Produced monthly for Clients & Friends of the Advisory Group Associates.
Our Mission. Sharing ideas that make a real difference.
This “TAX TIPS NEWSLINE” is compiled by its founder, Frank Zerjav CPA and team of Professional Tax Associates, and then it is sent by email each month because you need tax and compliance knowledge. It’s a big part of your life and the entities that you operate.
Our firm engages in strategic tax planning for professionals, business owners, investors and individuals. Our responsibility to our clients is to minimize their tax burden by appropriate proven methods, which helps them to keep more of what they earn. Our primary objective is the well-being of clients, as well as their satisfaction with the work we do.
Inside this Month’s Issue
· Report of Foreign Bank & Financial Accounts (FBAR)
· Important Legal Documents For All Couples
· Your Rights As A Taxpayer
· More Business Owners Switching to C Corp Status
· Stretch an IRA over generations
· Launch a “Solo” Individual 401(k) Plan
· ROTH IRA Conversion Strategy to Avoid Taxes
· Business Tax Deductions
· Wide Range of Services Offered
REPORT OF FOREIGN BANK & FINANCIAL ACCOUNTS (FBAR)
This information report (FBAR) filing deadline is June 30, 2015.
IRS had issued, during 2014, its “Reference Guide on the Report of Foreign Bank and Financial Accounts (FBAR),” which summarizes and augments previously published information on that report that must be filed by U.S. persons who have financial interests in or signature authority over financial accounts maintained with financial institutions located outside of the U.S.
The FBAR is not filed with a federal tax return. A filing extension, granted by IRS to file an income tax return, does not extend the time to file an FBAR. There is no provision to request an extension of time to file an FBAR.
The Financial Crimes and Enforcement Network (FinCEN) has delegated enforcement authority regarding the FBAR to the IRS.
• Recordkeeping. The Reference Guide provides that, generally, records of accounts required to be reported on the FBAR should be kept for five years from the due date of the report, which is June 30 of the year following the calendar year being reported. The records should contain the following: a) name maintained on each account; b) number or other designation of the account; c) name and address of the foreign bank or other person with whom the account is maintained; d) type of account; and e) maximum value of each account during the reporting period. Retaining a copy of the filed FBAR can help to satisfy the recordkeeping requirements. An officer or employee who files an FBAR to report signature authority over an employer’s foreign financial account is not required to personally retain records regarding these foreign financial accounts.
• If a filer does not have all the available information to file the return by the June 30 filing due date, the Reference Guide provides that the filer should file as complete a return as possible by June 30 and amend the report when additional or new information becomes available.
IMPORTANT LEGAL DOCUMENTS FOR ALL COUPLES
According to the US Census Bureau, the number of unmarried adult couples has greatly increased over the past 50 years. Nowadays, it is more socially acceptable to move in together before getting married and more and more people are thinking twice about marriage.
Many of the people that are thinking twice about marriage are doing so because they saw what happened to their parents’ marriage - ending in a bitter divorce - and in some cases even seeing what has happened to themselves and/or friends. For this reason, they would rather just live together and make the finances less murky.
Legal Documents for Unmarried Couples
Unfortunately, while not getting married clears up the murky water for divorce, it muddies up the water when it comes to long-term planning. This is an area where many unmarried couples fail to take the steps needed to ensure they are protected and are able to help and provide for their loved ones. Here are 3 documents all unmarried couples need to have for the long-term:
1. Will. Having a will is a big deal for an unmarried couple. In most states, if you pass away without a will, the court will dictate how your assets will be dispersed. Most likely they will go to your spouse, then to your children. In the event you have neither, they will go to siblings or your parents. The problem is that you could have a loved one – an unmarried partner - who will not get anything from the court because you are not related by birth or marriage.
This is why you need to have a will. While your siblings could give physical belongings back to your partner, it will be difficult to give cash or stocks, especially if they are in large amounts. There also could be issues with family members not wanting to give anything to your partner as well. To benefit everyone, it makes sense to have a will set up in place to make sure your assets go where you intend them to go.
2. Power of Attorney. A power of attorney, also called a health care proxy, gives someone the right to make health related decisions on your behalf, should you be in a position to not make the decision yourself. A common example is if you were in a coma, someone else would have the ability to make the decision to keep you on life support.
But it doesn’t stop there. It could also mean making decisions for you if you have Alzheimer’s or other diseases as well. The reason you need to have a power of attorney is because without it, your unmarried partner cannot make any decisions for you. The only ones that can are family members, and without being married, your partner is not a family member.
3. Durable Power of Attorney. While a power of attorney helps you in medical situations, a durable power of attorney allows for financial decisions to be made for you should you become incapacitated. Don’t mistake “incapacitated” for dying. It simply means that a person is temporarily or permanently impaired and unable to make rational decisions. This could be any number of accidents or instances not related to passing away.
As with the examples above, the courts look at family members to make decisions on your behalf and your partner is not a family member if you are not legally married.
An Example of the Need for These Documents
Let’s say that you get into an accident and someone else needs to start making decisions on your behalf. Since you and your partner are not married, they have zero say in the matter. The court turns to your parents, who you don’t have the greatest relationship with. Would you rather have them make decisions on your behalf or your partner? Most would answer their partner, but without these documents, your partner can not make the decision, let alone any decision.
While this example might sound a little on the extreme side, it happens more often than you would think. And furthermore, even if you think your parents have your best intention in heart, do they have the intentions you truly want, the one you have discussed and know your partner knows?
Final Thoughts. Take the few hours at an attorney’s office and set up these 3 documents if you are living together with your partner and have no plans on getting married. Ideally, you will never need to use two of them, but there is the chance they will need to be used. In that regard, it is better to have your bases covered and know who can make the decisions on your behalf.
YOUR RIGHTS AS A TAXPAYER
IRS Publication 1 explains your rights as a taxpayer and the processes for examination, appeal, collection, and refunds. It is also available in Spanish. Following is a summary:
THE TAXPAYER BILL OF RIGHTS
1. The Right to Be Informed
Taxpayers have the right to know what they need to do to comply with the tax laws. They are entitled to clear explanations of the laws and IRS procedures in all tax forms, instructions, publications, notices, and correspondence. They have the right to be informed of IRS decisions about their tax accounts and to receive clear explanations of the outcomes.
2. The Right to Quality Service
Taxpayers have the right to receive prompt, courteous, and professional assistance in their dealings with the IRS, to be spoken to in a way they can easily understand, to receive clear and easily understandable communications from the IRS, and to speak to a supervisor about inadequate service.
3. The Right to Pay No More than the Correct Amount of Tax
Taxpayers have the right to pay only the amount of tax legally due, including interest and penalties, and to have the IRS apply all tax payments properly.
4. The Right to Challenge the IRS’s Position and Be Heard
Taxpayers have the right to raise objections and provide additional documentation in response to formal IRS proposed actions, to expect that the IRS will consider their timely objections and documentation promptly and fairly, and to receive a response if the IRS does not agree with their position.
5. The Right to Appeal an IRS Decision in an Independent Forum
Taxpayers are entitled to a fair and impartial administrative appeal of most IRS decisions, including many penalties, and have the right to receive a written response regarding the Office of Appeals decision. Taxpayers generally have the right to take their cases to court.
6. The Right to Finality
Taxpayers have the right to know the maximum amount of time they have to challenge the IRS’s position as well as the maximum amount of time the IRS has to audit a particular tax year or collect a tax debt. Taxpayers have the right to know when the IRS has finished an audit.
7. The Right to Privacy
Taxpayers have the right to expect that any IRS inquiry, examination, or enforcement action will comply with the law and be no more intrusive than necessary, and will respect all due process rights, including search and seizure protections and will provide, where applicable, a collection due process hearing.
8. The Right to Confidentiality
Taxpayers have the right to expect that any information they provide to the IRS will not be disclosed unless authorized by the taxpayer or by law. Taxpayers have the right to expect appropriate action will be taken against employees, return preparers, and others who wrongfully use or disclose taxpayer return information.
9. The Right to Retain Representation
Taxpayers have the right to retain an authorized representative of their choice to represent them in their dealings with the IRS. Taxpayers have the right to seek assistance from a Low
Income Taxpayer Clinic if they cannot afford representation.
10. The Right to a Fair and Just Tax System
Taxpayers have the right to expect the tax system to consider facts and circumstances that might affect their underlying liabilities, ability to pay, or ability to provide information timely. Taxpayers have the right to receive assistance from the Taxpayer Advocate Service if they are experiencing financial difficulty or if the IRS has not resolved their tax issues properly and timely through its normal channels.
The IRS Mission: Provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.
MORE BUSINESS-OWNERS SWITCHING TO C-CORP STATUS
Key factor: For years, most individual share-holders were taxed at a lower federal rate than the maximum corporate rate. But the current top individual federal income tax rate of 39.6% is almost 5% higher than the top average corporate rate of 35%. Plus, tax reform calls to lower the corporate rate, which would create even more separation, are getting louder each year.
Finally, consider these potential drawbacks for an S-Corp status:
An S corporation can have only one class of stock (although it may have both voting and nonvoting shares).
Because amounts distributed to a shareholder can be classified as dividends or salary, the IRS often scrutinizes payments to ensure compensation is reasonable.
Due to the one-class-of-stock restriction, an S corporation cannot allocate a disproportionate share of tax losses or taxable income to a particular shareholder or group of shareholders.
STRETCH AN IRA OVER GENERATIONS
How would you like to leave tax-sheltered assets to your kids and grandkids that can actually increase in value over time? It’s not a pipe dream.
Strategy: Take advantage of the “stretch IRA” concept. As the name implies, this technique enables a family to stretch out the benefits of retirement savings over a longer period than usual. In the interim, the funds continue to grow tax-deferred.
Keeping it going requires coordination between the IRA holder and his or her heirs.
With a traditional IRA, you can accumulate savings for retirement without any current tax erosion. The IRA may be funded by annual contributions, subject to tax law limits, or a rollover from a qualified retirement plan like a 401(k), or both.
You must begin taking annual “required minimum distributions” (RMDs) after reaching age 70½.
RMDs are taxable at ordinary income rates. Thus, the tax rate on these mandatory IRA payouts may be as high as 39.6%, plus the extra taxable income from RMDs may trigger phase-out rules for valuable tax breaks.
The amount of the RMD for a particular year depends on your combined traditional IRA account balances as of Dec. 31 of the prior year and a life-expectancy divisor from IRS-approved tables. For instance, the RMD for a 75-year-old with IRA balances of $500,000 is $21,834 ($500,000 divided by the applicable life expectancy divisor of 22.9 from the standard IRS life expectancy table).
Alternatively, if you’ve designated your spouse as the sole beneficiary of the IRA and he or she is more than 10 years younger than you are, the RMD is calculated using a divisor based on your joint life expectancies. This will result in smaller annual RMDs than the amounts calculated using the divisors from the standard life expectancy table. Going back to our example, if a 75-year-old with $500,000 in IRA assets has a 60-year-old spouse, the joint life expectancy divisor is 26.5, and the RMD is reduced to only $18,868.
5 steps to stretch an IRA. The basic thrust behind the stretch IRA concept is to keep as much in the account for as long as you possibly can: RMDs should be minimized both before and after the IRA owner’s death.
1. Ensure that you have properly established the beneficiaries for all your IRAs. Double-check the paperwork, and then check it again.
2. Name successor beneficiaries. Doing so will ensure that RMDs will be calculated using divisors based on the beneficiary’s life expectancy (found in another IRS-approved table), which will be big numbers if the beneficiary is a generation or more younger than you. If you don’t name any beneficiary, your estate must liquidate your IRAs and pay the resulting income tax hit sooner rather than later.
3. Don’t withdraw a dollar more than the required annual amount. Don’t guess; use an
online calculator. This will allow you to preserve a larger nest egg for your heirs.
4. Upon the death of the IRA owner, beneficiaries can calculate RMDs based on their own life expectancies. Usually, these beneficiaries will be younger than the owner. If so, the life expectancy divisors will be bigger, and the RMDs will be smaller than while the owner was still alive.
5. If there are multiple beneficiaries, establish separate accounts for each one. Reason: After you die, RMDs generally must begin in the year of death or the following year. Unless separate accounts are used, the RMDs must be based on the life expectancy of the oldest beneficiary. Therefore, using separate accounts will reduce the size of RMDs for the younger beneficiaries who have longer life expectancies.
To qualify for the benefits of a stretch IRA after the account owner’s death, the beneficiary must establish an account in the deceased IRA owner’s name by no later than Sept. 30 of the year following the year of death. This should give beneficiaries enough time to make decisions regarding inherited IRA funds.
Tip: The tax penalty for failing to take an RMD, whether you’re the original IRA owner or a beneficiary of an inherited account, is steep. It’s equal to 50% of the required amount (less any amount withdrawn).
LAUNCH A “SOLO” 401(k) RETIREMENT PLAN
Strategy: Set up a “solo 401(k) plan.” If you qualify, you can effectively benefit from both “employee” and “employer” contributions to your account. In many cases, this dual tax winner can’t be beat because it often allows you to sock away more money than any other type of retirement plan.
An employee participating in a traditional 401(k) plan can make an elective deferral contribution to the plan within the annual limits and the employer may match part of the contribution, usually up to a single digit percentage of your salary.
A solo 401(k) offers even more. You may defer up to $17,500 of compensation to your account, plus an extra catch-up contribution of $5,500 is allowed if you’re age 50 or older - the same as with elective deferrals to a traditional 401(k). Of course, the limits on deductible employer contributions still apply, but here’s the kicker: Elective deferrals to a solo 401(k) don’t count toward the 25% cap. So you can combine an employer contribution with an employee deferral for greater savings.
The contributions to a solo 401(k) grow tax-deferred until you’re ready to make withdrawals.
If the business isn’t incorporated, the 25%-of-compensation cap on employer contributions is reduced to 20% because of the way contributions are calculated for self-employed individuals. But that still leaves you with plenty of room to maneuver.
Note that a solo 401(k) may offer other advantages. For instance, the plan can be set up to allow loans and hardship withdrawals. Also, you might roll over funds tax-free from another qualified plan if you previously worked somewhere else.
Tip: Contributions are discretionary. Therefore, you can cut back on your annual contribution - or skip it entirely - if your business is having a bad year.
ROTH IRA CONVERSION STRATEGY TO AVOID TAXES
If you have money in a traditional IRA and want to take advantage of a Roth conversion, you need to know about the pro-rata tax treatment of conversions.
If you have both tax deferred and after tax money in a traditional IRA, you could face hefty taxes on the deductible IRA money, since you must convert a pro-rata amount of deductible and non-deductible money.
If you want to convert just your after tax money, which is common when using a backdoor Roth IRA strategy, you can use this Roth IRA conversion strategy to avoid taxes if your 401k provider allows transfers of IRA money.
Roth IRA Conversion Strategy to Avoid Taxes. When you make a Roth IRA conversion for your IRA you must include a portion of tax-deferred money in the IRA in proportion to the amount held.
If your 401k provider allows transfers of IRA money, you can transfer your deductible IRA money to your 401k. When you convert your remaining non-deductible money in your traditional IRA to your Roth IRA, it will be tax free!
Tax Free Roth IRA Conversion Steps:
1. Identify how much money in your IRA was (or will be) deducted on your taxes.
2. Move your deductible IRA money to your 401k.
3. Make a Roth IRA Conversion with your non-deductible money.
4. Report your conversion with 100% basis on form 8606.
5. The conversion will be tax free.
Let’s say I have an IRA worth $100,000, with $50,000 (50%) tax deferred and $50,000 after tax. If you complete a conversion of $20,000 to a Roth IRA, you will be responsible for taxes on $10,000, or 50%. You cannot specify to convert only the after-tax money in the account.
If you used the strategy above, you would first move $50,000 of tax deferred money to your 401k. Then, when you make your $50,000 Roth IRA conversion, the taxable amount will be $0.
Which IRAs count? Don’t forget to account for all of your IRA money when you determine how you might make this work. All IRAs including rollover IRAs are considered one IRA for conversion purposes. The traditional IRA also includes your SEP-IRAs and SIMPLE IRAs.
Add additional money. Before your conversion, you can also contribute to a non-deductible traditional IRA at your broker of choice up to the IRA Limits.
Don’t have a 401k? If you don’t have a 401k, or your current 401k provider doesn’t accept incoming money, you could establish a solo 401k for the purpose of moving your deductible money in your traditional IRA.
Keep detailed records. If you do this, you need to keep very detailed records. For more see How to Track Your Roth IRA Contributions... and Why You Need To!
Early retirement and Roth IRAs. This strategy sounds like a lot of work to move money into a Roth IRA.... why would you want to hassle? If you are considering an early retirement, the Roth allows much more flexibility in early withdrawals than a traditional IRA. After a conversion, you only need to wait 5 years, then you can withdraw your conversion money tax free. A real benefit for anyone considering early retirement!
BUSINESS TAX DEDUCTIONS
Opportunities abound for small businesses to cut their tax bills. The key is understanding what’s deductible for your business.
Good record keeping is the key to lower tax preparation fees, painless IRS audits and more deductions.
Here’s a rundown of expenses to track:
Auto expenses: You may deduct mileage, parking fees and tolls for business use of your car. Most people take the standard mileage rate deduction because the record keeping requirements are less burdensome, but actual expenses often yield a larger deduction. Keep track of the mileage, odometer start and finish for each trip, destination, the starting point and business purpose.
Equipment, furniture and supplies: Look at your purchases and ask your tax preparer to run the calculations to see if you should expense it or depreciate it. Buying equipment just to get a tax deduction is not good business sense.
Professional and legal expenses, and association dues: Professional and legal expenses are deductible, but if the costs are part of startup expenses, you may need to amortize the cost. Association dues may include a portion for political contributions or lobbying, so those can’t be deducted. The association must disclose this amount or percentage.
Expenses to start up or expand your business: The biggest mistake in deducting expenses to start up or expand your business is failing to make an election to amortize or deduct these expenses in the first year. An election is required stating your intention to amortize them. Otherwise, the expenses become nondeductible until you sell or liquidate the business.
Professional publications and software: Here again, the common error is taking the cost as an expense instead of amortizing. Software licensing fees, for example, should be capitalized and amortized unless it has a life of only one year, such as an annual maintenance agreement. Professional publications should be amortized over the subscription period if prepaid.
Gifts and advertising: Client gifts are deductible up to only $25 per gift. And if you advertise, deductions taken for costs that cover multiple-year contracts must be spread over all the contract years.
Home office: If you have a legitimate home office, don’t be afraid to deduct it. To qualify, the room must be used exclusively for business. It can’t double as a spare bedroom or toy room for your kids. You can deduct a portion of rent, utilities, insurance, taxes, maintenance, professional cleaning, depreciation and interest.
Telephone and internet: Any dedicated services for your business are deductible. If you use your home or personal cell phone for business, you may only deduct the portion used for business purposes.
Education and training: You may deduct the cost of continuing education or certification for the business you’re already in, but education that qualifies you for a new line of business is not deductible.
Interest on loans: You can fully deduct interest on loans and credit cards used for your business. If you have a loan from a relative, make sure it conforms to IRS rules.
Entertainment and travel expenses: Keep excellent records here, and keep a log of who you met, why, where, when and for what business purpose. Only 50 percent of meals and entertainment costs is deductible, and none of the costs associated with country club memberships are deductible.
Insurance: Insurance premiums for the business for one year or less are deductible currently, while excess prepaid premiums are deductible in subsequent years.
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Tax Professional Standards Statement. The TAX TIPS NEWSLINE is published monthly to provide general educational tax compliance tips, information, updates and general business or economic data compiled from various sources. This document supports the marketing of professional services and does not provide substantive determination or advice affecting specific tax liability. It is not written tax advice directed at the particular facts and circumstances of any taxpayer. Nothing herein shall be construed as imposing a limitation from disclosing the tax treatment or tax structure of any matter addressed. To the extent this document may be considered written tax advice, in accordance with applicable requirements imposed under IRS Circular 230, any written advice contained in, forwarded with, or attached to this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code.
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