Did your paycheck seem a little higher? If so, it could be a tax time bomb.

Many tax experts talk about shifting your tax burden from one year to the next. While in theory it may make sense, how can you make it work for you in practice?

The concept

Since the tax code is complex in its construction, there are often opportunities to reduce your tax burden by controlling the amount of your taxable income. This is because:

• Income tax rates vary from 0% to 37% depending on your income and filing status.
• Many tax breaks have income limits.
• Tax breaks have income phase-out ranges.
• Incremental taxes like the alternative minimum tax are triggered by income level.

So if you can shift your income and expenses from one year to the next, you could create a net tax obligation for both years that might be lower than if you did nothing. Here are six great ideas to accomplish this.

Six great tax shifting ideas

Idea 1 – Know the rules. Identify whether you are a good candidate for using shifting as a tax planning strategy. For singles, the income tax rate increases 80% or more on earnings over $40,125. For married couples, that increase occurs with adjusted gross income over $80,250. But other tax benefits are lost at different income levels. Common tax breaks subject to income limits are child tax credits, earned income credits, educational credits, premium health care credits and many educational tax benefits.

Idea 2 – Load up your contributions. If you itemize your deductions, consider loading up your cash and non-cash contributions into the year that lowers more highly-taxed income. For example, you could shift next year’s donations to your church into this year. This bunching of itemized deductions into one year makes even more sense with the higher standard deductions introduced in 2018.

Idea 3 – Leverage the cash basis concept. You can take a deduction when you pay for it. A credit card receipt is good on the date you run the transaction and not when you pay your monthly bill to the credit card company. Knowing this, you could pay a property tax statement or a house payment either a little early or a little late to change whether that deduction occurs in this year or next.

Idea 4 – Stop working. There are many cases when this technique is an important tax shifting tool. The most common example applies to those who are under the full retirement age and receiving Social Security benefits. If this applies to you, consider actively managing your part-time work or you could end up paying taxes on some of your Social Security benefits or even losing some of them. Work can also hurt your tax situation when a dependent’s wages put you over the earnings threshold to receive the Health Insurance Premium Tax Credit. It may make sense to stop working or arrange to get your last paycheck delayed into the following year.

Idea 5 – Manage retirement plan distributions. Those over age 59½ can use distributions from pre-tax retirement plans to tightly control their taxable income. Your withdrawal calculation should include evaluating how to maximize the tax efficiency of your income. An analysis may indicate it is better to take out a little more this year to get these retirement earnings taxed at a lower rate than if you waited until next year.

Idea 6 – Manage your stock and investment sales. You have up to $3,000 in investment losses that can offset your higher-taxed ordinary income. Use this to your advantage when deciding whether to take a stock loss this year or next. If done correctly, you can match your stock loss against ordinary income which is taxed at a higher rate.

By shifting your taxable income to the right level, you can often reduce your tax bill. Please call if you wish to have a review of your situation.

You own some stock that has increased in value. To avoid a possible taxable gain by selling the stock, you wish to give it directly to a child or grandchild. This simple idea has some interesting tax consequences to consider.

Value of the gift

When you gift stock there are not one, but two values to consider.

1. Gift value. This is the market value of the stock at the time of your gift. Since there is a possible gift tax to you if the value of all gifts given by you to a person during the year is $15,000 or over ($30,000 for a married couple) you will need to calculate this value prior to finalizing your decision to provide the gift.
2. Value (basis) of the stock. You will need to determine the cost to you when you originally purchased the shares. This includes any brokerage or other fees. Provide the date(s) you purchased the stock and these costs to the person who will be receiving the gift.

Provide important information

Basis is key. Those receiving your direct gift of stock are not required to sell it. But when they do, they will need to know:

• The original cost of the stock and when it was purchased.
• The date and fair market value of the stock when it was given.
• If the giver paid any gift tax.

Timing is important. If the recipient of your gift sells the stock right away, the tax rate applied will depend on the length of time the stocks were owned by you. A gain on a stock held one year or less is considered ordinary income. More than one year is a long-term capital gain. The time-frame of this calculation usually goes all the way back to your purchase records.

The benefits

Some wrinkles

If your stock has a loss it is usually a better idea to sell the stock and take the tax benefit of the loss. If the stock you gift has a fair market value less than your cost, providing the information noted here to the recipient of your gift is even more important.

Please ask for help if you are considering a gift of stock or property. If handled incorrectly, your gift could create unforeseen tax consequences. But used in conjunction with other contribution techniques it can be a powerful tax planning tool.

* An additional 3.8% Medicare Tax or Net Investment Income Tax may also apply.

New state tax laws are making more and more taxpayers tax cheats without them realizing it is happening. Think it can’t happen to you? Here are some examples.

• Your small business registers for sales tax in Texas and you receive a letter from some obscure Texas town that says you need to send them a registration fee. Where did this come from?
• A Florida widower with income marries a retired woman who lived in Utah for nine months. The woman has no income. He has never been to Utah, even to visit. Per Utah tax law he must now pay income tax to Utah on his Florida income if he files a joint federal tax return.
• A Delaware resident owes Minnesota income tax for consulting work even though she never steps foot in Minnesota. This is because the company who the Delaware resident did work for has a physical presence in Minnesota. The same situation is true in California and other states.
• You decide to retire in Nevada to enjoy the sunshine. You then receive an audit letter from New York that says you need to pay them income tax, even though you no longer live there. They demand credit card statements, your driver’s license and more. You provide the information, yet their demands do not go away.
• California routinely sends out notices to small businesses throughout the country demanding detailed sales transactions for multiple years for any of their California businesses. If you do not reply, you could be in for an audit from this state.
• States are creating business fees to capture taxes from out-of-state small businesses. This is to get around national laws that protect interstate commerce. This new category of tax is in addition to income taxes and sales/use taxes.

Until national leadership provides unified interstate guidance, states will continue to get more aggressive with the creation of new tax laws. This is more prevalent as states struggle with lost revenue due to this year’s pandemic. There are even situations where two states can claim tax on the same income and you are stuck in the middle facing double taxation and tax penalties.

This ever-changing landscape requires annual review. This is especially true if you plan to move in the near future. Please call if you need help.

With the dramatic increase in identity theft, what can be done to protect your Social Security number (SSN) from these would-be thieves? Here are some ideas.

Remember to periodically check your credit score with the major agencies to ensure your data has not been stolen. Once stolen, it is often difficult to get a new SSN issued.

Withdrawing funds from your retirement accounts must be done carefully to avoid a potential 10% early withdrawal penalty. Unfortunately, each retirement account type has different rules. Here are some tips for Roth IRAs.

Roth IRA basics

Roth IRA accounts differ from other IRAs in that your contributions are made in after-tax dollars. If you follow the Roth IRA rules, your withdrawals of any earnings in the account can be tax-free. Generally, to take advantage of the tax-free distribution from a Roth IRA:

• You must be age 59½ or older.
• You must have had funds in the Roth IRA account for more than 5 years.
• You must understand what is being distributed (contributions, converted funds or account earnings).
• You must know your possible tax-free distribution options.

If you do not comply with these rules you could be subject to income tax and a 10% early withdrawal (distribution) penalty. But wait! There are ways to avoid getting taxed and the early withdrawal penalty.

Roth IRA distribution tips

• Plan around the 10% early withdrawal penalty. Prior to withdrawing funds, ask for help to ensure you know whether you will be subject to the early withdrawal penalty.
• Remember that contributions have been taxed. What many forget is that your initial contributions have already been taxed. The portion of your early distribution from a Roth IRA account subject to income tax is only the untaxed earnings on your contributions.
• Qualified early withdrawals. If you use the distributions for a qualified reason, you can avoid the early distribution penalty. Some of the more common qualified early withdrawals from a Roth IRA are used for:
  • College. If you withdraw Roth IRA earnings to pay for college expenses, you will pay tax on the earnings withdrawn, but you will not be subject to the 10% early withdrawal penalty.
  • First-time home buyer. Even if you’ve had your Roth IRA for less than five years, you can withdraw up to $10,000 in Roth IRA earnings tax-free and penalty-free if it is used to buy a first home.
  • Account holder disability or death.
  • Unreimbursed medical expenses that exceed your itemized deduction threshold.
  • Substantially equal periodic payments. These must be made over the defined life-expectancy of the IRA holder using specific rules to avoid the early withdrawal penalty.
• No minimum withdrawal requirements. The Roth IRA rules do not require you to take money out when you reach a certain age. This means you can have an estate-planning strategy to never withdraw the funds in your Roth IRA. While the funds would be considered part of your estate, your heirs could withdraw the funds tax and penalty-free.
• Keep separate accounts. The taxability of a withdrawal can be complicated. Are you withdrawing contributions, converted funds or earnings? How long have the funds been in the Roth IRA? Because Roth IRA distribution rules can be complex, if you convert funds from another retirement account into a Roth IRA, do so in a separate account. It will then be easier to understand the impact of a withdrawal from the account.

If you have questions regarding your situation, speak to an advisor prior to taking any withdrawals from a Roth IRA or other tax-advantaged retirement plan.

There are a number of areas in the tax code that cause confusion as to the taxability of money received. Here are some of the most common areas of confusion.

Unemployment compensation. Unemployment compensation is typically required to be reported as taxable income. Because of the pandemic, millions of taxpayers could now be facing a tax surprise with their unemployment income. There are historic cases where federal and state taxing authorities are authorized to exempt unemployment income from taxation, so this is an area worth watching for possible future legislation.

Free services. Receiving free services is almost always taxable as ordinary income under IRS barter regulations. You should report the fair market value of services received as income on your tax return. If you exchange services, you can deduct allowable business expenses against the value of the services provided. So if you are trading goods or services, now is the time to be tracking this information.

Illegal activities. Even income received from illegal activities is taxable income and must be reported. The IRS even states that stolen items should be reported at the fair market value on the date the thief stole the item.

Jury duty pay. This is taxable as ordinary income. Yes, even doing your civic duty can be a taxable event.

Legal settlements. A general rule of thumb with legal settlements is to consider what the settlement replaces. If the settlement replaces a taxable item, like lost wages, the settlement often creates taxable income. This area is complex and often requires a detailed review.

Life insurance proceeds. Life insurance proceeds paid to you because of the death of an insured are generally not taxable. There are, however, a number of exceptions to this general rule. For example, you could have taxable income if you receive benefits in installments above the value of the life insurance policy at time of death or if you receive a cash payout of a policy.

Prizes. Most prizes received should be reported as ordinary income using the fair market value of the item received. This area has been a major surprise to contestants on game shows, along with celebrities who have received large gifts at events like the Academy Awards.

Alimony. Alimony is taxable to the person who receives it and deductible to the person who pays it for divorce decrees prior to 2019. For all divorces finalized after 2018, alimony is neither deductible by the person who paid it nor deemed additional income by the person receiving it. So be aware of these new rules if you are considering a change to old divorce decrees. Make sure you have proper documentation as part of a divorce decree to support your tax position.

Child support. Child support is not taxable to the person who receives it on behalf of the dependent. It is also not deductible for the person who pays it.

Some of these areas can be complicated, so please call to discuss if any of these situations apply to you.

You may be considering booking stock losses due to recent market drops in order to save on your bill from Uncle Sam. Selling losers can be a great strategy when these losses can offset stock gains and up to $3,000 in excess stock losses can offset your ordinary income. However, there is a little known rule called the wash sale rule that could surprise the unwary taxpayer.

Wash sales

If the wash sale rule applies, you cannot report a loss you take when you sell a security. Per the IRS,

Why the rule?

Many investors were selling stock they liked simply to book the loss for tax reasons. They then turned around and immediately re-purchased shares of the same company or mutual fund. If done repeatedly, shareholders could constantly be booking short-term losses on a desired company while still owning the shares in a chosen company’s stock indefinitely. Clever shareholders would even purchase the replacement shares prior to selling other shares in the same company to book the loss.

Some ideas

How does one take action to ensure the wash sales rule works to your advantage?

1. Check the dates. If you decide to sell a stock to book a loss this year, make sure you haven’t inadvertently acquired the same company’s shares 30 days prior to or after the sale date.
2. Dividend reinvestment. If you automatically re-invest dividends, you will want to make sure this doesn’t inadvertently trigger the Wash Sale rule.
3. It is only losses. Remember the wash sale only applies to investments sold at a loss. If you are selling stock to capture gains, the rule does not apply.
4. Consider similar transactions. The wash sale rule applies to buying and selling ownership in the same company or mutual fund. With the exception of some common versus preferred stocks in the same company, buying and selling similar (but not identical) shares does not apply to the wash sale rule.

If your loss is ever disallowed because of the wash sale rule you can add the disallowed loss on to the cost of the new security. When the security is eventually sold in the future, the previously-forfeited loss will be part of the calculation of future gain or loss. This also includes the original stock’s holding period to help define the transaction as a short-term or long-term sale.

You’ve got it all planned out. Your retirement savings accounts are full, you have started receiving Social Security benefits and your pension is ready to go. Everything is planned. What could go wrong? Here are five surprises that can turn your plan on a dime.

1. Health emergencies and long-term care. When a simple procedure could cost thousands, health care costs can put a huge dent in your plan. Long-term care can also cost thousands per month. Have you planned for this? If your health insurance is not adequate you may need to pull money out of your retirement accounts to pay the bills. While this withdrawal may not be subject to a penalty, it might be subject to income tax if the funds are from a pre-tax account.

Tip: Look into creative ways to enhance your health insurance coverage including supplemental health insurance and prescription drug cost coverage. Consider long-term care insurance and other alternative ways to reduce your potential living needs.

2. Taxability of Social Security benefits. If you have excess earnings, your Social Security benefits could be reduced. Even worse, if you are still working, your benefits could be subject to income tax.

Tip: If this impacts you, consider conducting a tax planning session to better understand your options including the possibility of delaying the receipt of Social Security benefits.

3. Your pension plan. Understand if your pension is in good financial health. Pensions will often offer a lump-sum payout option for you. Should you take it?

Tip: Review your pension plan’s annual statement. How solid is it? If there are risks, consider cash out alternatives and planning for the potential drop in future income.

4. Minimum required distributions. Forgot to take your minimum required distribution from your retirement plans this year? No worries, as it is not required in 2020. The tax bite, however, could be quite a surprise in future years as the penalty on the amount not withdrawn is 50%!

Tip: Select a memorable date (like your birthday) to review your distribution and take action so this tax surprise does not impact you.

5. Future tax rates. The federal government is spending over $1 trillion more than it brings in each year. Cash starved states are looking for new tax revenue. Don’t be surprised when future tax rates continue to rise during your retirement.

Tips:

• Create a retirement plan with higher state and federal tax rates
• Plan for increases in health care costs through Medicare
• Plan for more taxes on Social Security benefits
• Plan for higher capital gain and dividend taxes (now 20% versus 15%)

If you have not already done so, now is the time to review your tax situation and make an estimated quarterly tax payment using Form 1040-ES. The 1st AND 2nd quarter due date is now here.

Due Date: Wednesday, July 15, 2020

You are required to pay, or withhold from your paycheck, at least 90 percent of your 2020 tax obligation or 100 percent of your 2019 tax obligation.* A quick look at last year’s tax return and a projection of this year’s obligation can help determine if a payment is necessary. Here are some other things to consider:

• You may need to account for six months! Due to the pandemic, the 1st quarter estimated payment deadline was extended to July 15 along with the 2nd quarter due date. So your payment may need to account for six months of estimated taxes!
• Account for unemployment compensation income. If you receive unemployment compensation income, you need to review your income tax withholdings and potential tax obligation. This may require you to pay estimated taxes on or before July 15.
• Avoid an underpayment penalty. If you do not have proper tax withholdings during the year, you could be subject to an underpayment penalty.
• W-2 withholdings have special treatment. A W-2 withholding payment can be made at any time during the year and be treated as if it was made throughout the year. If you do not have enough money to pay your required estimated quarterly payment now, you may be able to adjust your W-2 withholdings to make up the difference.
• Self-employed workers need to account for FICA taxes. Remember to account for your Social Security and Medicare taxes as well. Creating and funding a savings account for this purpose can help avoid the cash flow hit each quarter when you pay your estimated taxes.
• Don’t forget state obligations. With the exception of a few states, you are often required to make an estimated state tax payment at the same time you make a federal estimated tax payment. Consider conducting a review of your state obligations to ensure you meet these quarterly estimated tax payments as well.

* If your income is over $150,000 ($75,000 if married filing separate), you must pay 110 percent of last year’s tax obligation to be safe from an underpayment penalty.