Many of Last Year's Tax Breaks - Extended

The major tax news at the end of last year was 55 tax breaks expired on December 31, 2013.  During all of 2014 tax planners and tax payers all were awaiting a final decision on whether or not many of these will be renewed or revised.  As the year draws to an end, Congress is backing off of revisions and proposing simply extending these breaks.

As a result those 55 tax breaks that expired last year will be extended.

Congressional Republicans on Tuesday said the measures would be renewed retroactively to Jan. 1, 2014 but only through the end of 2014.

In the next couple of weeks tax experts will be watching the Congressional action carefully.  Those 55 tax breaks are:

• Tax-free distribution from individual retirement plans for charitable purposes.
• Reduction in S corporation recognition period for built-in gains tax.
• Credit for energy efficient appliances
• Deduction for qualified tuition and related expenses
• Employer wage credit for activated military reservists
• Non business energy credits
• Deduction for state and local general sales tax
• Additional first year depreciation for 50 percent of basis of qualified property
• Incentives for biodiesel and renewable diesel fuel
• Credits for research and experimentation expenses
• The remaining 45 are mostly business credits

End-of-Year Tax Planning

It’s time to start making your year-end plans even though this year’s tax rules are pending in Congress and not yet finalized.  Lawmaking tax writers are waiting until the last minute to revive a series of tax breaks that lapsed at the end of 2013.  These include the deduction for state sales taxes in lieu of income taxes and direct transfers from IRAs to charity up to $100,000 for people age 70 ½ and up.  Despite the lawmakers’ reluctance to take action until after Election Day (Nov. 4) we believe many of the tax breaks will be renewed for 2014 and 2015.

The key to end-of-year tax planning is to weigh your options for both 2014 and 2015.  You want to minimize the tax impact for both years, not just one.

Some taxpayers can accelerate income into 2014 to take advantage of a lower income and tax bracket, while other taxpayers may be able to defer income into 2015 for the same reason.

State and local income tax are itemized deductions.  The decision to pay, underpay or overpay can affect either year depending on your situation.

There are a number of other deductions such as interest, charitable donations, and medical expenses that need to be considered.

Knowing your tax position before the holidays is always a good idea. Contact your Wealth Advocate to discuss your income tax concerns and end the year with a reliable plan.

Establishing Legal Residency in a New State

• Locate a place to live in the new state of choice. Purchase a home if you can, although it is not required.  You must spend at least 6 months and 1 day at this new home to claim residency in your new state.  The new state must be your “Domicile” (generally meaning "permanent home").
• Spend substantial time in the new “home” state during vacations and holidays.
• Next, establish a home address with the U.S. Postal Service by going to the nearest post office and filing a change of address form.  The new home must be your primary mailing address.
• Have your important documents transferred to your new home address (insurance, memberships, licenses, etc.).  
• Obtain a driver's license and car registration in your new home state, or apply for a non-driver's state ID card if you do not drive.
• Register to vote in your new home state.
• Register motor vehicles in your new home state and make sure insurance rates are based upon your new state residency.
• Establish a banking relationship in the new state.
• Establish new professional relationships such as an accountant, lawyer, dentist and doctor. 
• Establish social groups and relations in the new home state, such as joining a health club, country club, civic, or business groups.
• Become a member of a local church.
• If you have professional licenses, have them transferred to your new state. Do this by contacting the governing board of your occupation in the new state (nurses, physicians, social workers, attorneys, etc.). Temporary licensing can often be granted immediately while you are waiting for the permanent license.
• Purchase a resident hunting or fishing license in the new home state, and if you continue these sports in your previous state purchase a non-resident license there.
• If retaining any property in your previous state, make sure it is “non-homestead” (if applicable) property for property tax calculations.

NOTE FOR MINNESOTA RESIDENTS:  Minnesota courts have recently demonstrated in their rulings a reluctance to let the taxpayer establish a residency change while maintaining a “presence” in Minnesota.  The court cases suggest that a complete break with Minnesota must be established in order to evidence a taxpayer’s intent to change residency from Minnesota to another state.  Not all states have been as aggressive as Minnesota in establishing difficult rules to comply with.  Check your home state rules for specific requirements.

IF YOU CHANGE STATES FROM MINNESOTA- RECOMMENDATION:   Stay out of Minnesota (well) over half the year.  OVERDO residency changes related to intent factors!  Keep excellent records!  If you receive a residency audit notice from Minnesota, we recommend you retain a Minnesota tax attorney.

Fall is Tax Time

It’s the end of summer, the best time of the year to think about your income taxes. Seriously! 

Granted, there are some last minute moves that can and must be made at year-end, by December 31. Why wait until December?  More than halfway through the year is great for planning. You have a good idea of what your earnings will be, and you have time to take steps that could cut the taxes you will have to pay.

If you have not filed your 2013 tax return because it is on extension (you have until October 15, 2014), get it done now. Rushing through it in October is not a positive move.

For 2014, will you owe or get a big refund? You probably should adjust your withholding if either is the case.  Payroll withholding should provide “just enough,” not too much and not too little. Changing your withholding is easy. Just submit a new W-4 to your payroll office.

Do you pay estimates?  Now is a great time to reassess your estimated tax situation. You can adjust your 3rd quarter, (due September 15) and 4th quarter payments.

Is your 2014 tax-filing material building up in a pile? Straighten it out now. It will make it filing your return next year much easier.

Your favorite non-profit organization will happily pick up unwanted household items and clothing any time of the year. So help out the charities now. Just be sure to get a receipt and put it in your newly created tax filing system. Household goods, furniture, clothing and nick-knacks can add up to very meaningful contributions. List them out with the following information:  Description of item, approximate acquisition date, original purchase price or original value, date of donation, organization receiving donation, condition of item, (excellent, good, fair, etc.), estimated value (10% - 30% of original).  You will be surprised at the amount of the donation. If any item exceeds $5,000 in value you must obtain an outside, independent appraisal.

Earlier is better when it comes to retirement plan contributions. 

There are many other moves and ideas you can make or do. Contact your Wealth Advocate for more tax planning ideas.

Wade Financial Group is on your side for tax planning.

Reminder: Third Quarter Tax Payments Due

The 3rd payment of your estimated individual income tax is due on September 15, 2014.

If you mail your payment and it is postmarked by the due date, the date of the U.S. postmark is considered the date of payment.  If your payment is late or you did not pay enough, you may be charged a penalty for underpaying.

If you are paying an estimated payment based on your prior year total tax, you are paying a “safe harbor” estimate.  This safe harbor estimate allows you to have significant increases in income and will not incur a penalty if all your estimates are paid on time.  If you are not paying an estimate based on your prior year tax and if you need to change your estimated tax payment we are available to assist you or you may call your tax preparer for assistance.

There are several methods to pay your estimated income tax:

• Pay by check using the US mail.  Be sure to enclose the estimated payment voucher with your check and write your social security number on your check and note that it is for the 3rd quarter of 2014 taxes.  The IRS prefers you to not staple your check to the voucher.  The mailing address for Minnesota residents is:
• Internal Revenue Service
• P.O. Box 802502
• Cincinnati, Ohio 45280-2502
• Pay online at www.irs.gov/e-pay.  You can pay using either of the following electronic payment methods:
• Direct transfer from your bank account
• Credit or debit card
• Pay by phone: for the latest details on how to pay by phone, go to www.irs.gov/e-pay
• To pay by phone by direct transfer from your bank account call EFTPS Customer Service at 1-800-555-4477
• When paying by phone using a debit or credit card the IRS charges a “convenience” fee which varies by provider, card type and payment amount.  The providers to call for paying by debit or credit card are:
• WorldPay  1-888-972-9829 or www.payusatax.com
• Official Payments Corporation  1-888-872-9829 or www.officialpayments.com
• Link2Gov Corporation  1-888-729-1040 or www.pay1040.com 

Summertime is a good time to refresh gift planning ideas

Charitable Trusts

As interest rates change, certain types of trust gift planning change.
Charitable Remainder Annuity Trusts: These trusts pay an annuity to the donor or another person for a set term, with the remainder going to a charity.  The donor gets an up-front deduction for the value of the charities remainder interest, which is larger when a higher interest rate is used.
Charitable Lead Annuity Trusts:  These trusts pay an annuity to a charity for a set term, with the remainder passing to the donor or someone such as a family member.  The donor gets to claim an up-front deduction for the present value of the charities annuity interest, which decreases as interest rates rise. Grantor-retained annuity trusts, where the person who sets up the trust gets an annuity for a set term are also hurt by higher rates.  Any balance left after the term expires goes to whoever the grantor originally named. Higher rates boost the potential gift tax bill.

Other Gifting Strategies

Do not waste the annual gift tax exclusion of $14,000: 
You can give up to $14,000 each to a child, grandchild or other person free of gift tax and it does not count against your “life-time” exemption.  If you’re married, your spouse also can give $14,000, doubling the tax free amount.
The 2014 “life-time” estate and gift tax exemption is $5,340,000.  You will not owe any gift tax on gifts over $14,000 as long as you do not use up your $5.34M exemption.
Pay a Donee’s tuition or medical costs directly:
The payments made directly to the educational institution or medical facility do not count against the $14,000 annual gift tax exclusion.
Give Appreciated Assets When Donating to Charity:
The appreciation escapes capital gains tax and you get to deduct the full value if you’ve owned the asset for over a year.
Keep Receipts and Records for Personal Property Donations:
Donations of gently used household items, clothing, furniture, etc. can add up to a substantial sum.  Keep a list of the items donated and note the condition of the item (e.g. excellent, good, fair).   An acceptable value for most items donated is 15% to 25% (or more) of the original cost.

Tom's Tax Tips: Vacation Property

Renting the Vacation Property:

If you rent your vacation home for less than 15 days a year, the rental income is tax-free and you can deduct interest and property tax payments (and casualty losses) on the house, but not the rental expenses, for the entire year.

You do not deduct the following:

• Personal use days
• Any days that you stayed at the rental property to perform routine repairs and maintenance including:
• repairing the bathroom toilet
• shampooing carpets, floor cleaning
• painting, caulking
• shopping for furniture or supplies 
• décor changes
• Meetings with property managers 
• Meetings with association boards

Maintenance days are not counted as personal days, even if your friends or relatives joined you for recreational purposes. These type of days should not be considered personal days and should be documented on a calendar or written document including receipts.

If you rent your vacation home out for 15 days or more during the year, and personal use does not exceed the larger of 14 days or 10% of the rental days, you must include the rent in income.  You get to deduct 100% of any property management fees in addition to rental expenses and it gets complicated because you need to allocate rental expenses between the days the property is rented and those used for personal purposes.  If personal use is 30 days and rental use is 120 days, 80% (120 divided by 150) of your mortgage interest, property taxes, insurance premiums, utilities and other rental expenses.  You can claim depreciation of 80% of the value of the house (no depreciation on the land part of the purchase).

If you limit your personal use to 14 days or 10% of the rental days, the vacation home is considered a business and up to $25,000 in losses may be deductible in each year.  I say losses “may” be deductible because real estate losses are considered “passive losses” by the federal tax law.  Passive losses can be used to offset taxable profit when you ultimately sell the vacation property.

Selling the Vacation Property:
Although the rule that allows home owners to take up to $500,000 of profit tax-free applies only to your principal residence, there is a way to extend the break to your second home: make it your principal residence before you sell. That's not as crazy as it might sound, nor is it as lucrative as it used to be.

Historically, retirees were selling the family home and moving full time into what had been their vacation home. Before 2009, this had a very special tax appeal. Once you live in that home for two years, up to $500,000 of profit could be tax free — including appreciation in value during the years it was your second home. Any profit attributable to depreciation while you rented the place, though, would be taxable. Depreciation reduces your tax basis in the property and therefore increases profit dollar for dollar.

In 2008 Congress cracked down on this break for taxpayers who convert a second home to a principal residence. Now a portion of the gain on a subsequent sale of the home is ineligible for the home-sale exclusion of up to $500,000, even if the seller meets the two-year ownership and use tests. The portion of the profit that's subject to tax is based on the ratio of the time after 2008 when the house was a second home or a rental unit to the total time you owned it.

This can still be a great deal if you've owned your second home for many years before the law changed. Let's say you have owned a vacation home for 18 years and make it your main residence in 2014. Two years later, you sell the place. Since the six years after 2008 the place was your second home (2009 and 2010) is 30% of the 20 years you owned the home, only 30% of the gain is taxed. The rest qualifies for the exclusion of up to $500,000.

Tom's Tax Tips: Stretch IRAs

What is a Stretch IRA?

A stretch IRA refers to an individual retirement account that is inherited by a beneficiary who is eligible to take the required minimum distributions from the account over the beneficiary's own life expectancy. This includes any type of individual beneficiary such as children, grandchildren, nieces, nephews, even friends, but not charitable beneficiaries since they do not have a life expectancy. It also does not apply to surviving spouses, who can simply elect to take an IRA inherited from a deceased spouse and roll it over into their own IRA.

Benefits of a Stretch IRA

The advantage of stretch IRAs from an estate planning perspective is that if a grandparent leaves the IRA to a grandchild or grandchildren, then the IRA can continue to grow tax-free for the benefit of the grandchildren since the grandchild's life expectancy will require the grandchild to withdraw relatively small required minimum distributions over many years leaving the principal and much of the tax-free growth inside the IRA.

Tom's Tax Tips: Alternative Minimum Tax

How does the Alternative Minimum Tax Work?

The Alternative Minimum Tax (AMT) is a separate, independent tax calculation completed on a separate tax form (#6251).  AMT uses its own set of rates and its own rules for deductions which are generally less generous than the regular tax rules. Because of these separate, complicated rules, the only way to determine if you owe the AMT tax is by filling out the forms (essentially doing the tax calculation a second time).  Thank goodness for professional tax software made available to everyone at an economical cost (and of course qualified professionals who complete your tax return for a fee).

If your gross income is above $75,000 and you have write-offs for personal exemptions, taxes and home-equity loan interest you most likely fall into an AMT tax category.   Ditto if you exercised incentive stock options during the year, or if you own a business, rental properties, partnership interests or S corporation stock. If you earn more than $100,000, AMT calculations are pretty much required.

Alternative Minimum Taxable Income

AMT rules require adding back some tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. Here is where the most everyone making over $75,000 gets hit!

First, add back the personal and dependent-exemption deductions ($3,900 each in 2013).   Then, if you do not itemize, the standard deduction is added back ($12,200 for joint filers in 2013; $6,100 for singles in 2013).  The state, local and foreign income and property tax write-offs, as well as your home equity loan interest, if the loan proceeds are not used for home improvements also get added back.

The AMT also ignores some itemized deductions, such as investment expenses and employee business expenses, and some medical and dental expenses. AMT rules add the interest from some private-tax-exempt activity bonds to income. Finally, AMT rules force you to pay taxes on the “spread” between the market price and the exercise price of incentive stock options granted by your employer. For example, if you exercised an option to buy 1,000 shares of stock for $3 a share and the stock was trading at $15, the spread would be $12 a share, or $12,000. Under the regular rules, you wouldn't pay current taxes on this amount, but under the AMT, it’s considered income.

Alternative Minimum Tax Benefits

AMT rules allow a couple of small benefits you do not receive under the regular tax rules. For example, while you can’t deduct state, local and foreign taxes under AMT rules, you can exclude the refunds, which are considered income under the regular tax rules. And because you’re taxed on the spread on your incentive stock options, your tax basis for the option shares you bought is higher under AMT rules, meaning your future AMT tax bill will be lower when you sell those optioned shares.  This stock basis adjustment, of course, requires good record keeping.

The AMT form has quite a few other rules that are pluses and minuses related to rental properties, partnerships, and other business entities. My intention is to give you a glimpse of the complicated rules so I will limit the rules explanation to the above paragraphs.

Exemption Parameters

Lastly, the AMT exemption is deducted from the recalculated AMT taxable income -- $80,800 for 2013 joint filers; $51,900 for unmarried persons; $40,400 for those who use married filing separate status. However, this exemption is reduced by 25 cents for each dollar of AMT taxable income above the applicable annual threshold. For 2013, the thresholds are $153,900 for married joint-filing couples, $115,400 for singles, and $76,950 for folks who use married filing separate status.  After the exemption (if any) has been deducted, the result is subject to the AMT rates:

1. 26% on the first $179,500 for 2013 or $89,750 for if you are married and file separately from your spouse and
2. 28% on the excess. If the AMT exceeds your regular tax, you have to pay the greater amount. 

Technically, the AMT is shown on your federal income tax return as just the liability over and above the regular tax, and this figure is entered on page 2 of Form 1040.

ALERT:  There may be a recovery of some of the AMT paid.  It’s possible to be eligible for the so-called minimum tax credit, which allows taxpayers to claim a credit on their tax return in future years for some or all of the extra AMT tax you paid.  Another tax form, 8801, is necessary to determine if you are eligible. For whatever reason, the tax rules say that exercising incentive stock options is one of the few things that qualify you for the AMT credit, so if that’s the reason or one of the reasons you paid an AMT tax, make sure this credit calculation form is included in your tax return.

2014 Tax Planning

2014 Tax Planning Difficulties

Fifty-five tax provisions expire on Dec. 31, 2013. This doesn't affect your 2013 tax return, but tax planning for 2014 will be a different story. Consideration of extenders has been complicated by possible overall tax reform and budget considerations. Uncle Sam could bring in billions by letting some or all of the extenders fade away. That would mean, however, that individual taxpayers would lose such popular tax breaks as the itemized deduction for state and local sales taxes, the above-the-line deductions for tuition and fees and educators' out-of-pocket classroom expenses. The consensus is that Congress will take up the extenders in 2014, but whether that will be before or after the Nov. 5 midterm election is unclear. The longer lawmakers wait, the harder it will be to plan and implement your 2014 tax strategy.

Take Advantage of Inflation Tax Adjustments

One thing we do know for sure for 2014, inflation had a nominal effect on around 40 tax provisions. Most notable is that income brackets were widened a little, meaning you can earn a bit more next year without being bumped into a higher tax bracket. Most people claim the standard deduction, and those amounts for each filing status in 2014 were increased slightly, as was the personal exemption amount, going from $3,900 to $3,950. However, the amounts you can contribute to your workplace pension plan and individual retirement account in 2014 have stayed the same as in 2013.

New Simplified Home Office Business Use Deduction

The IRS has provided a new, optional, “Safe Harbor Home Office” expense deduction effective for tax years beginning on or after January 1, 2013!

The deduction allowed is $5 per square foot of the “qualified use” space up to 300 square feet.  The maximum deduction is $1,500.  

·    A home office is considered the taxpayer’s primary place in which he or she conducts trade or business.

·    The home office may or may not be part of or attached to the taxpayers residence.  It may be a separate structure on the property used exclusively, on a regular basis, as a home office.

·    A home office is where the taxpayer will meet clients, customers or patients during the normal course of business.

·    Home-related itemized deductions are claimed 100% (without allocation) on Schedule A (for example, mortgage interest and real estate taxes).

·    No depreciation deduction or later recapture on sale of the home is allowed if the “safe harbor method” is used.

·    Of course, even under the simplified method, it is the taxpayer’s responsibility to ensure  good records which prove the exclusive use of the home office continue to be maintained to substantiate the claim.

This deduction is an alternative to the calculation, allocation and substantiation of actual expenses required under the IRS code section 280A.  If the deduction is greater using the 280A method you can still use that method.  Taxpayers are allowed to change their treatment from year to year.

Need for a Will

A will is important because if you do not designate who will inherit your property, a state statute will. The statutory distribution scheme (known as “intestate distribution”) will often provide for results differing from your wishes. If you have property in several states, the rules in each state may be different concerning who will be entitled to your properties.

Typically, intestate law divides the decedent's estate between the surviving spouse and living children; however, many people are surprised by the actual division made by state law. Even if the decedent does not have children, the spouse may not inherit the entire estate.

Perhaps most importantly for those of you with minor children, a will gives you the opportunity to designate a guardian for your children if your spouse does not survive you. You have better understanding than a court as to who of your relatives or friends will best be able to care for your children, both emotionally and financially. Your will can put this designation in place, identifying the best person for each type of function.

Moreover, because your children are minors, the court will require a fiduciary (e.g., a guardian or trustee) to be appointed to receive and manage that property the children inherit. This can be a cumbersome and expensive process, requiring court supervision throughout the time the children are minors.

A will can also simplify the probate process for your survivors. For example, you can designate a personal representative (also known as an executor) to handle the transfer of properties in your estate. You can direct how taxes and debts should be paid. You can waive state limitations on funeral expenses payable from your estate and enable your estate to take maximum advantage of estate tax savings.

We do hope that this explanation is a sufficient beginning to enable you to understand the practical necessity of having a Last Will.

Please contact one of our Wealth Advocates at Wade Financial Group to arrange an appointment to discuss this matter in more detail.