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Make Your Child a Tax-Free Millionaire!

Want to jump start your child’s retirement with a million dollar tax-free account? Consider this:

The million dollar idea

As soon as your child begins to earn income, open a Roth IRA and set a contribution goal to reach before they graduate from high school. Assuming an eight percent expected rate of return, the investments made by age 19 will grow to FORTY times its value by the time they reach 67 (current full retirement age). For example, $2,500 invested before graduation will be $100,000 at retirement. If you can bump that up to a $25,000 investment before graduation, at retirement it will be worth $1 million!

Why it works

Compounding interest occurs when interest is earned on the interest generated from the initial contribution. The more time the investment has to grow, the more exponential growth will occur. By starting to save prior to graduating from high school, the investment will have almost fifty years of compounding growth.

Even better, while contributions to Roth IRA’s must be after-tax contributions, any earnings are TAX-FREE as long as the rules are followed! Simple to say, but how do you get $25,000 into a child’s Roth IRA? Here are some tips.

Tips to achieve the goal

  • Hire your child. Roth IRA contributions are limited to the amount of income your child earns, so earned income is key. If you own your own business or even make some money on the side, consider hiring your child to help with cleaning the office, filing or other tasks they can handle.
  • Look for acceptable young age work ideas. Baby sitting, yard work, walking pets, shoveling, and lawn work are all good ideas to get your child earning some income at a younger age. Cash based income is harder to prove, so don’t forget to keep track of the income and consider filing a tax return, even if not required.
  • Leverage high school years. Ages 15-18 will be when your child has their highest earning potential before graduation. Summer jobs, internships and part-time jobs during the school year can produce a consistent income flow to contribute to the Roth IRA and still provide spending money.
  • Parent or grandparent matching idea. The income earned by your child doesn’t have to be directly contributed by them to the Roth IRA – it simply sets the contribution limit. Make a deal that for every dollar of income your child saves for college, a parent or grandparent contributes a matching amount to their Roth account. College and retirement savings in one!

By helping your child get a head start on saving, it should ease any anxiety regarding retirement and help them focus on school, starting their career, and other personal development goals. If you have questions about Roth IRA’s or any other tax-related issues, please call to discuss them.

Understanding Tax Terms: Pass-through Entities- What are they? Why should you care?

Small business owners have a number of options on how to organize their business for tax purposes. Many small, single owner, businesses are not incorporated, and are deemed “sole proprietors”, in the eyes of the IRS. Other business entities, like C corporations, are taxed as a separate entity with distributions to owners taxed a second time as dividends. Still others are deemed “pass-through” entities like S corporations, Partnerships and Limited Liability Companies (LLC).

Pass-through entities

Pass-through entities do not pay taxes at the company level. Instead, the business tax return reports the net income to the IRS, but then distributes the taxable income to their respective owners via a K-1 tax form. Each individual owner then reports their share of the K-1 net income on their individual tax return and pays the tax on this and any other personal income.

Generally, business owners like pass-through entities because:

  • The business income is taxed once instead of twice as in the case of C corporations.
  • The business format provides owners a level of legal protection that is not available by doing business as a sole proprietor.

What you should know

  • Individual tax rates. Changes in individual tax rates have an impact on the amount of tax paid by all small businesses that are organized as pass-through entities.
  • New 20 percent deduction. Starting in 2018, a new 20 percent qualified business income deduction is available for pass-through entities and sole proprietorships. There are limitations and other complexities involved, but the bottom line is many small business owners will see a tax break.
  • Can you pay the tax? Small pass-through businesses must pay income tax on all their business profits. However, the business entity is NOT required to distribute cash from the company to help pay the tax. So pass-through owners could see a tax bill without money to pay the tax.
  • Minority shareholder caution. Minority shareholders in pass-through entities are doubly cursed. They not only may not receive distributions to pay taxes due, but they are often precluded from selling their shares, and they do not have enough ownership to require distribution of funds through shareholder voting.
  • Very popular business entity type. According to the IRS the S corporation formation is a popular business entity type with 4.6 million S corporations in 2014 – roughly twice the amount of C coporations. LLCs are quickly becoming the new entity of choice with growth from 120,000 in 1995 entities to over 1 million entities today.

If you have any questions regarding your current small business organization or are looking to start a small business and need help choosing the best entity for your situation, please call.

Rent Your Property Tax-Free

Most income you receive is taxable income that is reported to you and to the federal/state tax authorities. However, renting out your home or vacation property on a short-term basis can be done tax-free if you follow the rules.

The rule: If you receive rental income for less than 15 days per year, that income is generally not taxable income.

Added benefit: In addition to tax-free rental income, you may still deduct your mortgage interest expense and property taxes as itemized deductions. Neither of these tax benefits is reduced by the income from up to two weeks of rental activity.

Would someone want to rent your property?

Sure it sounds good, but why would someone want to rent your property? Here are some ideas:

Special events. If a big event is in town, consider renting out your home for participants and fans. Common examples include:

  • Football games
  • Concerts
  • Golf tournaments
  • Conferences and expos
  • State high school tournaments

Vacation home rental. If you have a cabin or cottage, consider renting out your place for two weeks. If you find responsible renters, you may have an opportunity to find reliable repeat renters each year.

Hotel alternatives. Oftentimes travelers from other cities and countries would love to rent out homes or rooms within homes while traveling. This lets travelers have a real “local” experience.

Know the risks

The hassle factor needs to be considered prior to taking advantage of this free income opportunity. Having a proper rental agreement, damage deposit, and insurance are key factors to consider. Also remember that if you rent out your property for more than 14 days, all rent received is taxable and rental income rules apply. And don’t forget to review any local regulations prior to renting your property.

Home rental sites like VRBO and Airbnb can help you better understand your options for renting your property.

Salvage that Sunken Uncollectible Debt- Victims of reneged payment agreements might have a tax deduction

There are few things as frustrating as not being paid what is owed to you. If it becomes clear the debt is not going to be paid, you might be able to recoup some of the lost money via a tax deduction. The IRS has two classifications for bad debt: business and non-business, each with its own deductibility rules.

Business bad debt

In order to be considered a deductible business bad debt, the IRS states that the debt must be closely related to your trade or business. Business bad debt is typically unpaid customer invoices, but it can also include business-related loans. To qualify as a deduction, these two statements must be true:

  • The amount is already included as income or as an asset
  • The debt is considered to be partially or completely worthless

There are many ways to determine the worthlessness of a debt, but at a minimum, you should be able to produce a recap of collection efforts. You need to show the IRS that you did everything you could to collect the debt. If you determine the bad debt is valid, you can deduct it as a business expense.

Non-business bad debt

All bad debt not defined as business-related, is classified as non-business. For a non-business bad debt deduction, the debt must be considered 100 percent worthless. There is no partial deduction available. In addition, you need to prove that the debt is a loan intended to be repaid and not a gift – especially if loaned to a friend or family member. The best way to prove this is with a signed agreement.

If you determine the bad debt is valid, you can report the amount as a short-term capital loss. The loss is subject to capital loss limitations and you need to submit a statement with your tax return that includes the following:

  • Description of the debt
  • Amount of the debt and when it became due
  • Name of the debtor
  • Business or family relationship between you and debtor
  • Efforts you made to collect the debt
  • Why you decided the debt was worthless

While no one wants to be in a position to write off debt, it’s nice to know that you can at least benefit from a tax deduction. If you find yourself in this situation or are planning to loan funds in the future, call to set up a plan of attack.

What Does the IRS Have on You?- Here is how you can find out…

There are multiple situations where you need to find out what the IRS knows about you. It could be for the purpose of obtaining a loan, refinancing your house, or continuing your citizenship status. Possibly you are a few years behind on filing tax returns and need to know where to start. Or maybe you lost a return and simply need a copy for your personal records. Here are three items that will help you see what the IRS has on file for you:

  • Tax return transcripts and account transcripts: A tax return transcript is a summary document that shows most line items and amounts from your original return. It also includes the forms and schedules filed with the return. A tax account transcript has basic high level information such as return type, filing status and adjusted gross income. It will also show if an amendment has been filed. Both types of transcripts are available for the current tax year and the prior three years (ten years for account transcripts), and are often acceptable proof of income for loans, mortgages and financial aid. Transcripts from the IRS are free and can be viewed online or mailed to your home within 5-10 days.
  • Copies of tax returns: If a transcript is not sufficient, you can request an actual copy of the tax return as far back as six years. The current fee per copy is $50 and can take 75 days to receive. The fee is waived if you live in a federally declared disaster area.
  • Freedom of Information Act (FOIA) document request: If you are looking for IRS records besides your returns, a FOIA request might be for you. Per the IRS, “the FOIA applies to records either created or obtained by an agency and under agency control at the time of the FOIA request.” In order to receive the documents, submit a detailed request and conduct the necessary fee calculation. According to the FOIA, the IRS must provide records unless they fall under a handful of exemptions or exclusions. Examples of exemptions are records that have classified information or are involved in an ongoing investigation. The fee and response time varies by the scope of the request. A FOIA request is a good place to start if you have past due tax returns that need to be filed or are at odds with the IRS regarding an audit decision.

No matter what your tax situation is, it’s good to know what your options are if the time comes that you need to get information from the IRS. Please call if you need help making a request.

Make sure you’ve got a plan for your RMDs

After all the advice you’ve received about saving for retirement, taking money out of your traditional IRAs and other qualified retirement plans may feel strange. Yet once you reach 70½, the required minimum distribution (RMD) rules say you have to do just that.

Under these rules, you must withdraw at least a minimum amount from your retirement plans each year. Since the withdrawals are considered ordinary income, planning in advance can help you prepare for the impact on your tax return. Here some planning tips:

  • Make a list of your accounts. The rules require an RMD calculation for each plan. With traditional IRAs, including SEP and SIMPLE plans, you can take the total distribution from one or more accounts, in any amount you choose. You can also take more than the minimum.

However, withdrawals from different types of retirement plans can’t be combined. Say for instance, you have one 401(k) and one IRA. You have to figure the RMD for each and take separate distributions.

Why is that important? Failing to take distributions, or taking less than is required, could result in a penalty of 50 percent of the shortfall.

  • Plan your required beginning date. In general, you’re required to withdraw RMDs by Dec. 31, starting in the year you turn 70½. The rules provide one exception: You have the option of postponing your first withdrawal until April 1 of the following year.
  • Consider the ramifications of delaying your income. Delaying income can be a sound tax move. But because you’ll still have to take your second distribution by Dec. 31, you’ll receive two distributions in the same year, which can increase your taxes.

Give us a call if you have questions about your RMDs and how they’ll affect your taxes. We can help you create a sound distribution plan.

You’re child wants to start a business. Now what?

Has your child asked for your help with starting a business? If the answer’s yes, chances are you may not know where to start.

Since the failure rate for new businesses is high, it would be supportive for you to do whatever you can to increase your child’s chances of success. That includes considering the following:

  • Find out what groundwork has already been done. Before involving yourself, find out how much time, thought and effort your child has already devoted to the proposed business.

If the enterprise is no more than an idea, you can suggest approaches to researching the market and determining the resources, knowledge and skills that will be needed. However, your input should be limited to guidance and ideas. Your child should do the work.

Once your child has completed the necessary groundwork, and if the project still seems reasonably feasible, you’ll be ready to consider the next steps.

  • Help your child stay motivated. To succeed, your child must be motivated. They make like the idea of self-employment but lose interest when confronted with the realities of planning and preparation.
  • Determine what kind of financial support you’ll offer (if asked). Whether you’re making a loan or buying an ownership interest, never put up more money than you can comfortably afford to lose.

Try not to be the sole source of capital. Make it clear that you’ll lend or invest a specific amount and no more. You also may wish to set restrictions on the use of the funds within the business. Risk is part of the business experience, and your child should have some personal assets at stake.

  • Put everything in writing. Specifically, loans should be supported by signed notes that include repayment terms and require interest at market rates. Investments should be supported by partnership agreements, shareholder agreements or similar documents that describe operating arrangements, profit and loss sharing, buyout provisions and closing contingencies.
  • Don’t forget tax planning. You’ll probably want to allocate any taxable income to your child, and you certainly will want to be able to write off your loss if the business goes bad. Proper documentation will be paramount, since the IRS closely scrutinizes family transactions.

If you’re thinking about helping your child get started in a business, give us a call. We can offer guidelines to fit your particular circumstances.

Steer clear of these 5 retirement plan mistakes

Participating in a 401(k) or similar retirement plan is a tax-advantaged way to save for retirement. If you have the option of participating in a 401(k) plan, avoid these five common mistakes:

  • Not taking full advantage. Too many employees opt out of the plan or don’t contribute as much as they can afford. At a minimum, try to set aside enough to receive the full employer-matching contribution.
  • Investing too much in company stock. Try not to put all your eggs into one basket when it comes to company stock. Even if the company is doing well now, things can change. If you lose your job, you don’t want to lose your retirement savings, too.

If your employer uses company stock for the matching contribution, you may have no choice. But at least you can select other investments for your own contributions.

  • Borrowing from your plan. Take a loan from the plan only as a last resort. Remember, these savings are for your retirement, not to fund everyday needs. When you borrow from the plan, you’re losing the tax-deferred growth on those funds.
  • Withdrawing your savings if you change jobs. It’s tempting to cash out your savings if you change jobs. But if you do, you’ll owe taxes and probably a penalty. More importantly, you’ll lose the future tax-favored growth that you might need in retirement. Instead, talk to your financial advisor about a rollover into an IRA or your new employer’s plan.

Reminder: Third Quarter Estimated Taxes Due- Now is the time to make your estimated tax payment

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 third quarter due date is now here.

Due date: Monday, Sept. 17, 2018

SPECIAL NOTICE: With major tax law changes in place for 2018, forecasting your tax obligation is more important than ever. If you need a review of your situation consider doing so immediately to avoid any surprises at tax time.

Remember, you are required to withhold at least 90 percent of your current tax obligation or 100 percent of last year’s 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:

Underpayment penalty. If you do not have proper tax withholdings during the year, you could be subject to an underpayment penalty. The penalty can occur if you do not have proper withholdings throughout the year. A quick payment at the end of the year may not help avoid the 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 funds to pay the estimated quarterly payment now, you may be able to adjust your W-2 withholdings to make up the difference.

Self-employed. Remember to account for the need to pay 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 also required to make estimated state tax payments if you’re required to do so for your federal taxes. 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 separately), you must pay 110 percent of last year’s tax obligation to be safe from an underpayment penalty.

3 important ages that matter for retirement planning

There are a few special ages that may play important roles in your retirement planning. Here’s a reminder of those ages and why they matter:

  1. Age 50: At this age, you can make extra “catch-up” contributions to your IRA and 401(k) savings. For 2018, these are $1,000 and $6,000, respectively.
  2. Age 59½: Once you’ve reached 59½, you’re eligible to make penalty-free withdrawals from your IRAs.
  3. Age 70½: After you reach 70½, you’re required to take minimum distributions from your traditional IRAs annually