Why Proactive Planning is More Important Than You Realize

There's an old saying that reminds us "if you fail to plan, you plan to fail." Whoever coined that phrase was talking about the world of small business accounting whether they realized it or not.

Financial and tax literacy aren't just an important part of running a business. They're literally the foundation upon which everything else is built. Tax literacy helps to make sure that you're not only taking care of your obligations but that you're not paying more money than you should ultimately have to. Financial literacy helps to avoid problems like cash flow issues which could cause even a seemingly successful business to close prematurely.

These are also important concepts to know for individuals, too. It helps avoid problems like not budgeting properly, they can help you understand the true impact of inflation and more. All of this is in the name of avoiding common problems that typically hold people back.

But the thing to understand is that these are not skills that you're born with - you have to be proactive about learning them. You also want to make sure that you have the right partner by your side to help make this process as easy as possible.

The Power of a Well-Laid Plan

One of the major reasons why planning is so crucial in this context is because it helps avoid one of the single biggest problems that both businesses and individuals often face: not budgeting properly.

Indeed, the lack of a sound (and realistic) budget is often one of the major contributors to money problems for most people. When no semblance of a plan is in place, it's far too easy to overspend. It's also likely that you're not paying nearly as much attention to your finances as you should be. This in turn leads to a significant amount of financial stress, which isn't something that you can just get rid of overnight.

What people don't realize is that by coming up with a plan and creating that budget, it can actually put them closer to their goals - not farther away from them. Yes, it may take a bit of additional time to make that big purchase, but you're not going to overspend. You're not going to use funds that were allocated for something more important. You can also see the progress you've made and how far you have left to go, which can help create a much-needed perspective on the entire situation.

Another way in which financial and tax literacy - along with planning - can help both businesses and individuals comes down to avoiding the dreaded trap of "living paycheck to paycheck." It's something that far too many private citizens know all about, and it can even rear its ugly head for business owners, too, albeit in a slightly different context.

For individuals, it's safe to say that they're up against a number of hurdles in addition to a lack of financial literacy. The current job market is nothing if not rough. Economic uncertainty abounds, especially given everything going on right now with the war in Ukraine.

But at the same time, you have to start somewhere - and that "somewhere" involves gaining the knowledge you need to take control of your finances. Not everyone has the opportunity to earn extra income - like by picking up a second job or by moving to a new position that pays more.

Instead, try prioritizing your interests in a way that better aligns with the funds you do have available. Sure, private citizens may want to travel more or purchase a larger home, but your plan may illustrate to you that it just isn't in the cards right now.

The same is true of businesses - you may want to aggressively expand into a new market, but doing so without some type of plan in place is little more than a recipe for disaster.

In the end, financial and tax literacy are two of the most important elements of our society that people just aren't paying enough attention to. But by making an effort to understand your situation and the world around you, you'll find yourself in a much better financial position than the one you were in when you started.

If you'd like to find out more information about why proactive planning is far more important than you may realize, or if you just have any additional questions that you'd like to go over with someone in a bit more detail, contact your tax preparer for this tax year NOW!

Highlights of College Savings Plans (Sec 529 Plans)

The Qualified State Tuition Plan, often referred to as the Sec 529 Plan, is a tax-beneficial incentive for parents, grandparents, and others to save money for an individual’s future college tuition and fees. There is no federal tax deduction for making contributions. But the tax benefit of these plans is that the earnings within the plan accumulate tax-deferred and then are tax-free when withdrawn if used for college tuition and related qualified expenses. Let’s take a simplified example.

Example: Jo’s parents establish a 529 plan when she is age 5, and contribute $10,000 to the plan. The $10,000 is invested in mutual funds that pay dividends of $400 per year. The tax on the dividends is deferred until the time when funds are withdrawn from the plan, and only payable if the distribution isn’t used for eligible education expenses. Let’s say that Jo enters college in 13 years and with the dividends earned over those years and an increase in the value of the original $10,000 to $15,000, the account is worth $20,200. Jo’s tuition and related expenses for her first semester is $25,000. The entire $20,200 is withdrawn to pay those expenses, so none of the dividends received and none of the $5,000 gain in the value of the account will be taxable. If Jo’s parents were in a 24% tax bracket, the tax savings by investing in the 529 plan compared to putting $10,000 in a regular brokerage account will be at least $1,530. The benefit would be compounded if more than $10,000 was contributed to the 529 plan.  

Contributions - To maximize the tax benefits of a plan, it should be established for a child as soon after birth as possible when funds are available for contribution. For tax purposes, there is no limit on the amount that can be contributed, but contributions are considered gifts and each individual contributing to a plan would have to file a gift tax return if the gift exceeds the annual inflation-adjusted gift tax exclusion, which is $16,000 for 2022 (up from $15,000 for years 2018 through 2021). 

A special gift provision permits a contributor to contribute up to 5 times the annual gift tax exclusion amount to a qualified tuition account in a single year and treat the contribution as having been made over the five-year period beginning with the calendar year in which the contribution is made. Why would someone want to do this? Because by front-loading the contributions, they would accelerate the accumulation of earnings within the account. When making 5 years’ worth of 529 plan contributions in one year, a gift tax return is required in the year of contribution. If the contributor dies within the 5-year period, any amount contributed that is applicable to the years within the five-year period remaining after the year of the contributor’s death are able to be included in the contributor’s gross estate for estate tax purposes. 

Although the income and gift tax laws don’t cap how much can be contributed to a qualified tuition plan, the 529 plans do limit the maximum amount that can be contributed per beneficiary based on the projected cost of a college education, and the maximum amount will vary between plans, though most have limits in excess of $200,000, with some topping $475,000. Generally, once an account reaches that level, additional contributions cannot be made, but that doesn’t prevent the account from continuing to grow.

Modifications – Since originating these plans, Congress has continued to modify the purpose of the plans by allowing plan funds to be used for more than just college tuition and fees. Over the years, they have allowed plan funds to be spent on additional expenses, including books, supplies, equipment, reasonable room and board, and computer technology. 

More recently, the following qualified expenses were added: 

• Elementary and Secondary School Tuition Expenses – The Tax Cuts and Jobs Act (2017) included a provision that treats withdrawals from 529 plans for elementary or secondary school (kindergarten through grade 12) tuition expenses as qualified expenses. However, the annual withdrawal for each beneficiary is limited to $10,000 (regardless of the number of 529 plans in the beneficiary’s name). This special $10,000 amount applies only for tuition (not books, supplies, room and board, etc.) paid to public, private or religious schools. 

Be Cautious – Since the greatest tax benefit and primary goal of these plans is accumulating tax-deferred investment income, which then can be withdrawn tax-free to pay qualified education expenses, using these funds too early will not achieve that desired goal. Thus, you should carefully consider whether to use the funds for elementary and secondary school education expenses or to wait and tap the account for post-secondary education, with the latter choice maximizing investment income.

• Apprenticeship Expenses – The category of qualified expenses was expanded by the Secure Act to include fees, books, supplies, and equipment required to participate in registered apprenticeship programs certified by the Secretary of Labor under Sec 1 of the National Apprenticeship Act, effective for distributions made in years after 2018. 

• Repayment of Student Loans – Another Secure Act addition to 529 plan qualified expenses is effective for distributions after 2018 of up to $10,000–a lifetime limit–that may be used to pay the principal and interest on qualified higher education loans of the designated beneficiary or a sibling of the designated beneficiary. To prevent double-dipping, Sec 529 plan distributions used to pay interest on the education loan cannot be used for the above-the-line deduction allowed for student loan interest. 

In addition to 529 plans Congress has also provided tax credits to help fund a child’s college education, though the rules for these credits aren’t entirely straight-forward. For example, one favorable twist of the tax code allows a grandparent (or others) to directly pay to the educational institution the child’s tuition without being subject to the gift limitations or reporting. On top of that, assuming the child is a dependent of their parent, the parent may qualify for a higher education credit even though the grandparent paid the tuition. The parent’s eligibility depends on their income, since the credits phase out once the adjusted gross income of the individual claiming the credit exceeds an amount based on filing status and the type of credit claimed.   

If you need assistance with long-term education planning, give your tax consultant a call soon!

Toss Your Paystub Every Week? Maybe It’s Time To Take a Closer Look

What you do with your paystub often depends on how you get paid. If you have direct deposit there’s a good chance that you just rip the entire thing up without a glance, confident in the fact that the money is in your bank account and all is good in your world. If you deposit your check, you probably rip off the bottom without a glance and toss it on your way into the bank or at the drive-through window. But the fact that you’ve been paid doesn’t mean that the information on your paystub isn’t important. There are good reasons for taking a closer look at the information that’s provided, and for understanding what it all means.

The most important reason to double-check your paystub is to make sure that you’re being paid correctly and that the right amount of money is being withheld on your behalf by your employer. You know better than anybody what your income is supposed to be, and mistakes do happen, but you won’t know if you don’t check. Plenty of people have found out the hard way – at tax time – that their employer hasn’t been withholding the amount that they wanted them to, and they end up with a shortfall that they have to make up.  

Another good reason for looking at your paystub is to understand exactly where your money is going and what it is funding. We all remember the shock of receiving our first paycheck and finding out that it came to far less than what we thought it would be based on our salary or hourly wages. We were told it was taxes … but do you know what that really means? The information provided below should provide a better understanding of what those deductions from your gross income are, and where they are going.

Breakdown of Paystub Information:

Unfortunately, there is no one set format for paystubs. In fact, some states don’t even require employers to provide their employees with the specifics of where their money is going each week. For those who do receive paper records of their withholding amounts and more, here’s what you’re likely to find, and what it means.

Wages – This is one of the most important pieces of information on your paystub. Whether you are paid a salary or an hourly basis, the wage portion of your paystub will provide you with what the gross amount is that you’re being paid, what portion of those wages are taxable, and what your net income/check amount is. Most stubs will reflect both the wages for the pay period and the year-to-date totals.

Taxes – Every citizen is obligated to pay a portion of their income to the federal government, as well as any applicable state and local taxes. This money is used to pay for both services and administrative costs. Deductions will also be taken for the FICA tax that pays into the Social Security Administration and Medicare. Though the taxpayer may not currently be benefiting from these programs, the idea is that everybody will be eventually, and those who are working pay for those who no longer are.

Non-Taxed Deductions – Most paystubs will also reflect deductions taken from your pay for items that are not taxable. This may include contributions to a 401(k) retirement account or money that you direct into other pre-tax accounts. 

Benefits – If you receive benefits such as health insurance, life insurance, sick time, and vacation time, your employer may provide information on your paystub about how much they pay on your behalf, or how much you have elected to pay for options such as a specific level of insurance coverage. 

Additional Deductions – You may also see deductions taken for other items that you have requested, such as Health Savings Account contributions, parking passes, childcare expenses, and more. All of these line items should be for selections that you have agreed to. If you do not recognize an expense, it’s a good idea to check with your Human Resources department and ask them to identify it.

Knowing what you’re earning and where your money goes is just the first step to economic stability and understanding. If you or your spouse needs help filling out a new W-4 for their employer, contact your tax preparer now! Don’t wait until the end of the year, it will be too late!

Understanding Tax Lingo

When discussing taxes, reading tax related articles or instructions one needs to understand the basic lingo and acronyms used by tax professionals and authors to be able to grasp what they are saying. It can be difficult to understand tax strategies if you are not familiar with the basic terminologies used in taxation. The following provides you with the basic details associated with the most frequently encountered tax terms.  

Inflation Adjustments – The standard deductions, tax rates, amounts that can be contributed to retirement plans, virtually all amounts claimed as deductions and credits are annually adjusted for cost-of-living changes from the prior year or other base year as required by the tax code. Thus, when determining an amount, care should be taken to determine the year-specific amount. The numbers used in this article are for the year 2021.  

• Filing Status—Generally, if you are married at the end of the tax year, you have three possible filing status options: married filing jointly, married filing separately, or, if you qualify, head of household. If you were unmarried at the end of the year, you would file as single, unless you qualify for the more beneficial head of household status. A special status applies for some widows and widowers.

Head of household is the most complicated filing status to qualify for and is frequently overlooked as well as incorrectly claimed. Generally, the taxpayer must be unmarried AND: 

• pay more than one half of the cost of maintaining his or her home, a household that was the principal place of abode for more than one half of the year of a qualifying child or certain dependent relatives, or

• pay more than half the cost of maintaining a separate household that was the main home for a dependent parent for the entire year. 

A married taxpayer may be considered unmarried for the purpose of qualifying for head of household status if the spouses were separated for at least the last six months of the year, provided the taxpayer wanting to qualify for the head of household status maintained a home for a dependent child for over half the year.

Surviving spouse (also referred to as qualifying widow or widower) is a rarely used status for a taxpayer whose spouse died in one of the prior two years and who has a dependent child at home. The main benefit of this status is that the widow(er) can use the more favorable married joint tax rates rather than the head of household or single rates. In the year the spouse passed away, the surviving spouse may file jointly with the deceased spouse if not remarried by the end of the year. In rare circumstances, for the year of a spouse’s death, the executor of the decedent’s estate may determine that it is better to use the married separate status on the decedent’s final return, which would then also require the surviving spouse to use the married separate status for that year.

If a taxpayer is married to a non-resident alien, the taxpayer has two options: file as married separate reporting only their income, deductions and credits or elect to file a joint return with the spouse including the world-wide income of both of them on a joint return.

• Adjusted Gross Income (AGI)—AGI is the acronym for adjusted gross income. AGI is generally the sum of a taxpayer’s income less specific subtractions called adjustments (but before certain below-the-line deductions and the standard or itemized deductions). The most common adjustments are penalties paid for early withdrawal from a savings account, and deductions for contributing to a traditional IRA or self-employment retirement plan. Many tax benefits and allowances, such as credits, certain adjustments, and some deductions are limited by the amount of a taxpayer’s AGI.

• Modified AGI (MAGI)—Modified AGI is AGI (described above) adjusted (generally up) by tax-exempt and tax-excludable income. MAGI is a significant term when income thresholds apply to limit various deductions, adjustments, and credits. The definition of MAGI will vary depending on the item that is being limited. 

• Taxable Income—Taxable income is AGI less deductions (either standard or itemized). Your taxable income is what your regular tax is based upon using a tax rate schedule specific to your filing status. The IRS publishes tax tables that are based on the tax rate schedules and that simplify the tax calculation, but the tables can only be used to look up the tax on taxable income up to $99,999. The tables for 2021 have not been released yet, but those for 2020 can be found in the 1040 instructions beginning on page 66.  

Marginal Tax Rate (Tax Bracket)—Not all of your income is taxed at the same rate. The amount equal to your standard or itemized deductions is not taxed at all. The next increment is taxed at 10%, then 12%, 22%, etc., until you reach the maximum tax rate, which is currently 37%. When you hear people discussing tax brackets, they are referring to the marginal tax rate. Knowing your marginal rate is important because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your marginal rate is 24% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $240 in federal tax ($1,000 x 24%). Your marginal tax bracket depends upon your filing status and taxable income.

Taxpayer & Dependent Exemptions – In the past, taxpayers were able to qualify for an exemption amount for the filer, spouse if filing jointly and each dependent, which was also subtracted from AGI to determine taxable income. However, beginning in 2018 and through 2025 the deduction for the exemption amounts has been suspended and replaced with a higher standard deduction and child tax credit. 

• Qualified Child—A qualified child is one who meets the following tests:

(1) Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences;

(2) Is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual;

(3) Is younger than the taxpayer;

(4) Did not provide over half of his or her own support for the tax year;

(5) Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and

(6) Was unmarried (or if married, either did not file a joint return or filed jointly only as a claim for refund).

• Dependents— Even though there’s currently no deduction for dependent exemptions, there are still some significant tax benefits for taxpayers who are able to claim a dependent. To qualify as a dependent, an individual must be the taxpayer’s qualified child or pass all five of the following dependency qualifications: the (1) member of the household or relationship test, (2) gross income test, (3) joint return test, (4) citizenship or residency test, and (5) support test. The gross income test limits the amount an individual can make and still qualify as a dependent if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you pay over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support.

• Qualified Child—A qualified child is one who meets the following tests:

(1) Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences;

(2) Is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual;

(3) Is younger than the taxpayer;

(4) Did not provide over half of his or her own support for the tax year;

(5) Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and

(6) Was unmarried (or if married, either did not file a joint return or filed jointly only as a claim for refund).

Deductions— A taxpayer generally can choose to itemize deductions or use the standard deduction. The standard deductions is illustrated below.

Filing Status Standard Deduction

Single $12,550

Head of Household $18,800

Married Filing Jointly $25,100

Married Filing Separately  $12,550

The standard deduction is increased by multiples of $1,700 for unmarried taxpayers who are over age 64 and/or blind. For married taxpayers, the additional amount is $1,350. The extra standard deduction amount is not allowed for elderly or blind dependents. Those with large deductible expenses can itemize their deductions in lieu of claiming the standard deduction. The standard deduction of a dependent filing his or her own return will oftentimes be less than the single amount shown above. 

For 2021 only, taxpayers claiming the standard deduction are also allowed to deduct from their AGI up to $300 ($600 for joint filers) of cash contributions made to qualified charitable organizations. Normally, charitable contributions are deductible only when itemizing the deductions described next.

Itemized deductions generally include:

(1) Medical expenses, limited to those that exceed 7.5% of your AGI.  

(2) Taxes consisting primarily of real property taxes, state income (or sales) tax, and personal property taxes, but limited to a total of $10,000 for the year. 

(3) Interest on qualified home acquisition debt and investments; the latter is limited to net investment income (i.e., the deductible interest cannot exceed your investment income after deducting investment expenses).

(4) Charitable contributions, generally limited to 60% of your AGI, but in certain circumstances the limit can be as little as 20% or 30% of AGI. For 2020 and 2021 the limit was increased to 100% of AGI for cash contributions.  

(5) Gambling losses to the extent of gambling income, and certain other rarely encountered deductions.

• Alternative Minimum Tax (AMT)—The   AMT is another way of being taxed that has often taken taxpayers by surprise. Even though the AMT was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments pay at least a minimum amount of tax, it sometimes snares lower income taxpayers. Your tax must be computed by the regular method and also by the alternative method. The tax that is higher must be paid. The following are some of the more frequently encountered factors and differences that contribute to making the AMT greater than the regular tax.

  • The standard deduction is not allowed for the AMT, and a person subject to the AMT cannot itemize for AMT purposes unless he or she also itemizes for regular tax purposes. Therefore, it is important to make every effort to itemize if subject to the AMT. 

  • Itemized deductions:

    • Taxes are not allowed at all for the AMT.

    • Interest paid for loans to purchase non-conventional homes such as motor homes and boats is not allowed as an AMT deduction but is deductible for regular tax. For years 2018–2025, interest paid on home equity debt is also not allowed for either AMT regular tax purposes. LEE: you had put red shading on this whole paragraph

• Nontaxable interest from private activity bonds is tax free for regular tax purposes, but some is taxable for the AMT.

• Statutory stock options (incentive stock options) when exercised produce no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) is income for AMT purposes in the year the option is exercised.

•  Depletion allowance in excess of a taxpayer’s basis in the property is not allowed for AMT purposes.

A certain amount of income is exempt from the AMT, but the AMT exemptions are phased out for higher-income taxpayers.  

Your tax will be whichever is the higher of the tax computed the regular way and by the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation, and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom-line tax and raise a question of possible AMT. Fortunately, due to tax reform that increased the AMT exemption amounts and the phaseout thresholds, fewer taxpayers are paying AMT. Tax Tip: If you were subject to the AMT in the prior year, you itemized your deductions on your federal return for the prior year, and had a state tax refund for that year, part or all of your state income tax refund from that year may not be taxable in the regular tax computation. To the extent that you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not included in the subsequent year’s income. 

• Tax Credits—Once your tax is computed, tax credits can reduce the tax further. Credits reduce your tax dollar for dollar and are divided into two categories: those that are nonrefundable and can only offset the tax, and those that are refundable. In addition, some credits are not deductible against the AMT, and some credits, when not fully used in a specific tax year, can carry over to succeeding years. Although most credits are a result of some action taken by the taxpayer, there are some commonly encountered credits that are based simply on the number or type of your dependents or your income. These and another popular credit are outlined below.

  • Child Tax Credit—Thanks to the American Rescue Plan Act, the child tax credit for one year only (2021) has been increased to $3,000 for a child under age 18 ($3,600 if under age 6), up from $2,000 in 2020. Unlike other years, the credit is fully refundable and there is no requirement for the taxpayer to have earned income.

The credit has two phaseouts for higher income taxpayers. Phaseout      is $50 for each $1,000 of MAGI above the thresholds. The threshold phases out the increase in child credit for 2021 over $2,000 per child. The first phaseout threshold is $150,000 for married filing joint filers, $112,500 for those filing as head of household and $75,000 for others.  The second phaseout applies to the $2,000 portion of the credit with thresholds of $400,000 for married filing taxpayers and $200,000 for others.  

Congress mandated that the IRS estimate this credit for taxpayers based upon their 2020 returns and pay half of the estimated credit in monthly installments beginning July 2021. Taxpayers will need to reconcile the advance payments with the actual credit determined when they complete their 2021 return; repayment of excess advance amounts may be required depending on AGI.  

• Dependent Credit – A nonrefundable credit is also available to taxpayers with a dependent who isn’t a qualifying child. The $500 dependent credit is not refundable and subject to the second phaseout discussed above for child tax credits.   

Earned Income Credit—This is a refundable credit for a low-income taxpayer with income from working either as an employee or a self-employed individual. The credit is based on earned income, the taxpayer’s AGI, and the number of qualifying children. A taxpayer who has investment income such as interest and dividends in excess of $10,000 is ineligible for this credit. The credit was established as an incentive for individuals to obtain employment. It increases with the amount of earned income until the maximum credit is achieved and then begins to phase out at higher incomes. To find out more info about the EIC, see the IRS website.

Residential Energy-Efficient Property Credit—This credit is generally for energy-producing systems that harness solar, wind, or geothermal energy, including solar-electric, solar water-heating, fuel-cell, small wind-energy, and geothermal heat-pump systems. These items currently qualify for a 26% credit with no annual credit limit. Unused residential energy-efficient property credit is generally carried over through 2022.The credit rate reduces to 22% in 2023 The credit expires after 2023. 

• Withholding and Estimated Taxes—Our “pay-as-you-go” tax system requires that you make payments of your tax liability evenly throughout the year. If you don’t, it’s possible that you could owe an underpayment penalty. Some taxpayers meet the “pay-as-you-go” requirements by making quarterly estimated payments. However, when your income is primarily from wages, you usually meet the requirements through wage withholding and rely on your employer’s payroll department to take out the right amount of tax, based on the withholding allowances shown on the Form W-4 that you filed with your employer. To avoid potential underpayment penalties, you are required to deposit by payroll withholding or estimated tax payments an amount equal to the lesser of:

1. 90% of the current year’s tax liability; or

2. 100% of the prior year’s tax liability or, if your AGI exceeds $150,000 ($75,000 for taxpayers filing as married separate), 110% of the prior year’s tax liability.

If you had a significant change in income during the year, we can assist you in projecting your tax liability to maximize the tax benefit and delay paying as much tax as possible before the filing due date.

As always folks, don’t trust anything from the internet. These posts are meant to inform and educate, not to advocate for any position. Always reach out to your own tax preparer for your own advice!

Tax Benefits When Saving for College Education

A common question among parents is, “How might I save for a child’s post-secondary education in a tax beneficial way?” The answer depends on how much the education is expected to cost and how much time is left until the child heads off to college or a university or enters an apprenticeship program.

The amount of funds that will be required will depend upon whether your child will be attending a local college, attending a local college and then transferring into a university, going straight to a university, or beginning an apprentice program. If the child will be attending college or an apprenticeship locally, you generally only need to be concerned about tuition, books, and other class materials, and the child can live at home, whereas the child attending a university, unless it is local, will add housing and food costs on top of substantially higher university tuition. Another factor is whether the student will leave school after obtaining a bachelor’s degree or will be doing graduate studies for an advanced degree.

When the time comes, your child may qualify for a scholarship or grant, but you can’t depend on that when working out a college savings plan.

The federal tax code has two beneficial savings plans to use. Neither plan provides a tax benefit to making the original contributions. The benefit is that growth due to appreciation of the investments, if any, and earnings (dividends and interest) are tax-free when withdrawn for qualified education expenses. Thus, the sooner each plan is started, the better, because it will have more years to grow in value.

Both savings plans allow the funds to be used for kindergarten education and above. However, these plans provide tax-free accumulation, and the more the funds are used for expenses at lower levels of education, the less tax benefits they will provide. Careful consideration should be given to using these savings plans for anything other than post-secondary education.

More tax benefits will be gained by front-loading the contributions and thus having a larger amount for which the growth and earnings can be compounded. You should also be aware that anyone, not just you, can make a contribution to the child’s college savings plans. So if your child has any well-heeled grandparents, other relatives, or friends who would like to help, they can also contribute.

The two savings plans currently available for college savings are the Coverdell Education Savings Account and the Qualified Tuition Plan, most commonly referred to as a Sec. 529 plan (529 denotes the section of the tax code that governs it).

Coverdell Education Savings Account – This type of plan only allows up to $2,000 in contributions per year, which generally rules it out as a practical method for college savings, other than as a supplement to other means of saving.

Sec. 529 Plan – This approach is likely your best option. State-run Sec. 529 plans allow significantly larger amounts to be contributed; multiple people can each contribute up to the gift tax limit each year without being subjected to gift tax reporting. This limit is $15,000 for 2021, and it is periodically adjusted for inflation; in 2022, it will increase to $16,000. A special rule allows contributors to make up to five years of contributions in advance (for a total of $75,000 in 2021 and $80,000 in 2022).

Sec. 529 plans allow taxpayers to put away larger amounts of money, limited only by the contributor’s gift tax concerns and the intended plan’s contribution limits. There are no limits on the number of contributors and no income or age limitations. The maximum amount that can be contributed per beneficiary (the intended student) is based on the projected cost of college education and will vary among the states’ plans. Some states base their maximum on an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits over $200,000, with some topping $530,000. Generally, additional contributions cannot be made once an account reaches that level, but this doesn’t prevent the account from continuing to grow.

Taxpayers are not limited to participating in the 529 plan offered by their state of residence and can shop around for the plan with the best growth potential and highest maximum contribution.

When the time comes for college, the distributions will be part earnings/growth in value and part contributions. The contribution part is never taxable, and the earnings part is tax-free if used to pay for qualified college expenses. In addition, the portion of the distribution representing the return on the contributions, if used for qualified education expenses, will qualify for the American Opportunity Tax Credit, which can be as much as $2,500, provided your income level does not phase it out.

Gifts – In addition to the annual gift tax exclusion, a donor may make gifts (with no specific dollar limitation), which are totally excluded from the gift tax when making payments directly to an educational institution for tuition. This includes both college and private primary education. However, these gifts can only pay for tuition, which does not include books, supplies, or room and board. It is critical that the payments be made directly to the educational institution for them to be excluded from the gift tax. Reimbursement paid to the donee will not qualify.

The tuition exclusion is often overlooked yet can be beneficial. For instance, a grandparent can use the tuition gift to reduce their estate while helping a grandchild pay for tuition and giving the child’s parents an education credit at the same time.

For additional details or assistance in planning for a child’s higher education, please call your tax preparer.

Can’t Pay Your Taxes? Here Are Some Payment Options

Although most (74% in 2020) American taxpayers receive a refund each year when they file their income tax returns, there are those who for one reason or another end up owing. Of those who owe Uncle Sam many don’t have the means to pay what they owe by the return due date (usually in April). 

Generally, tax due occurs when a wage earner has under-withheld on his or her payroll or a self-employed individual failed to make adequate estimated tax payments during the year. This can be a huge problem for those who are unable to pay their liability.   

It is generally in your best interest to make other arrangements to obtain the funds for paying your 2021 taxes rather than be subjected to the government’s penalties and interest for payments made after April 18, 2022. Here are a few options to consider.

·         Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.

·         Home Equity Loans and HELOCs - Use the equity in your home—that is, the difference between your home’s value and your mortgage balance—as collateral. As the loans are secured against the equity value of your home, home equity loans offer extremely competitive interest rates—usually close to those of first mortgages. Compared with unsecured borrowing sources, such as credit cards, you’ll be paying less in financing fees for the same loan amount. Unfortunately, obtaining these loans takes time, so if you anticipate that you’ll need funds from such a loan to pay your taxes that are due in April, you should get the application process started right away.

·         Credit Card – Another option is to pay by credit card with one of the service providers that work with the IRS. However, since the IRS will not pay a credit card discount fee (the fee charged by the credit card company), you will have to pay the fees due and pay the higher credit card interest rates.

·         Short-Term Payment Plan – If you can fully pay the tax owed within 180 days and owe less than $100,000 including tax, penalties, and interest, you can apply for a short-term payment plan online at the IRS web site. You won’t be charged a set-up fee but will still have to pay penalties and interest until the balance owed is fully paid. Setup fees will be charged if you apply for a payment plan by phone, mail, or in-person instead of online.

·         IRS Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement where you can make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. Interest will also be charged at the current rate. There is a user fee to set up the payment plan. However, the IRS generally waives the fee for low-income taxpayers who agree to make electronic debit payments. In making the agreement, a taxpayer agrees to keep all future years’ tax obligations current. If the taxpayer does not make payments on time or has an outstanding past due amount in a future year, they will be in default of their agreement and the IRS has the option of taking enforcement actions to collect the entire amount owed. Taxpayers seeking installment agreements exceeding $50,000 will need to validate their financial condition and need for an installment agreement by providing the IRS with a Collection Information Statement (financial statements). Taxpayers may also pay down their balance due to $50,000 or less to take advantage of the streamlined option.

·         Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because you are jeopardizing your retirement lifestyle and the distributions are generally taxable at your highest bracket, which adds more taxes to your existing problem. In addition, if you are under age 59½, the withdrawal is also subject to a 10% early withdrawal penalty that compounds the problem even further.

Filing Extensions – Don’t mistake the ability to apply for an extension of time to file your tax return as also being an extension to pay any tax liability. It is not and does not grant you an extension of time to pay. The penalties and interest on the amount due will continue to apply as of the original due date of the return.   

Enforced Collections - If the taxes cannot be paid timely, and the IRS is not notified why the taxes cannot be paid, the law requires that enforcement action be taken, which could include the following:

• Issuing a Notice of Levy on salary and other income, bank accounts or property (IRS can legally seize property to satisfy the tax debt)

• Assessing a Trust Fund Recovery Penalty for certain unpaid employment taxes.

• Issuing a Summons to the taxpayer or third parties to secure information to prepare unfiled tax returns or determine the taxpayer’s ability to pay.

Note: To collect delinquent tax debts, certain federal payments (vendor, OPM, SSA, federal salary, and federal employee travel) disbursed by the Department of the Treasury, Bureau of Fiscal Service (BFS)) may be subject to a levy through the Federal Payment Levy Program (FPLP).

Fresh Start Initiative - The IRS also has what is called the “Fresh Start” initiative to offer more flexible terms in its existing Offer-in-Compromise program which, under certain circumstances allows taxpayers to settle their tax debt for reduced amounts. This enables financially distressed taxpayers to clear up their tax problems faster than in the past. While resolving tax problems might previously have taken four or five years, taxpayers may now be able to resolve their problems in as little as two years.  

If you have questions about the payment options or an offer-in-compromise, please call your tax preparer. Don’t just ignore your tax liability because that is the worst thing you can do.  

Child Tax Credit Loss

As your children grow older, you can easily be surprised by a larger tax bill. To help ease the possible burden, consider these tax implications as your dependent children age.

A higher tax bill in your future

At age 6: Loss of excess Child Tax Credit. In 2021, the Child Tax Credit is $3,600 for children under the age of 6. This is an extra $600 that will go away after your child ages out of the benefit. Even more important, this benefit is currently scheduled to disappear after 2021.

At age 13: loss of your Dependent Care Credit. If your children are in daycare and you offset some of this cost with the Dependent Care Credit you will lose this benefit when they reach age 13. The impact: a 50% credit against up to $16,000 in qualified daycare expenses in 2021. The good news here is that your children may no longer need the care as they get older.

At age 17 or 18: loss of the Child Tax Credit. While children under the age of 6 get an extra $600, after the age of 17 the balance of this credit goes away. This could amount to a tax bill increase of $2,000 to $3,000 per child, depending on your income. But stay tuned, Congress is actively looking to change this tax benefit.

At age 19 (24 if a full-time student): loss of the Earned Income Tax Credit (EITC). The EITC pays a potential credit worth up to $6,728 for people with three or more qualifying children. Children stop being counted when they turn 19, or when they are 24 if they are full-time students.

What to do

Many of the child-related credits and deductions are meant to offset the cost of raising a child. Prepare now for the inevitable change in your tax situation that occurs when they go away. Here are some ideas:

• Know the age triggers. Note the tax years that these changes will occur. If a child is approaching one of these key years, adjust your spending to save a little more during the year to account for the change.

• Revise your withholdings. At the beginning of each key year, look at adjusting your withholdings on your paycheck to ease the potential tax burden.

• Conduct a tax forecast. Understand what the true impact of the change might be. You may find the tax hit less of a burden than you think. If you need help planning ahead, don’t hesitate to call.

Remember folks, never take advice from strangers on the internet! Always talk to your own tax preparer about your specific situation. These posts are meant to educate and inform, and aren't to be taken as actionable advice.

Are you withholding enough for your taxes?

As we enter mid-year, it's a good time to check your tax withholdings to ensure you haven't been paying too much or too little. This is especially true if your income was impacted by the pandemic or you have a change to your marital status, or number of dependents.

This quick checkup will ensure you are not surprised with a large tax bill when you file your income tax return.

Get a rough estimate

The IRS has an online tool that will help you calculate how much your current withholdings match what your final tax bill will be. In order to get an accurate reading, you need to have a copy of your latest paycheck or last quarterly estimated tax filing (Form 1040 ES). It may also help to have your last tax return on hand if you expect to take similar credits and deductions this year.

The IRS tool is here: IRS Withholding Calculator

Enter your data, including your filing status, dependents and any information about credits. Then refer to your last paycheck or withholding statement and enter in your total withholdings so far this year. Also enter what you expect to earn by year-end.

After you enter your information, the tool prints a result and provides an estimate of your under or over withholding for tax. But remember, this tool is a rough estimate. If you are concerned about your situation it is always best to ask for help to get a better read or run through alternative scenarios.

How to fix a problem

Whether you're paying too much or too little, you can fix it by filling out a new W-4 form and giving it to your employer. If you do so, you'll have to file another W-4 at the start of 2022 to return your withholding schedule to normal. If you're filing quarterly estimated taxes, you can adjust your next quarter's estimate in a similar way.

Why a checkup is important

In a perfect world, you would not owe too much nor get too large a refund. Unfortunately, the federal government refunds more than $3,000 a year to the average taxpayer. Think of that money as an interest-free loan the government borrowed from you. Conversely, a shortfall means writing a large check when you file your tax return. That's a surprise few of us need.

Remember folks, never take advice from strangers on the internet! Always talk to your own tax preparer about your specific situation. These posts are meant to educate and inform, and aren't to be taken as actionable advice.

Minimizing Tax on Social Security Benefits

Whether your Social Security benefits are taxable (and, if so, the amount that is taxed) depends on a number of issues. The following facts will help you understand the taxability of your Social Security benefits. 

For this discussion, the term “Social Security benefits” refers to the gross amount of benefits you receive (i.e., the amount before reduction due to payments withheld for Medicare premiums). The tax treatment of Social Security benefits is the same whether the benefits are paid due to disability, retirement or reaching the eligibility age. Supplemental Security Income (SSI) benefits are not included in the computation because they are not taxable under any circumstances.

• The amount of your Social Security benefits that are taxable (if any) depends on your total income and marital status. 

• If Social Security is your only source of income, it is generally not taxable. 

• On the other hand, if you have a significant amount of other income, as much as 85% of your Social Security benefits can be taxable. 

• If you are married and lived with your spouse at any time during the year and file a separate return from your spouse using the married filing separately status, 85% of your Social Security benefits are taxable regardless of your income. This is to prevent married taxpayers who live together from filing separately, thereby reducing the income on each return and thus reducing the amount of Social Security income subject to tax.

• The following quick computation can be done to determine if some of your benefits are taxable:

Step 1. First, add one-half of the total Social Security benefits you received to the total of your other income, including any tax-exempt interest and other exclusions from income. 

Step 2. Then, compare this total to the base amount used for your filing status. If the total is more than the base amount, some of your benefits may be taxable. 

The base amounts are: 

• $32,000 for married couples filing jointly;

• $25,000 for single persons, heads of household, qualifying widows/widowers with dependent children, and married individuals filing separately who did not live with their spouses at any time during the year; and 

• $0 for married persons filing separately who lived together during the year. 

Where taxpayers can defer their “other” income, such as Individual Retirement Account (IRA) distributions, from one year to another, they may be able to plan their income so as to eliminate or minimize the tax on their Social Security benefits for at least one of the years. However, the required minimum distribution rules for IRAs and other retirement plans have to be taken into account. 

Individuals who have substantial IRAs — and who either aren’t required to make withdrawals or are making their post-age 72 required minimum distributions without withdrawing enough to reach the Social Security taxable threshold—may be missing an opportunity for some tax-free withdrawals. Everyone’s circumstances are different, however, and what works for one person may not work for another.

Gambling Tax Gotcha – Because gambling income is reported in full as income and the losses are an itemized deduction, the gross gambling winnings increase a taxpayer’s adjusted gross income (AGI) for the year. This can cause more of your Social Security benefits to be taxable, even if gambling losses exceed your winnings, simply because winnings are added to the AGI and losses are an itemized deduction.  

If you have questions about how these issues affect your specific situation, or if you wish to do some tax planning, please shoot us an email.

Remember folks, never take advice from strangers on the internet! Always talk to your own tax preparer about your specific situation. These posts are meant to educate and inform, and aren't to be taken as actionable advice.