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Taxable or Not Taxable?- Some of these items may surprise you.

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.



Understanding Tax Terms: Wash Sales- Surprise! Your stock loss is not deductible.

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,

A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

  1. Buy substantially identical stock or securities,
  2. Acquire substantially identical stock or securities in a fully taxable trade,
  3. Acquire a contract or option to buy substantially identical stock or securities, or
  4. Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

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.



Tax Surprises for the Newly Retired

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%)


Reminder: 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 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.



Five Big Tax Mistakes- Don't let them happen to you!

Every year taxpayers are hit with tax surprises that could be avoided if they just knew the rules. Here are five big ones that are easy to avoid with some simple planning.

Mistake #1. Withholding too little. This results in a tax surprise when filing your income tax return. Don’t be too hard on yourself if this happens to you. Social Security withholdings change each year and not understanding how your employer calculates how much tax to withhold can also contribute to withholding too little.

The plan: Check your withholdings after filing each year’s tax return. Make adjustments as necessary by filing a new Form W-4 with your employer. This is especially important if you have received unemployment benefits or need to make estimated tax payments due to the recent pandemic.

Mistake #2. Inadvertently withdrawing funds from retirement plans. Amounts taken out of pre-tax retirement plans like 401(k)s and IRAs can create taxable income. The most common inadvertent withdrawal occurs when you roll over funds from one retirement plan to another. If done incorrectly, the entire rollover could be deemed taxable income.

The plan: Do not touch your retirement accounts if at all possible. (Exception: When you reach age 72, you may be subject to required minimum distribution rules.) If you do withdraw funds, ensure you have the proper withholdings taken out at the time of withdrawal. Direct rollovers into your new plan are always a better alternative than receiving the withdrawal from the plan administrator and then conducting the transfer yourself.

Mistake #3. Not taking advantage of tax-deferred retirement programs. There are numerous opportunities to shelter income from tax through tax-deferred retirement programs.

The plan: Review your retirement savings options and plan to contribute as much as possible to your plans. Pay special attention to plans that include an employee match component. This attention can reduce your taxable income each year.

Mistake #4. Direct deposit mix-ups. You may now have tax refunds directly deposited in up to three bank accounts. The problem: what if one of the account numbers is entered incorrectly? Unfortunately, unlike replacing a lost check, the IRS does not have a good means of correcting this type of error. There have been instances where taxpayers have lost their refund when this occurs.

The plan: Many taxpayers do not feel comfortable giving the IRS direct access to their bank account. If you are in this camp, the digital deposit problem is solved as you will receive a physical check for any overpayment. If you use direct deposit, avoid depositing your refund into more than one account. Ideally, have a second person double check the account number on your tax form prior to submitting the return.

Mistake #5. Not keeping correct documentation. You know you drove the miles, donated the items to charity, had the medical expense and paid the daycare. How can the IRS be disallowing your valid deductions? Remember that without correct documentation the IRS is quick to disallow them.

The plan: Set up good record keeping habits at the beginning of each year. Create both a digital and paper folder separated by income and expense type. Keep a contemporaneous mileage log and properly document your charitable contributions.



Deducting Summer Activity Expenses- Don't forget to save receipts

The kids are out of school and summer is well underway. Make sure you understand the rules regarding the tax deductibility of summer activities and related daycare expenses through the use of the Child and Dependent Care Credit. Collecting those receipts now can save plenty during tax time.

What is deductible?

20 to 35% of qualified un-reimbursed expenses with a maximum amount of $3,000 for one person and $6,000 for two or more qualifying persons.

How it works

To receive the credit you must;

  • Have a dependent under the age of 13 or have a spouse or dependent who is physically or mentally unable to care for themselves
  • Have earned income (wages) to support the dependent
  • The expenses allow for care while you work or look for work
  • Have qualified expenses
  • Financially support and maintain a home for the dependent
  • If married, both you and your spouse must be working or looking for work.

Some summer-time tips

  1. Daycare expenses are the most common qualifying expense for the Dependent Care Credit.
  2. In-home daycare during the summer months also qualifies. Your sitter cannot be a dependent, a spouse or someone under the age of 19.
  3. Day camps qualify for the credit.
  4. OVERNIGHT camps and summer school/tutoring do NOT qualify
  5. Track the mileage of qualified transportation to and from any qualified activity. For instance, if your daycare provider takes the kids on a field trip, the mileage would be part of the qualified activity.
  6. Even cooking and housekeeping expenses can count if at least partly for the protection and safety of a qualifying person.
  7. Placing your child in a day camp while one of you volunteers at a charity would not work in determining qualified dependent care expenses.

Don’t forget to get the provider’s name, address, and Social Security Number/Tax ID number. Also retain and receipts and canceled checks to support your proof of payment. This information will be required when you fill out your tax return.



Tax Tips to Aid in Retiring Early- Don't forget to look at the retirement specials on the tax menu

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Estate Taxes: What EVERYONE Should Know

Most taxpayers ignore the federal estate tax, thinking they will never be touched by it. Unfortunately, you do this at your own peril. Why? Because states often have this tax AND politicians have a habit of frequently changing the rules. The best approach for all taxpayers is to understand the basics of the estate tax. Here is a quick summary of common questions you should be able to answer.

Q. Who pays estate taxes?

A. The tax is levied against the estate of a deceased person, which is considered a separate legal entity by the IRS. But the surviving family is effectively responsible for paying the estate tax because it cuts into their inheritance.

Q. What is included in the taxable estate?

A. Your estate includes personal property owned at the time of death, such as a home, cars, cash, collectibles and investments. Investments include securities, real estate, bank accounts and retirement accounts. The total taxable estate is the value of these assets minus deductible expenses and debts.

Q. How are assets valued?

A. The value for tax purposes is generally the property’s fair market value (FMV) on the date of death. Therefore, the basis for computing gain or loss is stepped up to this value. For example, if Diane Monet paid $10,000 for a painting and it’s worth $25,000 at her death, the estate value is $25,000. There are other valuation options in addition to FMV, so this area can get complicated in a hurry.

Q. How is the estate tax calculated?

A. For federal purposes, the tax is 40% of assets in excess of the federal exemption. The federal exemption for 2020 is $11.58 million. The exemption amount is scheduled to decrease to $5 million in 2026. There continues to be an ongoing debate over what this federal exemption amount should be, so it is a good idea to pay attention to future discussions out of Washington, D.C. to understand how it could impact your estate.

Q. Can a married couple double the exemption?

A. Yes. If handled correctly, a couple can effectively shelter up to $23.16 million ($11.58 million times 2) from federal tax in 2020. Remember, this amount is scheduled to be dramatically reduced in 2026.

Q. What is an inheritance tax?

A. Not to be confused with an estate tax, an inheritance tax is paid by those who receive the money from the estate of the person who dies. While there is no federal inheritance tax, six states (Iowa, Pennsylvania, New Jersey, Kentucky, Nebraska and Maryland) could tax you if you inherit money.

Q. What about state taxes?

A. Eight states and the District of Columbia currently have an estate tax. The exemption amounts in these states vary, with one as low as $1 million! If you live in one of these areas you better know the rules and have a plan: Connecticut, District of Columbia, Illinois, Massachusetts, Maryland, Minnesota, New York, Oregon and Washington.

Q. How are gifts to others handled?

A. When you give a gift to someone, the federal government generally does not care. But when the value of all gifts to one person in a given year exceed an annual threshold, you must report this to the federal government. This threshold in 2020 is $15,000. The gift tax rules are currently incorporated into the estate tax system. So careful planning is required in this area, especially if you are providing gifts to help finance various items like someone else’s education.

Does this cover everything about estate taxes? Not by a long shot. But hopefully by understanding some of the basics, you will have a better idea of knowing when to ask for help.



Common Tax Filing Mistakes

With the tax filing extension giving you until July 15th to file your return, it is easy to overlook ways to avoid receiving a letter from the IRS. Here are some of the most common tax filing mistakes:

Forgetting a W-2 or 1099. The IRS does an effective job comparing W-2s and 1099s they receive from organizations to the amounts you claim on your tax return. If they do not match, rest assured you will receive a notice in the mail asking for clarification.

Duplicate dependent reporting. If more than one tax return claims the same person as a dependent, the second return will be rejected. The IRS does not try to determine which tax return is correct. They leave that up to you.

Forgetting a name change. If you fail to change your name with the Social Security Administration after getting married and you file a tax return with your new last name, be prepared for either a rejected tax return or an adjusted tax return.

Other missing information. When preparing your tax return, often the return is held up because key information is missing. These missing items range from property tax and mortgage interest statements, to confirmations of charitable donations and tuition.

Signing the e-file authorization form. Your tax return cannot be e-filed without proper authorization. After reviewing your return, a properly signed Form 8879 must be received.



Should I Pay My Tax Bill With a Credit Card?

The IRS has allowed tax payments with credit cards for the past few years. Is it a good payment method for you? Here is how it works.