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Your Social Security Benefits: Are They Taxable?

Mar 12th, 2014
by jblankenship.
2 comments
Image courtesy of Salvatore Vuono at FreeDigitalPhotos.net

Image courtesy of Salvatore Vuono at FreeDigitalPhotos.net

If you’re receiving Social Security benefits, either for disability, retirement, or survivor’s benefits, when you file your tax return you will need to figure out if the benefits you’ve received during the prior year are taxable to you.

You’ll receive a Form SSA-1099 from Social Security sometime in the first months of the year, showing what your benefits were in the prior year, as well as any deductions that were made throughout the year – including Medicare premiums (Part B and/or Part D) if applicable, and federal income taxes withheld.

But are the benefits taxable to you?  At most, 85% of your benefit might be taxed – and it’s possible that none of your benefit is taxable, all dependent upon your total income for the year.  See this article for a detailed explanation of How Taxation of Social Security Benefits Works.  The IRS recently published their Tax Tip 2014-23, which details some facts about taxability of Social Security benefits.  The actual text of the Tip is below:

Are Your Social Security Benefits Taxable?

Some people must pay taxes on part of their Social Security benefits.  Others find that their benefits aren’t taxable.  If you get Social Security, the IRS can help you determine if some of your benefits are taxable.

Here are seven tips about how Social Security affects your taxes:

  1. If you received these benefits in 2013, you should have received a Form SSA-1099, Social Security Benefit Statement, showing the amount.
  2. If Social Security was your only sources of income in 2013, your benefits may not be taxable.  You also may not need to file a federal income tax return.
  3. If you get income from other sources, then you may have to pay taxes on some of your benefits.
  4. Your income and filing status affect whether you must pay taxes on your Social Security.
  5. The best, and free, way to find out if your benefits are taxable is to use IRS Free File to prepare and e-file your tax return.  If you made $58,000 or less, you can use Free File tax software.  the software will figure the taxable benefits for you.  If your income was more than $58,000 and you feel comfortable doing your own taxes, use Free File Fillable Forms.  Free File is available only at www.IRS.gov/freefile.
  6. If you file a paper return, visit www.IRS.gov and use the Interactive Tax Assistant tool to see if any of your benefits are taxable.
  7. A quick way to find out if any of your benefits may be taxable is to add one-half of your Social Security benefits to all your other income, including any tax-exempt interest.  Next, compare this total to the base amounts below.  If your total is more than the base amount for your filing status, then some of your benefits may be taxable.  The three base amounts are:
    • $25,000 – for single, head of household, qualifying widow(er) with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year.
    • $32,000 – for married couples filing jointly
    • $0 – for married persons filing separately who lived together at any time during the year.

For more on this topic visit www.IRS.gov.

7 Debunked Myths About Mortgages

Mar 10th, 2014
by jblankenship.
2 comments

Guest post by Diana Fishlock for Zillow.com.  Diana Fishlock has researched and written articles on a wide variety of subjects for newspapers in New York, Pennsylvania and Maryland. She lives near Harrisburg, PA and writes for Zillow.

Young Businesswoman Real Estate Agent in Front of HomeSecuring a mortgage can be a daunting, confusing process for first-time home buyers as well as experienced homeowners considering moving or buying a second home. There are lots of myths and misconceptions about mortgages, such as who qualifies and what makes a good one.

Myth 1: Prequalified means preapproved.

Reality: Prequalifying for a mortgage and being preapproved are two different steps. Prequalifying is a lot simpler. It requires informing a lender about debts, income and assets in a general sense. Prequalifying helps buyers loosely determine their affordable price ranges.

For preapproval, a buyer must submit to the lender much more detailed information, including a financial history. The lender then verifies the borrower’s debt-to-income ratio before agreeing in writing to loan a specific amount. Preapproval indicates to home sellers that a buyer is approved by a lender and serious about making a purchase.

Myth 2: Buyers should choose the mortgage lender with the lowest interest rate.

Reality: The annual percentage rate (APR) is a better measure of the cost of a mortgage because it includes not only interest rate, but points and other fees. With all of the high costs of buying a home, owning a home and maintaining the property, it’s important to consider all the costs.

Myth 3: Buyers should always choose the lender who offers the lowest APR.

Reality: There are other important factors too. It’s important for buyers to look at lenders’ costs and fees, which can add up quickly. But borrowers should opt for well-known, reputable lenders. Buyers should ask friends and neighbors for recommendations on lenders they used for buying or refinancing homes. They can also read online reviews of lenders on Zillow Mortgage Marketplace. Reviews include information on which lenders were easy to work with, available to answer questions and clear and respectful with their responses.

Myth 4: Salary is the most important factor to lenders. 

Reality: While lenders like to work with borrowers who earn large salaries, they’re looking for the whole package with the lowest risk. Lenders factor in debt, credit ratings and both financial and work histories. A borrower with a big paycheck but numerous loans and a history of job-hopping isn’t as attractive to lenders as the patient saver who stayed at one job for years. Lenders also want to see someone who made a habit of saving money, not a person whose parents made a big deposit right before it was time to buy a house.

Myth 5: Bigger downpayments are always better.

Reality: Putting 20 percent down is great for buyers with loads of cash on hand, but these days many people can secure favorable mortgages with 10, 5 or even 3.5 percent down. With interest rates low, some homebuyers prefer to use as little cash as possible for a downpayment and opt instead to keep a bigger nest egg for buying furniture and appliances or maintaining a safety cushion.

Myth 6: Refinancing is a smart decision.

Reality: Refinancing is not always the best decision. Refinancing a mortgage to pay a lower interest rate or consolidate loans can be a very good idea. Refinancing is not the right choice for homeowners who don’t plan on staying in their houses for many years, or those whose credit has depreciated. Any savings realized from lowering the interest rates for homeowners planning to move soon may be eaten up by the lender’s closing fees. Homeowners with poor credit risk getting higher interest rates on their refinances.

Myth 7: Homeowners should pay off their mortgages as soon as possible.

Reality: Although outright homeownership is a major achievement, homeowners should be in less of a rush to pay down their principals if they have more expensive debts to pay. Homeowners should pay off their highest-interest rate debts first, which usually means credit cards. Interest on a mortgage is also tax deductible, while credit cards and car loans are not. Paying off a mortgage ahead of schedule is beneficial to avoid some interest payments but should be evaluated on an individual basis.

Mortgage shopping can be a long, frustrating process without the right information. Smart homebuyers who can separate myth from reality can secure the best mortgages available, saving money and inconvenience by locking in a great rate with a reputable lender.

Education Tax Benefits

Mar 3rd, 2014
by jblankenship.
2 comments
Locke's Some Thoughts on Education

Going to college can be a stressful time for students and parents. Some of the costs of your education can be offset by tax credits and reductions to income.  These credits and reductions can be complicated, so it takes a bit of coordination to keep things straight. 

More than one education tax benefit may be taken in one year, but generally the expenses must be segregated from one another in your reporting.  In other words, you couldn’t take two tax benefits based upon the exact same education expenses, with some exceptions.  For example, you can use most qualified expenses for the tax credits and apply the expense toward eliminating the 10% penalty on IRA distributions at the same time.

Generally though, most tax benefits for education can only be applied once to each expense.  Only one of the following credits may be used per student in any given year: American Opportunity Tax Credit, Lifetime Learning Credit, or Tuition and Fees Deduction.  If you have enough students with the appropriate circumstances, it is feasible that you could use all three types of benefit in a single tax year.

Listed below are the three primary tax benefits and the specifics around them:

  • American Opportunity Tax Credit.  This credit can be up to $2,500 per eligible student. The AOTC is available for the first four years of post secondary education. Forty percent of the credit is refundable. That means that you may be able to receive up to $1,000 of the credit as a refund, even if you don’t owe any taxes. Qualified expenses include tuition and fees, course related books, supplies and equipment.

    There are income limitations on this credit. Generally, your Modified Adjusted Gross Income must be less than $80,000 (if single) or $160,000 (if married) to claim the full credit. The credit is phased out above those levels and eliminated at $90,000 and $180,000 respectively.

    The AOTC is not allowed if you file Married Filing Separately, or if you are claimed as a dependent on another taxpayer’s return. In addition, the credit is not refundable if you are under age 24 and are essentially dependent upon your parents (that is, they are alive) and you are unmarried. If you are under age 18 none of the credit is refundable.

  • Lifetime Learning Credit.  With the LLC, you may be able to claim up to $2,000 for qualified education expenses on your federal tax return. There is no limit on the number of years you can claim this credit for an eligible student. The credit is 20% of the first $10,000 of education expenses for the student.

    This credit has income limitations as well. If your Modified AGI is less than $53,000 (single) or $107,000 (married filing jointly) the credit is fully available. The phaseout occurs at $63,000 and $127,000 respectively. Again, you are not allowed to use this credit if you file Married Filing Separately, or are the dependent of another taxpayer.

  • Tuition and Fees deduction. This benefit provides a reduction in your Adjusted Gross Income of up to $4,000 for modified AGI less than $65,000 (single) or $130,000 (married filing jointly), or $2,000 if your modified AGI is above those limits but less than $80,000 or $160,000 respectively. Above those limits the deduction is not available. Like the other benefits, the Tuition and Fees deduction is not available if filing MFS or you are the dependent of another taxpayer.

    One difference with this deduction is that you can include course materials in the deduction only if purchased directly from the educational institution (other benefits allow any source of purchase of course materials).

  • Student loan interest deduction. Other than home mortgage interest, you generally can’t deduct the interest you pay. However, you may be able to deduct interest you pay on a qualified student loan. The deduction can reduce your taxable income by up to $2,500. You don’t need to itemize deductions to claim it.

The Unmarried Penalty With Social Security (and the Divorce Advantage)

Feb 26th, 2014
by jblankenship.
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Okay, penalty probably is the wrong term for it – maybe the better term would be short-change.

You’ve undoubtedly heard of the marriage penalty for income taxes – this is where it can be beneficial tax-wise for two people to remain single than to be married and be forced to file either jointly or separately.  The tax code contains several ways that this is true.  But did you know that there is a way that married folks might level the field versus singles in the Social Security law-scape?  Plus, divorced folks may also have an advantage over singles AND married folks who were never divorced (or who divorced after marriage of less than ten years)?

The Marriage Advantage

When a worker remains single over his or her working life, there is an inequality in benefits paid out based on his or her record when you compare it to that of a married person.  Here’s what happens:

Let’s say Dave and Eddie are the same age, with the same earnings record over their lifetimes (in fact they worked side-by-side for most of their careers).  Dave has been single his whole life, but Eddie married Valerie 30 years ago and they remain married.  Both Dave and Eddie are 66 this year, and they both file for their Social Security benefits, at a rate of $2,000 per month.

At the same time, Valerie didn’t work very much outside the home (not enough to be eligible for Social Security benefits on her own record – she only worked one day at a time). However, since she’s also 66 this year, she can file for a spousal benefit based on Eddie’s Social Security record, in the amount of 50% of Eddie’s age 66 benefit, or $1,000.

So, for the exact same amount paid into the Social Security system over the years, Eddie’s earnings have generated benefits 50% greater than Dave’s.

And it doesn’t stop there – if Dave and Eddie both live to age 80, but then Valerie lives another five years after Eddie’s death, she will receive a survivor benefit equal to Eddie’s benefit for those additional five years.  There is no survivor benefit paid on Dave’s record since he was never married.

The Un-Divorced Penalty

When a worker is married for more than 10 years, gets divorced and then remarries, each spouse that he is either currently married to or was married to for more than ten years is eligible for spousal benefits based upon the worker’s record.  In this way, the Social Security record of someone who has been married more than once (if the marriage(s) lasted at least 10 years before divorce) will bear even more fruit than the record of Eddie above and definitely more than Dave.  For example:

Tom was married to Jane for 22 years and then they divorced.  Not long after, he married Dana and remains married to her to this day.  Jane never remarried, and she never worked outside the home – and neither did Dana.  All three, Tom, Jane and Dana are 66 this year.  Tom decides to file for his own Social Security retirement benefits at $2,000 per month, and Dana files for the spousal benefit based on Tom’s record, for $1,000 per month.  Jane also decides to file for Spousal Benefits based on Tom’s record as well (Jane didn’t remarry after her divorce from Tom), and her benefit is $1,000 per month as well (50% of Tom’s age 66 benefit).

So, with the exact same earnings record as Dave and Eddie (from our first example), benefits paid on Tom’s record amount to $4,000 per month – double the benefits paid on Dave’s record, and 33% more than the benefits paid on Eddie’s record.

The Alternative Minimum Tax

Feb 24th, 2014
by jblankenship.
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Image courtesy of pakorn at FreeDigitalPhotos.net

Image courtesy of pakorn at FreeDigitalPhotos.net

You may not be aware of this, since income taxes are so complicated that not a lot of folks do much digging into the nuances, but there is another income tax rate that could affect you in certain circumstances.

This other income tax is called the Alternative Minimum Tax, or AMT.  This “alternative” tax applies when you have income above certain thresholds. Essentially it ensures that you pay a certain minimum amount of income tax if your deductions reduce your income so much that your ordinary income tax falls below the minimum applied by the AMT.  It gets pretty complicated, but I’ll go over the high points below.

Alternative Minimum Tax (AMT)

AMT has a separate set of rules for definitions of income and expenses, rules for accounting and timing, and exemptions and tax rates.  AMT limits the tax benefit of certain types of income and deductions, otherwise available to some taxpayers under the “normal” rules.

If you have a high income for the year but your taxable income is relatively low due to a large number of dependents, a high amount of your income is long-term capital gains, large Schedule A deductions, or a large amount of tax-free income from private activity bonds, you may be subject to AMT taxation.  Form 6251 is the appropriate form to use when determining if your income is subject to AMT.

Using Form 6251 you add to your taxable income those items that are used to determine the Alternative Minimum Taxable Income (AMTI), as explained below.

Starting with your taxable income (before exemptions) on line 41 of your Form 1040, you must make the several adjustments, adding back in many deductions from Schedule A (some medical expenses, mortgage interest, taxes, and miscellaneous deductions).  In addition to those additions, there are differences in the way that AMT rules define investment interest expense, depletion, stock option exercises, and quite a few specialized items that will only be of interest to business owners.

After these adjustments are made to your income, the AMT tax rates are applied. If the tax calculated is greater than the ordinary income tax, you’ll have to file with the AMT rates applied.

The IRS recently published their Tax Tip 2014-10 which lists out a few facts that may help you to understand the AMT.  Especially helpful is the AMT Assistant Tool, for which a link is provided below.  The complete text of the Tip is listed below:

What You Should Know about AMT

Have you ever wondered if the Alternative Minimum Tax applies to you? You may have to pay this tax if your income is above a certain amount. The AMT attempts to ensure that some individuals who claim certain tax benefits pay a minimum amount of tax.

Here are some things from the IRS that you should know about AMT:

  1. You may have to pay the tax if your taxable income, plus certain adjustments, is more than the AMT exemption amount for your filing status. If your income is below this amount, you usually will not owe AMT.
  2. The 2013 AMT exemption amounts for each filing status are:
    • Single and Head of Household = $51,900
    • Married Filing Joint and Qualifying Widow(er) = $80,800
    • Married Filing Separate = $40,400
  3. The rules for AMT are more complex than the rules for regular income tax. The best way to make it easy on yourself is to use IRS e-file to prepare and file your tax return. E-file tax software will figure AMT for you if you owe it.
  4. If you file a paper return, use the AMT Assistant tool on IRS.gov to find out if you may need to pay the tax.
  5. If you owe AMT, you usually must file Form 6251, Alternative Minimum Tax – Individuals. Some taxpayers who owe AMT can file Form 1040A and use the AMT Worksheet in the instructions.

Visit IRS.gov to find out more about AMT. Also, see the Form 6251 instructions. You can get it at IRS.gov too or by calling 800-TAX-FORM (800-829-3676).

Get Your Kids to Help You With Your Taxes

Feb 17th, 2014
by jblankenship.
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wharvey galsSometimes as parents we get overwhelmed with the costs of raising kids.  What with the high cost of soccer camp, video games, and lessons on the clarinet, it can be woefully expensive raising kids.

Sometimes though, there are surprising ways that kids can help out with costs – and your income taxes is one of those places where having kids does help.  The IRS recently published their Tax Tip 2014-11 which lists eight ways that having children can help to lower your taxes.

The actual text of Tax Tip 2014-11 follows:

Eight Tax Savers for Parents

Your children may help you qualify for valuable tax benefits.  Here are eight tax benefits parents should look out for when filing their federal tax returns this year.

  1. Dependents. In most cases, you can claim your child as a dependent.  This applies even if your child was born any time in 2013.  for more details, see Publication 501, Exemptions, Standard Deduction and Filing Information.
  2. Child Tax Credit. You may be able to claim the Child Tax Credit for each of your qualifying children under the age of 17 at the end of 2013.  The maximum credit is $1,000 per child.  If you get less than the full amount of the credit, you may be eligible for the Additional Child Tax Credit.  For more about both credits, see the instructions for Schedule 8812, Child Tax Credit, and Publication 972, Child Tax Credit.
  3. Child and Dependent Care Credit. You may be able to claim this credit if you paid someone to care for one or more qualifying persons.  Your dependent child or children under age 13 are among those who are qualified. You must have paid for care so you could work or look for work.  For more, see Publication 503, Child and Dependent Care Expenses.
  4. Earned Income Tax Credit.  If you worked but earned less than $51,567 last year, you may qualify for EITC.  If you have three qualifying children, you may get up to $6,044 as EITC when you file and claim it on your tax return.  Use the EITC Assistant tool at www.IRS.gov to find out if you qualify or see Publication 596, Earned Income Tax Credit.
  5. Adoption Credit. You may be able to claim a tax credit for certain expenses you paid to adopt a child.  For details, see the instructions for Form 8839, Qualified Adoption Expenses.
  6. Higher education credits. If you paid for higher education for yourself or an immediate family member, you may qualify for either of two education tax credits.  Both the American Opportunity Credit and the Lifetime Learning Credit may reduce the amount of tax you owe.  If the American Opportunity Credit is more than the tax you owe, you could be eligible for a refund up to $1,000.  See Publication 970, Tax Benefits for Education.
  7. Student loan interest. You may be able to deduct interest you paid on a qualified student loan, even if you don’t itemize deductions on your tax return. For more information, see Publication 970.
  8. Self-employed health insurance deduction. If you were self-employed and paid for health insurance, you may be able to deduct premiums you paid to cover your child under the Affordable Care Act. It appies to children under age 27 at the end of the year, even if not your dependent.  See Notice 2010-38 for information.

Where to get IRS Forms and Publications

Feb 12th, 2014
by jblankenship.
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Image courtesy of Arvind Balaraman at FreeDigitalPhotos.net

Image courtesy of Arvind Balaraman at FreeDigitalPhotos.net

When you are preparing your taxes, inevitably you run across a form or publication that you need in order to complete your filing.  But where can you find all these forms and publications?

The IRS recently published their Tax Tip 2014-06, which details information about where you can find these forms and publications.  The actual text of the Tip follows below.

Four Ways to Get IRS Forms and Publications

The IRS offers free tax forms and publications on many topics.  Here are four easy ways to get the tax products you need from the IRS:

  1. On the Internet.  Get everything you need 24 hours a day 7 days a week on www.IRS.gov. To view and download tax products, click on the ‘Forms and Pubs’ tab.  Many products appear online before they’re available on paper.
  2. Order by phone.  Call 1-800-TAX-FORM (1-800-829-3676) Monday through Friday, 7 a.m. to 7 p.m. local time.  Hours of service in Alaska and Hawaii follow Pacific Time.  You’ll typically receive your order by mail within 7 to 10 days.
  3. In IRS Offices.  Get the tax products you need at IRS Taxpayer Assistance Centers across the country.  Visit www.IRS.gov to find the nearest IRS Center.  Select the ‘Help and Resources’ tab, and then click on ‘Contact Your Local IRS Office.’ Use the ‘Office Locator’ tool to search for the closest office by zip code.  You can also select your state for a list of offices and services available at each office.
  4. In Your Community.  Many libraries and post offices offer free tax forms during the tax filing season.  Some libraries also have copies of common IRS publications.

Updates to IRS Fees for Installment Agreements and OIC

Feb 10th, 2014
by jblankenship.
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Image courtesy of renjith krishnan at FreeDigitalPhotos.net

Image courtesy of renjith krishnan at FreeDigitalPhotos.net

Just like pretty much everything else in the world, the cost of doing business with the IRS has gone up.  The good news is that some fees did not increase for calendar year 2014, but some fees have gone up by significant rates.

Installment Agreement

This is where you have a balance due to the IRS for unpaid taxes, penalties and interest, and you’re unable to pay the amount at the present time in a lump sum.  So you set up an installment agreement with the IRS – where you agree to pay a set amount on a monthly basis until your balance is paid off.

If you set up a direct-debit payment plan – where the payment is pulled directly from you bank account – the fee to set this up remains unchanged from 2013 at $52.  This is the preferred method to set up such a plan, for the obvious reason that the IRS has direct access to debit your account for the payment, rather than relying on you to make the payment manually.

On the other hand, if you set up your installment agreement so that you control when the payment is sent (by paper check, for example), the fee for setting up this type of arrangement has increased in 2014 from $105 to $120, an increase of 14.2%.  Likewise, if you already have an agreement set up with the IRS and you need to restructure or reinstate a suspended installment agreement, the fee has increased from $45 to $50, an increase of 11.1%.

Offer in Compromise

An Offer in Compromise (OIC) is where you have a balance due to the IRS and you’re petitioning the IRS to settle the debt for less than the original balance due. (Sounds wonderful, doesn’t it? It’s not as easy as it sounds.)

In cases where your debt to the IRS is so great and your assets and income are so little that it is unlikely you’d be able to pay off the debt within a reasonable period.  There is a pre-qualification process that can help you to understand if you may be eligible for an OIC – the Offer in Compromise Pre-Qualifier.  Keep in mind that this is only a pre-qualification, there are no guarantees that the IRS will accept your application and offer. *Be very wary of tax professionals who claim that they can get you an OIC to pay your debt for “pennies on the dollar”. As with most things, if it sounds too good to be true, it probably is.

So if you pass the pre-qualification tests, you can then submit an application for an Offer in Compromise.  The fee for this application has increased in 2014, from $150 to $186, an increase of 24%.  If the application is approved, you have the option of either paying the compromise amount in one lump sum, or by periodic payments (much like the installment agreement above).  There is no additional fee for an installment agreement for OIC.

If you meet the low income requirements you will not need to send the application fee or make monthly payments while your offer is being reviewed.

myRA? What’s the point?

Feb 5th, 2014
by jblankenship.
4 comments
Image courtesy of stockimages at FreeDigitalPhotos.net

Image courtesy of stockimages at FreeDigitalPhotos.net

After the President’s state of the union announcement of the new myRA account, my first reaction was: Did we need this?  What’s so “out of reach” about a regular Roth IRA?  And if there was a great hue and cry for this, why hasn’t the marketplace provided it already?

After all, there are custodians who will provide a no-fee Roth IRA with no account minimum already (TD Ameritrade comes to mind). Plus, there are plenty of ways to get a bond-like return with no costs or account minimums as well.

All that I can find that is different about the myRA accounts is that the bond investment (same as the TSP “G” fund) has downside protection – meaning that the funds in the myRA account will never reduce in value, only grow or stay the same.

As with any gift (and downside protection is indeed a valuable gift), there is a cost associated with it.  Think about it: bonds fluctuate in value day in and day out, year in and year out.  If the value of the bonds decreases, somehow the investor’s dollar has to remain constant.  The only way to do that is to have other funds available to hedge the value fluctuations, and someone has to provide those funds.  Since these myRA accounts have no fees associated with them, the investor isn’t paying for the hedge. I KNOW! How about all taxpayers foot the bill?!

One other difference with the myRA is that the intent is to have this available via widespread employers – at no cost to the employer – via payroll deduction.  First of all, there is cost associated with making changes to payroll.  Adding in a new deposit destination doesn’t just happen automatically, someone has to take action to set it up – and that costs money.

Other than those two facts, all of the remaining features that I’ve been able to read about are exactly the same as a Roth IRA – contributions are not tax deductible, withdrawals at retirement age are tax free, withdrawal of contributions can be done without tax or penalty at any time, and the account can be rolled over into a Roth IRA at any time (myRAs must be rolled over when the balance grows to $15,000, or a maximum of 30 years from initial investment).

From my perspective the myRA is only going to complicate matters more than they already are.  Folks who had the desire to save money in a Roth IRA were already figuring out how to do it on their own.  Having this additional option is (I believe) destined to the same result as the Coverdell ESA – great idea, but there are too many alternatives already in place with 99 44/100ths percent of the same features.

Far be it for me to disparage attempts to help people save more.  I spend a lot of time encouraging folks to do just that, all the time.  I suspect that the myRA will likely do not much more than just confuse folks who know someone named Myra (I knew a Myra when I was a kid, she was our pastor’s wife and she taught my sister to play the piano).  She was a very nice lady and an excellent piano teacher, but if she did anything to promote retirement savings, it was lost on me.

Net Unrealized Appreciation is not subject to the 3.8% surtax

Jan 29th, 2014
by jblankenship.
1 comment
Image courtesy of Matt Banks at FreeDigitalPhotos.net

Image courtesy of Matt Banks at FreeDigitalPhotos.net

When you take advantage of the Net Unrealized Appreciation (NUA) treatment for stocks transferred from your employer retirement plan, you need to fully understand the tax treatment both when you transfer the stocks and when you eventually sell the stock.

Stock that you’ve chosen to treat with NUA tax treatment has three potential tax components –

  1. The basis of the stock – this is the original purchase cost of the stock, which is subject to ordinary income tax the year when you transfer the stock from the employer’s plan into your brokerage account.
  2. The Net Unrealized Appreciation – this is the difference in the total value of the stock minus the basis (from #1 above) on the date that you transfer it from your employer’s plan. This amount is not taxable until you sell the stock, and then it is taxed at long-term capital gains rates, no matter how long you’ve owned the stock.
  3. The non-NUA appreciation – this is any gain that has occurred in the value of the stock after you transferred it into the brokerage account, up to the date that you sell the stock.  This amount is taxed at short-term capital gains rates if held less than 1 year after the transfer, or long-term capital gains rates if held more than 1 year.

Here’s an example:

Ed has worked for ABC company for 30 years and will retire this year.  He has built up a 401(k) plan worth $500,000, of which $100,000 is stock in ABC company.  The basis of this stock, which he’s purchased over the years, is $75,000.  Ed wants to take advantage of the NUA provision for treatment of his ABC stock.

Ed transfers the $400,000 balance of his account that is not ABC stock into an IRA.  He then transfers the $100,000 of ABC stock into a brokerage account (non-IRA).  For the year, Ed must include the basis of the ABC stock ($75,000) as ordinary income on his tax return.

Later, when Ed is ready to sell his ABC stock, six months have passed, and the stock has increased in value to $115,000.  Ed sells the stock, and when he files his taxes for that year, he will have long term capital gains of $25,000 of NUA gain, and then short-term capital gains of $15,000 (the gain since he transferred the funds to the brokerage account).  If more than 1 year had passed, the NUA gain and the additional gain would all have been considered long-term capital gains.

In a nutshell, that’s how NUA treatment taxation works. Or rather, how it used to work, but there’s more to it now since the passage of the Affordable Care Act.

0.9% Additional Medicare Tax on Earned Income

First of all, the basis amount (#1 above) is subject to ordinary income tax.  This brings up the question – if your income is above the limits as a result of this distribution and newly-recognized ordinary income, will it also be subject to the additional 0.9% Medicare tax on earned income?  The answer is no – this basis is treated as a distribution from your retirement account, and since your contributions were already subject to Medicare taxation, this is not subject to further taxation for Medicare purposes.

3.8% Medicare Surtax on Unearned Income

Secondly, given that upon the sale of the stock you’ll have (potentially) significant unearned income, you might wonder about the new 3.8% Medicare surtax on unearned income – does this apply?  Yes and no.

The “no” applies to the NUA as of the transfer into the taxable brokerage account (#2 from above).  This amount will not be included if you have unearned income that is subject to the 3.8% Medicare surtax.

The “yes” applies to the additional capital gains that have occurred in the account since you transferred it to the brokerage account.  This amount can potentially be subject to the 3.8% Medicare surtax, if you are otherwise subject to this tax, on top of the capital gains treatment.  From our example above, Ed’s additional gain of $15,000 would have this potential additional tax.

What about a loss?

If you experience a loss after the transfer into the brokerage account (the value becomes less than the basis, in other words) and you subsequently sell the stock, the loss is treated as a long-term capital loss, the same as any other capital transaction.  If the loss was experienced before you distributed the stock from the account – that is, upon the distribution the value of the stock was less than the basis – you may be able to deduct the loss as a miscellaneous itemized deduction, subject to the 2% floor.

Watch out for scams at tax time

Jan 27th, 2014
by jblankenship.
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Image courtesy of chanpipat at FreeDigitalPhotos.net

Image courtesy of chanpipat at FreeDigitalPhotos.net

You’ve probably seen news reports about how identity theft is rampant around the time tax returns are being filed.  All sorts of nefarious schemes are out there, via the phone or email.

The IRS recently published their Special Edition Tax Tip 2014-02, which details the warnings from the IRS about scams.  The full text of the Tip is below.

IRS Warns of Tax-time Scams

It’s true: tax scams proliferate during the income tax filing season.  This year’s season opens on Jan. 31.  The IRS provides the following scam warnings so you can protect yourself and avoid becoming a victim of these crimes:

  • Be vigilant of any unexpected communication purportedly from the IRS at the start of tax season.
  • Don’t fall for phone and phishing email scams tha use the IRS as a lure.  Thieves often pose as the IRS using a bogus refund scheme or warnings to pay past-due taxes.
  • The IRS doesn’t initiate contact with with taxpayers by email to request personal or financial information.  This includes any type of e-communication, such as text messages and social media channels.
  • The IRS doesn’t ask for PINs, passwords or similar confidential information for credit card, bank or other accounts.
  • If you get an unexpected email, don’t open any attachments or click on any links contained in the message.  Instead, forward the email to phishing@irs.gov. For more about how to report phishing scams involving the IRS visit the genuine IRS website, www.IRS.gov.

Here are several steps you can take to help protect yourself against scams and identity theft:

  • Don’t carry your Social Security card or any documents that include your Social Security number or Individual Taxpayer Identification Number.
  • Don’t give a business your SSN or ITIN just because they ask.  Give it only when required.
  • Protect your financial information.
  • Check your credit report every 12 months.
  • Secure personal information in your home.
  • Protect your personal computers by using firewalls and anti-spam/virus software, updating security patches and changing passwords for Internet accounts.
  • Don’t’ give personal information over the phone, through the mail or on the Internet unless you have initiated the contact and are sure of the recipient.
  • Be careful when you choose a tax preparer.  Most preparers provide excellent service, but there are a few who are unscrupulous.  Refer to Tips to Help You Choose a Tax Preparer for more details.

For more on this topic, see the special identity theft section on IRS.gov.  Also check out IRS Fact Sheet 2014-1, IRS Combats Identity Theft and Refund Fraud on Many Fronts.

The Inequity of Spousal Social Security Benefits

Jan 22nd, 2014
by jblankenship.
4 comments
Cover of "Sid and Nancy: The Criterion Co...

Cover of Sid and Nancy: The Criterion Collection

We’ve covered a lot of ground talking about Spousal Benefits and strategies for filing, and other facts to know about Spousal Benefits.  But did you realize that there is a flaw in the process that shortchanges some couples when it comes to Spousal Benefits?

Here’s a pair of example couples to illustrate the inequity:

The first couple: Jane has worked her entire life and has earned a Social Security benefit of $2,600 per month when she retires.  Her husband Sam has been a struggling artist his whole life, as well as a stay-at-home Dad to their three kids when they were young.  As a result, Sam has never generated enough income on his own to receive the requisite 40 quarter-credits to have a Social Security benefit of his own.

The second couple: Sid and Nancy have both worked and had earnings within the Social Security system over their lifetimes.  Sid had a higher level of earnings, generating a Social Security retirement benefit of $2,600 when he’s ready to retire.  Nancy operated a home-based business part-time while the kids were young, and worked outside the home for several years after they were all finished with high school.  As a result, Nancy has a retirement benefit of $1,000 built up for when she’s ready to retire.

The result is this: Both couples, if they file at Full Retirement Age (FRA), will be eligible for the exact same benefit amounts. For the sake of my illustration and to keep things simple, all four individuals reach FRA at the same time.

Jane files for her own retirement benefit of $2,600.  Sam, without an earnings record, can now file for the Spousal Benefit in the amount of $1,300.  Altogether they will receive $3,900 per month.

Sid also files for his own retirement benefit of $2,600.  Nancy then files for her own benefit of $1,000, and since she’s eligible to file for the Spousal Benefit, she will receive a Spousal Benefit offset amount of $300 – bringing her total benefit to $1,300.  Altogether they will receive $3,900 per month.

Exactly the same benefit amount.  Nancy receives nothing extra from Social Security for her earnings record.

One Difference

There is one difference in the options available to these two couples.  Having read my columns on the subject, Sid and Nancy decide that Nancy should file a restricted application for Spousal Benefits only, which would result in the same $1,300 per month benefit.  Nancy can then later, at age 70, file for her own benefit which has been increased due to Delayed Retirement Credits.  This amounts to a 32% increase, which would bring her total benefit to $1,320 per month at that time.

So for her work record, Nancy can increase her overall benefit by $240 per year.  Doesn’t seem fair, does it?  Don’t get me wrong, I don’t think a stay-at-home parent should be penalized and receive nothing for his or her time in that critical occupation, nor do I think that spouses with low or no income should suffer either.  But it does seem that there should be *some* additional benefit for the lower-earning spouse who has generated a benefit on his or her own record.

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Book Review: The $1,000 Challenge

Jan 20th, 2014
by jblankenship.
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I picked up this book at FinCon 2013, the Financial Blogger’s Conference held last year in St. Louis.  The author, Brian J. O’Connor, is the Personal Finance Editor and syndicated “Funny Money” columnist at The Detroit News.  The book is the compilation of a 10-part series O’Connor wrote in 2010, wherein he opened up his personal financial situation to his readers and attempted to come up with ways to save an on-going $1,000 per month on regular, everyday expenses.

The result is a surprisingly interesting (not to mention humorous!) journey with the author into the depths of personal financial dealings – everything from babysitting expenses to transportation costs to groceries.  The author takes each section of his personal finances in turn, laying out what the current costs are, and the steps he took to make reductions in his monthly outlay.  He the takes the series a step further to recommend steps for folks in three “saving” situations: Freeing Up Cash (where you’re looking for ways to increase your savings contributions, for example), Making Ends Meet (when you are constantly coming up just a bit short each month in paying your regular expenses), and Pinching Pennies So Hard That Lincoln Gets A Headache (for folks suffering through long bouts of unemployment or underemployment and have to make drastic changes).

For each situation the author provides sound advice that can be applied to other monetary situations, with a wide array of methods for saving. It seems like this might be a dry reading, but the author has a wonderful way of dropping in little bits of humor to really keep you interested.  Of course, what would you expect from a column known as “Funny Money”?

In addition to the financial aspects of making these changes, O’Connor supplies some real-world advice to help you stay the course and make it all work for you.  Here’s a quote from the Entertainment category, where the author drives home the point that you can’t live solely on Ramen noodles for long:

Trust me. Meal planning, shopping for bargains at the grocery store, and learning to love every part of the chicken – except the McNugget! – will be much easier to bear if you go out for a good crab cake once in a while. Otherwise, you become one very crabby cake yourself.

I won’t ruin it for you by telling how it turns out, but suffice it to say that I believe virtually anyone can gain valuable insights into reducing day-to-day expenses from this book.  And who doesn’t want to save money?

Social Security and the Non-Citizen Spouse

Jan 15th, 2014
by jblankenship.
2 comments
Citizenship ceremony, 1960

Citizenship ceremony, 1960 (Photo credit: Oregon Nikkei Legacy Center)

With our increasingly global society today, many married couples are made up of a US citizen and a non-citizen.  In some cases, the non-citizen spouse has never been covered by the US Social Security system – he or she may have been covered by another system in his or her home country.  In other cases, the non-citizen spouse may have worked in a Social Security-covered job while living in the US, and so may have generated a Social Security earnings record of his or her own.

At any rate, it is important to know that your lawful spouse who is a non-citizen may be eligible for Social Security benefits based on your earnings.

As long as other qualifications are met (length of marriage, age of the spouse, and your filing status with Social Security), your non-citizen spouse may qualify for Spousal Benefits based upon your record.  By the same token, your non-citizen spouse will also be eligible for Survivor Benefits upon your passing, as long as all other qualifications are met.

The good news is that if the non-citizen spouse is receiving a pension from another system (such as in his or her home country), this will not trigger GPO (Government Pension Offset) treatment of the Spousal or Survivor Benefits.  These foreign pensions only trigger WEP (Windfall Elimination Provision) impact, and then only to the individual receiving the pension’s own retirement benefit, not the Spousal or Survivor Benefit.

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Medicare Part B and D Premiums for 2014

Jan 8th, 2014
by jblankenship.
2 comments
B

B (Photo credit: Flооd)

Even though other retirement-related items increased for 2014, such as the taxable income limit for Social Security tax ($117,000, up $3,300), the earnings limits for pre-Full Retirement Age Social Security benefits ($15,480 before FRA year, $41,400 during FRA year), and the COLA for Social Security benefits (+1.5%), the premium for Medicare Part B coverage remained the same for 2014, at $104.90 per month.

However, if your income in 2012 was above $85,000 for single filers or $170,000 for married filers, you will have to pay more for your Medicare Part B insurance, but it’s the same increase as in 2013.  Medicare Part D coverage for upper income folks will rise slightly.  The maximum increase for both Part B and Part D tops out at $300.10 per month, for a total premium of $405 per month.

This income amount is actually your Modified Adjusted Gross Income, which is equal to your regular AGI (bottom line on the first page of your 1040 tax return) plus tax-exempt interest, foreign earned income, and Series EE US Savings Bonds that were used for education (and which would otherwise be non-taxed).

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Penalty for Having No Health Insurance

Jan 6th, 2014
by jblankenship.
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English: President Barack Obama's signature on...

English: President Barack Obama’s signature on the health insurance reform bill at the White House, March 23, 2010. The President signed the bill with 22 different pens. (Photo credit: Wikipedia)

Note: this provision has been repealed beginning with tax year 2019.

As you may already be aware, individuals are required to carry health insurance on themselves and their dependents, as of January 1, 2014.  This is the mandate set forth in the Affordable Care Act – and of course it’s an important part of making the whole Act work.  Small businesses (less than 50 employees) have a similar mandate to provide coverage for employees beginning in 2015, or face penalties themselves.

Without mandating insurance coverage for everyone, the system can’t sustain the lower-cost options for folks who desperately need the medical coverage. This includes folks who are not covered by any other means (employer, Medicare, Medicaid or individually-purchased policies) and who have medical problems that require costly care.  With the mandate, healthier individuals will also have to pony up and purchase health insurance, so that the overall cost is spread among both healthy and not-as-healthy individuals.

There are a few ways that the penalty can be avoided:

  1. Having an insurance policy purchased via the Affordable Care Act Healthcare Exchange for your state.
  2. Having an insurance policy from any other source that meets the minimum standards of the “bronze” level plan on the exchanges.  This includes employer-provided healthcare or other group policies (such as via an association), as well as individually-purchased policies.
  3. If the coverage costs more than 8% of your household Adjusted Gross Income – this applies to employer-provided insurance as well as the net cost of a bronze-level policy from the exchange.  If your income is so low that the cost of either type of policy is more than 8% of your AGI, you will not be penalized.
  4. If you have to go without coverage for a period of less than 3 months, such as when changing jobs, you will also not be penalized.
  5. The same goes for folks who can prove that a hardship has caused them to go without coverage, such as if your policy was canceled and you otherwise cannot afford a policy. (This one is a bit odd, it seems that the situation is covered via #3 above, but I guess that wasn’t complicated enough!)

If you don’t fit any of the above exceptions, you may owe this penalty.  The penalty is the greater of either $95 per person in the household (half that if the dependent is under 18), capped at $285; or 1% of Adjusted Gross Income over the minimum to file a tax return ($20,300 for couples or $10,150 for singles, plus $3,950 per dependent).  At no time can the penalty be more than the cost of the basic bronze-level policy offered on the exchanges.

When your income is less than certain limits, you will receive a tax credit for a portion of the cost of the insurance coverage.  These limits are prescribed by the Act, and the upper limit is 4 times the federal poverty limit – for a family of four, this amounts to $94,200; for a single person, the limit is $45,960.  The credit varies between the limit for filing (mentioned above) and the 400% poverty limit line.  This credit can be paid directly to the insurance provider, lowering your monthly premium (if you’ve purchased via the exchanges) or you can wait to receive the refundable credit when you file your income tax return.

A Quirk

There’s a quirk about this law concerning the penalties for not having insurance: The penalty, which is actually called a tax, is administered by the IRS, collected with your income tax return each year.  However, unlike income taxes and other taxes collected with your income tax return, the IRS cannot use a lien against your property or a levy against your income in order to collect the penalty if owed.  In addition, any amounts unpaid are not charged interest (as with other taxes).  The only way that the IRS can force payment of the penalty is by withholding refunds from other taxes reported on the tax return.  If you’re astute, you’ll notice that there is a planning opportunity there – although not recommended nor for the faint of heart.

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2014 IRA MAGI Limits – Married Filing Separately

Jan 1st, 2014
by jblankenship.
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Separated Strawberry

Separated Strawberry (Photo credit: bthomso)

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 55% for every dollar (or 65% 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 2014.  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 55% for every dollar over the lower limit (or 65% 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 2014.  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.

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2014 MAGI Limits for IRAs – Married Filing Jointly or Qualifying Widow(er)

Jan 1st, 2014
by jblankenship.
1 comment
rendered universal joint animation. Español: M...

rendered universal joint animation. (Photo credit: Wikipedia)

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 Jointly or Qualifying Widow(er)):

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 work, and your MAGI is $96,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $96,000 but less than $116,000, you are entitled to a partial deduction, reduced by 27.5% for every dollar over the lower limit (or 32.5% 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 $116,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. 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 at your job, but your spouse IS covered by a retirement plan, and your MAGI is less than $181,000, you can deduct the full amount of your IRA contributions.

If you are not covered by a retirement plan but your spouse is, and your MAGI is greater than $181,000 but less than $191,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% 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 $191,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. 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 Jointly or Qualifying Widow(er)):

If your MAGI is less than $181,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $181,000 and $191,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, 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 $191,000 or more, you cannot contribute to a Roth IRA.

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2014 MAGI Limits – Single or Head of Household

Jan 1st, 2014
by jblankenship.
1 comment
David Lee Roth IRA ruins my perfect shot

David Lee Roth IRA ruins my perfect shot (Photo credit: nickfarr)

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 this page to determine eligibility.

For a Traditional IRA (Filing Status Single or Head of Household):

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

If you are covered by a retirement plan at work, if your MAGI is $60,000 or less, there is also no limitation on your deductible contributions to a traditional IRA.

If you are covered by a retirement plan at your job and your MAGI is more than $60,000 but less than $70,000, you are entitled to a partial deduction, reduced by 55% for every dollar over the lower limit (or 65% 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 $70,000, you are not entitled to deduct any of your traditional IRA contributions for tax year 2014. 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 Single or Head of Household):

If your MAGI is less than $114,000, you are eligible to contribute the entire amount to a Roth IRA.

If your MAGI is between $114,000 and $129,000, your contribution to a Roth IRA is reduced ratably by every dollar above the lower end of the range, 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 $129,000 or more, you cannot contribute to a Roth IRA.

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