Thursday, July 28, 2011

Manage the Tax on Your Social Security Benefits

Social Security (SS) income is not taxable until a taxpayer’s AGI (without Social Security income), 50% of their Social Security income, tax-exempt interest income, and certain other infrequently encountered additions total and exceed a specific threshold. The threshold is $32,000 for married taxpayers filing jointly, zero for married taxpayers filing separately and $25,000 for all others. Once the threshold is exceeded, the Social Security income subject to tax varies from 50% to 85%.

Few taxpayers understand this threshold for SS taxation and make no attempt to utilize strategies to minimize the SS taxability or take advantage of the unused threshold amount.

If a taxpayer’s only income for the year is from Social Security then there is no tax on the Social Security. However, if that is true and the taxpayer has other possible source(s) of income, the taxpayer can actually take in additional income without causing any of his SS income to become taxable. Take, for example, a 68-year-old single individual with an annual SS income of $18,000. The threshold for single individuals is $25,000, and subtracting ½ the SS income in this example from the $25,000 leaves a $16,000 difference. That is an additional $16,000 of income the taxpayer could have had that year without causing any of his SS benefits to become taxable. For 2011, a single individual age 65 or older gets a standard deduction of $7,250 and an exemption of $3,700. Thus in our example, if the taxpayer had an IRA and took a distribution from it of $16,000, he would have only been taxed on $5,050 ($16,000 - $7,250 - $3,700), and the tax would have been a minimal $505 because he is in the lowest possible tax bracket, 10%.

If that same taxpayer had been saving his IRA for his beneficiaries to inherit, then he just saved them a lot of money, because they would be taxed on the IRA based on their tax rates which will no doubt be higher. They can inherit the bank account he put the distribution in without any tax (assuming the total value of his estate is under the estate tax exemption amount for his year of death). He also reduced his IRA value so when he reaches the 70-½ mandatory distribution age he will not have to take out as much, potentially again reducing his tax.

If a taxpayer is 70-½ years of age or over, they are required to start taking required minimum distributions (RMD) from IRAs and most other retirement plans. The amount of the RMD can impact the taxation of the taxpayer’s Social Security benefits. For 2011, a taxpayer age 70-½ and over can make a direct IRA to charity distribution which also counts toward the taxpayer’s RMD for the year. The distribution is not included in income (therefore does not impact the taxability of the Social Security) and the charitable contribution is not deductible, since the distribution from which the contribution was made is not includable in the income for the year.

An added benefit is when a taxpayer has a substantial charitable contribution and he only marginally itemizes. Donations to charities are tax deductible only when a taxpayer itemizes deductions. By replacing the RMD income and charitable contribution with a direct IRA–to-charity rollover the taxpayer has the satisfaction of contributing to a favorite charity while at the same time being able to exclude the distribution from income and utilize the standard deduction to reduce his tax bite.

Foreign government Social Security benefits received by U.S. Residents are taxed according to the treaty with that country. For example, per treaty provisions, SS benefits from our neighbor Canada are taxed in the same manner as U.S. Social Security benefits. Some U.S. States do not tax U.S Social Security benefits. However, states are not a party to the federal-level tax treaties and may treat the foreign Social Security payments differently. For example, although the state of California does not tax any amount of U.S. Social Security, it treats Canadian Social Security benefits as a fully taxable pension.

If a taxpayer receives a retroactive Social Security payment during the current year that is related to a prior tax year, the entire payment must be included in the current year’s income. This may cause the SS benefits to be taxed at a higher rate than they would have been if they had been reported in the prior year. To adjust for this inequity, the IRS provides a special lump-sum calculation.

Some or all of a taxpayer’s Social Security benefits may have to be repaid if the taxpayer has earned income above an annual threshold and the taxpayer is under the full retirement age. The full retirement age currently is 67 and the 2011 earnings threshold is $14,160.

If you have additional questions related to the strategies suggested in this article and would like to see how they would impact your tax situation, please give our office a call.

Friday, July 22, 2011

Tips to Help You Determine if Your Gift is Taxable

If you give someone money or property, you may be subject to the federal gift tax. Most gifts are not subject to the gift tax, but here are some tips to help you determine whether your gift is taxable or if you are required to file a gift tax return.


1. Most gifts are not subject to the gift tax. For example, there is usually no tax if you make a gift to your spouse or to a charity. If you make a gift to someone else, the gift tax usually does not apply until the value of the gifts you give that person exceeds the annual exclusion for the year. For 2011, the annual exclusion is $13,000.

2. Gift tax returns do not need to be filed unless you give someone other than your spouse money or property worth more than the annual exclusion for that year.

3. Generally, the person who receives your gift will not have to pay any federal gift tax because of it. Also, that person will not have to pay income tax on the value of the gift received.

4. Making a gift does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than gifts that are deductible charitable contributions).

5. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. The following gifts are not taxable gifts:
  • gifts that are not more than the annual exclusion for the calendar year, 
  • tuition or medical expenses you pay directly to a medical or educational institution for someone, 
  • gifts to your spouse, 
  • gifts to a political organization for its use, and 
  • gifts to charities.
6. Gift Splitting – You and your spouse can make a gift up to $26,000 to a third party without making a taxable gift. The gift can be considered as made one-half by you and one-half by your spouse. If you split a gift you made, you must file a gift tax return to show that you and your spouse agree to use gift splitting. You must file a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, even if half of the split gift is less than the annual exclusion.

7. Gift Tax Returns – You must file a gift tax return on Form 709 if any of the following apply:
  • you gave gifts to at least one person (other than your spouse) that are more than the annual exclusion for the year; 
  • you and your spouse are splitting a gift; 
  • you gave someone (other than your spouse) a gift of a future interest that he or she cannot actually possess, enjoy, or receive income from until at some time in the future; or 
  • you gave your spouse an interest in property that will terminate due to a future event.
8. You do not have to file a gift tax return to report gifts to political organizations and gifts made by paying someone’s tuition or medical expenses.

If you have questions related to gifts, gift planning, or a requirement to file a gift tax return, please give our office a call.


Monday, July 18, 2011

Is the IRS Withholding Some or All of Your Refund?

If the IRS kept all or a portion of your federal refund, it may be because you owe money for certain delinquent debts. If that is true, the IRS or the Department of Treasury's Financial Management Service (FMS), which issues IRS tax refunds, can offset or reduce your federal tax refund or withhold the entire amount to satisfy the debt.

Here are some important facts you should know about tax refund offsets.
  1. If you owe federal or state income taxes, your refund will be offset to pay those tax liabilities. If you had other debt such as child support or student loan debt that was submitted for offset, FMS will take as much of your refund as is needed to pay off the debt and will send it to the agency authorized to collect the debt. Any portion of your refund remaining after an offset will be refunded to you.
  2. You will receive a notice if an offset occurs. The notice will reflect the original refund amount, your offset amount, the agency receiving the payment, and the address and telephone number of the agency.
  3. You should contact the agency shown on the notice if you believe you do not owe the debt or if you are disputing the amount taken from your refund.
  4. If you filed a joint return and you are the spouse who is not responsible for the debt, but are entitled to a portion of the refund, you may request your portion by filing IRS Form 8379, Injured Spouse Allocation. If you know that your spouse has outstanding debts and anticipates an offset, you can attach Form 8379 to your original individual tax return. If not, it can be filed by itself after you are notified of an offset.
  5. If you reside in a community property state, overpayments (refunds) are considered joint property and are generally applied (offset) to legally owed past-due obligations of either spouse. There are exceptions; please call for additional details.
For assistance with completing Form 8379, please call.

Tuesday, July 12, 2011

Limited Window of Opportunity on Bush-era Tax Breaks

Last December, Congress extended a number of the Bush-era tax breaks, but only for a limited length of time. It is probably a safe bet that most won’t get extended further, considering the size of the national debt. Although numerous tax breaks were extended, only a few provide you with an opportunity to take actions that can reduce your tax bite. But if you want to take advantage of those tax breaks, you need to act this year or next. Here is a list of those extended tax breaks and what will happen when they expire.

Individual Tax Rates – The Bush-era tax cuts reduced and replaced individual tax rates with six tax brackets that increase with income: 10, 15, 25, 28, 33, and 35 percent. They will revert to their original higher levels of 15, 28, 31, 36, and 39.6 percent beginning in 2013. That will result in the lowest bracket increasing by 5 percentage points and the highest bracket increasing by 3.6 percentage points, affecting all taxpayers from low to high incomes. In certain circumstances, it may be appropriate to accelerate income to take advantage of the lower rates.

Capital Gains and Qualified Dividends – Under the Bush-era tax cuts, the maximum tax on long-term capital gains (assets owned for more than one year) was reduced from 20 percent to 15 percent for taxpayers in the 25 percent and higher tax brackets. The tax cuts also provided for a zero tax rate to the extent a taxpayer is in the 10 and 15 percent income tax brackets. These lower rates will revert to the higher rates in 2013, impacting taxpayers in all tax brackets. Do you have potential capital gains that you might sell before 2013 to take advantage of the current lower rates?

American Opportunity Tax Credit – The American Opportunity Tax Credit (AOTC) replaced the Hope Education Credit in 2009 and provides a maximum tuition credit of $2,500, of which up to 40 percent can be refundable and applies to the first four years of post-secondary education. This enhanced credit will expire after 2012 and is set to be replaced by the Hope Education Credit that provides a reduced maximum credit of $1,800, of which none is refundable; the Hope credit is only applicable to the first two years of post-secondary education. This will primarily affect lower income families. Note: The administration wants to make the AOTC permanent so watch for further developments.

Home Energy-Savings Improvement Credit – This on-again, off-again credit has been extended for one additional year, 2011, but it has been substantially reduced and only provides a credit up to $500 (it was $1,500 in 2010) and a reduced credit percentage of 10 percent (down from 30 percent in 2010). In addition, the $500 credit limit is reduced by any credit taken after 2005. To take advantage of this credit for energy-saving exterior windows, skylights, doors, insulation, heating systems, etc., you need to act before the end of 2011.

Coverdell Educational Accounts – The $2,000 maximum contribution to Coverdell education accounts will revert to a $500 maximum after 2012. If you want to maximize the contributions for a child’s future education needs, you need to do so before 2013.

Sales Tax Deduction – If you are planning to make a big ticket purchase and want to deduct the sales tax [http://www.irs.gov/individuals/article/0,,id=152421,00.html] as part of your itemized deductions, you need to act before the end of 2011. The option to deduct the larger of state and local income tax or sales tax expires after 2011.

Tax-Free IRA to Charity Distributions - The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000 per year) from their Traditional or Roth IRA account to a charity will expire at the end of 2011. The distribution is tax-free, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have Social Security income and/or do not itemize their deductions.

If you have questions related to how these or other tax benefits might fit into your tax planning, please call our office.

Thursday, July 7, 2011

Standard Mileage Rate Boosted July 1

The IRS recently announced that it is revising the optional standard mileage rates for computing the deductible costs of operating an automobile for business, medical, or moving expense purposes and for determining the reimbursed amount of these expenses that is deemed substantiated. This modification results from recent increases in the price of fuel. These increased rates are effective July 1, 2011.
  • Business Use increases to 55.5 cents per mile (up from 51 cents for the first half of 2011.
  • Medical & Moving increases to 23.5 cents per mile (up from 19 cents for the first half of 2011.
  • Charitable rate is statutory and remains fixed at 14 cents per mile.

The revised standard mileage rates apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2011, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2011, and (2) for transportation expenses an employee pays or incurs on or after July 1, 2011.
 
To see the IRS announcement, click here.
 
Please feel free to contact our office if you have additional questions.