Getting Your Financial Ducks In A Row Rotating Header Image

IRA

Tax Credits That Can Increase Your Refund

Mar 5th, 2012
by jblankenship.
5 comments

The IRS recently issued their Tax Tip 2012-41, which lists out some of the tax credits that are refundable.  Most tax credits are not refundable, meaning that if the amount of the credit is more than your tax for the year, the credit is limited only to the amount of your tax.

For example, if you had tax payable of $1,500 and then had Education Credits, Energy Credits, and/or Foreign Tax Credits amounting to more than $1,500.  Your credits will be limited to $1,500 since that’s your tax payable and the credits are not refundable.

On the other hand, there are a few credits that are refundable, as listed below in the actual text from Tax Tip 2012-41.

Four Tax Credits that Can Boost Your Refund

A tax credit is a dollar-for-dollar reduction of taxes owed.  Some tax credits are refundable meaning if you are eligible and claim one, you can get the rest of it in the form of a tax refund even after your tax liability has been reduced to zero.

Here are four refundable tax credits you should consider to increase your refund on your 2011 federal income tax return:

1.  The Earned Income Tax Credit is for people earning less than $49,078 from wages, self-employment or farming.  Millions of workers who saw their earnings drop in 2011 may qualify for the first time.  Income, age and the number of qualifying children determine the amount of the credit, which can be up to $5,751.  Workers without children may qualify as well.  For more information, see IRS Publication 596, Earned Income Credit.

2.  The Child and Dependent Care Credit is for expenses paid for the care of your qualifying children under age 13, or for a disabled spouse or dependent, while you work or look for work.  For more information, see IRS Publication 503, Child and Dependent Care Expenses.

Note: this credit was incorrectly identified in the IRS Tax Tip as refundable.  It is not refundable – sorry for the confusion.

3.  The Additional Child Tax Credit is for people who have a qualifying child.  The maximum credit is $1,000 for each qualifying child.  You can claim this in addition to the Child and Dependent Care Credit.  The Child Tax Credit is non-refundable, but if you qualify you can utilize the Additional Child Tax Credit to receive the remainder of the non-refundable credit as a refund.  See IRS Publication 972, Child Tax Credit for more details.

4.  The Retirement Savings Contributions Credit, also known as the Saver’s Credit, is designed to help low-to-moderate income workers save for retirement.  You may qualify if your income is below a certain limit and you contribute to an IRA or workplace retirement plan, such as a 401(k) plan.  The Saver’s Credit is available in addition to any other tax savings that apply.  For more information, see IRS Publication 590, Individual Retirement Arrangements (IRAs).

Note: this credit was incorrectly identified in the IRS Tax Tip as refundable.  It is not refundable – sorry for the confusion.

There are many other tax credits that may be available to you depending on your facts and circumstances.  Since many qualifications and limitations apply to various tax credits, you should carefully check your tax form instructions, the listed publications and additional information available at www.irs.gov. IRS forms and publications are available on the IRS website at www.irs.gov and by calling 800-TAX-FORM (800-829-3676).

8 Things to Consider Before Rolling Over Your 401(k)

Feb 22nd, 2012
by jblankenship.
1 comment
K'nex
K’nex (Photo credit: -Snugg-)

Employers have been giving us lots of opportunities to make this decision of late: when leaving an employer, whether voluntarily or otherwise, we have the opportunity to rollover the qualified retirement plan (QRP) such as a 401(k) from the former employer to either an IRA or a new employer’s QRP.

This decision shouldn’t be taken lightly – although often it is the best option for you.  Moving to an IRA gives you much more control over your destiny, so to speak, by allowing you to choose from the entire universe of allowable investment choices.  Using your new employer’s QRP can give you a better sense of control over the account as well, although the flexibility of an IRA is generally preferable to another QRP.

But sometimes it makes the most sense to leave your money in the old plan.  Listed below are eight possible reasons that you might want to do just that.

  1. If you are happy with your former employer’s plan, consider it well-managed, low cost, and possibly with some investment options that are not readily available (such as desirable mutual funds that are closed to new investors), you may want to leave the plan intact.  This would be especially beneficial if you don’t have another employer plan to roll over into, or you are squeamish about establishing your own IRA.
  2. If you have commingled deductible and non-deducted IRA contributions in your outside IRA accounts, having an active 401(k) plan can help you to “separate” the deductible IRA assets from the non-deducted.  See this article for more information.  Essentially this benefit gives you a way to bypass the “little bit pregnant” rule wherein the IRS treats all IRA funds pro-rata taxable and non-taxable when making distributions… a common issue when doing a Roth IRA conversion, for example.  If you don’t have an active 401(k) plan available, this option is lost.
  3. If you have an investment in your former employer’s stock in your 401(k), you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover.  The point is, if you’ve taken even a partial rollover of your 401(k) in a prior year, the NUA treatment is no longer available to you.
  4. If you think you may be returning to this employer, it might make sense to leave your funds where they are.  This is especially true for government employers with section 457 plans – due to the nature of these plans’ ability to provide you with retirement income without penalty much earlier than an IRA or a 401(k) plan could.  With the vagaries of governmental policy changes, if you’ve withdrawn and closed your account and come back to work for the same agency, the old plan may no longer be available to you since you’re a “new” participant.
  5. If you’re in the year when you’ll reach age 55 or older, and are not moving to a new employer (either retiring or undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty.  If you move these funds over to an IRA, this option is lost.
  6. On the off-chance that you might need a loan from your retirement funds, you should know that IRAs do not have this provision.  Retain at least some balance in the plan if you might need this option – but also you should check with your plan administrator to see if this option is available for non-employee plan participants, because it might not be (and actually, it likely is not).  But keeping in mind #4, if you’ve maintained a healthy balance in the plan and you return to work with this same employer, you’d have a much larger account to work with if you needed to borrow.
  7. Funds in a 401(k) account are protected by ERISA – and as such are generally not available to creditors.  Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy.  At any rate, ERISA protection is pretty much an absolute, so this is yet another reason you might consider leaving funds in a former employer’s 401(k) plan. Funds moved from an ERISA-protected account can carry the protection on, but new contributions to the account do not.
  8. Take your after-tax contributions out first, if your plan happens to include these.  If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.  You can convert these contributions directly over to a Roth IRA in most cases.  This is because the 401(k) isn’t subject to the “little bit pregnant” rule alluded to earlier.  Once you’ve removed the after-tax contributions and put them into a Roth IRA, you can then rollover the rest of your 401(k) if it makes sense.
Enhanced by Zemanta

Ordering Rules for Roth IRA Distributions

Feb 8th, 2012
by jblankenship.
1 comment
Tax
Tax (Photo credit: 401K)

Did you know that there is a specific order for distributions from your Roth IRA? The Internal Revenue Service has set up a group of rules to determine the order of money, by source, as it is distributed from your account.  This holds for any distribution from a Roth account.

Ordering rules

First, over-contributions or return of your annual contribution for the tax year.  This means that if you’ve made a contribution to the Roth IRA in the tax year, the first money that you withdraw from the account will be the money that you contributed that year.  If you over-contributed to your account a prior year. Growth on this over-contribution or annual contribution needs to be removed at this time as well, with tax and penalty paid as required.

Second, regular annual contributions to the account.  The next money that comes out is the total of all of the money you’ve contributed to the Roth IRA over the years. Of course, this is reduced by all previous distributions from the account.  This amount would include rolled over contribution amounts from other Roth IRA or Roth 401(k) accounts. Growth (interest, capital gains, or dividends) on these contributions comes out later.

Third, tax-free converted amounts from IRAs or 401(k) accounts would be distributed.  Only the amount of the conversion is counted at this point.  As with the contributions, the growth or earnings within the account comes out last.

Fourth, conversion amounts that were taxed at the time of the conversion are distributed.

Fifth and last, earnings, capital gains, and growth on your contributions will be distributed.  This is everything left in the account after the other categories of funds have been removed.

Here’s an example: Jane, age 50, has a Roth IRA with a balance of $50,000.  She has made annual contributions to the account over the years in the amount of $25,000 – part of which was a contribution this tax year of $5,000.  She also made a conversion into this account with $10,000, all taxed, from an IRA a couple of years ago.

When Jane takes money out of the account, she can remove this year’s contribution of $5,000 first of all – no tax on that distribution.  After that, the remaining $20,000 of contributions to the account would come out, also tax free.  This money is followed by her conversion of $10,000.  If it’s been less than five years since the conversion, there will be a 10% penalty on the conversion since she’s under age 59½.  Any withdrawal above and beyond $35,000 would represent growth and earnings on the account, which would also be subject to the penalty since she’s under age 59½.

Enhanced by Zemanta

Facts About the 72t Early Distribution

Feb 1st, 2012
by jblankenship.
1 comment
Ossekeag Creek Marsh
Image by wallygrom via Flickr

In case you don’t know what a 72t distribution is, this is shorthand for the Internal Revenue Code Section 72 part t, and the most popular provision of this code section is known as a Series of Substantially Equal  Periodic Payments – SOSEPP for short.

Enough about the code section already.  What is this thing?  A SOSEPP is a method by which you can access your IRA funds prior to age 59½.  In order to take advantage of this rule, you determine the amount of the annual distribution from your IRA (this is done in a prescribed manner, more on this in a bit) and then begin taking the distributions.  Once you start the SOSEPP, you have to keep it going for the longer of five years or until you reach age 59½.

Methods of Distribution

There are three ways that you can determine the amount of the distribution from your IRA, and all are based upon the balance of the IRA account and your age.  The first method is the simplest, known as the Required Minimum Distribution method.

The Required Minimum Distribution method for calculating your Series of Substantially Equal Periodic Payments (under IRC §72(t)(2)(A)(iv)) calculates the specific amount that you must withdraw from your IRA (or other retirement plan) each year, based upon your account balance at the end of the previous year, divided by the life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year. This annual amount will be different each year.

The second method is called the Fixed Amortization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account, from which you then create an amortization schedule over a specified number of years equal to your life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

The third method is similar to the second, but it is called the Fixed Annuitization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account and an annuity factor, which is found in Appendix B of Rev. Ruling 2002-62 using the age you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you’ve calculated your annual payment under one of the two fixed methods, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

An Important Note

It’s important to know that the amounts you’ve calculated are and will be the exact figures for your payments from the account, no more, no less.  It’s not allowable to simply name your own amount and take that each year – you have to use the prescribed amount from one of the methods.

The way to impact the amount of the payment is to adjust the balance in the IRA.  If you have more than one IRA available, you can rollover funds into one account and therefore increase or decrease your payment.  This has to be done prior to establishing the SOSEPP though – it’s not allowed to deposit money into or remove funds from your IRA while the SOSEPP is in place (well, other than the required payments from the account each year).

Any deviation from the prescribed payments will cause the SOSEPP to be “busted”, which can result in some not-so-nice consequences – which you can read more about here.  For more about the SOSEPP, see the IRA Owner’s Manual.

Enhanced by Zemanta

Pre-Death Planning: Roth Conversion

Jan 25th, 2012
by jblankenship.
2 comments
Eilaine Roth
Image via Wikipedia

Financial planning often requires us to face our own certain demise – something that we often don’t want to do, but still a certainty that we all must face.

Among the things that we want to do when planning for the inevitable would be to make certain that our surviving loved ones have access to adequate monetary resources to support themselves, in the most cost-effective manner.  Another thing that we hope to accomplish is to make the transition as easy as possible for our loved ones.  One way to do this is to convert a good portion of your IRA or other tax-deferred funds to a Roth IRA account.  Here’s why:

By converting to a Roth account, you will make the funds in that account available to your heirs totally tax free.

Granted, your estate will also be smaller by the amount of tax that you paid on the conversion.  At the same time, your heirs will also not have to go through the rather painstaking process of managing the IRD deduction, if the estate is of a size that requires estate tax to be paid.  This will simplify the overall process dramatically, and depending upon the size of your overall estate this could be a significant.

On the downside of this, it’s likely that if you convert your account in a single year the tax paid on the conversion would be much, much higher than if your heirs paid tax on the ordinary required distributions if the account is left as a traditional IRA.

However, if you converted your account over several years in smaller amounts using a strategy like filling up the brackets, the overall tax cost of the conversion will be less, maybe even less than the cost that your heirs would experience otherwise.

You can always use recharacterization strategies to make sure that the whole process is as tax-efficient as possible. And in today’s tax climate (and market volatility) there are literally very few reasons not to go ahead with a Roth conversion strategy.

Enhanced by Zemanta

Net Unrealized Appreciation Treatment

Jan 18th, 2012
by jblankenship.
No comments yet
NUA ALONE
Image by paddynapper via Flickr

When you have a 401(k) plan that contains stock in your company, there is a special provision in the tax law that may be beneficial to you. This special provision is called Net Unrealized Appreciation, or NUA, treatment. It allows you to take advantage of potentially lower tax rates on the growth, or unrealized appreciation, of the stock in your company.

When your company stock is withdrawn from the account, you pay ordinary income tax only on the original cost of the stock. Then later when you sell the appreciated stock at a gain, you pay capital gains tax (at a lower rate) on the growth in the value of the stock.

The Way It Works

The distribution from your 401(k) must be a total Lump Sum Distribution in a single calendar year.  This means that your entire 401(k) balance, including not only the stock, but also any other funds in the 401(k) plan, must be withdrawn in one year.

Commonly the funds that are not company stock will be rolled over into an IRA or another 401(k) plan.  Only company stock (and only your company) can be treated with the NUA provision.

The company stock is moved into a taxable investment account – in kind.  This means that you move the actual stock rather than selling the stock and moving the money.  If you sell the stock before you move it, you won’t have NUA treatment available to you.

When you move the stock over from your 401(k) into a taxable account, you will have to pay ordinary income tax on the original cost of the stock.  This means that you need to know what is the basis (the amount you originally paid) for the stock.  Your company or 401(k) administrator will have this information for you.

Although the entire account has to be withdrawn in a single year, you don’t have to elect NUA treatment for the entire holding of company stock.  You could move only a portion of the stock if you choose to, and rollover the remaining stock to an IRA.  You may choose to do this because the amount of company stock is more than you care to pay ordinary income tax on during that tax year.  More on this a bit later.

An Example

For example, let’s say you have a 401(k) with a $500,000 balance.  $200,000 is invested in the stock of your company, and the basis is $100,000.  You can move the company stock into a taxable investment account, and pay ordinary income tax on $100,000.  If you’re in the 25% bracket, this would amount to $25,000.

The remaining $300,000 is rolled over to an IRA.  When you take money out of the IRA, as with any IRA, you’ll pay ordinary income tax on the money that you withdraw from the IRA.

At any point later you can sell the stock in the taxable account and pay tax at the capital gains rate, which is 15% these days, much lower than the ordinary tax rate. (That 15% rate is for long-term capital gains, and any stock that you elect NUA treatment for is taxed at that rate. This rate could be as low as 0% if you are otherwise in the 10% or 15% income tax bracket.)

Since paying tax on the entire $100,000 basis in your company stock would require a significant tax payment ($25,000 in our example), you might wish to work this out in a different fashion, reducing the tax.  Here’s where a twist to the tax code could REALLY be helpful – possibly eliminating taxation.

Basis Allocation Twist

When you move only a portion of the company stock, you need to allocate the basis between the NUA stock and that which was rolled over.  Since, in our example, the basis was $100,000 and the total company stock was worth $200,000, you could elect to rollover $100,000 worth of the stock to your IRA (along with the other $300,000 of funds), allocating the basis of $100,000 to the rolled over stock.  Then, when the remaining $100,000 of stock is moved from the 401(k) to the taxable account, there is no basis to be taxed at ordinary income tax rates.  The entire transaction has occurred without tax – and when you sell the stock, the entire value is taxed at capital gains rates.

This move is allowed because the tax law states that when there is a partial rollover of an account into an IRA, the rolled portion is “treated as consisting first of the portion that is includible in gross income” – meaning the basis in the stock, plus the other funds in the account.

So there you have it – Net Unrealized Appreciation in a nutshell.  If you need more details, you can check out the IRA Owner’s Manual for additional information.

Enhanced by Zemanta

Charitable Contributions From Your IRA – 2012 and Beyond

Jan 4th, 2012
by jblankenship.
9 comments
K S Hegde Charitable hospital
Image via Wikipedia

At the end of December, 2011, the provision for Qualified Charitable Distributions (QCD) expired.  That provision allowed the taxpayer age 70½ or older to make direct distributions from an IRA account to a qualified charity, bypassing recognition of the distribution as income.  For more information on the expired provision, see the original article about charitable distributions from your IRA.

With the expiration of this provision, you can still make charitable contributions of money distributed from your IRA.  The difference is that these contributions are no different from a contribution that you’ve made from your savings account or regular income.  In order to achieve a tax advantage from the contribution, you will itemize the charitable contribution on your tax return.  Of course, in addition to this, if the money is from your IRA you’ll also have to recognize the distribution as income.

Let’s look at both ways to fully understand what’s different now.

The old way

Under the expired provision if you qualified, you could make a direct distribution from your IRA account to the qualified charity of your choice.  Then when you were ready to file your tax return for the year, you wouldn’t include the amount of the direct distribution to the charity as income.  This could also include your Required Minimum Distribution (RMD) for the year, as well.

By doing this, you didn’t have to recognize this income at all – which doesn’t seem so important until you see how it works in the new way.

The new way

Now that the QCD provision has expired, you can still make charitable contributions from your IRA, but it’s not as advantageous as the old way.  Under this method (which can be enacted by anyone over age 59½ without penalty) you take a distribution from the IRA, and then send it to the charity of your choice.

(In actuality, the distribution doesn’t have to be from an IRA, but we’re doing a compare and contrast against the expired QCD arrangement, so that’s what we’ll use for the examples.)

When you get around to filing your tax return for the year now, you’ll have to recognize the distribution from your IRA as income.  Later on the return, you can include the charitable contribution as an itemized deduction, eventually lowering your taxable income by the same amount.  However, since you have to include the distribution as income, this will increase your overall income (unless you have Net Operating Losses from your business to offset the income), and will therefore also increase your Adjusted Gross Income (the bottom line of your Form 1040).  The significance to this is that many tax provisions depend upon the Adjusted Gross Income (AGI) figure.

An example is deductible medical expenses – these are only deductible to the extent that they are in excess of 7.5% of your AGI.  Miscellaneous Itemized expenses are subject to a similar “floor”: they must be greater than 2% of your AGI in order to be deductible.  In addition, certain phase-outs are impacted by AGI level as well.

So you can see that increasing your income can have a significant impact on your overall tax return.  Here’s a quick example of how this could impact a taxpayer.

Example

Taxpayer is single, age 73, and is subject to RMDs from his IRA.  He wishes to make a charitable contribution of $10,000 from his IRA funds to his church.  If this were 2011, he could make his distribution directly from the IRA to the church. Here’s how his tax return worked out:

Income (pension and IRA)

$50,000
Adjusted Gross Income

$50,000
Medical Expenses

$10,000
Deductible Medical Expenses (above 7.5% of AGI)

$6,250
Charitable Contributions (beyond the direct QCD)

$1,000
Exemption

$3,700
Taxable Income

$39,050
Tax

$5,888

Under the 2012 method, Taxpayer takes the distribution from his IRA and then sends it to his church.  Here’s how the tax return works out now:

Income (pension and IRA, plus his $10,000 additional distribution)

$60,000
Adjusted Gross Income

$60,000
Medical Expenses

$10,000
Deductible Medical Expenses (above 7.5% of AGI)

$5,500
Charitable Contributions (includes the additional $10,000 distribution)

$11,000
Exemption

$3,800
Taxable Income

$39,700
Tax

$5,955

Under the new method in our example, the tax cost was increased by $67.  This doesn’t seem like a lot, but if the circumstances were a bit different this could become sizeable – and who likes to pay extra taxes of any amount?

Bear in mind that this provision has expired and subsequently been extended in the past, so it’s possible that it could be extended again at some point in the future.  Stay tuned.

Enhanced by Zemanta

2012 IRA MAGI Limits – Married Filing Separately

Jan 1st, 2012
by jblankenship.
2 comments
if there was ever a doubt
Image by drcw via Flickr

Note: for the purposes of IRA MAGI qualification, a person filing as Married Filing Separately, who did not live with his or her spouse during the tax year, is considered Single and will use the information on that page to determine eligibility.

For a Traditional IRA (Filing Status Married Filing Separately):

If you are not covered by a retirement plan at your job and your spouse is not covered by a retirement plan, there is no MAGI limitation on your deductible contributions.

If you are covered by a retirement plan at your job and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 50% for every dollar (or 60% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If you are covered by a retirement plan at your job and your MAGI is more than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2012.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

If you are not covered by a retirement plan but your spouse is, and your MAGI is less than $10,000, you are entitled to a partial deduction, reduced by 50% for every dollar over the lower limit (or 60% if over age 50), and rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

Finally, if you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $10,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2012.  You are eligible to make non-deductible contributions, up the annual limit, and those contributions can benefit from the tax-free growth inherent in the IRA account.

For a Roth IRA (Filing Status of Married Filing Separately):

If your MAGI is less than $10,000, your contribution to a Roth IRA is reduced ratably by every dollar, rounded up to the nearest $10.  If the amount works out to less than $200, you are allowed to contribute at least $200.

If your MAGI is $10,000 or more, you can not contribute to a Roth IRA.

Enhanced by Zemanta

Using An IRA Rollover to Eliminate Federal Spousal Rights

Dec 14th, 2011
by jblankenship.
No comments yet
Marriage
Image by Lel4nd via Flickr

Qualified Retirement Plans (QRPs), which include 401(k), 403(b) and many other employer-based plans, are governed by federal law under ERISA.  One of the tenets of ERISA is that there are certain rights for the spouse of the employee-participant in the plan.  One of those rights is that the spouse must consent to any distribution from that plan that is in the form of anything other than a Qualified Joint and Survivor Annuity (QJSA).

Depending upon your circumstances, this might not be the way you would like for things to work out.  For example, if you’re planning to get married and you want to ensure that your future spouse doesn’t control distributions from your retirement plan, you could rollover your QRP to an IRA before your marriage – because an IRA isn’t covered by ERISA like the QRP is.  A prenuptial agreement could be used to limit a spouse’s rights to an IRA, but it cannot usurp the ERISA rules.

If you’re already married and you have a reason to consider this option, hopefully it’s not because there are storm-clouds on the horizon for your marriage.  If this is the case, you will likely have some difficulty in enacting this rollover.  The problem, as mentioned before, is that the spousal rights provision requires that your spouse signs off on any distribution other than the QJSA.

If you’re going through a divorce, it’s possible that you’d need to have your ex-spouse sign off on a distribution from your QRP if the QRP isn’t part of the assets to be split.  If the QRP isn’t being split for the divorce, you’ll want to make sure that you have a statement in the decree that ensures that the QRP is positively identified as belonging solely to you. Otherwise, your ex could make a claim against a portion of your QRP later, under ERISA.

Bear in mind that the spousal distribution rights from the QRP also apply to death benefits from the plan, in addition to lifetime benefits.

One other thing to keep in mind is that your own state’s law may provide rights to your IRA to your spouse anyhow.  If that is the case, the rollover to the IRA would not have the effect you expected.

Enhanced by Zemanta

Year End Income Tax Planning

Dec 5th, 2011
by jblankenship.
5 comments
Estate
Image via Wikipedia

Once you’ve reached the last month of the tax year, there aren’t a lot of things that can be done to minimize your income taxes.  But there are a few things that could be done.

For example, you could double up your real estate taxes by prepaying next year’s tax during December.  Doing this with, for example, a $3,000 per year real estate tax bill could result in a reduction of tax for the year of $750 if you’re in the 25% bracket.  Keep in mind though, that you’ll have forked out this money long before it is actually due in most cases, and for the next year you won’t have this deduction available if you used it in this year.

The same could be done with your charitable contributions – there’s no reason that you can’t make additional contributions to your favorite charities at the end of this year instead of waiting until next year.

You could also send your final estimated state income tax payment due in January of next year during December and claim that payment on this year’s itemized deductions as well.

Prepaying your January mortgage payment will credit that mortgage interest to this year as well, further increasing your itemized deductions.

Other itemized deductions could be “stacked” in one year, such as medical expenses (subject to the 7.5% floor) and miscellaneous deductions (subject to the 2% floor).

It’s important to keep in mind that the moves that you make this year might reduce your tax now – but you might have an adverse impact on next year’s income tax by doing so.  It will pay to run the calculations based on what you know about this year’s tax and next year’s tax to make sure that it is in your best interest to do this.

Here’s how it might play out: if you prepaid your next year’s real estate tax during this year, it might reduce your deductions below the Standard Deduction – which could be a good thing.  In doing this, you would get to use the Standard Deduction to increase your tax deductions on next year’s return when you specifically reduced your deductions for that year by prepaying the deductible real estate tax in during this year.  In this fashion you might be making the most of the standard deduction and your itemized deductions year after year – one year using the “stacked” deductions, the next using the standard deduction.

These prepayment options could have a negative affect if you are subject to the Alternative Minimum Tax (AMT).  Prepaying your state tax, mortgage interest and some medical expenses might trigger or cause an increase in AMT.

One tactic that you might consider is selling a taxable investment that has an inherent loss; this is especially useful if you’ve sold another investment at some point in the tax year that has resulted in a taxable gain.  Losses can be used to offset those capital gains dollar for dollar, and an additional $3,000 in capital losses can be used to reduce your ordinary income as well.

You can also make up for underpayment of estimated tax by taking a withdrawal from an IRA (especially if you’re over age 59½) and having tax withheld from the withdrawal.  This can also be accomplished by having more tax withheld from your paycheck if you’re still working, by filing a new W4.

Another move you can make includes the Qualified Charitable Distribution from your IRA – allowing you to bypass recognizing that income, including your RMD.  This can only be done if you’re at least age 70½ and subject to Required Minimum Distributions.

You can also delay your first RMD (if you reached age 70½ this year) until as late as April 1 of next year, although that will mean you have to take two RMDs next year.  But in some circumstances that may be the better option.

You can also make a deductible contribution to your IRA, if you qualify – but you don’t have to do that before the end of the year, you have until April 15 to do that.

This isn’t an exhaustive list of year-end tax moves, just several of the more prominent ones.  Hopefully you’ll find what you need here to help with your year-end tax plans.

Enhanced by Zemanta
← Earlier Posts Newer Posts →