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Consider Donating Appreciated Stock & Mutual Funds

One way to reduce your tax bill this year is to donate appreciated stock to a charity of your choice versus making a cash donation. While this will be a tough challenge in today’s market, it is still one of the best tax planning strategies available to you. This part of the tax code provides a tax benefit in two ways:

1. Higher deduction. Your charitable gift deduction is the higher fair market value of the appreciated stock on the date of your donation and not what you originally paid for it.

2. No capital gains tax. You do not have to pay tax on the profits you made after selling the stock. As long as you have owned the investment for more than one year, you can avoid paying long-term capital gains tax on the increased value of your stock.

A Sweet Example

Winnie and Christopher each own 100 shares of Honey, Inc. that they purchased three years ago for $1,000. Today the stock is worth $5,000 (after taking a bit of a sticky hit in the down market). Winnie sells the stock and donates the proceeds to “Save the Bees” while Christopher donates his stock directly to “Honey Overeaters: Finding a Cure”. Assuming a 15% long-term capital gains tax rate*, a 25% income tax bracket, and no other limitations:

Not only does Christopher see $750 in additional federal tax benefit by donating his appreciated stock, but Honey Overeaters has $600 in additional funds to use for their charitable program.

Other benefits

  • The Alternative Minimum Tax (AMT) does not impact charitable deductions as it does with other deductions.
  • Remember, this approach also provides more funds to your selected charity. By donating cash or check, those additional funds are instead paid as federal taxes.
  • This tax benefit could be worth even more if our honey lovers have more income. The maximum long-term capital gain tax rate can be as high as 20%, and also be hit by a potential 3.8% net investment income tax.
  • This benefit is for everyone who itemizes deductions that have qualified assets, not just the wealthy.

Things to consider

  • Remember this benefit only applies to qualified investments (typically stocks and mutual funds) held longer than one year.
  • Be careful as investments such as collectibles and inventory do not qualify.
  • Consider this a replacement for contributions you would normally make to qualified organizations.
  • Talk to your target charitable organization. They often have a preferred broker that can help receive the donation in a qualified manner.
  • Contribution limits as a percent of adjusted gross income may apply. Excess contributions can often be carried forward as deductions for up to five years.
  • How you conduct the transaction is very important. It must be clear to the IRS that the investment was donated directly to the charitable organization.

If you think this opportunity is right for you, please contact a trusted advisor to ensure you handle the donation correctly.

* The total tax rate on this type of investment can be as high as 23.8% (20% capital gains tax plus 3.8% net investment income tax) if you have qualified investment income above applicable threshold amounts.



Plan Your 2023 Retirement Contributions

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Triple Tax: aka The Lottery

Now that the dust has settled on the big lottery winnings, it is worthwhile to see how the tax math works. Seen in the light of day, it is a great way for federal and state governments to triple tax this income and get even the lowest income households to pay it. So as media outlets shine a light on the lucky winner, consider what the tax looks like.

The bottom line when seen from a wage stand point is that 74% or more of the income used to play the lottery does not end up in the hands of the winner. The true winner is the tax man. Just one more example of tax collection and ethics taking different roads.



Should You Expense or Depreciate Your Capital Asset?

If you own a business, you know that you may accelerate the expensing of qualified capital purchases. This can be done within two special provisions in the tax code:

Section 179

The annual amount of qualified assets that may be expensed (instead of depreciated) was raised to $1.08 million for 2022. This benefit can be maximized as long as the total assets purchased by your business don’t exceed $2.7 million. Qualified purchases can be new or used equipment, as well as qualified software placed in service during the year.

Bonus Depreciation

There is also an option to chose additional first-year bonus depreciation of 100 percent of the cost of qualified property.

To qualify the property must be purchased and placed in service before 2023. After that, an annual phaseout lowers the bonus deduction percentage. Property can be new or used, but it can’t be in use by you before it was acquired. There are a few exclusions for electrical energy and gas or steam distribution.

Not interested in claiming the bonus depreciation expense? Then you may choose to opt out of this provision for each category (class) of property you place in service.

What should you do?

Taking advantage of these provisions may be good for your business, but that’s not always the case.

Remember, if you use these special asset-expensing provisions, depreciation expense taken this year is given up in future years. How many future years depend on the recovery period of the asset, but the additional tax exposure could be up to two decades! This is especially important to consider if your company is organized as a passthrough entity, like an S Corporation, as more income could be exposed to higher marginal taxes.

The short-term tax savings these two provisions provide is often too good to pass up. However, if you have some predictability in your business, it probably makes sense to forecast your projected pre-tax earnings with and without the accelerated depreciation to ensure you are making the correct long-term tax decision.



Don't Run Afoul of the IRS's Nanny Tax

The IRS is more strictly enforcing rules that determine whether a worker is actually your employee, rather than an independent contractor.

So be careful if you regularly pay a gardener, housekeeper, nanny, babysitter or any other household service provider. You don’t want to run afoul of the IRS’s household employee rules, often referred to as the Nanny Tax.

Do you have a household employee?

Many taxpayers unwittingly establish an employer relationship when they hire someone to help around the house. To decide whether a household worker is your employee, the IRS looks at whether you:

  • Control how and when their work is done
  • Provide them with supplies and equipment

The IRS also considers whether the relationship is permanent, and whether a worker is economically dependent on their employment with you. A worker may be considered an employee whether or not their work for you is part- or full-time, or paid hourly, weekly or by the job.

Tip 1: The more independent the worker is, the less likely they are to be considered your employee. Have your worker set their own hours and use their own tools. Also have them invoice you for their work and provide you with receipts.

Tip 2: If the worker works for another company that issues them a W-2, or they run their own company that offers services to the general public, you are generally safe from having them considered as your employee.

Tax consequences

If you think you have a household employee, here is what you need to know:

  • The $2,400 limit. If you pay less than $2,400 in a year (or $1,000 in any calendar quarter) you generally are not responsible for paying employment taxes. But if your payments are over these limits, you may need to withhold and pay Social Security, Medicare and unemployment insurance taxes.
  • Overtime. You may be required to pay overtime, depending on federal and state laws.
  • Timing is important. Employment taxes must be paid regularly throughout the year or you could face fines and penalties.
  • Other considerations. You may also need to purchase worker’s compensation insurance to cover you should there be any accidents while they are working for you.

If you are going to rely heavily on the services of a domestic worker, it’s worth thinking carefully about the relationship at the outset. Consider getting a formal employment contract in place, and call for help to create a plan to handle your tax obligations.



Inflation Spikes Social Security for 2023- How much you pay and checks received are all going up!

2023 Cost-of-Living Adjustment (COLA) changes are here. This is what you need to know.



Leveraging Your Children's Lower Tax Rate- One of the best places for parents to look for tax savings

If you’re a parent, your dependent children can be a source of tax savings. There are the well-known provisions in the tax code such as the Dependent Child Care Credit and the Child Tax Credit, but there’s also an opportunity to shift some taxable income to your children.

Shifting income to your children works because the tax rate increases as your income rises. This provides an incentive to shift income to your lower-earning dependent children. Here’s how to make it work:

Shifting income rules

In 2022, the first $1,150 of unearned income for each child is not taxed and the next $1,150 in unearned income is taxed at the lowest rate of 10 percent. Typical unearned income includes interest, dividends, royalties and investment gains.

Tip: Transfer enough income-producing assets to each child to approach the annual unearned income limits as closely as possible. Depending on your marginal tax rate you could be saving as much as 37 percent in federal income tax on the transferred amounts.

Tip: In addition to the unearned income, consider purchasing investments that will have long-term capital gain appreciation. This may help manage the timing and rate of capital gains tax when the investment is later sold.

Tip: Remember excess investment income could be subject to the additional 3.8% Medicare Surtax. Any investment income that can be shifted to your children could also save you this additional tax bite as well.

Leverage your children’s earned income

Income your children make from wages is considered earned income. If you own a small business, finding ways to employ your children can be a way to shift income from your higher tax rate to their lower rate. Care must be taken to be able to defend the work being done by your child and the amount they receive for their work. Some ideas include:

  • Use your child in an advertisement for your business.
  • Have your child clean your office a few times per week.
  • Put your child in charge of making local business deliveries.
  • Have your child help assemble items or help with mailings.

Tip: If you are a sole proprietor, you may hire your dependent children under age 18 and won’t be required to pay Social Security and Medicare taxes.

Caution: Moving assets from you to your children could affect their ability to receive financial aid for college. Make sure to consider how your tax strategy affects college financing.

There are many opportunities to leverage the tax advantages of having children. Reach out if you would like help creating a plan for your family.



Effective and Marginal Tax: Know Yours!- Understanding the difference between these two tax rates

The tax code is filled with terms we rarely use in everyday conversation. Two of the more common are Marginal Tax Rates and Effective Tax Rates. Knowing what they mean can help you think differently about your potential tax obligation.

Definition

Marginal Tax Rate: This is the tax rate applied to the next dollar you earn. Since our income tax rates are progressive, the next dollar you earn could be taxed at as little as zero or as high as 37%!

Effective Tax Rate: This is the tax rate you actually pay. It is total taxes paid divided by your total taxable income. Said another way, after taking your income and then applying taxes, deductions, credits, exemptions, and other adjustments, you are left with your true tax obligation. This obligation is a percent of your income.

A Simple Example

Consider two single people; Joe Cool who earns $50,000 and Chuck Browne who earns $500,000. If we had a flat tax of 10%, Mr. Cool would pay $5,000 in tax and Mr. Browne would pay $50,000 in tax. Both of their Effective Tax Rates would be 10% AND their Marginal Tax Rates would also be 10% because each additional dollar they earn would be taxed at the same 10%. However it is a different picture when you apply our progressive tax rates:

If we use the 2022 U.S. tax table for a single filer, Joe Cool pays $6,617 and Chuck Browne pays $148,753 in federal tax. This is because tax rates applied to Joe Cool’s income are (10 – 22%) while Chuck’s income over $50,000 gets Marginal Tax Rates of (22 – 35%). Ignoring other tax factors, our two taxpayers’ tax rates are:

Why Care?

  • Calculating Returns. The true return you receive on any taxable investment will be determined by your Marginal Tax Rate. A $500 profit from a new investment could cost Joe Cool 15% in federal tax, but it could cost Chuck Browne 35% in federal tax.
  • Phaseouts can provide a dramatic impact on Effective Tax Rates. The simple examples above do not account for income limits applied to many tax benefits. Additional income could have a very dramatic impact on Joe Cool if it triggers losing things like an Earned Income Credit, or Child Tax Credit. This could increase Joe’s Effective Tax Rate while not touching his Marginal Tax Rate.
  • Extra work can help the taxman more than you. There have been cases where adding a second job can actually cost you money by not understanding the impact of the income on your Effective Tax Rate. This is especially true for retired workers receiving Social Security Retirement Benefits. That extra job may make your Social Security benefits taxable.
  • It’s not that simple. In addition to all the different income phase-outs for credits and deductions, your Effective Tax Rate could be impacted by the elimination of itemized deductions, the Alternative Minimum Tax, and the marriage penalty.

So look at last year’s tax return and calculate your Effective Tax Rate. Then look at your income and determine the Marginal Tax Rate to be applied on your next dollar of income. Finally, if you anticipate an increase in earnings, consider forecasting the impact on your Effective Tax Rate.



The New $7,500 Tax Credit That Isn't- What you need to know

A highly-touted tax credit in the recently-passed Inflation Reduction Act is meant to incentivize Americans to purchase clean and electric vehicles. The bottom line, however, is that practically speaking YOU CAN’T GET IT.

Why few credits will be seen

As the new legislation is currently written, nearly all the electric vehicles sold today do not qualify for the new credit that begins in 2023. This is because:

  • The vehicle must be manufactured in North America AND
  • Powered by batteries with materials sourced in either the U.S. or from free trade partners AND
  • If by some stroke of luck you find a new vehicle that qualifies, the price must be below $55,000 for a sedan and $80,000 for a van, truck or SUV.

Tax code as behavior modification

The new electric vehicle tax credit is a classic example of the continued shift from using income taxes to pay for federal spending to using the tax code to get us to do what the government wants. In this case:

  • The government is trying to get manufactures to shift sourcing away from countries like China.
  • The government wants to motivate the creation of manufacturing jobs in the U.S.
  • The government wants to incentivize the manufacturing of lower-priced electric vehicles.

What this means for you

What this means for the average consumer is little to anything…right now. If you have your sights set on getting a clean or electric vehicle, make the decision without the influence of the credit. If maximizing the credit is important for you, you now need to pay attention to income limits and will need to wait for some time to see if the credit influences manufacturers to change their sourcing and assembly plans.



Understanding Tax Terms: Contemporaneous Records- Everyone needs to know what this means!

If you have problems getting to sleep at night and you turn to the IRS tax code for help, you might find some vocabulary that is very foreign to you. One of the more uncommon words used by the IRS is the term “contemporaneous.” So what does it mean and why should you care?

Contemporaneous defined

According to the IRS, it means that the records used to support a claim on your tax return are created and originated at the same time as your claimed deduction. In other words, if you realize that you forgot to get a receipt for something, you are out of luck if you try to get one at a later date.

Not fair!

Perhaps you know you had the expense, but you simply forgot to get a receipt. You can cry foul, but time and again the IRS has had tax courts uphold their elimination of a taxpayer’s deduction for lack of contemporaneous documentation. Here are some areas where the term contemporaneous is especially important:

  • Charitable contributions
  • Business deductions for expenses and capital purchases
  • Mileage logs
  • Tip records
  • Gambling losses
  • Business travel expenses

The donation of vehicles, boats and planes is often the most cited area where lack of contemporaneous documentation is a problem because these types of donations have a high estimated market value that changes from month to month. But timely, written acknowledgement from the charitable organization is also required for any donation of $250 or more.

What you need to know

  • Always get a receipt. Before you leave a donated item, always ask for a receipt. In the case of a vehicle, make sure the charitable organization gives you a 1098-C that is fully filled out. In addition, make sure the organization uses your vehicle or is a qualified charitable group that allows you to take the full market value of your donation.
  • If you forget, call right away. As soon as you realize a confirmation or receipt is missing, call to get one sent to you. Request that the receipt be dated as of the date of the service or activity.
  • Think tax year. Understanding the definition of contemporaneous is important, because it is not always precisely defined. If the documentation is received in the same year as the donation or transaction, you are usually in good shape.
  • Keep a log. Many transactions require the correct documentation at the time the activity occurs. This is true with deductible mileage, gambling loses and tip income. So keep a log of your activities as they occur.
  • Wait to file. To meet the IRS definition of contemporaneous, the receipt or acknowledgement must be received the earlier of either when you file your tax return OR the due date (including extensions) of your tax return. This is particularly true with charitable contributions. So if you want to play it safe, do not file until all documentation is in hand.