Lending to friends and relatives can be tricky, and not only because of the stress it can place on your relationships. There are tax issues involved as well. If you have to lend money to someone close to you, here are some tips to do it right in the eyes of the tax code.

Charge interest

Yes, you should charge interest, even to friends and family. If you don’t charge a minimum rate, the IRS will imply interest in the loan and tax you for the interest income they assume you should be getting. This can occur even if you’re not actually getting a dime.

Charge enough interest

Not only should you charge interest, the amount must be reasonable in the eyes of the IRS. If it’s not, the IRS will imply interest at their minimum applicable federal rates (AFRs). To stay on the safe side, always charge the interest rate at or above these AFRs, available on the IRS website. The good news is these interest rates are low and almost always below the prime interest rate.

Know the exceptions

If you don’t want to charge interest, you don’t have to IF:

• The money is a gift. In 2021, you and your spouse can each give up to $15,000 to an individual each year.

OR:

• The loan is less than $10,000 and is not used to purchase income-producing property.

If you don’t charge interest and the loan is used to purchase income-producing property such as capital equipment or to acquire a business, special tax rules apply. In this case it’s good to ask for assistance.

Get it in writing

If you expect repayment, write out the terms of your loan. There are a variety of basic loan document formats online that you can use. Creating a loan document may seem unnecessarily formal when dealing with a friend or family member, but it’s important for two reasons:

1. Document your tax code compliance. By documenting the terms and charging a stated interest rate, you can clearly show you are within tax code rules.
2. Avoid misunderstandings. Creating a written document will make it clear that it is a real loan, not an informal gift. Your friend or relative will know that you expect to be paid back and when you expect repayment.

What follows is a true story. A story with a sad ending. But one that has a lesson for everyone. Stick with the story, with a high degree of certainty most tax surprises can be identified with a little help.

The ingredients

Background. Back in the 1970s, U.S. Savings Bonds were a popular savings alternative. Grand parents purchased them for kid’s college. Many used them to build funds for retirement. Even better, you paid ½ the face value and later (usually 20 years) the bonds matured at twice what you paid for them. So a $1,000 investment yielded $2,000 when it reached maturity.

Our ingredients. In our case, this tax bomb had the following ingredients:

The bomb is set

Joe purchased Series E saving bonds each year in the 1970s. With half down and promise of double value upon maturity, Joe amassed a nice $140,000 retirement fund. After 20 years the bonds matured. Joe did not yet need the money, so he converted them to Series H savings bonds. This effectively deferred the interest income on the old, Series E, bonds since the bonds were not cashed.

With the new Series H savings bonds, Joe paid federal income tax each year on the interest earned. Meanwhile the taxable interest from the series E bonds continued to be deferred.

The result? Joe thought he was paying tax on the interest each year…BUT there was a sleeping tax bill on interest of $70,000 just waiting until Joe cashed in his series H bonds!

The bomb explodes

Joe received word that his series H bonds would no longer pay interest. So he tells his grandson to go to a bank and cash in the bonds. Heck, why have bonds that no longer pay interest? And…it’s no big tax deal because he has been paying tax on his Series H bond interest each year. The grandson has financial power of attorney so he does as his grandfather asks.

Surprise! He receives a notice from the IRS saying he owes them $24,000! This includes plenty of penalties and tax.

Lessons for all of us

• Never disregard 1099s or printed details. When the grandson cashed the bonds, if he looked closely on the face of the bonds, he may have noticed the deferred interest. But it would contradict what grandpa had told him. Further, his grandpa probably received a Form 1099 that was disregarded because he believed he was already paying the tax.
• Old savings bonds can be confusing. There are many different issues and flavors of savings bonds. When you see any uncashed bonds, conduct the necessary research to understand your potential obligations. This is especially true for bonds past their maturity date.
• Ask before you sell. Always understand the tax consequences BEFORE you sell any property. Even the most innocent of transactions can have their own tax time bomb. So call an expert before you buy or sell.
• Tax planning matters. While Joe would always owe federal income tax when he cashed the bonds, he could have reduced his effective tax rate by cashing them over time instead of all in one year. In this case, it exposed a lot of income to a much higher tax rate. He could have saved over $10,000 in tax with a little planning!

Because neither the bank nor federal taxing authorities believe it is part of their duty to help you make knowledgeable tax decisions, you are on your own. This one-way street of knowledge makes having an expert on your side more important than ever!

There are a lot of positive things about getting married, but the IRS’ marriage penalty isn’t one of them. The marriage penalty occurs when you pay more tax as a married couple than you would as two single filers making the same amount of money. It pops up again and again in the federal tax code. Thankfully, legislation in recent years is shrinking the problem, but it still exists. Here is what you need to know.

Tax Social Security benefits

Probably the worst example of the ongoing marriage penalty is imposed on older couples. Talk about insult! You make it to retirement as a couple and then get your Social Security taxed more quickly. This occurs because two single seniors start getting their Social Security retirement benefits taxed when their income exceeds $25,000. So the married threshold should be $50,000, right? Nope, it is $32,000. When you consider up to 85% of this benefit is taxable, is it a marriage penalty on couples that can least afford it!

Accelerating phase-outs

The tax code is filled with various income phaseouts for benefits, credits and deductions. Thankfully most now have the marriage penalty taken out, but it still exists in things like the Adoption Credit and Roth IRA contribution limits. But probably the worse example is that the earned income tax credit (EITC) phase-outs favor single versus married taxpayers. A single mother of three in 2021 can qualify for the EITC with income less than $51,464, while a married couple loses the EITC with combined income over $57,414. This is often one of the driving reasons for not marrying when you have lower income and children are in the home.

Affordable Care Act piles onto the marriage penalty

The Affordable Care Act also penalizes married couples with lower thresholds on its 0.9 percent wage surtax and 3.8 percent investment income tax. The income thresholds for these surtaxes are $200,000 for single filers and $250,000 for married couples filing jointly. As a result, singles who each earn $125,000 to $200,000 can get hit with the extra tax after they marry.

Even Itemizing deductions favors single taxpayers

One of the new provisions in the tax code that limits itemizing deductions is the $10,000 upper limit on taxes, like property taxes and sales taxes, that can be used for itemizing deductions for a single taxpayer. The limit for a married couple? Not $20,000. It is the same $10,000! Congress must not think a family may need a bigger place to stay or need to spend more for the extra family members.

The tax rate problem is now better

However, there is some good news on the marriage penalty front. Prior to law changes in 2017, most married couples paid higher tax rates than if they were two single people. This penalty is now eliminated for all but the highest earners. The marriage penalty now comes into play in the 34% tax bracket that begins with combined incomes well over $200,000. Most of us can see the results of this penalty in the news as celebrities conduct their tax planning and delay or avoid tying the knot.

The most import part of the marriage penalty is awareness of the problem. By knowing the tax pitfalls you can plan around them, and perhaps influence a change for the future.

If you work remotely in another state or are thinking about changing your residence from one state to another, you may be caught in the middle of a major state tax audit. If you keep a home in your original state or you later decide to return, you could have even more tax problems. State tax authorities may argue you never really left, and that you owe them a big tax bill for all the income you earned while away. Here are tips to ensure this does not happen to you.

Understand domicile

Tax residency is usually based on the concept of domicile. You may have many homes, but you can only have one domicile. A domicile is the place you intend to be your permanent home, and where you intend to return after being away. When these cases go to court, they are often decided by determining a person’s intentions regarding their domicile. Consider this hypothetical example:

Illinois resident Steve Seeyoulater moves to an apartment to pursue a lucrative job opportunity in Arizona leaving his wife and children behind in St. Paul, Minnesota to finish the school year. Steve reasoned that since he spent more than 70 percent of his time in Arizona, he could file his state return there and take advantage of its lower tax rate. The state of Minnesota could easily disagree with Steve’s assumption, since on the surface Steve may intend for his permanent home to remain where his family is, in Minnesota. In this case, both states will have a claim on Steve’s income.

Know the rules before you move

Before moving or working remotely, research the residency rules in your home and destination states. They often vary from state to state. Some states have specific guidelines on the number of days its residents must be in the state. Others are less exact.

Keep good records

If you say you are in a state for a certain period of time, be ready to support your claim. If during an audit your credit card receipts conflict with where you claimed to be at the time, you will have problems.

Demonstrate your intentions

If you’re going to file as a resident of a new state but also have a potential tax claim in another state, you have to be able to demonstrate your sincere intent to change your domicile. Here are some things you can do:

• Change your driver’s license to reflect your new home.
• Register to vote in your new state.
• Relocate your checking and savings accounts to a local bank.
• Use local service providers. Start going to a new, locally based doctor, dentist and church.
• Make sure as many things near and dear to your heart are located in the new state. These can include your loved ones, pets or favorite personal items.
• Spend the required amount of time in your new home, according to the state’s tax laws.

The last thing you want is a call from a state auditor looking for income tax. By being prepared, you can greatly reduce the risk of a surprising tax bill. Reach out if you’d like to discuss your unique situation.

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

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.

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If you use an installment sale to help sell property, you can benefit from tax deferral and possibly lower your overall tax bill. But you need to watch out for certain tax traps if you do.

Installment sale defined

Generally, you create an installment sale when you receive payments for sold property in the tax year of the sale and at least one other tax year. For instance, if you sell real estate for a profit in 2021 and receive payments in 2021 through 2026, your real estate transaction is an installment sale.

Tax implications

An installment sale creates a tax event in each year you receive payments. In the above example, part of your gain is taxable in 2021 and each year through 2026.

Note that property held longer than one year qualifies for favorable capital gains tax treatment. The current tax rate on long-term capital gains is from 0 to 20 percent, compared with the top ordinary income tax bracket of 37 percent.

You also have the ability to pay all the tax due on the sale up-front, to avoid paying tax on the installments in future years. In some cases you’ll reduce your overall tax bill this way, though it may require some help with tax planning.

Benefits of an installment sale

With an installment sale, you may be able to lower your total tax on the sale of the property by spreading this income out over several years. In addition, the buyer will often pay a rate of interest to you higher than a typical bank loan for the remainder of the amount due.

Installment sale tax traps

Related parties caution. If you sell property to a related party and the property is then disposed of within two years, in most cases all the remaining tax comes due immediately. The tax law definition of related parties is more expansive than you might think. It includes:

• Spouses
• Children
• Grandchildren
• Siblings
• Parents
• A partnership or corporation in which you have a controlling interest
• An estate or trust you’re connected to

To avoid this major tax surprise, consider stipulating in the contract that the property can’t be disposed of within two years.

Depreciation recapture potential. Also be cautious if you took any depreciation on the property in prior years. In some circumstances you will owe extra tax related to that depreciation when you sell the property.

Gains not losses. Be aware that installment sale treatment is only available for gains, not losses. Other special rules may apply, so reach out if you need advice specific to your situation.

Of course, tax discussions now in Congress might impact how installment sales and long-term capital gains are taxed in the future. If you’re planning an installment sale, consider reaching out for a consultation to discuss the tax implications.

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 print a result and provide a 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.

For years you have put away money from your pay into your employer provided 401(k) retirement savings account. Your employer may have even matched 50% of your contribution. Now you want to take some of this money out in the form of a loan to help pay your bills or to buy a car. Before you take action, here are some things to consider.

Loan versus withdrawal

If you withdraw funds from a 401(k) prior to age 59 ½ you may be in for a surprise at tax time. Withdrawals are subject to income tax and often are subject to a 10% early withdrawal penalty. A better option is to consider loaning yourself the money. 401(k) loans are available for up to 50% of your account balance.

The advantages

There are many advantages of borrowing money from your own retirement account.

The disadvantages

When making the tough decision to borrow your retirement savings, remember to first consider all your alternatives. But most important, understand if you leave your job you must repay the loan or face a potential tax hit!

This often overlooked bookkeeping and payroll tax requirement can cause a tangle of tax problems if not handled correctly. Could you be impacted? This is what you need to know.

Nanny tax explained

In an effort to capture income from household employees, the tax code requires you to obtain employee information, pay the related state and federal taxes, and withhold taxes for anyone you employ around the house. The requirement comes into play if you pay any one individual $2,300 or more (in 2021). You must then submit a W-2 for each of these household employees.

Who is covered?

The household workers typically covered by this law include:

• babysitters
• caretakers
• house cleaners
• domestic workers
• drivers
• health aides
• housekeepers
• maids
• nannies
• private nurses
• yard workers

Employee or Not an Employee

Before you panic, first determine whether your help is an employee or not. If in the eyes of the tax code, your help is not an employee the nanny tax rules DO NOT apply. What does the IRS look for?

1. Who controls how the work is done? If the worker clearly does, then the person is self-employed and not your employee.
2. Whose tools are used? If the worker’s tools are used then they are more likely self employed and not your household employee.
3. Work exclusively for you? If the worker has a number of customers then they are less likely to be your household employee.
4. Does an agency supply the worker? If an agency supplies the worker and controls what work is done and how it is done, the worker is not your employee.
5. Daycare services at an offsite location. If your childcare is conducted in the worker’s home, that worker is generally not your employee.

Some Suggestions

• Have your help become incorporated. The reporting rule only applies to hired individuals. If your household help is in a LLC or Sub chapter S-Corporation, it is up to that company to employ the worker and pay their employment taxes.
• Be aware of the annual limit. Make sure your total payments do not exceed the reporting threshold each year.
• Determine if the hired help are truly employees or self-employed.
• Rotate services. If you have help with yard work consider employing a number of helpers to make sure no one person is paid above the reporting threshold.
• Make the determination now. If you think you may have a household employee, ask for a review. Waiting until the end of the year can create a reporting problem for tax payments due during the course of the year.
• Follow the IRS checklist.If you know you are hiring a qualified household employee, here is a brief checklist provided by the IRS to help keep you out of harm’s way:
  • Find out if the person can legally work in the U.S. (form I-9)
  • Find out if you need to pay state taxes
  • Withhold social security and Medicare taxes
  • Withhold federal income tax if required
  • Determine if you are required to pay federal and/or state unemployment taxes
  • Determine the payment method and make tax payments
  • Get an employer identification number (EIN)
  • File W-2s each year and provide copies to your household employees
  • File household employment tax form with your annual tax return
  • Keep good records