This publication provides summary information regarding the subject matter at time of publishing. Please call with any questions on how this information may impact your situation. This material may not be published, rewritten or redistributed without permission, except as noted here. This publication includes, or may include, links to third party internet web sites controlled and maintained by others. When accessing these links the user leaves this web page. These links are included solely for the convenience of users and their presence does not constitute any endorsement of the Websites linked or referred to nor does Willis & Jurasek have any control over, or responsibility for, the content of any such Websites. All rights reserved.
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.
Using Losers to Make Winners
Effectively using your investment losses can make a big impact in your taxable income. Why? These losses could offset income that is barely taxed, or it could offset income taxed at 39.6% or higher! Here are some ideas to make those losers into winners on your tax return.
Understanding the Home Gain Exclusion- When is a tax planning session essential?
One of the biggest tax benefits available today is the exclusion of gains when you sell your qualified home. Here is what you need to know.
The tax benefit explained
For those who qualify, a married couple can exclude up to $500,000 ($250,000 for unmarried taxpayers) in capital gains from the sale of your principal residence. This exclusion can be taken once every two years as long as you meet a two-years out of five residency and ownership test before you sell the property.
Special situations can cause complications
Often tax planning is required to ensure you maximize this tax benefit. Here are some situations that require a review prior to selling your home.
Ownership and principal residency tests met using different years. As long as the two-year requirement is met for both tests you can take the deduction. It does not matter that you use different years for each test. The most common example of this occurs when you rent a home or condo and then buy it later.
Life events complicate things. Marriage, divorce, and death are common life-events that require planning to maximize the gain exclusion tax benefit. For example, you can take advantage of the full $500,000 gain exclusion after the death of a spouse, but usually only during the time you are able to file a joint tax return.
Selling a second home requires planning. While you can use the gain exclusion every two years, you need to be careful with a second home. You may be able to plan your living arrangements to make each home a primary residence during different tax years to meet the two-year requirement for both properties. This means you need to determine your primary residence each year with good record keeping in case you are audited.
Business use of your home. You will need to adjust your home basis (cost) for any business activity and depreciation of your home. This can create a depreciation recapture tax event when you sell your home.
A partial gain exemption is possible. There are exceptions to the two-year tests when certain events occur. The normal exceptions include a required move for work, health reasons, or unforeseen circumstances. Since the IRS definition of each is vague, you should review your options if you are required to move.
Record keeping matters. Be prepared to document the gain on your property and how you meet the residency and ownership tests. Please keep all documents relating to the purchase and sale of your property. Save any receipts that document improvements to your home. Also keep an accurate record to support your claim of principal residence if you own a second home.
Given the potential for tax savings, please ask for help before selling your home or vacation property.
Review IRA Beneficiaries Now- Lost in the pandemic is a tax law change that may require your attention
Lost in the media storm during the coronavirus pandemic is a law change enacted in late 2019 that eliminates an IRA withdrawal technique known as the stretch IRA. Here is what you need to know.
Time to review beneficiaries
While the chances of you having a severe reaction to the coronavirus are low, it is a reminder of the importance to review your retirement and legal documents. Key among this review should be the beneficiaries you have assigned to all your retirement accounts. This includes reviewing primary beneficiaries and establishing secondary beneficiaries on all your IRAs, 401(k)s, 403(b)s and similar accounts. But it doesn’t stop there, you also need to understand and adjust beneficiaries because of new stretch IRA rules.
The old stretch IRA technique
With the stretch IRA technique, you name a younger person—say, a child or grandchild—as beneficiary of your account. When you die, this non-spouse beneficiary can stretch out receiving the balance of funds from these inherited accounts over his or her longer life expectancy. A stretch IRA could allow withdrawals to go on for decades!
In the meantime, the funds in the account continue to grow with any taxes owed being deferred until the funds are withdrawn.
Current situation
As you can imagine, the federal government wants their share of the earnings built up in these accounts. The old rules could put off the receipt of tax for another 30 years or more! Under the new rules, funds in an IRA or defined contribution plan, like a 401(k), must now be distributed to non-spousal beneficiaries within ten years of the account owner’s death.
What you need to know
This rule change makes assigning beneficiaries for your retirement accounts more important than ever, but the rule does not apply in all cases. The new rules do not apply to:
- A surviving spouse.
- Disabled or chronically ill individuals.
- Individuals who are not more than ten years younger than the account owner.
- A child of the account owner who has not yet reached the age of majority.
So as you review your beneficiaries, be aware of who will be required to withdraw funds sooner using these new rules. Changing your account beneficiaries with an understanding of these new rules can provide significant tax savings.
Consider converting funds into another account type. Fortunately, you can take some of the sting out of the situation by converting a traditional IRA to a Roth IRA. Unlike a traditional IRA, Roth contributions are never tax-deductible, but payouts from a qualified Roth account are 100% tax-free. While you must pay tax on the transfer in the year of the conversion, your heir will not have to deal with getting taxed when taking funds out of the account.
In other words, your beneficiary can arrange to take tax-free withdrawals from the Roth IRA, as long as the account is emptied out within ten years. Not quite a stretch IRA, but still a good deal.
Tax efficiency becomes more important than ever. Should you pay the tax with a pre-conversion to a Roth IRA to save the hassle for your heirs? Should an heir take the money out all at once? How much should you take out of an inherited account each year? Given the progressive nature of our tax system (currently 0% to 37%), taking a planned approach can save you a bundle in tax as the funds are withdrawn. This makes creating a tax plan and reviewing it more important than ever!
In light of all the pandemic uncertainty, this is an area you can review now to not only be better prepared, but to create a strategy that can yield tremendous tax savings for you and your heirs.
Beware: COVID-19 Tax Scams are Here- Economic impact payments bring out thieves
The coronavirus pandemic is bringing out the best in most of us. Unfortunately, it is also bring out some of the worst of us as well. Be aware of the following scams.
Tax Savvy Moves to Consider Now
Within the coronavirus pandemic are tax planning opportunities. Here are a few to consider.
Get Your Money: Ensure You Receive a Stimulus Payment- Status and non-filer tools launched by IRS
The IRS recently announced the launch of web sites for non-tax filers to register to receive their economic impact payment and a new Get My Payment tool. Here is what you need to know.
Background
As a response to the coronavirus pandemic, the government is sending $1,200 to single taxpayers with income less than $75,000 ($98,000 with phaseouts). $2,400 is being sent to married taxpayers with income less than $150,000 ($198,000 with phaseouts). An additional $500 is being sent for each child under the age of 17.
The Problem
The payments are being made based on 2019 or 2018 tax returns. If you do not need to file a tax return, you run the risk of not receiving this payment. Additionally, getting payments out to everyone is technically complex. The IRS must look at both 2019 tax returns and 2018 tax returns, PLUS they are directed by Congress to match these files against two years of Social Security filings for seniors. Not an easy task!
The Solution
The IRS worked to launch a way to register to receive your payment and to determine the status of your payment. You can find the sites here:
For non-filers: Submit information to receive an Economic Impact Payment
Payment status and direct deposit registration: There is also an IRS provided Get Your Payment tool to register to receive your payment via direct deposit.
It can be found here: Get My Payment Tool
This tool will also be used to review the status of your payment.
Who should use
If you fall into one of these cases, you need to review whether it makes sense to use these tools.
Not required to file. If you have not filed a tax return in either 2018 or 2019, using the non-filer tool or other tax filings methods is the only way to receive the payment.
College students. If you are not a dependent on someone else’s tax return, you need to look into using the non-filer tool. If you are a dependent, it may also be worth a conversation to see if you can or should change your filing status in 2019 in order to receive this payment.
Non-filer. Even if you know you need to file a tax return, but have not yet done so, consider using the tool. You will still need to file a tax return, but in the meantime, you can receive your payment.
Seniors. Seniors that do not file tax returns in 2018 or 2019 will eventually receive the payment based upon their form 1099-SA or railroad retirement information. The non-filer site asks you not to register, but you may receive the payment sooner AND protect your identity from would be thieves by filing a tax return.
To check on status or speed things up. Want faster payment? Payment not yet received? Use the Get My Payment tool to help understand the status of your payment.
The Economic Impact Payments are now officially being sent out, so the sooner you let the IRS know that your payment should be included, the sooner your payment will arrive.