
• Personal Use 10% or Less of the Rental Days – If your personal use of the home totals 10% or less of the rental days, the expenses are allocated according to personal versus rental days in the same manner as when the personal use exceeds 10% except that a loss is allowed, but the loss cannot include any amount attributed to depreciation.

When figuring the personal use days, include days used by an owner, co-owner, or family member of the owner/co-owner and days used under a reciprocal arrangement. However, you can exclude “fix-up” days, which are days spent repairing and maintaining the property.

A number of other rules apply to special situations not covered here. If you have questions about how the vacation rental rules will apply to your unique circumstances, please give tour office a call.

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Bunching Your Deductions Can Provide Big Tax Benefits

If your tax deductions normally fall short of itemizing your deductions or even if you are able to itemize, but only marginally, you may benefit from using the “bunching” strategy.
The tax code allows most taxpayers to utilize the standard deduction or itemize their deductions if that provides a greater benefit. As a rule, most taxpayers just wait until tax time to add everything up and then use the higher of the standard deduction or their itemized deductions.

If you want to be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year and take the standard deduction in the next.

For the most part, itemized deductions include medical expenses, property taxes, state and local income (or sales) taxes, home mortgage and investment interest, charitable deductions, unreimbursed job-related expenses, and casualty losses. The “bunching strategy” is more commonly associated with medical expenses, tax payments and charitable deductions, although there are circumstances in which the other deductions might come into play. There are many opportunities to bunch deductions, and the following are examples of the bunching strategies most commonly used:

• Medical Expenses – You contract with a dentist for your child’s braces. The dentist may offer you an up-front, lump sum payment or a payment plan. By making the lump sum payment, the entire cost is credited in the year paid, thereby dramatically increasing your medical expenses for that year. If you do not have the cash available for the up-front payment, then you can pay by credit card, which is treated as a lump-sum payment for tax purposes. If you use a credit card, you must realize that the credit card interest is not deductible, and you need to determine if incurring the interest is worth the increased tax deduction. Another important issue with medical deductions is that only the amount of the total medical expenses that exceeds 7.5% of your adjusted gross income (AGI) is actually deductible. If you are caught by the Alternative Minimum Tax (AMT), then only the amount that exceeds 10% of your AGI is actually deductible. So, there is no tax benefit in bunching medical deductions if the total is less than 7.5% of your AGI (10% if taxed by the AMT).

If the current year is an abnormally high-income year, you may, where possible, wish to put off making medical expense payments until the subsequent year when the 7.5% (10%) threshold is less.

Special Note: Beginning in 2013, the medical income threshold increases from 7.5% to 10% for taxpayers under the age of 65, so that change needs to be factored into your planning.

• Taxes – Property taxes on real estate are generally billed annually at mid-year, and most locales allow the tax bill to be paid in semi-annual or quarterly installments. Thus, you have the option of paying it all at once or paying in installments. This provides the opportunity to bunch the tax payments by paying one semi-annual installment or two quarterly installments and a full year’s tax liability in one year and only paying one semi-annual installment or two quarterly installments in the other year. In doing so, you are able to deduct 1-½ year’s taxes in one year and 50% of a year’s taxes in the other. If you are thinking of making the property tax payments late as a way to accomplish bunching, you should be cautious. The late payment penalty will probably wipe out any potential tax savings.

If you reside in a state that has state income tax, the state income tax paid or withheld during the year is deductible as a federal itemized deduction. So, for instance, if you are paying state estimated tax in quarterly installments, the fourth-quarter estimate is generally due in January of the subsequent year. This gives you the opportunity to either make that payment before December 31st, and be able to deduct the payment on the current year’s return, or pay it in January before the January due date and use it as a deduction in the subsequent year.

A word of caution about the itemized deduction for taxes! Taxes are only deductible for regular tax purposes. So, to the extent you are taxed by the AMT, you derive no benefits from the itemized deduction for taxes.

• Charitable Contributions – Charitable contributions are a nice fit for “bunching” because they are entirely payable at the taxpayer’s discretion. For example, if you normally tithe at your church, you could make your normal contributions during the year and then prepay the entire subsequent year’s tithing in a lump sum in December of the current year, thereby doubling up on the church contribution one year and having no deduction for charity in the other year. Normally, charities are very active with their solicitations during the holiday season, giving you the opportunity to make the contributions at the end of the current year or simply wait a short time and make them after the end of the year.

If you think a “bunching” strategy might benefit you, please call our office to discuss the issue and set up an appointment for some in-depth strategizing.

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Important Times to Seek Assistance

Waiting for your regular appointment to discuss current tax-related issues can create problems or cause you to miss out on beneficial options that need to be timely exercised before year-end. Generally, you should call this office any time you have a substantial change in taxable income or deductions. By doing so, we can advise you about how to optimize your tax liability, avoid or minimize penalties, estimate and pre-pay required taxes, document deductions, and examine and explore tax options. You should call this office if you or your spouse:

• Receive a large employee bonus or award
• Become unemployed
• Change employment
• Take an unplanned withdrawal from an IRA or other pension plan
• Retire or are contemplating retirement
• Exercise an employee stock option
• Have significant stock gains or losses
• Get married
• Separate from or divorce your spouse
• Sell or exchange a property or business
• Experience the death of a spouse during the year
• Turn 70½ during the year
• Increase your family size through birth or adoption of a child
• Start a business or acquire a rental property
• Receive a substantial lawsuit settlement or award
• Get lucky at a casino, lotto, or game show and receive a W-2G
• Plan to donate property worth $5,000 ($500 if a vehicle) or more to a charity
• Plan to gift more than $13,000 to any one individual during the year

In addition, you should call whenever you receive a notice from the government related to your tax return. You should never respond to a notice without first checking with our office.

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September 2012 Due Dates

Individual Due Dates

September 1 - 2012 Fall and 2013

Tax Planning Contact our office to schedule a consultation appointment.

September 17 - Estimated Tax Payment Due

The third installment of 2012 individual estimated taxes is due. Our tax system is a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:

• Payroll withholding for employers;
• Pension withholding for retirees; and
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than the $1,000 de-minimis amount, no penalty is assessed. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

• The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
• The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for higher-income taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.

Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.

However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than the 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call our office as soon as possible.

CAUTION: Some state de-minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call our office for particular state safe harbor rules.

September 2012 Business Due Dates

September 1 - 2012 Fall and 2013 Tax Planning

Contact our office to schedule a consultation appointment.

September 17 - Corporations

File a 2011 calendar year income tax return (Form 1120 or 1120-A) and pay any tax, interest, and penalties due. This due date applies only if you timely requested an automatic 6-month extension.

September 17 - S Corporations

File a 2011 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you requested an automatic 6-month extension.

September 17 - Corporations

Deposit the third installment of estimated income tax for 2012 for calendar year corporations.

September 17 - Social Security, Medicare and withheld income tax

If the monthly deposit rule applies, deposit the tax for payments in August.

September 17 - Nonpayroll Withholding

If the monthly deposit rule applies, deposit the tax for payments in August.

September 17 - Partnerships

File a 2011 calendar year return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each partner with a copy of K-1 (Form 1065) or a substitute Schedule K-1. September 17 Fiduciaries of Estates and Trusts File a 2011 calendar year return (Form 1041). This due date applies only if you were given an additional 5-month extension. If applicable, provide each beneficiary with a copy of K-1 (Form 1041) or a substitute Schedule K-1.

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